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Aeroplan operator Aimia’s gains may be too much, too soon

Aimia Inc., the operator of Aeroplan, will likely post a decline in profit this year, and 2014's earnings will probably be even lower. And yet the company's shares are hitting 52-week highs. What gives?

It is a rare case where investors are overlooking near-term earnings volatility and buying into a long-term vision for growing sales and profits. That's a refreshing change from the market's frequent inability to look beyond the nearest quarter.

The issue with Aimia, though, is that the downside is known, here and now, while the upside is yet to come. And the shares seem priced as if a revitalized Aeroplan will make Aimia soar.

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Certainly, it's understandable why the company's shares have risen in recent weeks. Aimia had a summer of uncertainty: Investors learned of problems in its relationship with long-time partner CIBC and worried what the switch to a new credit-card issuer might mean in terms of lost customers. A three-way deal among CIBC, Toronto-Dominion and Aimia seemed to be the best of all possible worlds.

Aimia now says its financial-partner discussions "enabled [a] transformation to deliver on member needs."

The price CIBC was paying to Aimia for each reward point was locked in at below-market rates. Aimia had less money to spend on Air Canada flights, and didn't have the number and quality of options many Aeroplan customers were looking for. (As Aimia said at its Toronto investor day last week, it had "constrained ability to invest in product to address member expectations.")

As part of the new deal, TD and CIBC will pay 15 per cent more per point, which Aimia sees translating into better seats. Really, the entire program is getting an overhaul: From the heavily promoted "Distinction" program, to the revocation of an unpopular miles-expiration policy, Aimia believes it has "initiate[d] a multi-year journey to rework the entire member experience."

The funny thing about loyalty programs, however, is that sometimes your "worst" customers can be your best. Aimia sells a certain number of reward points that are transferred to consumers who never use them. There's no ultimate cost to Aimia for fulfilling these unused, or "broken," points. They're nearly pure profit.

Aimia had a "breakage" rate ranging from 17 per cent to 21 per cent in the last five years, with a higher breakage rate better. With the new agreement, and hopes for increased member engagement, Aimia has cut its breakage-rate estimate to 11 per cent.

That, combined with additional marketing spending on the revamped plan, will cut profitability: Its margin of adjusted EBITDA (earnings before interest, taxes, depreciation and amortization), which was 18 per cent in 2012, will fall a full six percentage points, Aimia says. The analysts at Accountability Research Corp., who have had a "sell" rating on the stock this year, say the market has "ignored" the implications of the margin reduction by sending the shares higher.

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Aimia told investors last week that its "primary goal" is its top line, generating more revenue by "upgrading the membership profile" and getting existing Aeroplan members to spend more on their credit cards and earn more points. It hasn't offered guidance, however, on the expected costs in procuring the rewards, and what that means for its gross margins.

All the noise has analysts essentially scrapping the next six quarters and introducing price targets based on 2015 earnings, for which Aimia has not issued guidance.

As befitting a belief that this is "the re-establishment of a growth engine," as TD Securities analyst Brian Morrison puts it, many are assigning earnings multiples at the top of Aimia's historical range, even though most estimates of 2015 adjusted EBITDA are below 2012 levels. (This describes the methodology behind Mr. Morrison's target price of $22.)

Even the optimism has its limits, however. Adam Shine of National Bank Financial increased his "rather conservative" multiples by 50 per cent in his most recent report, but the end result became an $18 target price – pretty much where the shares stand today. (He downgraded the stock to "sector perform.")

If Aeroplan experiences a resurgence, all will be well. After all, Aimia can absorb lower margins on its rewards points by selling lots more of them. That will translate into more dollars of absolute profit. That's the plan, as part of Aimia's strategic aspirations is to "break away from the pack."

At today's prices, however, Aimia stock seems to have already broken from the pack – well in advance of the company executing its plan.

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About the Author
Business and investing reporter and columnist

A business journalist since 1994, David Milstead began writing for The Globe and Mail in 2009. During eight years at the Rocky Mountain News in Denver, Colo., he individually or jointly won nine national awards from SABEW, the Society of American Business Editors and Writers. He has also worked at the Wall Street Journal. More


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