Much to the chagrin of scholars and index investors, I refuse to be convinced that the market is rational. There are just too many examples of companies that rise too high or get beaten down in the short term.
I remember looking at all sorts of different companies during the 2008-09 Great Recession that traded for a mere fraction of the net assets on their balance sheet. Sure, some of those turned out to be financial companies that were filled with toxic assets, but there were also hundreds more that were unfairly beaten down.
I think there are a lot of similarities between Bombardier Inc. (TSX: BBD.B) shares today and all those depressed shares of the Great Recession. Sure, Bombardier isn’t trading at a fraction of its net assets, but it is trading at a fraction of its potential.
Let me explain.
The company has moved all-in on its new line of CSeries aircraft. And for years, things were advancing — at least slowly. The plane was designed, tests were beginning, and customers were starting to come on board.
And then, in February, disaster hit. The company announced it wasn’t going to start deliveries of the new line of planes until late 2015, which was a full six months later than it previously promised investors.
And if that weren’t enough, Bombardier stumbled again, this time in July, when it announced it was shutting down all CSeries test flights because of an engine problem. This has since been sorted out and test flights have resumed, but the market is concerned that yet another delay in shipments could be the result.
This doesn’t sound like great news. Why am I so positive?
Because the market is missing the forest for the trees.
Just about all the heavy lifting is done with the CSeries project. The company is 90% there; all it needs to do is make a few adjustments, keep test flying for a few more months, and it’ll be ready to start production. And yet, the market is valuing the company like it’s going to be several years away from CSeries sales. That’s just not going to happen.
One of the nice things about the airplane business is customers commit to orders long before they intend on taking delivery. This allows investors to look at the potential revenue coming down the line and value the company accordingly.
At this moment, Bombardier has firm orders for 243 CSeries aircraft, the majority of which are the more expensive CS300 model. At a purchase price of $71 million per plane, the company is looking at sales of $17.25 billion over the next handful of years.
At a net margin of 5%, that’s nearly $900 million to Bombardier’s bottom line. To put it another way, the company is looking at an additional $0.15 per share in annual earnings from approximately 2015 to 2019, or an increase of 50% from current levels.
And that’s without another plane order or one of the options current customers hold for 162 additional planes being exercised. If the company converts on just half of those options, it’ll add approximately a nickel per share to its bottom line for the next few years.
At this point, investors are paying $3.70 per share for $0.31 of earnings. If those earnings jump 50% to $0.45 per share, a corresponding 50% jump in the share price could be a low estimate. Remember, at that point sales will be increasing, and chances are the company will be adding new CSeries customers.
Shares just might be worth more than 12 times earnings. Even at just a 15 times earnings multiple, the company would trade at $6.90. That’s an upside potential of 86.4%, and it could easily happen in just a few years.
The bottom line? Investors should look past Bombardier’s short-term failings and consider the long-term potential. It’s there, and it could turn out to be huge.
