It’s not often that I look to large blue-chip companies for investment opportunities. I prefer analyzing smaller easier to understand companies where I believe more market inefficiencies exist – it’s rare to find market inefficiencies among blue-chip stocks. However, every once in a while a large cap global company catches my eye, where the investment thesis alone is almost enough to justify buying. Enter Bombardier.

Bombardier is a very large Canadian company that operates globally. In a nutshell, they make planes and trains… but not automobiles. And that’s what makes them so attractive. Bombardier is a global leader in these two industries, and given the company’s strategic positioning and the long term growth potential (especially in its rail division), I think this is a company we should all have on our radar screens.

The Argument for Rail
Higher energy prices are beginning to have an impact on how people get around. North American consumers are beginning to change their tastes and are buying more fuel efficient vehicles at the expense of gas guzzling SUVs. Those who do drive are traveling shorter distances (US highway miles driven has been steadily dropping recently), and airlines are jacking-up ticket prices as fuel costs skyrocket. So, how are people going to get from one place to another? By taking the train.

I’ve always felt that one of the best leading indicators as to what might happen in North America as we move to a world of higher energy prices is to look at Europe. Europeans have been living in a world of higher energy prices for the past few decades. And anyone who’s ever been to Europe knows that riding the train is a way of life. A recent Barron’s article noted that American train travel amounts to only 20 miles per person each year. Compare that to Switzerland where each person travels over 1,200 miles each year via the train... and Europe is still planning on pouring billions into new train infrastructure (e.g. Russia plans to add over 5,000 miles of new railway track by 2015). North America is finally starting to see the benefits of having strong passenger railway infrastructure in place – trains are much more fuel efficient, they pollute less, and they greatly improve traffic congestion.

The big growth however comes from China who plans to quadruple its spending on railroads ($160 billion to be spent over next three years). Part of the plan includes another 10,000 miles of track to be laid by 2010, half of it dedicated to high-speed passenger trains.

Needless to say, the conditions for railways (particularly passenger) have never been better. It’s the perfect storm for strong a global long-term trend and Bombardier is well positioned as a global leader in this market.

Bombardier’s Transportation division specializes in passenger trains. They manufacture monorails, light rail vehicles, advanced rapid transit vehicles, subways, commuter trains, and intercity high-speed trains.

Now rail transportation isn’t Bombardier’s only business. In fact for most of the company’s history, the Aerospace business, where they manufacture and sell small aircraft, has been dominant. It wasn’t until last quarter where revenues in the Transportation division surpassed that of the Aerospace division. That being said, the Aerospace division is more profitable generating an EBIT (Earnings Before Interest and Taxes) margin of 8.7% last quarter vs. 4.8% for the Transportation division.

The Argument for Aerospace
The commercial airline industry is probably not the first place you’d want to put your money these days. Fuel costs are obviously having an impact on prices, and one would worry that airline demand may fall as consumers turn away from higher prices. However, the argument can be made that increasing globalization, growing emerging markets, the move by airlines to replace older jets with newer more fuel efficient jets, and the inclination of travelers to turn to flying to avoid long distance driving could offset any “demand destruction” caused by higher prices.

Besides it’s not like Bombardier is at risk of losing revenues from reduced demand. Bombardier’s backlog (the amount of orders booked, but not yet complete) for the Aerospace division represents over 2 years of sales. And this backlog has been growing… at a stunning pace actually. Two years ago the backlog for this division stood at close to $10 billion in orders. Last reported quarter the backlog was at $22.1 billion in orders.

Bombardier’s flagship products in the Aerospace business have always been its smaller regional and business jets like the Lear Jet or the Turboprop. Over the past few years the company has been developing their C-Series platform – a new larger commercial jet that will compete directly with Boeing and Airbus. This program is widely expected to be a major contributor to the company. The new C-Series jets are expected to offer airlines significant cost advantages – costing on average 15% less to operate than today’s comparable jets. Not surprisingly, the cost advantage over older aircraft is much higher.

Given how fuel prices and environmental concerns are beginning to change the way consumers travel, I would imagine the regional and business jet business is most at risk as people avoid flying short distances in favor of taking the train, or not traveling at all. For this reason, I think Bombardier’s new C-Series program (larger commercial jets designed for longer flights) will become the company’s new flagship product. But any launch delays will undoubtedly be very negative for the company. Unfortunately delays for this program have plagued the company in the past. Currently the planned entry into service for the first C-Series planes is 2013, but the company wants to wait for 50-100 firm orders from two to three customers before proceeding with the formal launch. We’ll look for more updates in the next quarterly release.

Financials
Bombardier’s share price performance basically boils down to three key numbers: EBIT margin, revenue growth, and backlog. Cash flow is typically a very important metric for any company, but I would make the argument that, for Bombardier, it’s not what you should focus on. Given that the company isn’t an income trust, that investors do not rely on the company’s small dividend payment, and that the company has received government grants in the past, cash flow shouldn’t be the primary driver for stock performance. So long as it is sufficient to meet capital requirements allowing the company to maintain liquidity, one shouldn’t be too concerned with the ebbs and flows of cash flow for this company.

EBIT Margin: Since 2005, Bombardier has consistently been able to improve its EBIT margin in both the Transportation and Aerospace divisions. Management has set a goal of 8% EBIT margin in the Aerospace division by fiscal year 2009 and 6% EBIT margin in the Transportation division by fiscal year 2010 (both numbers are significantly higher than where the company has been operating over the past few years). In the latest quarterly release (which for the company is the first quarter of fiscal 2009) the company has already achieved an EBIT margin of 8.7% for the Aerospace division and 4.8% for the Transportation division.

Revenue Growth: During 2008 revenue growth in the Aerospace division has slowed while revenue growth in the Transportation division has increased. I believe this trend could continue for a few more quarters (if not years).

Backlog: Bombardier’s results are driven by new orders from customers. For companies that manufacture and sell products that take a long time to produce, backlog is a key industry metric. For Bombardier’s Transportation division, backlog has grown from $20.9 billion in F2006 to $30.9 billion in F2008. At this level, the company essentially has almost 4 years of sales waiting in the pipeline – the highest in the industry. As mentioned earlier, the Aerospace division has a backlog of $22.1 billion – over 2 years of sales. The growth in this backlog number could be put under some pressure (particularly the component relating to the Transportation division) as the EUR continues to depreciate relative to the USD (a significant amount of orders are booked from European customers and thus are denominated in EUR).

Cash Flow: Bombardier’s cash flow is a bit of a moving target that’s hard to pin down. From period to period Bombardier’s cash flow can undergo some fairly large swings. These swings primarily arise from non-cash working capital changes (i.e., accounts receivables, accounts payables, etc.). For example, for the 2008 fiscal year, the company’s cash flow from operations was $2.333 billion, up from $0.891 billion in F2007. In the first quarter of F2009, cash flow from operations was $0.632 billion, up from $(0.358) billion in Q1/08. In each case the variance was almost entirely due to changes in non-cash working capital (e.g. a customer prepaying a certain amount for the manufacturing of an aircraft – good for cash flow, but you can’t book the revenue until work is complete). Needless to say, this is a very difficult number to predict from one period to the next. Fortunately, as mentioned earlier, I’m not particularly concerned with Bombardier’s cash flow generation so long as they can maintain liquidity and continue to payback debt.

Debt: Bombardier has been aggressively paying down their debt throughout F2008 and into F2009. Most of the company’s debt is now long-term in nature, not requiring repayment until 2013. The two charts below (from the company’s latest annual report) illustrates how the company’s outstanding debt obligations have declined recently and the term structure for those obligations.

One potential catalyst for the stock could be if Bombardier’s debt rating continues to be upgraded. The company is required to hold roughly $1.3 billion as collateral for various credit facilities – essentially restricting that cash from being used for other more profitable purposes. Given the company’s latest financial performance and debt repayment initiatives, future upgrades to the company’s debt rating are certainly possible. Fitch upgraded BBD.B’s debt rating to BB+ in May and sent the stock soaring. If others follow suit, it’s likely the company would be able to renegotiate the collateral requirements imposed by banks, thus freeing up some cash.

I could go on, but I would encourage anyone who’s interested in Bombardier to read through the company’s latest financial results.

Conclusion
The bottom line is Bombardier is a good long term story without too many near-term catalysts. The company has produced very strong results despite the so-called world economic slowdown. This economic slowdown won’t last forever, so when things do begin to turn around, expect more infrastructure projects being announced (i.e., railway projects) and expect more spending from the airlines.

Ownership Disclosure: I do not currently own shares of Bombardier, but will likely be purchasing some this week.

Disclaimer: Any information contained in the above article represents my opinions only, and should not be construed as personalized investment advice. I cannot assess, verify or guarantee the suitability of any particular investment to any particular situation and the reader of the article bears complete responsibility for its own investment research and should seek the advice of a qualified investment professional that provides individualized advice prior to making any investment decisions. All opinions expressed and information and data provided therein are subject to change without notice.