CAE (TSX: CAE)(NYSE:CAE) is a Quebec-based company focused on delivering training for several industries, including healthcare, civil aviation, and defence. Shares of CAE have dropped 3.2% over the past three months as of close on December 19. However, the stock is up 8.9% in 2018 so far.
Earlier this month, I’d discussed why I was high on CAE heading into 2019. In the second quarter of fiscal 2019, CAE reported a record $8.7 billion backlog. Revenue was up 20% from the prior year to $743.8 million and adjusted earnings per share, excluding the gain from the disposal of ZFTC, rose 15% to $0.23.
The Canadian stock market does not offer considerable exposure to the defence sector. CAE is one of the few options in this regard, but it has proven be to a dependable one. The most recent year was a big one for defence spending, especially in the United States. The Trump administration signed through a defence spending package that would see the military budget skyrocket to $716 billion. Investors should not expect this to taper off in 2019 and beyond.
In the spring, I’d discussed a January 2018 speech given by U.S. secretary of defense James Mattis in Maryland. Mattis was quoted saying, “great power competition” was now the primary focus of U.S. national security, not terrorism. The precarious economic outlook heading into 2019 will only intensify the urgency on the part of U.S. political leaders to maximize their military advantage going forward.
Sources familiar with fiscal 2020 budget negotiations have said that President Donald Trump is pushing a $750 billion budget proposal to the Pentagon. Mattis and other top military officials had originally suggested $733 billion in spending. The previous budget passed with significant bipartisan support, and there is little reason to believe that this proposal will receive much pushback from the Democratic side.
According to the annual Jane’s Defence Budget report, global defence spending rose 4.9% in 2018, the largest increase since 2008. This represented the fifth consecutive year global defence spending increased. The United States and China topped the list, with China also reporting a dramatic increase from $191 billion in 2017 to $207 billion in 2018. The geopolitical struggle between the two economic giants has intensified in 2018 with trade talks yielding little progress.
The Canadian defence budget declined year over year, but the federal government has committed to a 70% increase over the next decade.
CAE’s defence revenue rose 18% year over year to $320.3 million in the second quarter. The company has won contracts with the U.S. Navy and U.S. Air Force over the past year. CAE will also continue to provide the U.S. Army with fixed-wing flight training and support services at the CAE Dothan Training Centre.
Economic headwinds may squeeze budgets in 2019, but investors should bet on defence bucking that trend. All signs point to a sixth consecutive increase in global defence spending in 2019, which will benefit CAE’s business going forward.
