Divestor

It is virtually a given now that Bombardier will announce that Delta Airlines has ordered a bunch of C-series jets. The announcement will probably be Thursday as there is no reason for them to move back the earnings announcement unless if they want to have a huge feel-good party for their annual general meeting on April 29th.

However, in terms of pricing of securities, “buy the rumour, sell the news” is the cliche to follow here. Most (if not all, or even an over-reach) of this news has been baked into current market pricing, which means that investors will now have to focus on the finer details, such as: how much of a price concession did Bombardier make in order to ink the sale on the contract?

These price concessions inevitably will affect profitability of the overall entity, and while it is nice to sell jets at a near break-even profit margin, the corporation needs to eventually make money.

However, Bombardier has solved one of their massive problems which was a chicken-and-egg type matter: they now have an American purchaser of their jets, which is a lot better than how things were portrayed for them half a year ago. More importantly, they are current in a position to raise capital again from the public marketplace.

I will point out in a reduced profit scenario that the security of income from the preferred shares (or even the bonds) looks more favourable from a risk-reward perspective than the common shares. Back in February, investments were selling preferred shares (the 6.25% Series 4) at 18% yields, but today it is at a much more respectable 10%. I’d expect this to get around 7-8% before this is done.

My investment scenario is pretty much resolving to my initial projections – just have to continue to be patient and then the decision is going to be whether I sell and crystallize the gain, or just be content to collect coupons and sit on a large unrealized capital gain.

(Update, April 28, 2016): As expected, Bombardier has announced that Delta has purchased 75 C-Series jets with an option to pick up another 50. This is a huge win for the corporation, but again, the question remains: how much money will they actually be able to make when they produce these things? Let’s hope they’re able to actually get the production lines going and crank them out without issues, unlike their Toronto street cars…

The company expects the C-series program will consume $2 billion further cash for the next five years, of which the province of Quebec has generously chipped in a billion. After that they expect things to be cash flow positive. Who knows if this will happen!

(Update, April 29, 2016) The market has “sold the news” as I expected. I generally believe the common shares will have a significant drag compared to the historical charts due to dilution, but the preferred shares and debt should normalize to “reasonable” yield levels simply due to their standing being in front of line on the pecking order. This is assisted with the Beaudoin family’s very rational self-interest in maintaining their control stake with the Class A common shares which will translate into outwards cash flows being paid as scheduled. If the Government of Canada decides to chip in a billion dollars, it is icing on the cake, but it is not required as Bombardier will be busy for at least the next four years producing C-series jets. Assuming they can actually execute on the production and the jets live up to their reported (superior to competition) specifications, they should be good to at least pay off debts and preferred share dividends.

Each additional order of C-Series jets will be making profitable margin contributions and as these orders continue to come in, the common shares, preferred shares and debt will ratchet up, accordingly. I still believe they are under-valued but not nearly as much as they were late last year when everybody was in doom and gloom mode! The preferred shares are the sweet spot in terms of risk-reward.

Bombardier’s bond yield curve has gone much more favourable over the past couple months. Their March 2018 bond issue (the nearest maturity) is trading at par (coupon is 7.5%), while going out to January 2023 the yield to maturity is trading just north of 10%.

(Update on April 18, 2016: After rumours of Delta Airlines close to purchasing C-Series jets and the rejection of the Canadian government’s bailout offer, the yield curve has compressed even further – the January 2023 yield to maturity is now at a bid of 9.5% – the rejection of the bailout offer has to be a positive signal for the company, i.e. they have the financial wherewithal to go on their own without further equity injections).

So while the company isn’t completely out of the woods yet, the market is giving them an opportunity to refinance debt if they choose to do so – However, it is unlikely a bond offering will be made until 2017.

On the preferred share component of their capital structure, their BBD.PR.B series (floating rate) is trading a shade under 10% eligible dividend yield, while the BBD.PR.C series is at 12.7% – somewhat reflecting an increased relative risk of dividend suspension, coupled with a conversion risk (as the company has the right to redeem for equity at the greater of $2/share or 95% of VWAP).

Also muddling the market news is the proposed federal government investment in Bombardier which would likely cement its ability to maintain its credit rating and dividend-paying ability of its preferred shares.

I continue to remain long on the preferred shares.