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Analysts turn cautious on CAE amid military spending cuts

CAE Inc. has been ambushed with analyst price target cuts and at least one downgrade today after soft first-quarter results and worries that spending cuts in the military will slow growth in that business segment.

The flight simulator's military business accounted for 53 per cent of its revenue last year and the division's revenue and margins in the first quarter left analysts disappointed. While the company this year conceded that the business is being impeded by funding delays, this week it went a step further by cutting its fiscal 2012 growth forecasts.

"We expect the issue of tighter defence budgets to remain a drag on the stock for at least the next six to 12 months," commented Raymond James Ltd. analyst Ben Cherniavsky in a research note.

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Canaccord Genuity analyst David Tyerman cut his sales expectations for the segment, expecting permanently slower sales as he reduced his near-term margin assumptions. "Military sales prospects are murkier, given governmental finance constraints and related military structure reviews in some countries," Mr. Tyerman said.

CAE's commercial segment has performed well recently thanks to the improving economy and greater interest among airlines to expand service. But the recent economic turbulence is clouding the outlook there as well. "Indeed, if recent economic woes accelerate, then airline capacity cuts and/or order deferrals could be in the offing (again) this fall, which would be detrimental to CAE's business," warned Mr. Cherniavsky.

National Bank Financial analyst Cameron Doerksen cautioned that some of the concerns over the military segment could be overblown.

"We would argue that over the long term CAE's military business should at least be stable, if not continue to grow in spite of reduced defence budgets," Mr. Doerksen said.

He notes that militaries are generally increasing the amount of training performed on simulators as a cost saving measure, and the company has a strong defence work backlog of $2.2-billion. It also obtains 35 per cent of its military revenue from the U.S. defence budget, which is particularly vulnerable to cuts amid the country's debt crisis.

Downside: National Bank cut its price target by 50 cents to $14 but maintained an "outperform" rating; Raymond James cut its price target by $1.50 to $12 while maintaining a "market perform" rating; Canaccord Genuity maintained a "buy" rating and $16 price target; Desjardins Securities downgraded CAE to a "hold" and cut its price target by $2 to $14.

Open Text Corp.'s fiscal fourth-quarter results were slightly weaker than expected, across the board, and were particularly disappointing, given the recent robust results from its peer group, said Versant Partners analyst Tom Liston. While the company has successfully acquired a trio of solid companies over the past 12 months, it's putting some pressure on margins in the short term, he said.

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Downside: Mr. Liston cut his 12-month price target by $10 to $68 but reiterated his "buy" rating.

Related: Open Text posts higher profit, but misses forecasts

Canaccord Genuity analyst Gary Lampard has upgraded HudBay Minerals Inc. to a "buy" due to recent share price weakness. HudBay's second-quarter earnings were in line with expectations, but production volumes were a touch low, he said.

Upside: Mr. Lampard, who trimmed his EBITDA forecasts for 2012 and 2013, cut his price target to $14.80 from $16.20.

The recent pullback in Birchcliff Energy Ltd. shares "creates an opportune time to buy," argued Canaccord Genuity analyst Steve Toth. While the company reported second-quarter earnings that were only in line with expectations, "the stock should gain momentum over the next 12 months and reflect Birchcliff's significant growth profile in late 2012 and profitable operations," he said.

Upside: Mr. Toth upgraded the stock to a "buy" and raised his target price by 50 cents to $14.50.

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Global market uncertainty has prompted Canaccord Genuity analyst Scott Chan to slash his return on capital estimate for Onex Corp. by three percentage points to 12 per cent. But he also sees opportunities arising from the recent equity selloff, believing that Onex will take advantage of depressed valuations and invest capital.

Downside: Mr. Chan cut his price target to $42.25 from $44 but maintained a "buy" rating.

Related: Onex's profit spikes from asset sales

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About the Author
Investment Editor

Darcy Keith is The Globe and Mail's Investment Editor. He has been a business journalist since 1992 and joined the Report on Business in 2010 from Yahoo! Canada, where he was the senior editor of finance. More

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