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U.S. investors warming up to Air Canada's promise, says New York analyst

MONTREAL - Air Canada's financial promise is piquing the interest of U.S. institutional investors seeking a way to profit from the turnaround of another North American carrier, according to a New York analyst.

Helane Becker of Cowen and Company is optimistic that Air Canada's drive to cut costs by 15 per cent — which she estimates will net nearly $2 billion in the next few years — will improve earnings and help reduce its share discount compared with U.S. network carriers.

"Even if everything else stays exactly flat, revenues don't grow, you're talking about an awful lot of money that can fall to the bottom line and a stock that can really take off and I think there are a lot of big investors that are looking for new ideas that can invest in Toronto and Canada," she said in an interview after initiating coverage last week.

The long-time WestJet (TSX:WJA) analyst expects Air Canada (TSX:AC.B) will follow the strategy of U.S. carriers by cutting costs, paying down debt and returning capital to shareholders through a dividend or by buying back its shares, starting in late 2015 or early 2016.

That would propel higher Air Canada's share price, which has undergone a roller-coaster ride in the past two years. After bottoming out at 82 cents in the spring of 2012, it peaked at $9.90 this past January before pulling back by 48 per cent when the loonie fell. The shares have since partially recovered, closing at $7.30 in trading on the Tronto Stock Exchange on Thursday.

Becker said Air Canada's story isn't too well known in the United States even though its path has mirrored many American carriers. Air Canada has been on the upswing since it flirted with bankruptcy in 2009, six years after it obtained creditor protection.

The history of the airline industry in general is littered with carriers that have had to restructure or have disappeared entirely, making the sector notorious for destroying capital. It's behind Warren Buffett's antipathy towards the industry, which he complained has not made any money in the U.S. since the dawn of aviation.

But Becker said Air Canada's higher share price has helped to put Canada's largest carrier on the radar for large institutional investors that shun companies with small market capitalizations.

"I have gotten more calls...since our initiation from people I haven't talked to on U.S. airlines (before) ... so I think there must be some interest in the name here in the U.S.," said Becker, who joins Glenn Engel of Bank of America Merrill Lynch as Air Canada's only U.S.-based analysts.

Industry observers contend Air Canada is undervalued, trading at about half the earnings multiple of its U.S. peers. Becker sees that gap narrowing while the airline industry multiple increases closer to the railway industry, including Canadian National (TSX:CNR) and Canadian Pacific (TSX:CP).

Chris Murray of AltaCorp Capital said Canadian-based agencies like his have also seen growing interest from U.S. investors, which could help support higher share prices even though Canadian law limits their ownership to 25 per cent.

"The more interest, the more demand, the more attention... it's always certainly beneficial longer term for share prices," he said from Toronto.

Robert Kokonis, president of airline consulting firm AirTrav Inc., said a larger impact from greater foreign interest in the airline will come if ownership thresholds are raised by Ottawa or if more U.S. analysts follow Air Canada's operations.

"If we get maybe another couple of brokerages covering it then I think it will start to be a bit more of a game-changer but for now one (more) is interesting but not significant yet," he said in an interview from San Francisco.

Industry analysts polled by Thomson Reuters expect the airline's earnings will significantly improve in 2015, with adjusted earnings forecast to reach $1.77 per share on $13.7 billion of revenues, up from a 44 cents per share loss on $11.6.1 billion of revenues in 2011.

"It's really going to be a story about execution over the next couple of years...and, as investors gain additional confidence with that longer-term trend and the sustainability of the company, I think you're also going to see multiple expansion of the (shares)," said Murray, who has increased his target price for Air Canada's shares to $12.

He added that it's reasonable to expect the Montreal-based airline will eventually opt out of the new federal pension regulations and reward shareholders.

"I think a dividend would be unlikely but a normal course issuer bid (share buyback) would be a possibility and late 2015 is the earliest I could see it happening, maybe even 2016."

Follow @RossMarowits on Twitter.

The Canadian Press


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