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Let's get the pun out of the way first: It has been an up-and-down year for Transat A.T. Inc., the provider of air-based tour packages.

The April quarter, traditionally its biggest three months of revenue, yielded an unexpectedly large loss. The quarter that followed produced a positive earnings surprise.

The dichotomy can be seen in the headlines from Canaccord Genuity Corp. analyst David Tyerman's reports for the two periods: "Very weak, reducing outlook," followed by "Upside surprise, further gains possible from profit focus."

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Indeed, the recent good news has Transat's shares trading around $5.50, double their 52-week low. It's reasonable to think if the company can knock off the erratic results and deliver consistent numbers, it can reach and exceed its 52-week high of $7.74.

Yet, it's unclear how likely the company is to do that. And Transat shares aren't as cheap as they appear at first glance. That combination makes buying into Transat's ascension a gamble.

First, a few words about how Transat came to my attention: I was poking through a database of companies, looking for Canadian concerns that have relatively low market values compared to the amount of cash they hold.

Transat sticks out. Its market capitalization is just over $200-million, but it has nearly $300-million in cash and short-term investments and no debt on its balance sheet. Wow, I thought – each $5.50 share gets you more than $7.50 in cash, plus the entire business. It's like they're paying you to invest in Transat!

Alas, this is an excellent example of why investors always need to head to the securities filings to fully read up on a company. While Transat has no debt under International Financial Reporting Standards, it has a whopping $573-million in aircraft leases, known in financial parlance as "off-balance sheet arrangements" because they're, well, off the balance sheet.

To be clear, Transat isn't hiding this at all: On page two of its recent quarterly management's discussion and analysis, it says it uses a non-IFRS metric called "total debt" that includes these arrangements, and the number is highlighted on page three.

Still, if we adjust Transat's numbers for its total debt, we find that its enterprise value – market capitalization plus net debt – is about 11.25 times its forward EBITDA, or earnings before interest, taxes, depreciation and amortization, according to Standard & Poor's Capital IQ.

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This isn't so cheap after all. There are only about 550 companies on the TSX that have an EV/ forward EBITDA number, because forward figures require analyst estimates; only about 20 per cent of those have an EV/EBITDA above 11.25.

So that brings us back to Transat's business. Intense competition, expensive fuel and currency-exchange problems bedeviled the company in the April quarter, prompting management to promise cost cutting and product improvements. They seemed to deliver in the profitable July quarter, citing capacity control – flying fewer passengers, more profitably – versus chasing volume growth.

Ben Vendittelli of Laurentian Bank Securities, who has a "hold" and target price of $5.50, said in his note last month that the company's recent habit of losing money in the winter season should stop in fiscal 2013, which starts Nov. 1. Rather than compete purely on price, the company "intends to deliver the right packages to the market at the right prices, at the right times, in an effort to return to profitability."

That sounds like an excellent strategy. Which raises the question: If it's as easy as that, why wasn't Transat doing it before?

If you're not as cynical as I am, note that management's goal is a 2 per cent net income margin, which would have yielded $75-million in profit, or nearly $2 per share, over the last 12 months. While it has been five years since the company last achieved this margin, Mr. Tyerman of Canaccord says, "there is a lot of upside potential if the company can achieve management's goal."

Mr. Tyerman, who has a "buy" rating and a $7 target price, also says "we caution that this is a very risky call as Transat has whipsawed investors with positive and negative developments in recent years."

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It seems buying a ride on Transat shares yields a very uncertain destination; some signs point to profit, but there seems more of a risk that getting in now is a ticket to losses.


The following is a follow-up clarification to this story:

In Thursday's VOX column, I labelled Transat AT Inc. as expensive and risky. It may well be both, but the shares also may not be as expensive as I suggested.

To recap: I noted that while Transat, an air-tour operator, has nearly $300-million in cash and short-term investments and no debt on its balance sheet, it also clearly discloses $573-million in aircraft leases described as "off-balance sheet arrangements." Transat includes these in a figure it calls "total debt."

I then went on to note that if we adjust Transat's numbers for its total debt, we find that its enterprise value – market capitalization plus net debt – is about 11.25 times its forward EBITDA, or earnings before interest, taxes, depreciation and amortization, per Standard & Poor's CapitalIQ. I then noted only about 20 per cent of the roughly 550 companies on the TSX that have an EV/ forward EBITDA number have a multiple above 11.25.

This might have been multiple malpractice on my part, however. A better denominator to put in the calculation might have been "EBITDAR," a measure of earnings that excludes all the above items as well as "Rent," or, in this case, the aircraft lease payments.

Here's the argument: Say Transat had chosen to buy its airplanes and issue debt to pay for them. The debt would go into enterprise value, and the interest payments on the debt would be excluded in EBITDA. That way, EBITDA serves as an imperfect proxy for the cash flow that would, in part, pay for the planes.

Instead of using debt and paying interest payments, Transat uses leases and rent payments. So if you treat the $573-million in leases as debt and include them in enterprise value, then, shouldn't the annual outlay on the leases be excluded from EBITDA, just like interest, via the EBITDAR measure?

If you agree, you would calculate a multiple as either enterprise value to EBITDA, or as enterprise value (including the leases) to EBITDAR.

It was Transat which called this issue to my attention, although Treasury Director Richard Bilodeau said "Please note that is the view from the analysts of our business and not our view." They provided notes from analysts at TD Securities, CIBC and National Bank Financial who calculate their multiples this way.

It should be noted, however, that Ben Vendittelli of Laurentian Bank Securities calculated his EV/EBITDA multiple the way I did, by adding the aircraft leases into the EV while not backing out the aircraft payments from EBITDAR.

How much different does it make? A lot. Let's use Mr. Vendittelli's estimates for the current fiscal year, which concludes at the end of October, and fiscal 2013, which starts Nov. 1.

Mr. Vendittelli estimates Transat will conclude this fiscal year with just $3-million in EBITDA, but $88.6-million in EBITDAR thanks to $85.6-million in aircraft rental expenses. For 2013, his estimates are $65.5-million in EBITDA and $152.8-million in EBITDAR.

Using an enterprise value of $463-million – market cap of $209-million plus $254-million in net debt, including the leases – yields multiples of 7.1 times EBITDA and 3.0 times EBITDAR.

Both multiples are cheaper than the 11.25 than I suggested, in part because I used a consensus EBITDA estimate from Standard & Poor's CapitalIQ of $41-million, below Mr. Vendittelli's number.

But do they make Transat cheap?

TD Securities analyst Scott Farley, who has a "buy" recommendation and $7.25 target price, calculates adjusted EV/EBITDAR numbers for a Transat peer group of eight air travel and tourism companies that includes Air Canada and Thomas Cook Group. For the 2012 fiscal year, Transat's multiple is 7.2, while the average is 5.3 and the next-highest multiple is 6.4.

However, he estimates Transat's current share price as just 3.7 times fiscal 2013 EBITDAR, the second-lowest multiple of the group and below the 4.9 average.

Which, in the end, doesn't move me too far from my original conclusion, in which I noted another analyst describing his "buy" rating as "risky" because of the company's habit of "whipsaw[ing]" investors with erratic results. If Transat indeed delivers on its plans, shareholders will be rewarded; given its current track record, however, it's not trading at a deep discount.

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About the Author
Business and investing reporter and columnist

A business journalist since 1994, David Milstead began writing for The Globe and Mail in 2009. During eight years at the Rocky Mountain News in Denver, Colo., he individually or jointly won nine national awards from SABEW, the Society of American Business Editors and Writers. He has also worked at the Wall Street Journal. More


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