By Susan Taylor
TORONTO, Jan 22 (Reuters) - Air Canada said on Wednesday that it has eliminated a weighty C$3.7 billion ($3.37 billion) pension solvency deficit and moved to a “small surplus”, prompting some analysts to lift stock targets for the country’s largest carrier.
The Montreal-based airline said preliminary estimates on its Canadian registered pension plans reflect several factors, notably a 13.8 percent return on investments last year and improved discount rate.
Analysts said the funding surplus, estimated as of Jan. 1 2014, reduces risk for the flag carrier and could eventually free up cash for better uses, such as new planes or debt reduction.
The company’s more heavily-traded class B shares climbed more than 3.5 percent after the announcement, to C$9.28 on the Toronto Stock Exchange. The stock has more than tripled, from C$2.40 a year ago, as the company sharply cut costs and launched a low-cost subsidiary.
“This is a significant positive turn in Air Canada’s pension funding situation,” RBC Capital Markets analyst Walter Spracklin wrote in a note, which raised his stock target to C$13 from C$10. “As of January 2013 the pension solvency deficit was C$3.7 billion and C$4.2 billion in 2012.”
Air Canada said the improvement reflects a better return on investments, pension benefit changes that cut the deficit by about C$970 million, a company contribution of C$225 million to the deficit and a higher discount rate.
A 3.9 percent discount rate was used to value pension obligations, up from 3 percent last year. Each 10 basis point change in that rate results in about a C$150 million change in solvency liabilities, the carrier said.
Discounts rates, used to assess a plan’s solvency, are based on long-term government bonds and help actuaries judge how much assets will earn over time. The lower the discount rate, the bigger the deficit.
Final pension plan valuations will be completed in the first half of 2014.
Air Canada is currently required to pay C$150 million to C$200 million annually toward its domestic pension plans, under a special funding regulation with the federal government. It could opt out of that arrangement under certain circumstances, but the company said it would not do so in 2014.
“Should the company opt out of the regulations ... Air Canada could free up C$200 million of cash annually that could be deployed in other value-enhancing initiatives,” BMO Capital Markets analyst Fadi Chamoun wrote in a note that raised his stock target to C$12 from C$10.
Air Canada also said that 70 percent of its pension liabilities were matched with fixed income products to reduce interest rate risk and over the mid-term it wants to raise that to 100 percent.
“Air Canada’s three primary pension objectives are to ensure our employees’ and retirees’ pensions are secure, the pension solvency deficit is eliminated and that the costs associated with maintaining the pension plans remain affordable, predictable and stable,” Chief Executive Calin Rovinescu said in a statement. “We have, over the past four years, made significant progress on all these objectives.”