bmbruce wrote: May 4, 2018
Chorus Aviation Inc.
Q1 EBITDA a bit light, but investment thesis
remains intact
Our view: We consider Chorus shares to be an attractive yield investment,
with the long-term CPA agreement with Air Canada providing a visible
source of revenue. In addition, the progress that has now been made on
diversifying operations into regional jet leasing has added a component of
growth and potential for capital appreciation. Our $11.00 price target and
Outperform rating remain unchanged.
Key points:
Q1/18 EBITDA slightly below expectations. Chorus Aviation reported
Q1/18 adjusted EBITDA of $78MM, which was a touch below consensus
at $81MM (RBC at $87MM). Similarly, revenue at $348MM came in below
consensus at $360MM, but in-line with RBC at $346MM. However, the
EBITDA variance was mainly the result of increase expenses associated
with the leasing business, and not the result of a decrease in billable block
hours, or lower leasing revenues. Non-CPA leasing revenues grew ~123%
Y/Y in the quarter, and as we discuss below, the fundamentals of the CPA
business remain solid.
AC Rouge - More a friend than foe. Management provided added colour
regarding commentary from AC's quarterly call about the growth of Rouge
and how it is not expected to disrupt the use of regional jets. Chorus
management views Rouge as a partner - when Rouge takes on additional
destinations, this opens up new regional feed routes, which CHR then has
the opportunity to service. Management confirmed that they have won
new route mandates that were facilitated by Rouge, and reiterated that
demand within the CPA business remains robust.
Over $1.2Bn of capital for CAC. Along with the Fairfax convertibles, the
recent equity raise, and using a leverage ratio of 3 times, Chorus now
has approximately $1.2Bn of capital to be used for aircraft used in third
party leasing. They plan to deploy methodically, over a good mix of clients,
aircraft types and across several geographies, and expect to have the
capital fully deployed by mid-2019. With two new leaseback transactions
during the quarter, this brings the number of planes in the leasing business
up to 23, across 10 well-established lessees, located in 10 countries.
Maintaining Outperform and $11 price target. We made slight changes to
account for Q1/18 results, and updated our numbers based on new 2018
guidance given. We maintain our $11 price target, and continue to see
further valuation upside as investors become more comfortable around
the company's regional aircraft leasing business.
Target price/base case
Stable operations with new growth opportunities. Our base
case valuation at $11.00 is derived from a sum-of-the-parts
valuation. We value Chorus's core-CPA segment at a 6.5x EV/
EBITDAR multiple based on our 2019 estimates and we value
the company's new leasing segment at a 7.0x P/E multiple
based on our assumptions for operating and funding costs
attributable to the segment.
Upside scenario
Leasing business accelerates. Our $13 upside case anticipates
that after 2017 Chorus accelerates the expansion of its leasing
business by 20% and obtains a 13% yield on its leasing
portfolio.
Downside scenario
Leasing business goes negative. Our downside case at $7.50
assumes that Chorus is unable to secure further funding
beyond H2/18 to grow its leasing portfolio. Further, the
regional aircraft segment is more competitive than Chorus
anticipated, pressuring yields and putting an overall negative
valuation on the segment.
Investment summary
We rate Chorus Aviation Outperform, as we believe the CHR
share price does not represent the enhanced value of the
new CPA contract with Air Canada at current valuations. As
anticipated, management has delivered with Chorus and Air
Canada developing a new framework agreement, which we
believe is mutually beneficial and provides CHR with a level
of earnings and FCF stability. The new arrangement removes
inefficiencies inherent under the previous contract and
fundamentally transforms CHR into a sustainable company, in
our view.
Diversification progressing. With the new CPA in place and
long-term collective agreements secured with the Pilots and
Flight Attendants, management is focusing on diversification
efforts. The acquisition of Voyageur in the first quarter
of 2015 provides a platform for growth outside of the
CPA, with management noting on the call that they see
both maintenance and charter opportunities continuing to
develop. We expect CHR to make incremental progress with
growth outside of the CPA, with what we see as potential for
a more material impact on earnings (and valuations) longerterm.
Business model still provides significantly less risk than a
"plain vanilla" airline. The fixed-fee nature of the company’s
business model provides substantially less risk than a
conventional airline, in our view. Exposure to non-controllable
costs, including jet fuel prices, is limited as the costs are passed
through accordingly to Air Canada. Additionally, controllable
costs are no longer subjected to benchmarking of a group of
peers, and as such, the level of profitability has less exposure
to variability.