Air Canada Seen Rallying Further as Labor Issues Settled

Air Canada is forecast to rally beyond a 73 percent first-quarter advance as the company remains the third-cheapest airline stock in the Americas.

Canada’s largest carrier will climb about 22 percent over the next year, based on the average of 11 analysts’ estimates. Today’s close of C$3.13 left Air Canada with the third-lowest price-earnings ratio among 15 carriers based in the two continents, according to data compiled by Bloomberg.

The airliner has rebounded from a low of 82 cents in 2012, a year marred by wildcat strikes and the bankruptcy of its sole engine-repair supplier. A federal arbitrator let the company impose a cost-cutting contract on pilots in July, and the shares got another boost last month with the extension of a pension-funding cap.

“For the first time in the last two years, they are not facing any major labor issues,” said PI Financial Corp.’s Chris Murray, who raised his 12-month price estimate to C$4 from C$3.25 on March 26 and recommends buying Air Canada stock. “A lot of the major issues around the company have either been addressed, or there’s a path to dealing with them.”

The stock’s consensus rating is the eighth-highest among the 15 airlines.

Price Estimates

Air Canada dropped 4 percent in Toronto today amid concern that the outbreak of bird flu in China will curb demand for some international flights.

The average price target is now C$3.83, reflecting upgrades as recently as today, when Walter Spracklin, an analyst at RBC Capital Markets in Toronto, raised his target price on Air Canada to C$4 from C$3.50.

National Bank Financial’s Cam Doerksen boosted his prediction to $3.25 from C$2.80 on April 3, while Kevin Chiang, an analyst at CIBC World Markets, raised his estimate to C$4 from C$3 on March 12 after the pension deal.

The stock’s 79 percent climb this year has outpaced both the S&P/TSX and the Bloomberg Americas Airlines Index.

Air Canada has a policy against commenting on stock-price changes, said John Reber, a spokesman. Formerly a state-owned company, the airline was taken public in 1988 and emerged from an 18-month bankruptcy in September 2004. It returned to the stock market via an initial public offering about two years later.

WestJet Premium

Even with the past year’s gains, the Montreal-based carrier’s shares trade at discounts of 54 percent to rival WestJet Airlines Ltd. and 58 percent to the S&P/TSX index, according to data compiled by Bloomberg.

“Air Canada is still cheap on most valuation metrics,” said Daniel Bubis, president of Winnipeg, Manitoba-based Tetrem Capital Management, which oversees more than C$6 billion ($5.9 billion) in assets, including Air Canada and WestJet shares.

“When the stock got absolutely crushed, a lot of it was the labor unrest, the media attention,” he said. “There were flight disruptions, there was negative sentiment. Ultimately, those issues got resolved so you are getting the valuation discount shrinking.”

Earnings growth will help propel the stock higher, National Bank Financial’s Doerksen said in a telephone interview.

Excluding some costs and gains, Air Canada is expected to earn 65 cents a share in 2013 and 80 cents next year, the average estimates in Bloomberg surveys. On that basis, profit last year amounted to 19 cents a share.

Pension Costs

Lower pension costs are helping to fuel improvement. Last month, Air Canada reached an agreement with the federal government to stretch a cap on pension funding by seven years, a move that CIBC’s Chiang said will save the company more than C$400 million a year in cash outflow.

Air Canada’s pension solvency deficit declined by about 12 percent to C$3.7 billion as of Dec. 31 after the company’s retirement plans returned 14 percent in 2012, according to a March 22 filing.

Agreements with Air Canada’s main labor groups will probably cut the solvency deficit by an additional C$1.1 billion as of January 2014, pending regulatory approval, the company said in February.

“With the pension relief they got, their ability to get to the other side is a lot stronger now,” said Bubis at Tetrem. “And if interest rates ever go up again, that would be a huge boost to them on the liability side.”

A better economic outlook should also help the stock, he said.

Corporate Spending

“Business activity is picking up,” Bubis said. “Potentially, employment is coming back in North America, corporate spending also.”

None of that guarantees higher returns for investors, though, which is why Aston Hill Financial Inc., which oversees C$6.7 billion, pared its stake in Air Canada while maintaining its debt holdings.

“It’s a little risky being long both sides of the balance sheet, especially after the equities have run so well,” said Andrew Hamlin, an Aston Hill fund manager in Toronto. “We’ve made some good money there, and it’s not necessarily clear that their stock is going up another 20 percent.”

Cost Efficiency

Air Canada stills trails WestJet and other carriers on expenses.

Air Canada’s cost for each seat flown a mile, a measure of airline efficiency, amounted to 18.5 cents in the fourth quarter of 2012, data compiled by Bloomberg show. That was the highest average among 12 North American airlines tracked by Bloomberg. WestJet had costs of 14.1 cents, the data show.

“The cost difference between Air Canada and WestJet has narrowed, but I would say WestJet still has a very significant cost advantage even with all the changes that Air Canada has made,” Doerksen said.

Air Canada is working to narrow WestJet’s edge. Its new pilot contract, approved by a federal mediator, paved the way for the company’s Rouge low-cost unit, which will begin operating in July.

WestJet, meanwhile, is stepping up competition for short-haul Canadian and trans-border flights with its Encore unit.

“It has been our experience as we launch into new markets that we lower prices for guests traveling on our new routes as competitors match parts or even all of our relatively compressed fare structure,” Robert Palmer, a spokesman for WestJet, said in an e-mail.

Encore’s pricing has already had an impact, he said.

‘Pricing Pressure’

“Air Canada will have to digest that for the next little while,” said Bubis. “There is going to be pricing pressure for Air Canada on some of their profitable routes.”

Even so, Bubis said he plans to hang onto his Air Canada and WestJet shares because economic “tailwinds” are favorable. Both airlines have filled their planes to record levels in recent months.

“Airlines of today are not the airlines that we’ve seen in the past decades, where it was just lost capital,” Bubis said. “Now there’s more focus on return on capital, less new competition, more intelligent pricing. If you believe all that, then there is substantial room for airline stocks to move up, Air Canada included.”

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