With market caps over $3 billion, Air Canada (TSX:AC)(TSX:AC.B) and WestJet Airlines Ltd. (TSX:WJA) are highly mentioned in research looking for potential investments in the Canadian airline industry. There is one company, however, that looks even more attractive, and should benefit from the others’ success.
Chorus Aviation Inc. (TSX:CHR.B) operates as a capacity supplier for Air Canada rather than as an independent carrier flying under its own colours. This makes them more like SkyWest or Republic Airways Holdings, companies that also operate flights for major airlines.
As we will see, this business strategy has given Chorus some clear advantages.
A unique position in the industry
While Chorus handles the aircraft and flight operations, Air Canada handles the scheduling, pricing, product distribution, seat inventories, marketing, advertising, and customer service. Air Canada is in charge of collecting ticket revenues and in turn, pays Chorus a pre-negotiated rate.
A major risk is that 99% of Chorus’ revenue come from Air Canada. If Air Canada faces financial difficulties or opens up its capacity agreements to other carriers, Chorus would be in major trouble. Fortunately, Air Canada seems to be improving its financial position at a rapid rate. More importantly, the agreement between Chorus and Air Canada currently runs until the end of 2025, mitigating this risk for at least a decade.
A major dividend payer
Over the past five years, Chorus’s stock has consistently had a dividend yield in excess of 10%. Its current dividend (raised for three years in a row) gives investors a 7.58% yield. While this is lower than the historical average, the company is only paying out less than 80% of earnings. For 2016 the payout ratio is expected to drop to less than 60%, giving the company plenty of room to continue upping the payout.
In comparison, Air Canada hasn’t paid a dividend over the previous five years at all. WestJet’s payout, meanwhile, has always yielded less than 2% annually. Chorus’s reliable stream of revenues derived from the pre-negotiated rates from Air Canada has allowed the company to pay out dividends well above the rest of the airline industry.
An attractive valuation
Despite Chorus’s higher and more consistent dividend yield, it still trades at a valuation that’s in line with Air Canada and WestJet. Chorus only trades at 4.7 times price to cash flow, resulting in a 21% cash flow yield. WestJet, meanwhile, trades at 4.5 times and Air Canada at 3.0 times.
Although trading at a slight premium, Chorus has a much higher flexibility in what it does with this cash flow. While other airlines are using extra cash to expand operations or renovate terminals, Chorus doesn’t need to put as much capital back into the business. Chorus also receives payment from Air Canada whether or not the planes are full. These factors allow Chorus to dedicate that excess cash to dividends for shareholders.
A hidden value
Trading at only 7.7 times next year’s earnings, Chorus trades at a wide discount to the market average. With a 7.58% dividend, it also has a yield that is two to three times that of the TSX index. If you’re looking to invest in the Canadian airline industry and want an alternative to the major carriers, Chorus is for you.
Motley Fool Canada's market-beating team has just released a brand-new FREE report revealing 5 "dirt cheap" stocks that you can buy today for under $49 a share.
Our team thinks these 5 stocks are critically undervalued, but more importantly, could potentially make Canadian investors who act quickly a fortune.
Don't miss out! Simply click the link below to grab your free copy and discover all 5 of these stocks now.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Ryan Vanzo has no position in any stocks mentioned.