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The Weekly Contrarian Pick


ACNAF (Air Canada [Non voting shares: ACNAF (NASDAQ), AC.A (Toronto)]):


52 week range: 9.94-2.88

P/E Ratio



Institutional Holdings


P/E to Industry

Price/Book to Industry

Profit Margin to Industry

Montreal based Air Canada is the largest airline in Canada. The company's fleet of 157
aircraft provide service to over 545 destinations worldwide. The company is a member of
the Star Alliance of airlines (other members include Lufthansa, SAS, Thai Airways Int'l,
Varig Brazilian, and United Airlines. All Nippon Airways, Air New Zealand, and Ansett
Australia will be joining the alliance in 1999.). The company has suffered through a difficult
1998, and has seen its stock price plummet from over $9 a share at the height of the
public's love for the airline sector in April to the present $3.38 .

The company lost $0.31 in the third quarter due to a 13 day long pilots strike which cost
ACNAF $212 million. The strike caused revenues to decline by 17.9% during the quarter.
The company expects to incur fourth quarter operating and net losses as a result of the
strike, and will also report a loss for the year due to the strike.

The Asian economic crisis has hit the company hard this year. The Star Alliance's large
exposure to the Asian market has hampered member airlines this year as passenger and
cargo traffic have slumped noticeably. Air Canada's passenger traffic to Asia and Britain
has seen reduced rates of growth this year, and its cargo operations have suffered a 6.7%
decline in revenue ton miles. Cargo load factors in the airline industry as a whole have
suffered recently as the full effects of the Asia/Russia/Emerging markets collapse have
begun to be felt.

Air Canada is also suffering from a highly leveraged capital structure and operating costs
that are growing faster than revenue growth. ACNAF's costs have grown by 10% over the
past two quarters while revenues have increased by just 8%. The company expects fourth
quarter revenue growth rates to be flat to down, while capacity will increase by 5%. The
company has recognized the need to bring its cost structure into line with revenue growth,
and is taking measures to address the problem. The company plans to delay the delivery
of 5 Airbus aircraft and to make job cuts to bring costs down. Air Canada is also planning
to retire older planes earlier than planned, and fly fewer available seat miles as a means
to reduce costs.

We believe that ACNAF's cost cutting moves and a gradual recovery in Asian markets next
year will enable the company to stage a turnaround in 1999. The company will benefit
from any pickup in the Asian economies as its membership in the highly Asia dependent
Star Alliance begins to bring increased traffic to the company's routes via the numerous
code sharing agreements it has forged. An Asian recovery will put a halt to the decreases
in cargo load factors that have plagued ACNAF this year as cargo volumes pick up in
tandem with economic recovery. The Air Transportation Institute is expecting overall
industry ridership to increase next year, and Air Canada will benefit from any industry
recovery. Air Canada's earnings could surprise on the upside if Asian economies recover
faster than expected.

The end of strike related losses, and the accompanying abatement of strike-related
negative investor sentiment towards the stock, will enable the company to return to profit
in 1999 and the depressed stock price to stage a partial recovery. Throughout this year's
downturn, the company's domestic Canadian and U.S. operations have remained strong.
We expect this trend to continue next year. The company produced strong results in
October, with revenue passenger miles increasing by 8.4% and its load factor increasing
by 2.7%.

Air Canada is currently undervalued relative to both its historical norms and its industry.
ACNAF is trading at 1.4 times cash flow, versus 2.3 times for the airline industry. Other
valuation measures are equally undervalued: ACNAF trades at a trailing P/E of 4.3, versus
an industry average of 9.5; ACNAF has a Price/Book ratio of 0.58, versus 1.01 for its
industry. We expect Air Canada's depressed valuation levels to return to near the
industry norm as investors begin to put September's strike behind them and start to focus
on the company's future prospects. An expansion of the P/E ratio to the industry average
implies a price of $5 1/2 to $7 over the coming year.


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