CAE Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

CAE Inc. is a global leader in training for the civil aviation and defense industries, providing a diverse range of simulation and training solutions, and is also a growing player in healthcare.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

CAE operates across three primary segments: Civil Aviation Training, Defense and Security, and Healthcare. The Civil Aviation Training segment provides simulation and training solutions for airlines and aircraft operators. The Defense and Security segment offers similar solutions for military and security forces, while Healthcare segment focuses on simulation and training solutions for medical professionals. While not a focus in recent earnings calls, the Healthcare division is interesting as it is a market opportunity for expansion and growth.

Revenue Distribution:

In its most recent quarter (Q1 2024), CAE’s revenue distribution was largely split between Civil Aviation (55%) and Defense & Security (45%). Over the last year, civil aviation and military segments are the same size. This represents a shift from the past where Civil Aviation was larger, indicating that defense has been increasing it’s percentage of total revenues. Geographically, CAE derives the most revenue from North America, followed by Europe, then Asia. This is largely driven by both the civil and military segments, since these industries are stronger in those geographies. The business seems very global.

Industry Trends:

The aviation training market is experiencing strong growth, driven by increased demand for pilots and maintenance staff. The trend towards digital learning and the use of simulation technology has been increasing in civil aviation and has been an opportunity for CAE. The defense industry is also seeing continued demand for training solutions, given the evolving geopolitical landscape and advancements in military technology. New investments in software and hardware for simulation and training is an important secular tailwind for this company. The healthcare industry is also seeing increasing utilization of simulation-based training, due to its ability to reduce costs and improve learning outcomes.

Competitive Landscape:

CAE operates in a fragmented competitive market. In the civil market CAE competes with other simulation providers and in-house training centers. In defense, the company faces competition from other defense contractors. In healthcare, CAE faces competition from a range of players, including technology companies specializing in health care and other training providers. The business appears to be becoming less fragmented as major acquisition opportunities come available.

What Makes CAE Different? CAE’s global reach, long-standing relationships with major airlines, and deep domain expertise makes it a market leader in the industries it serves. It has a strong focus on innovation, and continually invests in its technology and training capabilities. The company’s brand name is solid in the business and is often cited as the premier training provider. Given the highly specialized nature of the training, scale is of considerable importance for this business.

Financial Analysis:

Revenue Growth: CAE has shown consistent revenue growth over the past decade. In the last 5 years, revenue has grown 37%. Given it’s business model and capital requirements, it is impressive.
Profitability: Profitability is mixed. The company has historically high operating and net margins, but these margins fell drastically during COVID. While improving, these margins haven’t gotten back to pre-pandemic levels. It’s unclear how the margins will fare in the future, but the business has shown an increase in operating efficiency.
Cash Flows: CAE has traditionally had predictable and positive free cash flow, which is needed to continue investing in R&D. The cash flow did turn negative during COVID as they cut into costs, this is now positive.
Capital Structure: CAE’s debt levels have been fairly stable over the long-term. The long-term debt is around €2 billion as of its latest earnings call, and this level of debt is manageable. The company is targeting a net debt/adjusted EBITDAR ratio of 2.0x to 2.5x for fiscal year 2024, and is currently well below those levels.

Recent Concerns and Challenges CAE’s results for fiscal year 2023 show that the company has had to make adjustments to the accounting methodology related to the fair market value of some of their investments. There are also concerns around the decline in ROIC, which is largely due to the increase in capital tied up in the business. In the most recent earnings call for the first quarter of fiscal year 2024, the company states it has an improvement in profits and is confident that the company is heading in the right direction. The debt load that was taken on due to recent acquisitions is a concern for many investors, and has caused a lot of fear in the market. However, the debt seems to be managed well.

Moat Analysis (2 / 5)

CAE’s competitive advantage stems from their extensive global presence, high client relationships and strong brand. These are a good source of competitive advantage, but are not a source of wide moat.

Intangible Assets (Moderate Moat): The company’s brand recognition and history of training excellence in its industries provides a degree of customer loyalty and brand recognition.
Switching Costs (Moderate Moat): The complex nature of CAE’s training solutions, coupled with the lengthy certification process, creates moderate switching costs for its customers.
Network Effects (No Moat): Network effects are largely absent for the business model.
Cost Advantage (Low Moat): CAE is a large player in its industries, and it could achieve certain cost advantages, however, it is difficult to achieve a sustainable cost advantage due to low barriers to imitation.

Although there are some aspects of a business model that could imply wide moat status (ie, long-standing relationships, brand recognition) these are not enough for a wide moat. The fact that other training firms are able to compete, and new entrants are coming into the market, it is clear this business only deserves a narrow moat rating. As a result, the moat receives a score of 2.

Risks to the Moat and Business Resilience

Technological Disruption: The rapid advancements in technology could create better or more efficient training solutions by competitors. CAE must continue to invest in R&D to remain competitive and ahead of its competitors.
Increased Competition: New entrants or increased competition from existing players could compress margins and erode profitability. To combat this, CAE must leverage its existing relationships with clients to help sustain revenues.
Dependence on Key Contracts: The company’s revenues are often tied to large contracts with government agencies, and the loss of some of these could negatively impact revenues.
Cyclicality: Given its exposure to industries tied to the global economy (especially aviation), the business is subject to economic cycles. If economies shrink, revenues will likely fall and vice versa.
Changes in Regulation and Policy: Changes in government or industry policies could negatively affect their core businesses, specifically the civil aviation and military divisions.

Understandability (3 / 5)

While the company’s business model is fairly straightforward to grasp-that is, providing training solutions to aviation, defense, and healthcare industries-the details surrounding the services and products, the level of detail that management provides in financial reports, and the level of analysis needed to fully analyze those reports, makes it difficult for the average investor to understand. Because of this, a rating of 3 is most appropriate.

Balance Sheet Health (4 / 5)

While the recent acquisition activity did burden the balance sheet with debt, most metrics indicate that the business is healthy. They have access to sufficient credit and a clear roadmap for how to pay down debt over the next several years. Although debt levels are elevated compared to the last few years, the levels are not necessarily concerning given that they are trending in the right direction. They also have a strong cash generation ability. However, they are not necessarily financially robust due to the debt load, so a perfect rating cannot be given. A 4/5 is a fair rating.