* Q2 EPS C$0.16 vs C$1.27 year-ago
* Q2 rev down 6 pct to C$1.06 bln
* Incurs C$4 mln cost due to Iceland volcano
* Shares rise 1.6 pct to C$10.19 on TSX (Recasts, adds details)
By Susan Taylor
OTTAWA, June 10 (Reuters) - Transat AT Inc TRZb.TO posted an 85 percent drop in quarterly earnings on Thursday, stung by "intense competition", tighter profit margins and a stronger domestic currency, the Canadian holiday travel operator said.
The company also announced the launch of Eleva Travel, a tour operator in Mexico that will open in July and initially target Mexicans traveling domestically.
"While the results are better than expected, these are still depressed figures for what is traditionally Transat's strongest quarter," said RBC Capital Markets analyst Tanya Messinger.
"In its first-quarter report, management guided for a loss in the second quarter due to heavy competition and package price weakness. As a result, these weak figures are not a surprise. We expect investors to focus on outlook, which indicates to us that conditions remain difficult."
With a significant portion of its inventory still unsold, the Montreal-based company said it could not issue a detailed forecast for summer results. A stronger Canadian dollar against European currencies will also hurt income, it said.
For its Canada-Europe market, Transat said capacity is about 15 percent above last summer and the percentage of available seats filled with paying customers is "slightly higher" than last year.
The market for Canadian travel to sun destinations is similar to last year, Transat said.
For the second quarter, ended April 30, Transat earned C$6.2 million ($6.02 million), or 16 Canadian cents a share, down from C$42.2 million, or C$1.27 per share, a year ago.
Adjusting for fuel hedging, restructuring gains and the revaluation of asset-backed commercial paper, it lost C$2.7 million, or 7 Canadian cents a share.
Messinger said she expected an adjusted loss of 15 Canadian cents a share, while the average estimate was for a loss of 9 Canadian cents a share.
Revenue fell 6.1 percent to C$1.06 billion as European sales fell 19 percent and lower fares offset an increase in customers.
Transat recorded C$4 million in costs due to the volcanic eruption in Iceland that closed European airspace in April.
"Although we expect near-term challenges to continue, in our view Transat is well-positioned to withstand the industry shakeout with C$207 million of cash versus on-balance-sheet debt of C$55 million," Messinger wrote.
Transat's class B shares rose 16 Canadian cents to C$10.19 on the Toronto Stock Exchange on Thursday. The stock was worth C$21.00 at the start of 2010.
$1=$1.03 Canadian Additional reporting by Ashutosh Joshi in Bangalore; editing by Rob Wilson