CHORUS AVIATION INC CHR.A
October 03, 2014 - 7:03pm EST by
eigenvalue
2014 2015
Price: 4.09 EPS $0.72 $0.73
Shares Out. (in M): 121 P/E 5.7x 5.6x
Market Cap (in M): 493 P/FCF 3.9x 3.9x
Net Debt (in M): 287 EBIT 129 127
TEV: 780 TEV/EBIT 6.0x 6.2x

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  • Canada
  • Dividend yield
  • Regional Airline
  • Small Cap
  • Buybacks
 

Description

Chorus Aviation (CHR.B)

Chorus Aviation is the holding company for Jazz, the dominant regional airline in Canada that works in close partnership with Air Canada. The majority of the Chorus business is structured in the form of a Capacity Purchase Agreement (CPA) with Air Canada, whereby Air Canada is responsible for scheduling, pricing, distribution, marketing, advertising, and customer service, and Chorus actually operates the flights (that is, Chorus provides the planes, the pilots, mechanics, etc.). Under the CPA, Air Canada collects the revenues from these flights and then pays Chorus under a relatively complicated formula that passes through certain costs such as fuel and terminal fees, and is keyed to the number of hours flown, number of passengers, and other variables. Chorus can also receive incentive fees each quarter depending on how well it performs in terms of on-time performance, baggage handling performance, and customer satisfaction.

Chorus presents a compelling investment opportunity for a few reasons:

  • It currently trades at a very undemanding ~5.7x earnings and ~3x TEV/EBITDA, and currently pays a $0.0375 monthly dividend for a yield of ~11%.
  • Because of the CPA, Chorus is insulated from most of the vagaries of the airline industry, primarily passenger revenue and fuel costs. This makes the earning power of the company much less volatile and thus lower risk.
  • The benchmarking arbitration case between Chorus and Air Canada that had been ongoing since 2010 and which had cast a pall on the company was successfully resolved in November of 2013, with a complete victory for Chorus.
  • Chorus has a shareholder-friendly management team that has done several things recently that indicate management’s view that the stock is cheap; in February of 2014, the company redeemed most of its convertible debentures (with the rest redeemed in the second quarter of 2014), and initiated a share buy-back that has already resulted in the cancellation of 1.7mm shares.
  • Chorus has a very seasoned work-force that includes a higher than normal percentage of senior employees who earn significantly higher wage rates; this has created the opportunity for the company to invest in highly accretive voluntary separation programs ($10mm in 2013 and ~$15mm in 2014) that have payback periods of less than 24 months.

The CPA has the effect of replacing one kind of risk, namely market risk associated with demand for air travel and energy costs, and replacing it with contractual risk. The current CPA term expires at the end of 2020, and is subject to renewal on terms to be negotiated for two additional 5-year periods.

The best indication of how much the CPA insulates Chorus from market risks is the historical earnings record, which shows markedly less volatility than that of a traditional, stand-alone airline over the period:

 

2008

2009

2010

2011

2012

2013

LTM Ended 6/30/14

               

Revenue

     1,636.3

     1,473.9

     1,486.2

     1,664.5

     1,710.7

     1,672.1

                       1,677.9

Gross Profit

        282.0

        267.1

        245.4

        252.4

        290.4

        303.6

                          316.8

EBITDA

        178.7

        159.1

        128.7

        146.1

        184.1

        196.8

                          212.0

EBIT

        106.2

          88.8

          86.8

        101.9

        127.4

        134.2

                          146.5

 

The key provision of the CPA is the mark-up on controllable costs that Air Canada pays to Chorus. Under the current terms of the agreement, this mark-up is set at 12.5%. The key risks to Chorus are that Air Canada fails to renew the CPA after it expires in 2020, or that Chorus negotiates an extension with Air Canada that pays a lower mark-up rate, which would put pressure on margins and dividends for Chorus.

I believe that Chorus is very likely to negotiate an extension to the CPA before it expires. Indeed, the CEO of Chorus, Joseph Randell, was quoted in a 2/20/14 article in The Globe and Mail saying that “We’re open to negotiations at any time.” From the standpoint of Air Canada, Chorus is basically the only game in town in terms of a regional partners, since it is many times larger than the next largest regional airline, and is already set up to work well with Air Canada’s systems. Furthermore, despite the arbitration process between the companies, the relations between the respective management teams are said to be cordial, and Chorus has performed quite well as measured by various metrics, such as the percentage of flights on time. Thus there is no fundamental reason why the companies can’t continue to work together if they can agree on a pricing formula that makes sense for both sides. Since there is no competitor that is even close in scale to Chorus (the only other notable competitor is WestJet’s Encore regional airline, which currently operates just 14 planes, compared to 125 planes for Chorus), the negotiations are not quite as one-sided in favor of Air Canada as they might be at first blush.

In the meantime, investors can collect a double digit yield and have downside protection in the event of a market dislocation such as what happened in 2008-2009 because of the way the CPA is structured. Chorus is relatively under-leveraged for an airline, with $393mm of total debt and $106.4mm of cash, compared to EBIT in the last twelve months of $146.5mm. 

 

 

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • Extension of CPA with Air Canada
  • Continued voluntary separation agreements with senior employees.
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    Description

    Chorus Aviation (CHR.B)

    Chorus Aviation is the holding company for Jazz, the dominant regional airline in Canada that works in close partnership with Air Canada. The majority of the Chorus business is structured in the form of a Capacity Purchase Agreement (CPA) with Air Canada, whereby Air Canada is responsible for scheduling, pricing, distribution, marketing, advertising, and customer service, and Chorus actually operates the flights (that is, Chorus provides the planes, the pilots, mechanics, etc.). Under the CPA, Air Canada collects the revenues from these flights and then pays Chorus under a relatively complicated formula that passes through certain costs such as fuel and terminal fees, and is keyed to the number of hours flown, number of passengers, and other variables. Chorus can also receive incentive fees each quarter depending on how well it performs in terms of on-time performance, baggage handling performance, and customer satisfaction.

    Chorus presents a compelling investment opportunity for a few reasons:

    • It currently trades at a very undemanding ~5.7x earnings and ~3x TEV/EBITDA, and currently pays a $0.0375 monthly dividend for a yield of ~11%.
    • Because of the CPA, Chorus is insulated from most of the vagaries of the airline industry, primarily passenger revenue and fuel costs. This makes the earning power of the company much less volatile and thus lower risk.
    • The benchmarking arbitration case between Chorus and Air Canada that had been ongoing since 2010 and which had cast a pall on the company was successfully resolved in November of 2013, with a complete victory for Chorus.
    • Chorus has a shareholder-friendly management team that has done several things recently that indicate management’s view that the stock is cheap; in February of 2014, the company redeemed most of its convertible debentures (with the rest redeemed in the second quarter of 2014), and initiated a share buy-back that has already resulted in the cancellation of 1.7mm shares.
    • Chorus has a very seasoned work-force that includes a higher than normal percentage of senior employees who earn significantly higher wage rates; this has created the opportunity for the company to invest in highly accretive voluntary separation programs ($10mm in 2013 and ~$15mm in 2014) that have payback periods of less than 24 months.

    The CPA has the effect of replacing one kind of risk, namely market risk associated with demand for air travel and energy costs, and replacing it with contractual risk. The current CPA term expires at the end of 2020, and is subject to renewal on terms to be negotiated for two additional 5-year periods.

    The best indication of how much the CPA insulates Chorus from market risks is the historical earnings record, which shows markedly less volatility than that of a traditional, stand-alone airline over the period:

     

    2008

    2009

    2010

    2011

    2012

    2013

    LTM Ended 6/30/14

                   

    Revenue

         1,636.3

         1,473.9

         1,486.2

         1,664.5

         1,710.7

         1,672.1

                           1,677.9

    Gross Profit

            282.0

            267.1

            245.4

            252.4

            290.4

            303.6

                              316.8

    EBITDA

            178.7

            159.1

            128.7

            146.1

            184.1

            196.8

                              212.0

    EBIT

            106.2

              88.8

              86.8

            101.9

            127.4

            134.2

                              146.5

     

    The key provision of the CPA is the mark-up on controllable costs that Air Canada pays to Chorus. Under the current terms of the agreement, this mark-up is set at 12.5%. The key risks to Chorus are that Air Canada fails to renew the CPA after it expires in 2020, or that Chorus negotiates an extension with Air Canada that pays a lower mark-up rate, which would put pressure on margins and dividends for Chorus.

    I believe that Chorus is very likely to negotiate an extension to the CPA before it expires. Indeed, the CEO of Chorus, Joseph Randell, was quoted in a 2/20/14 article in The Globe and Mail saying that “We’re open to negotiations at any time.” From the standpoint of Air Canada, Chorus is basically the only game in town in terms of a regional partners, since it is many times larger than the next largest regional airline, and is already set up to work well with Air Canada’s systems. Furthermore, despite the arbitration process between the companies, the relations between the respective management teams are said to be cordial, and Chorus has performed quite well as measured by various metrics, such as the percentage of flights on time. Thus there is no fundamental reason why the companies can’t continue to work together if they can agree on a pricing formula that makes sense for both sides. Since there is no competitor that is even close in scale to Chorus (the only other notable competitor is WestJet’s Encore regional airline, which currently operates just 14 planes, compared to 125 planes for Chorus), the negotiations are not quite as one-sided in favor of Air Canada as they might be at first blush.

    In the meantime, investors can collect a double digit yield and have downside protection in the event of a market dislocation such as what happened in 2008-2009 because of the way the CPA is structured. Chorus is relatively under-leveraged for an airline, with $393mm of total debt and $106.4mm of cash, compared to EBIT in the last twelve months of $146.5mm. 

     

     

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    • Extension of CPA with Air Canada
    • Continued voluntary separation agreements with senior employees.

    Messages


    SubjectRE: Div Yield
    Entry10/06/2014 11:26 PM
    Membereigenvalue
    Apparently management cut the dividend to be conservative when it was unclear how the benchmarking arbitration would turn out. When it was eventually ruled in favor of the company, management restored the dividend. I suspect the high yield is mostly because people are concerned that the current CPA is more favorable than Chorus could get today based on a fresh negotiation with Air Canada, so that if the deal is renegotiated before expiry, margins will come under pressure. And yes, the increased capex over the past few years was from the company investing in new Q400 model aircraft. The company expects maintenance capex of between $27mm and $31mm for calendar 2014 (source: 2/20/2014 earnings call). 

    SubjectRenegotiated deal with Air Canada
    Entry01/13/2015 04:30 PM
    Membereigenvalue

    Stock is up decently today on this news: 

    http://www.newswire.ca/en/story/1471291/air-canada-and-chorus-aviation-inc-announce-a-conditional-amended-and-extended-capacity-purchase-agreement

    As I expected, the company didn't wait until the end of the existing agreement to renegotiate an extension. It's a complex agreement with lots of parts, but the bottom line here looks like Chorus got a pretty good deal, where they will get essentially similar economics to what they would have gotten through the end of the existing agreement:

    "While it is anticipated that Jazz will achieve similar returns to its current fee structure until 2020, there will be a reduction in the fixed fee compensation structure beginning in 2021."

    In any case, this news signficantly reduces the worst case scenario risk for Chorus. 


    SubjectRe: Renegotiated deal with Air Canada
    Entry01/13/2015 05:12 PM
    Membersocratesplus

    just came across your writeup, thanks for posting.

    i am trying to understand why air canada wants this arrangement with chorus.  this seems like a classic case calling for vertical integration, where chorus's cash flow, if acquired by ac, would be more valuable to ac than chorus, based upon their respective cashflow multiples, ac's lower financing costs etc.

    you have not mentioned any takeout potential, and this renegotiation of the cpa seems to indicate that the parties like things the way they are, so maybe i am missing something.


    SubjectRe: Re: Renegotiated deal with Air Canada
    Entry01/21/2015 06:18 PM
    Membereigenvalue

    I think the arrangement is more of a by-product of the history of the company. They were originally all part of the same company, as described in the Wikipedia article for AC:

    "In 2001, Air Canada consolidated their wholly owned regional carriers Air BCAir NovaAir Ontario, and Canadian Regional Airlines into Air Canada Regional Incorporated. In 2002, the consolidation was completed with the creation of a new brand, Air Canada Jazz. Air Canada Jazz was spun off in November 2006."

    I don't have a strong view either way about a possible takeout by AC. I certainly wouldn't want to count on it because the arrangement has persisted for some time now and seems to be working well enough for both parties. 


    SubjectGood 4th Quarter Results
    Entry02/19/2015 01:38 PM
    Membereigenvalue

    Chorus reported pretty good results today for the 4th quarter:

    http://chorusaviation.ca/2015-02-19-Chorus-Aviation-announces-strong-fourth-quarter-and-year-end-earnings

    Slight increase in EBITDA year over year, and they raised the dividend a bit to 4 cents a month, for an 8% yield at the current price of $6.00-- up almost 47% from when I posted the idea in October.

    Clearly, the real driver of the stock recently has been the successful renegotiation of the Air Canada agreement, which has reassured investors that the company has a long term future beyond 2020, the original end date of the contract.

    I think most of the upside in this idea has already been captured at this point, but it is certainly not very expensive at the current price, especially because it no longer suffers from the meaningful headline risk associated with the contract renegotiation.

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