BUSINESS

Chorus Aviation wins battle with Air Canada but war to cut costs remains

11/26/2013 02:36 EST | Updated 01/26/2014 05:59 EST
MONTREAL - Chorus Aviation has won a lengthy battle with Air Canada over the markups its charges on flights, but the larger war over long-term cost reductions in an increasingly competitive market remain unresolved.

An arbitration panel on Tuesday supported Chorus's contention that there was no justification for changing the current 12.5 per cent markup on how much its Jazz subsidiary receives from Air Canada. The ruling relieves Chorus from paying retroactive payments to the country's largest airline (TSX:AC.B).

The two sides have battled over the permitted growth of controllable costs — including salaries and wages, maintenance and overhead — under their capacity purchase agreement or CPA. Both sides agreed to compare or benchmark Jazz costs in 2009 and later in 2015 to those of a specified group of similar operators in the U.S.

Chorus CEO Joseph Randell said the ruling means the company, which sells most of its fleet capacity to Air Canada, can "now move forward with certainty."

"Our long-term partnership with Air Canada continues to be a core component of our business and we believe this ruling provides us with additional flexibility to continue to operate as an industry leader and deliver value for all our stakeholders," he said in a news release.

The company plans to maintain its current 30 cents per share annual dividend as it review alternatives to enhance shareholder value.

Analysts said the ruling wasn't a surprise, but Chorus continues to face the challenge of reducing costs, competition from WestJet's Encore regional service and Air Canada's threat to find an alternative carrier to Jazz service to the United States.

Randell said Chorus understands Air Canada's desire to reduce costs and has "developed a framework of strategic options" to address Jazz's cost structure. But unless the two sides can agree on changes, terms of the CPA remain in force until Dec. 31, 2020.

Chorus and Air Canada will begin negotiations next year to set CPA rates for 2015 to 2017.

"In line with Air Canada's priority for cost reduction and sustainable profitability, Air Canada will both work with Jazz to explore cost reduction initiatives and continue to pursue its regional airline diversification strategy that includes the request for proposal process underway for certain existing U.S. regional transborder routes," Air Canada said in a news release.

Chorus' (TSX:CHR.B) shares surged more than 28 per cent after the company announced its arbitration win.

At midafternoon, the Halifax-based company's shares were up 77 cents at $3.50 the Toronto Stock Exchange on very heavy volume of more than 2.7 million shares. That allowed it to partially recover from a 37 per cent drop after its dividend was cut in half last May.

David Tyerman of Canaccord Genuity said he's skeptical that Chorus can substantially reduce the 30 to 50 per cent cost advantage Encore has and offer costs that are competitive with the Calgary-based carrier, Porter Airlines and other carriers in the United States.

"We think it is only a matter of time before Chorus will have to offer significantly better cost terms to Air Canada. Otherwise, it runs the risk of not having a business after 2020," he wrote in a report.

Tyerman said there's a "high risk" that Chorus' cash flows will have to be reduced materially, potentially putting its dividend at risk as it lowers costs to Air Canada, well before the CPA expiry date.

But analyst Walter Spracklin of RBC Capital Markets said the arbitration ruling could put a dividend increase "on the table" if the company increases it payout rate from 25 per cent to management's target of 55 to 60 per cent.

"Following the resolution, we see Air Canada and Chorus engaging in a more constructive manner, set to solidify the long relationship and derive additional value for the respective companies," he wrote.