AC - TD Waterhouse increases target price to $49. from $44Event We are increasing our Air Canada target price to $49.00 from $44.00 and moving to a BUY recommendation from Action List Buy. We are making immaterial revisions to our forecasts related to updated revenue and aircraft ownership expense assumptions. Impact: NEUTRAL Our target price change is due to an increased target multiple (to 9.0x EPS from 8.0x previously), which reflects Air Canada's higher current forward multiple and our expectation that its future earnings growth, strengthening FCF, and improving ROIC will prevent significant multiple contraction. Our target multiple is above the U.S. mainline average of 7.2x, but well below WestJet's current forward multiple of 22.0x (based on historically weak earnings) and below the historical highs of U.S. mainlines of 10x-11x. We are moving to a BUY recommendation due to recent share-price appreciation and the resulting 25.5% total return to target. On May 16, Air Canada announced plans to acquire Transat A.T. for $13.00/share. We believe that the transaction could be accretive to Air Canada's long-term earnings and cash flow while providing a source of capacity that it would otherwise be required to purchase/lease in the coming decade. Although we are not able to factor in the potential impact of concessions that may be required to complete a transaction, a scenario analysis (Exhibit 1) suggests to us that: 1. the acquisition of Transat would ultimately be accretive to Air Canada's EPS and represents a prudent use of capital, in our view; and 2. the potential value, assuming that concessions and integration risks are not overly onerous, could justify a higher offer price from Air Canada, if required. Although an acquisition could result in unexpected challenges during the integration process, we believe that it will ultimately generate positive shareholder value over the medium-to-long term. We believe that management will not move forward with a transaction if the required concessions end-up putting that value-creation at risk. TD Investment Conclusion We believe that Air Canada's share price will continue to move higher over the next 12 months as it increasingly factors in the improving quality of the business as indicated by its earnings growth, FCF potential, strengthening ROIC, and return of capital to shareholders.