Tuesday’s TSX breakouts: Hammered by COVID-19, this company becomes a potential takeover target

On today’s Breakouts report, there are 83 stocks on the positive breakouts list (stocks with positive price momentum) and 10 stocks on the negative breakouts list (stocks with negative price momentum).

Discussed today is a stock that is on the positive breakouts list - Chorus Aviation Inc. (CHR-T).

On Monday, airline stocks soared on news of positive COVID-19 trial data and optimism that a return to normal activities was on the horizon. Air Canada (AC-T) was the top performing stock in the S&P/TSX composite index on Monday with its share price rocketing 29 per cent. Meanwhile, Chorus Aviation saw its share price jump 19 per cent.

Yet, we are not out of the woods yet with a vaccine still at least many months away and coronavirus cases on the rise. As a result, airline stocks will likely see "back and fill' action where gains are not linear (not in a straight line) but rather ebb and flow. Expect to see rallies and pullbacks with the overall trend rising for these stocks. Consequently, do not be a buyer when these stocks pop but wait for the stocks to retreat and slowly accumulate positions if you have a longer-term time horizon as the economics for these companies will take time to improve.

A brief outline is provided below that may serve as a springboard for further fundamental research when conducting your own due diligence.

The company

Halifax-based Chorus Aviation owns Jazz Aviation LP, Air Canada’s regional airline that provides services to many smaller communities. The company has a Capacity Purchase Agreement (CPA) with Air Canada, which is effective until Dec. 2035. Under the CPA, Chorus has a fixed fee arrangement with Air Canada. This agreement provides Chorus with a degree of earnings stability but it has not insulated this stock from the downward pressure that we have seen across major airline providers.

Chorus also has a regional aircraft leasing subsidiary, Chorus Aviation Capital (CAC) with a fleet of aircrafts (outside of the CPA with Air Canada). On the second quarter conference call, management indicated that approximately 50 per cent of its third-party leased fleet is in operation.

Investment thesis highlights

• Sector rotation. This stock is a COVID-19 recovery play. The market is forward looking. Consequently, as more positive data from COVID-19 vaccine clinical trials are announced, airline stocks will continue to recover.
• Liquidity. At the beginning of August, management indicated that the company had approximately $228-million in liquidity (cash and available credit), cash available to help the company navigate these challenging times. On the earnings call, President and Chief Executive Officer Joe Randell said that he expects “liquidity to remain constant or very good to the end of the year in or around $200-million”.
• Takeover target. On Oct. 23, the company announced that it had received a non-binding, preliminary takeover offer from an undisclosed third party. Specifics of the offer were not revealed and there is no guarantee that an acquisition will be take place.
• Longer-term catalysts: 1) Improving operational results. 2) Reinstatement of its dividend even if it’s at a conservative level, below its prior level.

Quarterly earnings

After the market closed on Aug. 12, the company reported better-than-expected second quarter financial results. Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) was $91-million, surpassing the consensus estimate of $81-million. Adjusted earnings per share came in at 13 cents.

Given the challenges facing the travel industry, rent deferrals have been provided to lessees. Third-party leasing revenue firmed with approximately 38 per cent of lease revenue collected in July, up from 28 per cent in June and roughly 28 per cent in the second quarter.

Looking out, Jazz is expected to operate between 20 per cent and 30 per cent of its capacity in the second half of 2020 compared to the same period last year. The company delayed the delivery of six of the nine planned CRJ900 aircraft deliveries until Dec. 2020.

Dividend policy

On April 6, Chorus announced the suspension of its dividend in order to preserve capital in response to COVID-19. As a result, the share price plunged 10 per cent that day, closing at $2.29.

Prior to the suspension, Chorus paid its shareholders a monthly dividend of 4 cents per share or 48 cents per share yearly. The company maintained its dividend at this level since early 2015.

Analysts' recommendations

This small-cap industrials stock with a market capitalization of $608-million is covered by eight analysts, of which six analysts have buy recommendations and two analysts have “sector perform” recommendations.

The firms providing research on the company are: Canaccord Genuity, CIBC World Markets, Cormark Securities, National Bank Financial, Paradigm Capital, RBC Dominion Securities, Scotia Capital and TD Securities.

Revised recommendations

In October, three analysts revised their expectations.

• TD Securities’ Tim James reduced his target to $5.50 from $6.50.
• CIBC’s Kevin Chiang increased his target to $5 from $4.25.
• RBC’s Walter Spracklin cut his target to $3 from $4.

Financial forecasts

The consensus EBITDA estimates are $354-million in 2020, $388-million in 2021, and $417-million in 2022. The consensus earnings per share estimates are 56 cents in 2020, 59 cents in 2021, and 74 cents in 2022.

Earnings estimates have declined materially due to COVID-19. For instance, in March, the Street was forecasting EBITDA of $423-million in 2020 and $478-million in 2021. The consensus earnings per share estimates were 82 cents in 2020 and 98 cents in 2021.

Valuation

The stock is trading at an enterprise value-to-EBITDA multiple of 6.5 times the 2021 consensus estimate, just above the three-year historical average of 5.9 times.

The stock is trading at a price-to-earnings multiple of 6 times the 2021 consensus estimate, below the three-year historical average of 7.2 times and below its peak multiple of approximately 10 times during this period.

Many analysts derive a target price based on a blended multiple (application of an EV/EBITDA multiple and a P/E multiple to its different business segments).

According to Bloomberg, the average one-year target price is $4.53, suggesting there is nearly 27 per cent upside potential over the next 12 months. Individual target prices are as follows in numerical order: $3 (from Walter Spracklin at Dominion Securities), two at $3.50, two at $5, $5.25, and two at $5.50.

Insider transactions

Year-to-date, only one insider has reported trading activity in the public market – a relatively small purchase.

On Feb. 24, chief financial officer Gary Osborne purchased 950 shares at a price per share of $6.94.

Chart watch

Year-to-date, the share price has declined 56 per cent.

On Monday, the share price rallied 19 per cent on high volume with over 6.6-million shares traded. The three-month historical daily average trading volume is approximately 1.4-million shares.

In terms of key resistance and support levels, the share price has an initial ceiling of resistance around $4. After that, there is major resistance around $5. Looking at the downside, there is initial technical support around $3.

The Breakouts file is a technical analysis screen intended to identify companies that are technically breaking out. In addition, this report highlights a company’s dividend policy, analysts’ recommendations, financial forecasts, and provides a brief technical analysis for a security to provide readers with more information.

If a stock appears on the positive breakouts list, this indicates positive price momentum, and that a company may be worthwhile for investors to look at the fundamentals in order to determine if the recent price strength is warranted and will continue. If a security appears on the negative breakouts list, this indicates negative price momentum, and may be indicative of either deteriorating fundamentals or perhaps indicates a buying opportunity.

Securities screened are from the S&P/TSX composite index, the S&P/TSX Small Cap index, as well as Canadian small cap stocks outside of these indexes that have a minimum market capitalization of $200-million.

A technical analysis screen does not replace fundamental analysis, but can help identify companies worth having a closer look at.

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