Chorus Aviation Inc. offers its investors one of the loftiest yields on the Toronto market, but the betting is that the days of its outsized payout are numbered.
After all, shareholders can seldom avail themselves of an eye-popping 18.3-per-cent yield – about 10 times greater than what is on offer from safe 10-year Government of Canada bonds – without there being a catch somewhere.
In Chorus’s case, the stratospheric payout rate is flashing a warning. Many market players believe the current 60-cents-a-share annual dividend is doomed. The only question is how large a meat cleaver will be taken to the number.
But the situation at Chorus, a company best known for operating the Jazz regional airline service on behalf of Air Canada, is encouraging a few observers to suggest what amounts to an investment industry heresy.
Normally, when a company is at risk of a dividend cut, the standard advice to investors is to run for cover and wait out the damage on the stock price. After the stock craters, they can assess the staying power of the new payout before deciding to take the plunge.
But some analysts believe that Chorus’s stock price may go up even if it cuts its dividend.
The reason? The dividend is likely to be lowered to around 45 cents, at which point it would still sport a double-digit yield and be attractive to income-hungry investors.
That’s the forecast of Walter Spracklin, an analyst at RBC Dominion Securities Inc., who thinks the shares are “pricing in the most pessimistic reduction in dividends,” and believes the payout will likely be around 44 cents next year. That’s still a yield of 13 per cent, based on the recent share price. He has a “buy” on the stock and a target of $4.50.
Chorus’s dividend is in doubt because of an adverse arbitration ruling delivered earlier this month regarding the markup it can charge Air Canada, from which it receives the bulk of its revenue as a contract air carrier under an agreement running until 2020.
Air Canada contended the markup on Chorus’s controllable costs for providing services should be 9.5 per cent, down from the current 12.5 per cent.
The arbitration panel ruled in favour of Air Canada’s methodology on the cost issue, but not entirely. Although a final arbitration report hasn’t been issued, the thinking on the Street is that Chorus will be cut to a little more than a 10-per-cent markup, reducing its profitability.
Chorus shares had a one-day plunge of 11 per cent earlier this month in reaction to the arbitration news. But Mr. Spracklin said the market was “likely overreacting” and “we would be buyers at current valuations.” He’s expecting cash flow per share at Chorus to be about 56 cents a share next year, which would more than cover a dividend of 44 cents, in his view.
In terms of industry fundamentals, Chorus presents a mixed picture. The recent surge in the share price of Air Canada suggests that company’s financial health is on the mend, a good thing for Chorus, considering its fate is entirely tied to the big carrier. A stronger Air Canada takes some of the risk out of buying Chorus.
But Air Canada has taken steps to reduce its dependence on Chorus. It hired privately owned Sky Regional to fly out of Toronto’s Billy Bishop Airport, for instance.
Air Canada also recently transferred the operation of its fleet of 15 Embraer 175s planes to Sky. Chorus’s growth outlook may dim as a result of increased competition from what is emerging as a low-cost rival.
And not everyone in the investment community is buying the argument that Chorus shares might rally through a dividend cut. Cameron Doerksen at National Bank Financial Inc. estimates Chorus could fall to $2.60 a share if the dividend is chopped to 45 cents a share, or less. He rates the stock “underperform.”