A Heavenly Chorus Sings of High-Flying Aviation Returns

| About: Chorus Aviation, (CHRVF)

I’ll be blunt: I hate airlines as investments. Here’s why:

  • They’re unionized
  • They’re at the mercy of rising oil prices
  • Their margins are continually squeezed by cutthroat competition
  • They have surly flight attendants who serve crappy snacks that you have to pay for, they cancel underbooked flights with phony excuses about “equipment problems,” and they make you pay extortionate fees for checked baggage, which you’ll be lucky to ever see again.

OK, the last one isn’t an investment concern, I just had to get it off my chest after a recent cross-country trip.

One airline that has been unjustly tarred by association is Chorus Aviation (OTC:CHRVF), with the market driving its yield to a whopping 11.7%. Chorus operates regional flights for Air Canada (AIDIF.PK) and Thomas Cook Canada. It also runs a small, but growing, charter business focused on the oil-producing regions of Western Canada. A close look at Chorus’ business reveals that the negatives for most airlines don’t apply to it.

Chorus, like most airlines, does have a unionized workforce. However, as company representatives have told me, labor relations are good and they recently signed agreements extending to 2015. Moreover, the relative youthfulness of Chorus' workforce diminishes the union "tax," which tends to increase with the age of employees. Union rules require more pay and benefits for employees who are more senior, but not necessarily more productive. So young is good.

Amazingly, Chorus is 98% immune to fuel costs, because Air Canada and Thomas Cook cover these, as well as some other variable costs, for them. The one risk associated with this is that Chorus’ business hinges on Air Canada. If Air Canada went bankrupt or started to channel business to another airline, Chorus would be significantly affected. However, the Canadian government is unlikely to allow its flag carrier to go bankrupt and Chorus has a Capacity Purchase Agreement (CPA) with Air Canada that extends to 2020, guaranteeing it at least 339,00 block hours.

Airlines do have cutthroat competition, but it tends to be focused on the major hub routes. For example, it’s usually cheaper to fly from SFO to JFK (3000 miles) than to Medford (only 400 miles). Chorus flies mostly regional routes, and mostly into airports with limited landing and gating slots. So competitive pressures are limited. Over the last few years, its billable block hours have remained amazingly stable, with moderate seasonal dips in the fourth and first quarters.

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Until 2011, Chorus was a royalty trust. It was widely expected to slash its distribution when it converted to a regular corporation. But it surprised everyone by switching to a quarterly payout but maintaining the rate. Actually, it didn’t surprise me: it was obvious before that the company had ample cash flow to maintain the payout.

The market is still treating the dividend rate with disbelief. On the eve of Q1 earnings, the stock dropped 8%, only to recover the next day when it became clear the dividend would be maintained. In fact, Chorus’ earnings revealed that it’s only using 73% of its distributable cash for dividends, maintaining a substantial cushion.

When Chorus converted to a corporation, it created two share classes:

  • A-Shares – Traded as CHR.A on the Toronto exchange. A-shares are for non-Canadian shareholders. The U.S. pink sheets issue, CHRVF.PK, corresponds to A-shares.
  • B-Shares – Traded as CHR.B on the Toronto exchange. B-shares can only be owned by Canadian citizens.

The two classes represent the same ownership of the company and pay the same dividend.

The market has priced Chorus like an airline. But, with its extremely steady revenue, costs, and margins, it should be priced more like a utility.

Disclosure: I am long CHRVF.PK.