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Air Canada has been a TSX heavyweight this year, earning a nearly 300-per-cent return, but still trades at a discount to its U.S. counterparts.

Andrew Vaughan/The Canadian Press

Resembling a rocket more than a jetliner, Air Canada has been the top performer in the TSX Composite so far this year. No other stock has come close to the airline's nearly 300-per-cent return, aided by another big jump this week.

So it's understandable to worry the shares may have reached cruising altitude, with little more room to ascend. Some would extend their concerns to include the stock of discount competitor WestJet Airlines Ltd., which after a 40-per-cent gain this year is flying at unaccustomed heights.

Both stocks, however, are among the very cheapest on the entire Toronto Stock Exchange based on their price-to-earnings ratios and other earnings multiples. That fact, and the improving economics of the airline industry, suggest investors still have an opportunity to take flight.

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In this space in March, we encouraged investors to take a look at the entire North American airline industry even though most carriers' shares had already doubled at that point from their recent lows.

The thesis: While there was always a chance the industry could return to its usual practice of destroying its own profits through overly aggressive fare-cutting, the recent consolidation of players and a far more rational approach to competition suggested the airlines were at last growing their profits while focusing on their shareholders.

Little in the last eight months (particularly the gains in the shares) suggests this idea was wrong. Revenue trends are improving, while the airlines are cutting costs – a powerful combination that should lead to increased earnings.

At the time of our previous article, Air Canada was returning from what analyst Ben Cherniavsky of Raymond James calls "the brink of despair," when it was weighed down by labour issues and pension costs. The company had struck a deal with its employees that allowed for the creation of low-cost carrier Rouge, which launched earlier this year, and had cut its pension deficit thanks to plan changes and positive investment returns.

While a number of analysts in our March story had set aside their historic pessimism to recommend airline shares, Mr. Cherniavsky was a bit of a holdout, suggesting investors take profits. He has since warmed to Air Canada, upgrading the shares in August when they traded for $2.65, versus Friday's close of $6.81. He maintains an "outperform" rating and raised his target price last week to $8.

Mr. Cherniavsky notes Air Canada's high levels of debt have historically made the stock valuable in good years ($20 per share in 2000 and 2007) and nearly worthless in bad years (such as 2003 and 2009).

"After almost 15 years of trying, we haven't yet figured out how to value" the shares, he says. "But we do have a pretty good sense that the current sentiment towards this stock is improving at a time when industry fundamentals have been pretty good." He adds that there is a "striking" discount on Air Canada's shares versus others in the North American airline sector. "This, we believe, will generate some more 'buy the laggards' behaviour among investors, which should benefit Air Canada's stock."

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A key component of Air Canada's story is cost-cutting. The company is targeting a 15-per-cent cut in its cost per average seat mile, or CASM, a metric that breaks down an airline's costs to the most granular level. The company reported a 3.4-per-cent year-over-year decline in CASM in the third quarter, beyond analyst expectations, and suggests it will report another 2-per-cent to 3-per-cent decline in the fourth quarter.

Pick your metaphor for this crackdown on expenses. RBC Dominion Securities' Walter Spracklin says the "the cost transformation story is in its early days"; BMO Nesbitt Burns' Fadi Chamoun says "the company remains in the first inning in terms of its cost reduction opportunity." Both analysts have "outperform" ratings, with $8 and $7.50 target prices, respectively. Mr. Spracklin, who covers companies across the transportation industry, says Air Canada has "the most significant upside return potential in our coverage universe."

WestJet, by contrast, is being punished for its consistency. Its long-term track record of operational success means there's no share-rocketing "comeback" story to be told about the airline. While WestJet trades at a discount to most U.S. discount airlines, its earnings multiples are significantly above Air Canada's.

BMO's Mr. Chamoun raised his profit estimates for WestJet after the most recent quarterly results and added $3 to his target share price to bring it to $29 – just a bit above Friday's closing price of $27.45. "We believe that WestJet enjoys a robust nearterm as well as medium-term growth outlook and the company is executing well on its key strategic growth targets while maintaining a strong cost discipline," he says. It would take a pullback in its share price for him to raise his "market perform" rating, however.

Mr. Cherniavsky of Raymond James says he's concerned with "execution risk" as WestJet rolls out a number of pricing and seating initiatives while also seeking two new executives below the CEO level.

Yet there are those who say there are still gains to be had in WestJet, albeit not as large as those in Air Canada's shares. Mr. Spracklin says, "a solid balance sheet and a management team we view as among the best operators in the airline industry" position the company for profitable growth in coming years. Meanwhile, the shares trade toward the lower end of their historical range on the basis of enterprise value (market capitalization plus net debt) to EBITDAR (earnings before interest, taxes, depreciation, amortization and aircraft rent). He has a target price of $31 to go along with his "outperform" rating.

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Canaccord Genuity's David Tyerman says he expects annual gains in earnings per share of 13.6 per cent from 2013 to 2015. He has a "buy" rating on the stock and a $31 target price.

There seems to be no reason to put your tray tables in the upright position; the shares' descent won't begin any time soon.

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