Investors are asking whether Chorus Aviation Inc., the parent of regional carrier Jazz Air LP, can maintain its sky-high payout ratio.
Chorus began trading last week on the Toronto Stock Exchange, replacing the former Jazz Air Income Fund. As it makes the conversion to a corporate structure from an income trust, Chorus hopes to attract new investors with steady dividends.
But the cloud hanging over Chorus is doubt about whether it will be able to stick with a quarterly payout schedule of 15 cents a share. That translates into 100 per cent or more of its distributable income in 2011. Annually, it works out to a yield of 11.2 per cent, based on Wednesday's closing price of $5.35 a share.
Chorus says it can maintain its lofty payout rate despite the $450-million cost of embarking on a fleet renewal program in 2011 that will see it eventually acquire 15 Bombardier Q400 turboprops.
Any company with a payout ratio of more than 100 per cent raises questions about whether its dividend can be maintained, but Walter Spracklin, an analyst with RBC Dominion Securities Inc., said Chorus's situation isn't as scary as it sounds. The airline operator will be using a conservative method for calculating distributable income that includes deductions for capital spending and net working capital.
Investors shouldn't fret about the payout ratio, he said. "The introduction of these new aircraft is a temporary phenomenon, so Chorus isn't going to cut its dividend and then bring it back up."
A reliable stream of cash makes Chorus a surprisingly stable investment, at least compared with major carriers in the volatile airline sector.
Under a "capacity purchase agreement," Chorus's wholly owned Jazz unit is paid by Air Canada to operate a wide range of regional routes. In effect, Jazz serves as a charter airline for Air Canada, collecting fees through the pact, which runs through the end of 2020. The current rate schedule expires at the end of 2011, but is expected to be renegotiated for a three-year period.
With the economy slowly on the mend, the airline industry has enjoyed increased demand for travel. Analysts say Jazz is positioned to capitalize on the travel rebound and thrive, assuming Air Canada continues its return to fiscal stability. The downside is that Jazz has little margin for missteps, and if Air Canada gets into another cash squeeze, there would be a ripple effect on Chorus shares.
Mr. Spracklin thinks Chorus has struck a reasonable balance in its strategy to maintain 60 cents a share in annual payouts while adhering to commitments for the Q400 turboprops.
Chorus has lined up $383-million in loans for the airplane purchases, leaving it to allot $67-million for the "equity portion," some of which already has been prepaid, resulting in manageable additional payments ahead, he said.
Mr. Spracklin and Beacon Securities Ltd. analyst Michael Mills have 52-week price targets of $5.50 on Chorus.
The biggest risk is the possibility that Air Canada may fall again on hard times, dragging Chorus's prospects down with it. On Wednesday, Mr. Spracklin reduced his 52-week price target on Air Canada to $4 from $5, citing concerns over rising fuel prices, union contracts that expire March 31 and increased international competition.
Under the capacity purchase agreement, Air Canada is responsible for paying for Jazz's fuel costs, airport user fees and navigation fees. Jazz covers wages, salaries, maintenance and aircraft leases or purchase costs.
Chorus plans to gradually diversify beyond Air Canada, which shunned Jazz and instead signed a contract last October with Sky Regional Airlines Inc. to start flying in 2011 from Billy Bishop Toronto City Airport.
Last year, Jazz acquired a 25-per-cent indirect equity stake in Uruguay's Pluna, the flag carrier based in the South American country's capital of Montevideo.
Chorus's flight path
Q3 2010 revenue: $379.1-million
Q3 2009 revenue: $379.7-million
Q3 2010 distributions: $18.4-million
Q3 2009 distributions: $26.7-million*
*Monthly distributions were reduced to 5 cents a unit, starting in September 2009, compared with previous monthly payout of 8.38 cents. Effective with the three months ending March 31, 2011, the quarterly dividend will be 15 cents a share.