Chorus Aviation shares surge on optimism about impact of Air Canada arbitration

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MONTREAL - Chorus Aviation's shares regained some of their lustre in a 12 per cent surge Wednesday on improved third-quarter results and analyst optimism that arbitration with Air Canada won't be as bad for the company as initially feared.

The Halifax-based company's shares closed up 37 cents to $3.39 in Wednesday trading on the Toronto Stock Exchange.

Chorus (TSX:CHR.B) shares sustained a blow last month after analysts warned that the airline that provides regional service for Air Canada could be forced to cut its dividend after it lost an arbitration decision over so-called benchmarking.

Both sides agreed to compare, or benchmark, the growth of controllable costs at Chorus' operating subsidiary, Jazz Aviation, in 2009 and 2015 to those of a specified group of similar operators in the U.S.

However, it was sent to private arbitration after they disagreed on the methodology to ensure controllable costs — including salaries and wages, maintenance and overhead — are kept in check.

Under the decision, the panel accepted Air Canada's (TSX:AC.B) contention that it was paying too much to Chorus under its capacity purchase agreement but it also agreed to consider some adjustments proposed by Chorus, including for the age of its fleet.

"We are of the view that a proper application of Air Canada's methodology with the appropriate adjustments directed by the arbitration panel in their initial decision should not result in an adjustment to the controllable markup," CEO Joseph Randell said during a conference call.

A hearing on those adjustments will be held by the end of November. Air Canada has said the markup should be 11.41 per cent, but Randell said the adjustments should raise the markup to the 12.5 per cent it currently pays.

If the 11.41 per cent markup holds, Chorus would be forced to make $27 million in retroactive payments to Air Canada.

"We continue to believe that there will be no retroactive payments so I haven't had the discussions (with Air Canada about a payment schedule)," Randell told analysts.

Cameron Doerksen of National Bank Financial raised his target price for Chorus to $3. The stock price dropped 10 per cent since early October when he downgraded it on concerns about the benchmarking impact.

"If Air Canada's argument prevails, the mark-up could fall to 11.41 per cent, which would likely not prompt an immediate dividend cut," he wrote in a report.

But he still sees an eventual dividend cut.

Doerksen said the 60 cents per share dividend which generates a nearly 20 per cent dividend yield is attractive and likely sustainable through 2013.

"However, we still see increased cash needs for Chorus from higher interest expense and debt repayments related to its new Q400 deliveries as well as potentially lower block hours if more flying is shifted to Air Canada's other emerging regional flight provider Sky Regional."

Doerksen added that Chorus will also eventually pay cash taxes, which will be a further drain on cash.

In addition, Chorus reported Tuesday that its profit grew to $37.2 million, or 30 cents per share in the third quarter, up from $13.9 million or 19 cents per share a year ago.

Adjusted profits were 21 cents per share, compared to 15 cents forecast by analysts.

Operating revenue increased $435.6 million, from $411.7 million.

Chorus said the results for its most recent quarter included a $10-million unrealized foreign exchange gain on long-term debt and finance leases.