(Contains further clarification from an earlier version)
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.
How much difference does it make? A lot. Let's use Mr. Vendittelli's estimates from Ben Vendittelli of Laurentian Bank Securities 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. (It should be noted that while Mr. Vendittelli forecasts EBITDA, he believes a price-to-earnings multiple is the proper way to value Transat.)
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.