Chorus Aviation stock drops on cost mark-up decision

* Arbitration panel decision may mean dividend cut, analyst

* Chorus to provide update on financial implications

TORONTO, Oct 3 (Reuters) - Shares of Air Canada contract carrier Chorus Aviation Inc fell nearly 10 percent on Wednesday, and an analyst warned it might have to cut its dividend, after an arbitration panel ruled in favor of Air Canada in a cost dispute.

Under a capacity purchase agreement, Chorus operates 131 aircraft for Air Canada, the country's largest airline, under the Jazz brand. It flies to smaller destinations and to large communities in off-peak hours throughout Canada and into the United States.

Chorus said that a three-member arbitration panel has selected Air Canada's method of determining component unit cost drivers over Chorus's model, which compares its cost growth to that of a group of similar operators. The panel agreed, however, that some cost adjustments will be made in Chorus's favor, Chorus said.

Chorus did not disclose the financial impact of the panel's decision, saying it needed clarification and would provide an update later. Any award will be retroactive to 2010.

Chorus has estimated that, at worst, it would need to repay C$24.4 million ($24.7 million) to Air Canada for 2010 and C$24.7 million for 2011, National Bank Financial analyst Cameron Doerksen said in a research note.

The company had C$91.7 million in cash at the end of the second quarter and can afford the payments, Doerksen said.

But he warned that the lower free cash flow expected from the reduced Air Canada cost mark-up, balanced against Chorus's capital requirements for new plane purchases, suggest that the company might have to cut its dividend by 25-35 percent.

"This is clearly negative news for Chorus Aviation with negative implications for valuation and for the company's dividend," Cameron said.

"Recall that in a worst-case scenario, the mark-up Chorus is paid on its controllable costs by Air Canada could fall to 9.48 percent from 12.5 percent," he said.

The more heavily traded class B shares of Corus were down 36 Canadian cents at C$4.32 on the Toronto Stock Exchange on Wednesday morning, while Air Canada's stock was up 7 Canadian cents, or 5 percent, at C$1.42.

($1=$0.99 Canadian)

(Reporting By Susan Taylor; Editing by Peter Galloway)

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