Investors considering Jazz Air Income Fund units will have their eyes fixed next month on the new income trust's targeted yield, and the sight may be appetizing.
Industry experts are forecasting that Jazz's yield will be higher than Aeroplan Income Fund's initial 7-per-cent rate.
ACE Aviation Holdings Inc. is the parent company of Air Canada and also the Jazz regional airline and the Aeroplan loyalty program. When Montreal-based ACE spun off Aeroplan in the spring to create a trust, it targeted an annual yield of between 7.5 per cent and 8.5 per cent, but settled on 7 per cent, correctly sensing that robust investor demand would stay strong even at that lower yield.
ACE ended up selling a 14.4-per-cent stake in Aeroplan for $287.5-million in June, and brokers reported that the issue was vastly oversubscribed.
Demand for the Jazz initial public offering is also expected to be strong, but given that the regional airline industry is riskier than the frequent-flier rewards business, investors will be looking for a higher yield to reflect that higher risk, industry observers say.
Jacques Kavafian, an analyst at Research Capital Corp., said Jazz's yield will effectively be determined by the extent of demand for the IPO. He uses a 10-per-cent yield as a starting point, but reckons that could dip to between 8 per cent and 9 per cent, should brokers be swamped with requests from clients seeking Jazz units.
Based on the airline's previous performance, Jazz's estimated distributable cash is $107.5-million a year, according to the preliminary prospectus filed late Monday. Jazz is expected to assume about $215-million in long-term debt.
Independent trust analyst Harry Levant said yesterday that an 8.5-per-cent yield is possible because that rate "would be compensation to attract investors who may have become skeptical of income trusts."
As a safeguard against any disruptions to Jazz distributions, ACE as the majority owner is willing to forgo one-fifth of its Jazz payout entitlement, if necessary, until the end of 2006, Mr. Levant added.
At the upper end, Jazz's yield could be 10.75 per cent -- an attractive payout when compared with a handful of transportation trusts. That would be based on the trust having 100 million units outstanding at $10 a unit, placing a stock market value of $1-billion on Jazz.
Cargojet Income Fund, Canada's dominant independent cargo airline, has an estimated $1.10 a unit in annual distributions. That gives it a yield of just over 11 per cent.
The question is whether Jazz's yield will be closer to Cargojet's or to trucking trusts such as Transforce Income Fund (7.6 per cent) and Contrans Income Fund (8.7 per cent). If those trucking trusts are seen as comparable investments, and investors flock to Jazz units, then the IPO and total valuation would jump.
If Jazz carries a 9-per-cent yield, for instance, that would point to the new regional airline trust being worth about $1.2-billion. Assuming that ACE sells off a 15-per-cent Jazz piece -- in the same ballpark as the proportion sold in Aeroplan -- then the Jazz IPO could be almost $180-million. By contrast, at a 10.75-per-cent yield, the Jazz IPO would be valued at $150-million.
The key for investors will be whether they buy Jazz's story that its capacity purchase agreement with Air Canada shields the carrier from the volatile airline sector.
Under that pact, Air Canada pays an hourly rate to effectively book Jazz's seat capacity, but Jazz gets paid regardless of whether the flight is half-empty or full. Air Canada also pays Jazz's fuel bills, reducing some of the volatility on the regional carrier's income statement. "By passing through such costs to Air Canada, Jazz reduces its exposure to cost fluctuations and is well positioned to focus on operating with maximum efficiency," according to the Jazz prospectus.
Mr. Kavafian said Jazz has a sustainable plan, akin to a charter airline. "Investors have to get their heads around the business model. Air Canada pays Jazz no matter whether the seats are sold or not."
In the first nine months of this year, Jazz had operating revenue of $719-million, up 18 per cent from the same period in 2004.
"Air Canada determines routes and controls scheduling, ticket prices, product distribution, seat inventories, marketing and advertising for these flights," the prospectus said. While Air Canada picks up the tab for fuel, Jazz pays the crews' wages and other expenses such as plane maintenance.
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All that Jazz
Demand for the Jazz initial public offering is expected to be strong, but given that the regional airline industry is riskier than the frequent-flier rewards business, investors will be looking for a higher yield than ACE Aviation's Aeroplan Income Fund spinoff to reflect that higher risk, industry observers say.
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ACE Aviation (ACE.B - TSX)
| Yesterday's close | $38.70 |
| Change from previous | Down 35¢ |
| 52-week intraday high | $43.00 |
| 52-week intraday low | $28.00 |
| Market cap | $3.92-billion |
| Price/book ratio | 3.12 |
| 1-year total return | 36.03% |
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Jazz Air Income Fund
| Head office | Halifax |
| Nine-month revenue, '05 | $719-million |
| Nine-month operating profit, /05 | $93.7-million |
| Regional fleet | 119 planes, (including 56 Bombardier regional jets and 63 Dash-8 turboprops) |
***
Aeroplan (AER.UN - TSX)
| Yesterday's close | $12.84 |
| Change from previous | Down 26¢ |
| 52-week intraday high | $14.40 |
| 52-week intraday low | $11.10 |
| Market cap | $2.57-billion |
SOURCES: THOMSON DATASTREAM; BLOOMBERG FINANCIAL SERVICES
© The Globe and Mail
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