Morningstar's "Perspectives" series features investment insights from third-party contributors. We hear from Stuart Mitchell, manager of the SWMC European Fund.
We have sourced many of our most profitable investment ideas over the years from esoteric areas of the market. Often these opportunities are poorly researched by the investment community. We are witnessing one such opportunity currently in Dassault Aviation, the manufacturer of the Rafale fighter aircraft and private jets.
These are not usually mainstream investment industries and the company is barely known. While Dassault Aviation has been publicly quoted for 27 years, the free float remains small; rising from 2% to 14% when in 2015 Airbus began to dispose of its investment as part of its wider refocusing. The free float should rise to 38% by the end of 2017, as Airbus fully disposes of its holding. This might encourage the fund management industry to begin paying closer attention.
The company has the lustre of being 56% owned by the Dassault family, who have a justified reputation as long-term creators of value. We have profited from investing in Dassault Systèmes, the world leading 3D technology group, which is 41% owned by the Dassault family. Dassault Aviation boasts consistently impressive returns on capital over many years. Accounting is conservative – with R&D expensed through the P&L – while the company has a very strong balance sheet, holding some €2.5 billion net cash.
The Need for Speed
The Rafale has an unusual history. In the late 1970s the French, British, German, Italian and Spanish governments joined forces to develop a European jet fighter – known as the Eurofighter. The French government, however, broke away from the project in 1981 following disagreements over workshare and – more importantly – specifications. The first demonstration aircraft of what would become the Rafale was developed by Dassault Aviation, Thales and Safran in 1986. This was soon followed by an order from the French government in 1988, and the first Rafale entered service in 2001.
The Eurofighter was designed in the depths of the cold war to out-manoeuvre Russian aircraft in a dogfight. The likelihood of such aerobatics has greatly receded in recent times. By contrast, the Rafale has the advantage of being able to fly at very high speeds at low altitude. This is what has made the Rafale uniquely well-suited to the low-level bombing typical of recent warfare in Afghanistan, Libya, Mali, Iraq and Syria. The Eurofighter has been relegated to the role of a support aircraft. The Rafale has the added advantage of being able to carry more bombs.
The Rafale also has the advantage – in some eyes – of not being American. The echoes of General de Gaulle’s ‘troisième voie’ continue to reverberate. This seems to have resulted in the announcement of a significant number of new orders from India, Egypt, and Qatar over the past 18 months. There remains the possibility of further domestic orders from countries such as Malaysia and the UAE.
Recovery of Private Jets
Getting to grips with the private jet side of the business has been equally fascinating. Dassault’s business jet profits are currently depressed by unusually high R&D spending, 13% of sales versus 8% on average, as it prepares to launch a new range of jets focused on the more profitable large-cabin market. This has coincided with a cyclical low in the private jets following the crisis. However, jet orders have begun to recover again – rising from 64 in 2013 to 90 in 2014.
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