Description

Investment Thesis: Find me another North American airline that has generated positive operating cashflow in 2020 and is exiting covid with its capital structure essentially unchanged from 2019. Oh, and there was an unnamed takeover attempt in the Fall that we have likely not heard the end of. Despite its fortunes, CHR is still down 56% from Jan 2020 levels vs JETS -25%. 

Background: Chorus Aviation main business is being the regional airline carrier for Air Canada’s domestic routes. The company has a long-term agreement with AC (the CPA) that lasts until 2035. Under the agreement, AC pays CHR fixed annual service fees to operate ~690 daily flights to +80 destinations. Under the CPA, AC also pays CHR annual lease payments for the use of 71 aircraft (CRJ900, DH300, A220 and Q400) to service these routes. This Regional Airline business is ~80% of CHR’s EBITDA. While the market views being an AC subcontractor as a risk, I take the opposite view. 

First and most importantly, CHR’s EBITDA is only 1% of AC’s opex. So if AC wanted to bring this in-house and kick CHR out, the savings would be negligible. Moreover, AC (like other major airlines) is in the process of reducing its assets via sale-leasebacks. They don’t want to be taking on an entire fleet of regional planes. Lastly, AC & CHR are partners. While AC has renegotiated the deal in the past, the benefits were a net positive to CHR. For example, in Jan 2019 AC & CHR renewed the agreement and extended it out to 2035. Along with the renewal, AC also invested ~$100m into CHR equity at C$6.25/sh, making it a 9.99% owner in the company.

CHR’s other business line is aircraft leasing and is the growth engine for the company. The company focuses on leasing narrow body jets and turbo-props to regional airlines. CHR only entered the segment a few years back and already have 51 aircraft under lease to 14 airlines. In round numbers, each plane costs US$20-25m, CHR’s cost of debt is 4.0% and they charge 1.0% monthly lease rates. Planes are financed 25/75% split equity/debt on CHR’s balance sheet. CHR has a goal of increasing it’s fleet by 20 planes/year (pre-covid).

What is CHR worth: I think of valuation in 2 parts. The Regional Airline business is essentially a bond with fixed payments and timelines. The business generates ~$250m EBITDA a year which should tail off to $160-180m in the out years. Assuming a 7% discount rate, I calculate the NPV at ~$4.25/sh. This gives zero value for any potential extension post 2035. CHR was spun-out of AC in 2005, so it’s not crazy to assume a non-zero chance the CPA gets extended.

The second part is the leasing business. At 51 planes deployed on the economics outlined above I get US$23m of NI, or C$0.19 EPS. If you want to give them credit for adding 20 planes a year to the fleet that would generate another C$0.06 EPS. Comps like AER trade at 8x P/E. On that multiple, CHR’s leasing business is worth ~$1.20/sh today.

Combined, that puts CHR’s valuation at $5.45/sh 

Balance Sheet: CHR has $182m in cash and $2,088m in debt. The majority of the debt ($1.6bn) is secured by the aircraft leasing assets and financed by Export Development Canada. The remaining debt is $86m in 5.75% debentures and $200m in 6.0% debentures held by Fairfax. Fairfax invested in CHR in 2016 in order to provide capital to grow the leasing business. Along with the debentures they were given 24.4m warrants with a $8.25/sh strike, which if exercised would make them 13.0% shareholders

CHR asset coverage is very strong. The fleet has a net book value of $2.6bn as of Q3/20.

Dividend: Prior to covid CHR paid out a $0.04 monthly dividend. It was suspended during covid at the same time management cut their salaries. The reason being that the company didn’t want to be seen paying out investors and management at a time when they laid off the majority of its workforce and was negotiating government relief. With positive operating cashflow during covid and an unchanged capital structure it’s not a stretch to assume the dividend gets reinstated at some point. $0.04/month would be a 13.6% yield at the current stock price.

Catalysts: CHR has 2 near-term catalysts that can lead to unlocking value

1) Potential take-out: On Oct 23 2020 CHR announced “that it has received a preliminary, non-binding acquisition proposal from a third party that is subject to a number of significant conditions.” The stock was $2.37 prior to announcement. AC confirmed they were not the bidders and the press speculated that it was likely a Canadian financial player. As a Canadian airline, CHR has foreign take-over rules that cap foreign ownership at 49%. Fairfax was speculated as the most likely bidder as they are already a significant investor. Assuming the standard 30-40% premium on the initial bid would result in $3.25/sh. I think this is a strong floor value for the stock. While we have yet to hear anything else on this development, I'd note that since the initial disclosure we’ve had 5 new covid vaccines prove effective. There is light at the end of the covid tunnel. I don’t think it’s illogical to assume that the take-out value of an airline has increased since vaccines started. 

2) Government funding: Canada has been late to the party in terms of bailing out our airlines. That said, it feels like something is imminent. A few months ago PM Trudeau moved Michael Sabia onto the file. For those that don’t know him, read his bio (https://en.wikipedia.org/wiki/Michael_Sabia). Sabia successfully grew Canadian telco BCE before moving on to be CEO of the $330bn Caisse de Depot pension fund. Prior to Sabia heading the file, negotiations were being led by the Canadian Transport Minister. It seems pretty clear that Sabia was put in charge to get results. Supporting this view is commentary from AC’s Q4 call on Feb 13 (see below). 

I don’t think it’s crazy to assume that an announcement on government funding would be very bullish for Canadian airline stocks.

Catalyst

• covid ending and travel resuming
• Government bailout for the industry
• takeout