Bombardier: Issues to consider

Bombardier (BBD/B CN): Issues to consider

FY2018 results: Core EBIT fell, Core cashflow is negative & Covenants maybe under stress

Core EBIT fell: FY2018 EBIT and cashflow were inflated by one-off gains. On a like for like basis, Gross and EBIT margins fell. Cashflow was only positive because US$500m was extracted from suppliers and customers via working capital.

Core cashflow remains negative: Bombardier is still unable to fund its annual US$1bn+ capex budget from core operating cashflow. In FY2019, it is filling most of the gap with asset sales, but in order to avoid further capital raising, revenue will need to rise by 43% in FY2020, without any extra capex.

Covenants maybe under stress: We are very concerned that the consolidated capital structure presented to investors is very different to the structures used in their debt covenants. The cash balance is disingenuous because a) it is boosted by US$900m of factoring and b) at least US$1.5bn is ring-fenced in the transportation business.

This means that the rest of the group will have to fund any increase to their US$16bn of long term liabilities. Given the limited EBITDA excluding Transportation, any increase in debt could prove to be a problem. We believe the risk of a breach is far higher than generally perceived.

Background
Bombardier has four businesses. The first two, Lear jets and engineering, are wholly owned. They own 70% of the third, manufacturing train rolling stock and 66% of the fourth, commercial jets. The commercial jet business has been in the news thanks to the US imposing import tariffs on the sale of aircraft to Delta airlines. Bombardier has attempted to solve this problem by paying Airbus to take a 50% stake in the commercial jet business. Meanwhile Bombardier talks about being midway through a turnaround.

The stock came to our attention following our reports on taxation, pensions and creative accounting. We have sent our clients a report on the stock that investigates several issues and provides a valuation. Unfortunately, the report is only for our clients who are regulated professional investors.

Issues to consider

The company has liabilities of US$28bn, what is the realistic value of its assets?
With annual cash finance costs and taxes of US$900m, and management forecasting EBIT of US$850m in 2018, without cost capitalisation the company will still be loss making. When will it turn profitable?
Bombardier talks about an EBIT turnaround, how much of this is due to changing amortisation rates?
What are their forecasts for capital expenditure and capitalised costs over the next three years
Bombardier continues to have negative cashflow, at what point will debt and liabilities stop growing?
Commercial jets, how many would the company need to produce on an annual basis for this project to be profitable and cashflow positive?
Why are their accounting policies so different to Airbus and Embraer?
Why do most of the company’s finance and audit committee members live overseas?
Given the company’s accounting history, why are none of the company’s finance and audit committee members accountants?
What is the criteria used to select people for the finance and audit committee?
How does the Chairman, a family member, justify his pay rising back to levels close to when he was the Managing director?
Why do they talk about revenues at Aerostructures being US$1.5bn, when these revenues vanish on consolidation
The change in revenue recognition would appear to wipeout up to US$10bn of Transportation revenue, when was this booked?
Why did factoring increase so much last year? Was this to avoid breaching covenants at Transportation
Why did payable rise over US$1.5bn in the 4th quarter?

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Important
This note is written with the sole purpose of highlighting some issues we think are important.
It is not a recommendation to BUY or SELL any of the securities mentioned and should not be taken as such.
Readers should form their own opinions about the company and seek appropriate advice.
Please read the Bucephalus disclaimer.