Transat A.T. Inc. (TRZ/B), Canada’s biggest tour operator, may return cash to shareholders or consider acquisitions as soon as the end of 2014 as a two-year-old turnaround plan starts paying off, its top executives said.
The shares have surged 83 percent this year amid optimism over a profit rebound, while an index of small-capitalization Canadian stocks fell 1.8 percent. Montreal-based Transat said last month that fiscal third-quarter earnings more than doubled to C$30.8 million ($29.7 million), beating analysts’ estimates.
“We think the company is capable of generating C$50 million or more annually” in net income, Chief Financial Officer Denis Petrin said in an Oct. 10 interview at Transat’s headquarters. “When we have done this once or twice, we will start to have a considerable sum. We are not obliged to wait two years to decide what to do with it. Let’s at least allow next year to pass, then we will see. It’s a nice problem to have.”
Chief Executive Officer Jean-Marc Eustache and his team are pressing ahead with a C$75 million cost-cutting plan under which they trimmed capacity at the Air Transat charter carrier, negotiated cheaper aircraft leases, scrapped unprofitable air routes and won concessions from flight attendants.
The company, which served about 1.8 million travelers in 2012, also introduced higher-margin deluxe hotel packages and a new reservation system that allows staff to maximize sales by adjusting prices every 10 minutes instead of every day.
Transat’s cash-deployment options include buying back stock, reinstating the dividend and acquiring smaller rivals, Eustache said in the interview. Transat suspended its dividend in March 2009, citing a need to “conserve cash.”
Transat is expected to earn C$43.7 million this year and C$51.6 million in fiscal 2014, the average estimates in Bloomberg surveys of five and seven analysts respectively. It had about C$389 million of cash as of July 31, the highest end-of-quarter balance since October 2006, based on data compiled by Bloomberg. Transat had no long-term debt and C$684.7 million in “off-balance sheet arrangements” such as aircraft leases.
“Cash is important but you are getting very little return on cash now so it’s not helping earnings growth,” said John Zechner, chairman at J. Zechner Associates Inc. in Toronto, which manages about C$2.2 billion in assets and holds Transat stock. “At some point you want to see them deploy it into a more productive use.”
Repurchasing shares “would make sense,” Zechner said in a telephone interview.
Transat is coming off losses of C$16.7 million last year and C$14.7 million in fiscal 2011. Results for fiscal 2013, which ends Oct. 31, will show a profit, Petrin said without being more specific. Transat said last month that fourth-quarter profit will climb from the same period in 2012. It will report fourth-quarter results Dec. 12.
Transat fell 0.7 percent to C$10.86 in Toronto yesterday, giving it a market value of $417.7 million. In August 2012, it closed as low as C$2.91. The shares’ year-to-date gain ranked No. 15 among 220 companies in the S&P/Toronto Stock Exchange Smallcap Index.
Transat’s value is the cheapest relative to free cash flow among 32 Canadian consumer goods and services small-capitalization stocks, according to data compiled by Bloomberg. The company’s enterprise value amounts to about 0.5 times free cash flow, compared with an average of about 28 times for the group, the data show. Enterprise value is defined as market capitalization plus total debt minus cash.
“The stock was ridiculously underpriced, and it’s still cheap,” said Zechner. “They’ve focused on bringing their expenses down and getting their margins higher. Still, this is a volatile industry and I don’t think you can ever take your eye off the ball.”
Transat owes its losses of the past two years to its performance in its fiscal first and second quarters, which run from November through the end of April. Stiffer competition from rivals such as closely held Sunwing Airlines contributed to the losses, said David Tyerman, an analyst at Canaccord Genuity in Toronto who recommends investors buy Transat stock.
Transat estimates it and Toronto-based Sunwing each control 29 percent of the Canadian market for vacation packages to so-called sun destinations such as Mexico and the Caribbean from November through April, according to a company presentation to investors. Air Canada (AC/B), the country’s largest airline, has 14 percent, while Calgary-based WestJet Airlines Ltd. has 17 percent, according to Transat estimates.
“Our big challenge is the coming winter season,” CEO Eustache, 65, said in the Transat boardroom, which boasts a view of Montreal’s Mount Royal. “We’ve lost money in the past four winters. We have to deliver the goods this time.”
To get there, Eustache and his team plan to adjust Air Transat’s fleet based on seasonal needs -- removing fuel-guzzling Airbus SAS A330 wide-body jets during the winter months, and adding them back for service to Europe starting in May. Eustache calls the plan “our accordion fleet.”
In April, Transat said it would add four leased Boeing Co. (BA:US) 737 aircraft to its fleet on routes to sun destinations starting in May 2014, and would stop outsourcing the work to Canada’s CanJet Airlines. Including concessions made by labor unions, Transat said last month that it expects the moves to help save C$20 million annually starting in 2015.
Cheaper aircraft rents will also lower operating costs. Transat said in July it renewed leases on six A330s with International Lease Finance Corp. through 2020 and 2021 “with improved terms.”
Transat’s drive to improve profitability comes as Air Canada builds its new leisure carrier, Rouge, which will cost about 20 percent less to operate than the company’s main jet operations. Capacity will jump 9 percent to 11 percent next year, with most of the growth on international routes, Montreal-based Air Canada (AC/A) said Aug. 7.
“We know Air Canada is going to add capacity especially on the wide-body side, so there is risk there for sure,” said Canaccord Genuity’s Tyerman. “So far it hasn’t been a problem, but Air Canada is going to have a lot more capacity next year and in 2015. Meantime Transat is doing the right thing by controlling capacity and cutting costs, which is beneficial to margins.”
While Transat hasn’t made a decision on how to use its cash, Eustache said there will be no shortage of takeover targets if the company chooses to pursue acquisitions.
“We’re always approached to buy things, but now is not the time,” Eustache said, declining to identify possible transactions. “When we have turned the company around and it produces profits like we think it can, we can start thinking about expansion. Before that, we have to make sure Transat becomes a well-oiled machine again. We’re not there yet.”
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