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Canadian Helicopters offers takeoff potential

It was April of last year when Globe Investor called your attention to Canadian Helicopters Group Inc., a little-known and inexpensive stock that had made a big move to expand its business.

Indeed, the shares soared from around $23 to more than $36 over the next 12 months. But an earnings miss and some near-term concerns about the company's business have grounded the stock again, sending the shares back to around $25, or early 2011 levels.

With a price-to-earnings ratio of about seven, and a dividend yield topping 4 per cent, it's now one of the cheapest high-yielding stocks on the TSX. You might say it's poised for another liftoff.

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Historically, the Montreal-based company did about what you expect: Operate helicopter fleets for customers in the mining, energy and other industries, mostly in Canada. Last year's deal to acquire Helicopters (N.Z.) Ltd. gave it new geographical diversity. In fact, the company plans a name change to HNZ Group Inc. to play off the New Zealand brand and, it says, "increase Canadian Helicopters Group's global marketability and branding."

So what's wrong? While the New Zealand operations are already exceeding expectations, the company missed its targets in the quarter ended June 30. Canadian mining activity was softer than expected, and the company felt the loss of a medical-flight services contract in Ontario more keenly than first thought.

Most importantly, the company can see the sunset on one of the most important elements of its business: Contracts to support the U.S. military in its Afghanistan operations, which are worth more than $500-million (U.S.) over several years and have, analysts estimate, come close to providing nearly half the company's revenue in recent periods.

While portions of that business could extend into 2016, the contracts have already begun expiring, also contributing to the recent disappointing results. (The Afghanistan work provides the company with its highest-margin business, analysts say.)

So it's not so hard to see why the market has placed such a low multiple on Canadian Helicopters' shares: The company has to hustle to avoid a sharp drop in future revenue and profits. If they can't replace the Afghanistan business, the shares' current price won't be so cheap when compared to future earnings. (Timothy James of TD Securities, the sole analyst of five covering the company with a "hold" rather than a "buy" recommendation, cites the Afghanistan risk as one of the reasons for his rating and $29 target price.

Yet has the pessimism gone too far? Perhaps so. David Newman of Cormark Securities Inc. says his analysis of future cash flows, excluding all Afghanistan business starting in 2013, suggests an intrinsic value for the shares of about $27 apiece.

"We believe this value is close to a floor, with potential upside from [the company] utilizing its balance sheet to build or buy additional business," Mr. Newman says. (He has a "buy" rating and $35 target price, recently reduced from $40.)

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Indeed, the company recently announced a couple of new contracts. A four-year, $40-million (U.S.) deal to provide offshore oil and gas helicopter support to a Royal Dutch Shell affiliate in the Philippines is the first major Southeast Asian deal for the company since the HNZ purchase.

"The contract proved Canadian Helicopters' ability to compete for new business in the offshore oil and gas market, a market that has traditionally been untapped by [the company]," said analyst Kelvin Cheung of Clarus Securities Inc. (He has a "buy" rating and $38 target price, recently reduced from $40.)

The HNZ subsidiary also re-inked Rio Tinto to a new 10-year deal worth at least $125-million Australian ($127.3-million), $11-million Australian more than the current contract.

It is TD's Mr. James, the most cautious of the analysts, who offers perhaps the most succinct recommendation for buying the stock: "Canadian Helicopters has what we view as an excellent operational and financial track record, attractive dividend, solid balance sheet, and opportunities to grow its business in both new and existing markets."

Investors willing to bet the company can replace and even grow beyond its Afghanistan business need not pay much for the wager. They might find the shares airborne in coming years.

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