December 7, 2008

Value Idea: Bombardier Preferred

I have bought another preferred issue. The issue is BBD.PR.D trading on the TSX. It pays $1.31 or 13% yield. The issue pays fixed dividend until August 2012 then it exchanged for a floater paying dividends equal to the prime rate. I have managed to buy a small position on Friday@ $10.26 on the TSX, waiting to add more.

Business Overview
The company manufactures jets and train systems; its revenues almost split evenly between the two divisions.

The majority of its sales comes from Europe, while sales in Emerging markets are growing at a healthy clip. BBD has been announcing major contract wins over the last 6 months. The company will be further aided by the rapid decline in the Canadian dollar as it will lower the cost of BBD's goods to foreigners. The Canadian dollar is expected to remain subdued if a weak recovery and the pressure on commodities that would likely accompany it follows the global economic slowdown. After all, the loonie is 96% correlated to commodities, according to UBS. The company has a huge backlog of orders and potential for margin improvements; its backlog of $52 Billion.

Credit Assessment
The debt has been reduced by strong cash flow from operations. BBD's total debt in 2005 was $5.7 billion in the latest quarter it was $3.8. The company financial position continues to improve and coverage and leverage ratios are improving. In addition, the improving business fundamentals and growing revenues will allow for more improvements.

BBD's cash flow are strong and improving:
  • The company has cash position of $3.3 US. almost equal to its long term debt.
  • Free Cash flow to total debt have risen from 17% in 2005 to 42%.
  • Cash From Operation (CFO) has grown from $768 million in 2005 to $2 Billion in 2008.
While its Balance Sheet continues to de-leverage:

  • From table above liquidation value of assets is almost twice of BBD's total borrowings.
  • If I apply the same calculation from table above to historical figures we can good improvement. The liquidation value has undergone a drastic improvement in the quality of the collateral that secures BBD's debt and preferreds over time. (see chart)
  • Coverage ratios are also been improving

The BBD.PR.D issue price action does not make any sense over the last few months. The preferred should have some downside protection compared to the common. The preferreds with better security and dividends have mirrored the price performance of the common. The preferred is down 35% just the same as the common over the last 12 months.

Moreover the preferred dividend yield of 13% is higher than the common expected earning yields of 8.6% (P/E inverted).

What can go wrong?
  • BBD out of business: In this event I think there are good odds that the liquidation value of its assets can cover liabilities and unfunded pension benefits and spill over to common equity.
  • interest rates: higher rates in the future can decrease the preferred value, but it will be a floater in 2012 offsetting such risk. In the meantime I enjoy fixed rate.
  • liquidity of the issue: The issue has low volume so entering and exiting has to be done slowly. I still have not accumulated my full position but I am waiting opportunistically for good entry prices like the one I got today.
  • Sales backlog can be delayed by customers. However the train division will keep churning revenue and grow at high rates as government around the world spend on infrastructure to stimulate their economies; the company will be a beneficiary.
  • Pension plan unfunded liabilities. The company has a relatively large unfunded pension liabilities.
Given these risks, I think at this price and coverage ratios detailed above I have enough margin of safety not to risk any permanent loss of capital.

Over the past few posts I have been saying that fixed income is a huge opportunity these days. I can invest and compound my money at 12-18% in issues with better security than common stock. Some of these issues have a margin of safety that ensures there is no permanent loss of capital. I expect to make more investment like these. And to those who invest in treasuries earning less than 2% because it is risk-free, guess again!

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