Company: Chorus Aviation Inc. (CHR.TO)
Current Price: $2.15
Market Cap: $418M CAD
Price Target: $5.00
Full Disclosure: I am long CHR
Overview:
Chorus Aviation is an aircraft leasing company transitioning to an asset light manager model. Chorus is a global aviation solutions provider and asset manager focus on regional aviation. Together with its subsidiaries, it provides services that encompass every stage of a regional aircrafts lifecycle. The company generates significant Free Cash Flow (FCF), providing it with a path to deleverage its balance sheet and return capital to shareholders via buybacks and reinstatement of its monthly dividend. Given its deeply discounted valuation and large investor base (Brookfield Asset Management, Fairfax Financial, Air Canada), Chorus could become a takeout candidate.
Despite a few large investors, Chorus is not yet a widely held name as it flies under the radar of most small cap managers and for the most part has a misunderstood profile. Its small size, approx $500M mkt cap, shrinking revenues/EBITDA in 2024, high leverage and low trading liquidity do not screen well… but all of which miss the point.
On Competition: Most lessors are in the narrow-body and wide-body aircraft space while Chorus focuses on a smaller more niche regional jet space. Also, Chorus is not a pureplay lessor, as the company operates two segments: A Regional Aviation Services segment (eg Jazz which provides the largest regional airline service in Canada with a capacity purchase agreement with Air Canada, and Voyageur which provides specialized regional aviation services such as medical, logistical and humanitarian flights). Net/net CHR is a combination of regional jet services and assets thus is given a Holdco discount. Lastly, the recent negative update on the progress of Falko Fun III which has been a key in its transition to an asset-light model, has weighed on the name.
Focus on Free Cash Flows. Despite lower revenues/EBITDA expected this year, underlying operating cash flow/FCF has been improving, giving CHR plenty of financial flexibility. Net debt/Ebitda has been trending down as operating and FCF’s have been ramping higher over recent years. Lower revenues are associated with: (1) aircraft asset sales in the Regional Aircraft Leasing (RAL) segment consistent with asset l-ight leasing strategy to unlock embedded equity value, (2) a step down in fixed margin associated with a recently re-negotiated Air Canada capacity purchase agreement (CPA) as aircraft are coming off lease and fully depreciated (no debt associated with those planes). As the aircraft are fully amortized they move to the second lease, the lease rate is lower but cash flow is higher because they are debt free. The CPA is effective through 2035 providing a stable backbone to cashflows. While revenues and EBITDA are expected to decline 5% and 16% y/y in 2024, respectively, operating CF and FCF are expected to increase 10% and 3%, respectively as a result. Despite the $59-100M hit to ebitda on y/y basis in 2024, CHRs implied operating cashflow before changes in NWC is expected to come in at $356M (midpoint of FCF and capex guidance) vs $362M in 2023.
The legacy management of CHR are experienced operators, have been around since the Jazz airline was still a part of Air Canada. Regarding the asset mgmt arm, the mgmt team at Falko have years of experience in transacting and managing assets in the reginal aviation space.
Pay Debt> Buyback Stock> Reinstate Dividend. Deleveraging provides a path for return of capital via buybacks and possible reinstatement of CHRs dividend. CHR delevered from 4.4x to 3.6x in F2023 and is targeting 3x by year end 2024, close to the 2.5-3.5x target set at its IR day in 2023. This would put Chorus in a position to reinstate a dividend in 2025. Its previous $0.04/month dividend (pre-Covid) would imply a 24% yield today, a level which appears sustainable (~40% payout ratio on FCF) leaving plenty of room for buybacks. Currently CHR has a 10% buyback/NCIB in play, and has been actively buying stock at current levels. According to filings, as of Mar 7, the company has bot about 1M shares of its 15M share program for the year (notable incremental buying at this level should put a floor in the stock). Under the previous NCIB, CHR bot 9.2M shares at an average price of $3.25- indicating they will continue to support at current levels.
Catalyst: Closing of Falko Fund III. While previous funds were oversubscribed, Fund III has thus far struggled to raise third party capital. Though this might be changing with demand for alternative investments picking up. Any progress on the capital raising front would be a catalyst for the stock which isnt currently reflected in the share price. Management expects the Fund to launch by year end. Reinstating of Dividend. If net leverage targets achieved, a dividend could be reintroduced as ealry as 2025, which would attract wave of income oriented investors.
Optionality of takeover- Fairfax/BAM most likely buyers. CHR is trading back to levels where it received an acquisition proposal in Oct 2020. The most likley buyer at the time was Fairfax in our view given it owned $200M of convertible debentures and warrants struck at $8.25/shr. A portion of those debentures have since been redeemed and the warrants have expired, however, Fairfax veteran Paul Rivett remains on the board. Air Canada also owns 8.1% of CHR subject to restrictions around transfer rights under a shareholder agreement. Those restriction have expired as of Feb 2024, allowing AC to sell to a third party. Lastly, CHR funded its acquisition of Falko with the help of Brookfield Asset Management, who now owns 13.2% of common shares (along with its ownership of preferred shares), making BAM CHR’s largest shareholder. CHR is trading at a material discount to where BAM purchased its shares (~$3.79/share) and given its plans to transition to an asset manager model, BAM may choose to consolidate its ownership in Chorus ahead of the launch in Falko Fund III.
Valuation:
CHR has lagged the recovery in other aircraft lessors (AER/AL) as well as Air Canada, Chorus’s largest customer and 2nd largest shareholder. CHR is cheap, trading at 6.5x F25 EPC, 1.2x P/CF, 0.4x P/BV (BV of Bam prefs =$4.85/shr) and 0.5x where BAM purchased its initial stake. Limited downside, stock is extremely oversold, investors are noticing.
The short interest position has spiked since recent earnings and is now at peak levels. The equity has completely de-coupled from the listed debentures (CHR.DB.A and .B’s which are trading close to par, indicating no signs of distress in the debt market). Notable block activity at current levels between $2 and $2.15 indicate that selling is being absorbed by new buying (though short interest levels are unchanged). As investors realize the potential of this story, and as the company continues to gush cash flow, buyback stock , and close the Falko Fund III, expect there to be significant demand from buyers coupled with an aggressive short covering rally which will push this higher. The stock appears to have bounced off the lows and changing trajectory higher (due to block volume and multiple brokers accumulating for their clients). Once the easy supply has been accumulated it will be difficult to build a meaningful position without pushing the stock higher. Get in while you can.
Risks:
CHR is not a pureplay lessor (Jazz and Voyageur). As a smaller regional aircraft lessor, the addressable market is smaller overall.
Management has been committed to the deleveraging process however counterparty risk where contractual cashflows don’t come through is in theory possible. That being said, CHR has a capacity purchase agreement with Air Canada and leasing agreements with airlines viewed a credible safe counterparties.
Questions are welcome