CAE Inc.

• CAE is well-positioned to benefit from solid fundamentals in the civil aviation and defence sectors, supported by pilot shortages and increasing global military spending, respectively.
• Further training opportunities exist on top of those from CAE's recent transactions with Asian partners.
• Recent M&A activity in the aerospace & defence sector (the acquisition of Rockwell Collins by United Technologies in particular) provides a positive read-through and supports our constructive stance on CAE.

CAE is a global leader in providing training for the civil aviation, defence and security, and healthcare markets. The company is well-established around the globe, with over 8,500 employees, 160 sites and training locations in more than 35 countries. CAE has a diversified business base with a high degree of recurring revenue (60% services vs 40% products; 36% from the US, 28% from Europe and 36% from other markets, including Canada; based on FY17 revenue).

The outlook for civil aviation (58% of FY17 revenue) remains solid, with utilization rates near record levels. This trend is expected to continue on the back of strong commercial traffic, improving bizjet activity and a pilot shortage, with ~255,000 new airline pilots needed over the next 10 years.

Fundamentals for the defence industry (38% of FY17 revenue) are also strong on the back of an increase in defence spending in major markets (Canada, US and NATO countries) as well as the trend toward outsourcing training solutions. More specifically, we believe CAE is well-positioned to capitalize on the upcoming replacement of 88 Canadian jet fighters as well as the 15 Canadian Surface Combatant ships expected over the coming years.

As for healthcare, management continues to see positive results with Juno, its latest platform dedicated to nursing education. We expect stronger growth ahead given nursing education is the largest addressable market in healthcare education. In addition, we remain confident that CAE's recent partnership with two well-recognized scientific organizations in the US will help the company gain recognition for its products, which should translate into new business with other medical organizations. Looking forward, CAE could double the size of its healthcare division over the next five years and generate margins comparable to that of its other divisions.

We also expect the reshaping of its joint venture portfolio with airlines to unlock value for shareholders. CAE recently announced the sale of its interest in its partnership with China Southern Airlines (which included an exclusivity agreement) for US$96m. CAE will continue to provide training services to China Southern, but will now have the ability to expand its scope in Asia. CAE has already started looking into new partnerships and announced an agreement for pilot training with Singapore Airlines; it also acquired the remaining stake in its partnership with AirAsia. Overall, we believe further training opportunities would arise as CAE proceeds with cash deployment in other parts of the world.

Our target price of C$27 is derived from an average of three valuation methods. In our view, CAE's valuation is compelling with the stock trading at an EV/EBITDA multiple of 10.6x (based on FY19 forecast), well below the average of 14.3x for the top 5 US peers. Assuming ~C$550m in proceeds to buy back shares and a 13.5x EV/EBITDA multiple on our FY20 forecast, we derive a value of C$36/share, significantly higher than the current share price.