The twenty-one page Fundamental Research report places “Fair Value” of $3.03 on Canada Jetlines’ stock, which is ten times the current trading price in the $0.30 range. While the report looks well into the future with forecast revenue and cash flow growth out to 2025 for Canada’s first Ultra Low Cost Carrier (ULCC), for purposes of this discussion we’ll focus on the Fundamental Research outlook for 2018 and 2019.
As the first two Boeing 737 – 800 NG aircraft are slated to be in the air as of next June, with the fleet growing to six by the end of 2018, we’ll look at the year operations kick off and the full year following start-up.
Fundamental is calling for Canada Jetlines to transport just over 240 thousand passengers in 2018 with revenues of almost $36 million, growing to close to a million passengers in 2019 and revenues of $143 million. Its assumptions call for a base fare of $115 per ticket and ancillary (baggage, food, etc.) revenues of $34 per passenger. It sees EBIT (Earnings Before Interest Taxes) of $4.4 million in 2018 and $18.9 million in 2019. The company currently has 57.6 million shares issued and 94.6 million fully diluted.
Fundamental has listed the following risks:
- The company is in early stages and has yet to commence operations
- The existing Air Canada / WestJet duopoly dominates the Canadian aviation market
- Our valuation is dependent on a 2018 launch. Delays or other changes to the operational timeline could significantly impact our valuation.
- Access to capital and share dilution
The report looks at the success of ULCC operations in the United States for comparative purposes and a window on the future for Canada Jetlines, which is looking at costs 30% lower than the main Canadian competition.
“ULCCs exhibit significantly higher margins, due to their lower costs. Furthermore, ULCC airlines also appear to be significantly more liquid and solvent than the broader market. Perhaps most important for investors is that ULCCs generate a considerably higher return than the industry average. The ULCC business model has been successful south of the border, but that same success has not yet found its way to Canada.
The competition posed by the existence of multiple ULCCs in the U.S. is noticeably absent; it is estimated that the two largest airlines in Canada control approximately 92% of the domestic aviation market, as measured by available seat miles (ASM). What little is left is held by smaller niche airlines like Porter Airlines and Air Inuit (regional airlines that service Northern Canada), where lack of dense population centers warrants less air traffic and attention from the two major Canadian carriers.”
A major question that the market has, in terms of assessing future valuations and potential returns, is the amount of possible dilution that shareholders could face, as Canada Jetlines will require a significant amount of “start-up” cash to meet the requirements of Transport Canada.
In speaking with management, it was made clear to us that all efforts are directed to securing the bulk of the required capital with a debt instrument and a portion through an equity raise to minimize dilution. The team expects to have these details finalized over the next few months.
Fundamental looked at the valuation impact as it rubbed the crystal ball on potential future dilution.
It is well known that WestJet has announced its intent to launch a ULCC. On that point, Fundamental writes:
“Established air carrier WestJet is also gearing up to introduce the ULCC model. Initially aiming for a late 2017 release, WestJet has pushed back their anticipated launch date to summer 2018 (similar to Jetlines), and plans to unveil a 10 plane fleet. This poses a threat to Canada Jetlines, as a ULCC launched under the WestJet umbrella will have access to an established network of resources. However, a recent vote by WestJet pilots to unionize could jeopardize WestJet’s ability to charge ULCC air fares. This is due to common employer status regulations that transfer employment agreements to subsidiaries of parent companies.”
We encourage everyone to read the entire report, which is available by clicking here.
As a closing note, Fundamental’s Disclaimer in part contains the following:
“The analyst and Fundamental Research Corp. “FRC” does not own any shares of the subject company, does not make a market or offer shares for sale of the subject company, and does not have any investment banking business with the subject company. Fees were paid by JET to FRC. The purpose of the fee is to subsidize the high costs of research and monitoring. FRC takes steps to ensure independence including setting fees in advance and utilizing analysts who must abide by CFA Institute Code of Ethics and Standards of Professional Conduct. Additionally, analysts may not trade in any security under coverage.