Ottawa's pension relief gives Air Canada room to invest: analysts

OTTAWA -- A move by Ottawa to help Air Canada deal with a $4.2-billion deficit in its pension plan gives the airline some breathing room as it works to launch a new discount service.

But the rules imposed on Air Canada in exchange for the relief may turn off other companies looking for the same help with their pension plans, which have been hurt by volatile stock markets and super low interest rates.

"In the current low interest rate environment, Air Canada's pension solvency deficit funding payments would not be sustainable without the seven-year extension in place," Walter Spracklin wrote in an RBC Capital Markets note.

"The funding cap allows Air Canada the ability to invest in new growth opportunities, including a fleet replacement plan with 37 Boeing 787s, which is set to further improve profitability and operating cash flows."

Air Canada is this country's largest airline but it's in stiff competition with WestJet Airlines, a far more profitable company over the past decade.

WestJet (TSX:WJA) said Wednesday that Air Canada should get no more special treatment from the government.

"We look forward to working with the government to create a level playing field and an environment that supports a healthy industry that benefits the travelling public," WestJet chief executive Gregg Saretsky said in a statement.

In exchange for the pension relief, Air Canada agreed to rules that set limits on executive pay and prevent it from paying dividends to shareholders and buying back stock.

It is those rules that will make other companies think twice before asking Ottawa for help.

Canadian Pacific Railway (TSX:CP), Canadian National Railway (TSX:CNR), Bell Canada (TSX:BCE), MTS Allstream (TSX:MBT), Canada Post and NAV Canada had lobbied the federal government in hopes of gaining some measure of funding relief for their pension plans.

However, the railways and telecommunications companies pay regular dividends to shareholders and any move to cut or eliminate them would likely anger shareholders.

Fred Hospes, president and directing general chairman of District Lodge 140 of the International Association of Machinists and Aerospace Workers which represents workers at Air Canada, welcomed the limits on executive pay.

"I think the restrictions were required," he said.

"Our membership has been frustrated for years with the bonuses that the executives of Air Canada have been receiving while the employees have been giving up wages and pension concessions."

Hospes dismissed notions that the limits would hinder Air Canada's ability to recruit top executive talent at the airline.

"At the end of the day, let's be honest, these people are making a damn good living," he said.

In a statement, Finance Minister Jim Flaherty noted that Air Canada's unions and retirees were supportive of the company's request for help, adding that the "regulatory change is not costing Canadian taxpayers a single dollar."

The airline (TSX:AC.B) must make contributions to the pension plan of at least $150 million a year and totalling at least $1.4 billion over seven years (an average of $200 million a year), on top of its regular contributions.

Among other things, the pension agreement freezes increases in executive pay at the rate of inflation, prohibits special bonuses and puts limits on executives' incentive plans.

The airline will also be prevented from paying dividends and buying back stock as well as making any pension plan benefit improvements without regulatory approval.

RBC Capital Markets has given Air Canada an outperform rating, suggesting its analysts expect the airline's stock to do better over the next 12 months than the sector average.

With the deal place, Spracklin wrote in the note, "what we believe to be a significant risk discount and an overhang will start to lift and the AC shares will begin to approach fair valuation."

Kevin Chiang of CIBC World Markets raised his price target for Air Canada to $4 from $3, saying the "extension of the pension moratorium improves Air Canada's cash flow visibility and its cash flow generation."

Chris Murray of PI Financial maintained his buy recommendation but left his 12-month target price unchanged at $3.25, saying while the pension deal alleviates a significant risk factor "over the longer run we still believe that it remains interest rate paths that will ultimately determine the funding solvency of the pension plan."

Air Canada's class B shares were up six cents at $2.63 on the Toronto Stock Exchange.