WestJet Airlines Ltd.

WJA : TSX : C$30.15
HOLD 
Target: C$34.00

Disclosure : I fly westjet whenever possible – great service from Canada’s version of Southwest

COMPANY DESCRIPTION:
WestJet is Canada’s leading low-fare airline and is based
in Calgary, Alberta. WestJet employs about 6,600 full
time equivalent employees, and carries roughly 15
million guests to its 71 destinations across North
America and the Caribbean. WestJet is publicly traded on
the Toronto Stock Exchange under the symbols WJA and
WJA.a.
All amounts in C$ unless otherwise noted.

Transportation and Industrials — Airlines and Aerospace
Q3/14 PREVIEW: GOOD QUARTER EXPECTED
Maintaining HOLD
We are maintaining WJA at a HOLD due to the combination of moderate
implied return to our target and forecast uncertainty. We remain
uncertain about WJA’s RASM prospects (guidance of positive but lower
than Q2/14) and this could provide downside risk.
Good Q3/14 expected sales growth on margin expansion
We project a 38% increase in EPS for WJA in Q3/14 from better sales and
profitability from the company’s initiatives.
Key drivers should include further benefits from WJA’s Plus premium
economy, Encore regional and cost-cutting initiatives. In addition, we
expect a much less severe CAD/fuel headwind than in H1/14.
But, as noted above, WJA’s RASM picture remains fuzzy. There may be
downside risk to our Q3/14 EPS estimate due to RASM. We estimate each
1% reduction in RASM growth from our 3.1% forecast would result in a
$0.05 reduction in our Q3/14 EPS forecast.
Continue to use moderate valuation multiple
We continue to value WJA at a moderate 5.5x EV/NTM EBITDAR (5.5x
Q2/15E EV to Q3/15E – Q2/16E EBITDAR) valuation multiple. This
multiple is close to the industry valuation average and our $35.81 DCF
valuation.

Bombardier Inc.

BBD.B : TSX : C$3.50

BUY
Target: C$5.50

 

COMPANY DESCRIPTION:
Bombardier operates in two major and roughly equally sized
segments: 1) aerospace equipment including business jets and
small airliners, and 2) rail equipment. Products are sold and
manufactured on a global basis.
All amounts in C$ unless otherwise noted.

Transportation and Industrials — Airlines and Aerospace
BT PRESIDENT MEETING AND EUROPEAN TOUR
BUY for margin expansion potential, new products
We continue to recommend BUYing Bombardier (BBD) due to 1)
surprisingly good CSeries order flow at the Farnborough air show, 2)
increased focus on improving profitability at Bombardier Aerospace (BA),
and 3) margin improvement potential from the weak Canadian dollar.
BT continues to hold potential
BBD held an investor trip to Europe this week. Key stops included a
meeting with Bombardier Transportation (BT) President, Dr. Lutz Bertling
and plant tours of BT’s largest facility, Henningsdorf, and the Bombardier
Aerospace (BA) CSeries wing plant in Belfast. Takeaways include:
 BT sales growth looks positive. Growth should be in the 5-10% per
year range for the next 3 years, and 3-5% per year thereafter;
 BT still believes 8% EBIT margins are quite possible, which would
be a big pickup from the 6% targeted for 2014;
 The CSeries continues to progress, with production wings moving
through the Belfast plant. Belfast’s composite technology also
appears impressive and proprietary.
Forecast bumped on BT sales discussion; target bumped on forecast
The BT sales guidance was higher than we were projecting, so we
increased our forecast to be in line with the growth rates outlined by
management. Our target increased on our new forecast.
Valuation maintained at a premium level
We are maintaining our valuation multiple at 9.0x EV/NTM EBITDA in
one year (9.0x Q2/15E EV to Q3/15E – Q2/16E EBITDA). Our valuation
remains at a premium level, reflecting the significant EPS growth
potential from BBD’s new product and other opportunities.

 

HEICO Corporation

HEI : NYSE : US$52.05 BUY 
Target: US$65.00

COMPANY DESCRIPTION:
HEICO is a leading provider of commercial aerospace
spare parts and repair services, as well as niche
technology and electronic products for the space,
defense, industrial, medical and other markets. The
company reports its results in two operating segments:
Flight Support Group (FSG) and the Electronic
Technologies Group (ETG).

Transportation and Industrials — Airlines and Aerospace
Q3/14 PREVIEW
Investment recommendation
HEI is scheduled to report its Q3/14 results after the market close
on Aug. 26. In our view, sentiment on the stock has turned overly
negative due to concerns about slower growth in the commercial
aerospace market, margin improvement in the defense business,
and valuation. We believe the long-term positive thesis still holds,
and we believe the Q3/14 results will provide a positive catalyst.
We are maintaining our BUY rating and our $65 price target.

 

Investment highlights
 HEI management has gone out of its way to stress the
difficult Q3/13 comp (up 17% organic growth) in the FSG
segment. The comp Q2/14 results point to ~10% quarter for
FSG, which is in our model. We see the downside of FSG
organic growth as high single-digits. We believe anything
over 10% will be a strong catalyst, but an in-line quarter
(FSG organic growth of 8-10%) will not disappoint investors.
 We expect some ETG margin improvement (we model in
23%) but expect an additional step up in Q4/14.
 We believe HEI will raise its EPS guidance to up ~15%, from
the current 13%, which implies 2014 EPS of $1.76. We are
maintaining our 2014 $1.79 EPS estimate. We do not expect
any increase to the revenue guidance.
Valuation
Our $65 price target is based on the average of a 32.0x EPS
multiple and a 15.0x EBITDA multiple, applied to our 2015
estimates.

The Boeing Company Come Fly With Me

BA : NYSE : US$125.58 BUY 
Target: US$160.00
Transportation and Industrials — Airlines and Aerospace
737 RATE INCREASE AND IMPLICATIONS FOR THE SECTOR
Investment recommendation
We believe BA’s strong hint that rates will go up further on the
737 is a strong statement about its confidence in the commercial
cycle, and a positive catalyst. It will also help BCA margins and
cash flow as BA frees up additional slots to sell. With BA stock
outperforming the market since the commentary, we believe a
step up in 737 rates is a positive catalyst. We continue to like
Boeing for the potential cash flow upside, and strength in the
commercial cycle.
Investment highlights
 We believe that the 737 accounts for over 50% of BA’s
earnings, but is also a very significant program for SPR, DCO,
as well as most of our sector. We believe that a step up to
52/month on the 737 can add the most to BA, DCO, ESL and
SPR valuations.
 We are concerned that a rate of over 50/month from both
Boeing and Airbus adds additional risk if these rates are not
sustainable. We believe the supply chain is focused on
50/month as a natural threshold.

Valuation
Our $160 price target is based on the average of an 18.0x EPS
multiple and a 12.0x EBITDA multiple, applied to our 2015
estimates.

TransDigm Group

TDG : NYSE : US$190.97

BUY 
Target: US$200 
COMPANY DESCRIPTION:
TransDigm Group, headquartered in Cleveland, Ohio, is a
leading supplier of engineered components and systems
for military and commercial aircraft. Approximately 90%
of sales are from proprietary products, and approximately
75% from sole-source products

Transportation and Industrials — Airlines and Aerospace
COMPANY DECLARES $25 SPECIAL DIVIDEND
Investment recommendation
TDG announced it has wrapped up the financing for its $25 special
dividend. We believe leverage is now >6.0x, which is consistent with
prior peaks. Moreover, the company has lowered its weighted cost of
debt by ~1% through the refinancing. While the dividend is a positive
confirmation of the strong cash flow and aggressive balance sheet
management, to the extent that it signals a lack of significant
acquisitions, it appears to be a net negative. We maintain our BUY
rating and $200 price target.
Investment highlights
 While we applaud the special dividend, which was basically as
expected, it is difficult to view this as anything but slightly negative
for the M&A pipeline. The company still has significant capacity, but
the lack of meaningful deals is a concern. Key catalysts remain M&A
and capital return.
 Moreover, we believe commercial aftermarket growth could get
close to 10% and maybe just over for Q3/13, but we continue to see
full year commercial aftermarket up in line with guidance, high SS,
with little chance of market upside relative to expectations.
Valuation
We are maintaining our BUY rating and our $200 price target

HEICO Corporation BUY

HEI : NYSE : US$52.18

BUY 
Target: US$65.00

 

COMPANY DESCRIPTION:
HEICO is a leading provider of commercial aerospace
spare parts and repair services, as well as niche
technology and electronic products for the space,
defense, industrial, medical and other markets. The
company reports its results in two operating segments:
Flight Support Group (FSG) and the Electronic
Technologies Group (ETG).Transportation and Industrials — Airlines and Aerospace
SELL-OFF OVERDONE; MAINTAIN BUY, PRICE TARGET TO $65
Investment recommendation
We believe the 3.7% drop in HEI shares after its Q2 report was overdone.
Granted, the drop in ETG margins to ~20% was greater than expected and
the H2/14 ETG margin improvement may be slower than a one-quarter hit
would indicate. However, we continue to believe the fundamentals of the
business have not changed and would use the pull-back to revisit HEI
shares. While organic growth may slow due to more difficult comps, we
believe the FSG strength, strong cash flow, and expected 20% growth
across the cycle continue to justify a valuation premium. We maintain our
BUY rating and slightly lower our price target to $65.
Investment highlights
 The company did raise full-year EPS guidance by $0.03 (as expected).
However, we slightly lowered our 2014 EPS estimate to $1.79 (still
above guidance) based on a slower Q3/14 ETG margin improvement.
We maintain our 2015 and 2016 EPS estimates of $2.04 and $2.26,
respectively. Note that due to the lack of acquisitions, the company has
not raised its revenue guidance at all in 2014 (still at up 12%-14%).
 Organic growth in the FSG segment was an impressive 15%. The keys
for the stock in the near term are improvement in the ETG segment,
continued better-than-expected organic growth in the FSG segment,
and potential acquisitions, which would be positive catalysts. We
continue to believe HEI represents a high-quality stock with a very
strong outlook; the Q2/14 results represent a slight step back, but not
a change to our long-term positive thesis.
Valuation
We lower our price target to $65, based on the average of a 32.0x EPS
multiple and a 15.0x EBITDA multiple, applied to our 2015 estimates.

 

All amounts in US$ unless otherwise noted.

Spirit AeroSystems

SPR : NYSE : US$32.69

BUY 
Target: US$36.00

COMPANY DESCRIPTION:
Spirit AeroSystems is a leading tier-1 supplier of aircraft
fuselage, propulsion, and wing systems for commercial
and military aircraft programs. Based in Wichita, Kansas,
Spirit AeroSystems was spun out of Boeing in 2005, and
today is the largest non-OEM supplier of commercial
aircraft structures.

All amounts in US$ unless otherwise noted.

Transportation and Industrials — Airlines and Aerospace
2014 OFF TO A SOLID START;
GUIDANCE SEEMS CONSERVATIVE,
A350 KEY RISK
Investment recommendation
SPR posted a relatively clean Q1/14, with core EPS of $0.85 ($1.07 after
tax benefit and debt charge). Sales growth was an impressive 20% (13%
before benefit of four additional days in the quarter). Core operating
margins increased to 14.8%, led by Propulsion segment. While FCF
guidance increase reflects reduced 787 advance reimbursement, the lack
of any change to full year EPS guidance is a slight concern. The A350
appears to be the primary risk, but program schedule is encouraging. We
are maintaining our BUY rating, increasing our price target to $36.
Investment highlights
 We are raising our 2014 and 2015 EPS estimates to $2.82 and $3.02,
respectively. Moreover, we raised our FCF estimate to just over
$200M, in line with guidance. However, the relatively strong Q1/14
has increased our confidence in the 2014 opportunity and given
greater visibility on a $3.00 2015 EPS estimate, a key milestone for
the company.
 We had expected to hear about further progress on the Tulsa
divestiture by this time. While the company indicates it is still
committed to the sale, either interest levels are not where the
company expected, or the desire to unload the operations is not as
urgent as it was six months ago. We still believe this can be a positive
catalyst, but the impact seems lower. Note that Tulsa is included in
the 2014 guidance.
Valuation
We are increasing our price target to $36, based on the average of a 11.0x
EPS multiple and a 7.0x EBITDA multiple, applied to our 2015 forecast.

 

HEICO Corporation

HEI : NYSE : US$57.84 
BUY  Target: US$66.00

 COMPANY DESCRIPTION:

HEICO is a leading provider of commercial aerospace spare parts and repair services, as well as niche technology and electronic products for the space, defense, industrial, medical and other markets. The company reports its results in two operating segments: Flight Support Group (FSG) and the Electronic Technologies Group (ETG).

Transportation and Industrials — Airlines and Aerospace INITIATING COVERAGE WITH A BUY AND A $66 PRICE TARGET 
Investment recommendation We are initiating coverage of HEI with a BUY recommendation and $66 price target. We believe HEI will benefit from a continued “beat-and-raise” pattern, driven largely by strong 2014 commercial aerospace results. Additional acquisitions can also be positive catalysts. While PMA sales will continue to decline as a percentage of the total, commercial aerospace sales will continue to account for over 55% of estimated 2014 revenues.
Investment highlights  HEI has outperformed its initial EPS guidance by an average of 8.4% since 2005. We expect this pattern to continue in 2014. We model in Flight Support Group (FSG) segment sales up 17.2%.
 In addition to the improving fundamentals and the conservative guidance, in our view the stock will maintain its valuation premium due to the prospects of additional disciplined acquisitions, historically strong cash flows, better than industry growth, and strong execution.
Valuation We are initiating with a BUY rating and a $66 price target. Our price target is based on the average of a 31.0x EPS multiple, and a 15.5x EBITDA multiple, applied to our fiscal 2015 estimates. We believe multiples at the upper end of the range are appropriate considering 2014 upside and improving fundamentals.
Risks The key risks to our thesis on HEI include airline passenger and cargo traffic, premium passenger traffic, airline profitability, new product launches and certification, airline PMA product acceptance and certification rates, product pricing, material and fuel costs, US and international defense spending, export control restrictions and trends, economic growth, interest rates, industrial production and acquisition opportunities and timing.

WestJet Airlines Ltd. BUY

WJA : TSX : C$25.15
BUY 
Target: C$31.00

COMPANY DESCRIPTION:
WestJet is Canada’s leading low-fare airline and is based in Calgary, Alberta. WestJet employs about 6,600 full time equivalent employees, and carries roughly 15 million guests to its 71 destinations across North America and the Caribbean. WestJet is publicly traded on the Toronto Stock Exchange under the symbols WJA and WJA.a.
All amounts in C$ unless otherwise noted

Transportation and Industrials — Airlines and Aerospace
LOWER NEAR-TERM FORECAST ON FX, FUEL
BUY for EPS growth potential from initiatives
We think WestJet (WJA) looks attractive on a price-growth basis. We expect four key drivers outlined below to generate 15.9% average annual EPS growth from 2013-15. And yet, WJA trades at a reasonable P/E of 11.2x on our 2014E EPS estimate.
We expect strong EPS growth from: 1) Premium Economy launch, 2) Encore regional launch, 3) ongoing US and International growth, and 4) cost reduction initiative.
But FX and fuel headwinds could slow near-term progress
WJA estimates that its operating income is negatively impacted by $14.3 million ($0.08 EPS) for each one cent weakening of the Canadian dollar. Our new forecast assumes a $0.06 weaker Canadian dollar than our old forecast, implying a $0.42 EPS hit (hedges should help slightly).
Higher jet fuel costs also hit WJA profits by $11 million per one cent increase. We are forecasting US$0.03 higher jet fuel cost in 2014, implying a $0.18 EPS hit.
We expect WJA and other airlines (who are also hit by these factors) to put through price increases to offset these costs. But full cost recovery is likely to take time, based on our research.
Accordingly, we have reduced our near-term forecast for WJA. But our target is unchanged as we do not expect WJA’s mid-term outlook to be changed by these developments.
Good implied one-year investment return projected on moderate valuation multiple
We are projecting a 24.9% one-year return on a 5.5x EV/NTM EBITDAR (5.5x Q3/14E EV to Q4/14E – Q3/15E EBITDAR) multiple. Our target multiple is a slight increase versus WJA’s current valuation, and we think it is reasonable relative to the company’s historical valuation, sector valuations, and WJA’s prospects.

Hexcel Update

HXL : NYSE : US$42.80
BUY 
Target: US$50.00

COMPANY DESCRIPTION:
Hexcel is a leading supplier of advanced composites for
the commercial aerospace, defense, space and industrial
markets. Specific product offerings include carbon fibers,
specialty reinforcements, prepregs, fiber-reinforced
matrix materials, honeycomb, adhesives, and composite
structures.
All amounts in US$ unless otherwise noted.

Transportation and Industrials — Airlines and Aerospace
UPSIDE INTACT, MAINTAIN BUY AND $50 PRICE TARGET
Investment recommendation
Hexcel reported a basically in-line Q4/13. However, the lack of any upside
surprise was an excuse on a down day in the market to take profits, with
HXL down 7.0% as compared to 2.1% for the S&P 500 and 3.4% for the A&D
sector. The sell-off was overdone, in our view. Hexcel maintained its 2014
guidance and we see upside from better-than-expected execution and the
A350 ramp, which we expect will drive revenue and margin upside. We are
maintaining our BUY rating and $50 price target, and HXL remains one of
our top picks for 2014.
Investment highlights
 The company has maintained its full year 2014 outlook and we have
increased confidence in upside to the 2014 23% incremental margin
target. We currently model in a 27% target. Clearly, continued volume
growth is the key, with the A350 schedule largely driving the 2014 and
2015 performance. We see total growth of over 10%, with commercial
aerospace sales up 13%. We continue to be confident in the Industrial
and Space/Defense segments each up mid-single digits.
 We are slightly reducing our 2014 EPS estimate to $2.14 (slightly higher
tax), and raising our 2015 EPS estimate to $2.45. We are also initiating
a 2016 EPS estimate of $2.80. Seasonally, Q1/14 will be the softest due
to the spike in SG&A spend for employee compensation, but we expect
the strength of the A350 to offset the seasonal weakness in Q4/14.
Valuation
Our $50 price target is based on the average of a 22.5x EPS multiple and a
14.0x EBITDA multiple applied to our 2014 estimates. We believe HXL will
continue to justify a premium to the sector based on the secular composite
growth, better-than-expected execution, and cash deployment, and the
improving outlook for wind sales into 2014.

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