Air Canada's stock is trading not far above levels seen during COVID-19 pandemic-era lockdowns.Nathan Denette/The Canadian Press
The S&P/TSX Composite Index is up about 10 per cent over the past 12 months and now close to record highs. But there’s a flashing exception to this bullish enthusiasm: Air Canada AC-T, which is in a deep funk.
The share price has slumped 29 per cent over the past 12 months, meaning Canada’s largest airline is underperforming the benchmark by a baffling 39 percentage points. That’s a considerably worse performance than most of the carrier’s North American competitors.
The stock is trading not far above levels seen during COVID-19 pandemic-era lockdowns, when horrendous losses threatened Air Canada’s survival.
Something is out of whack here. Does that make the stock a buying opportunity?
Air Canada’s beaten-up share price is a reflection of a few stiff challenges, to be sure. For starters, the labour picture is unsettled. The airline’s negotiations with the union representing its 5,000 pilots have been dragging on for over a year, and the impasse has raised concerns about a potential strike.
The uncertainty over how this conflict will be resolved may have gained some urgency over the past week. A three-day strike by WestJet Airlines Ltd. mechanics over the Canada Day long weekend grounded planes, disrupting the plans of 110,000 travellers and giving investors a glimpse into what’s at stake should negotiations break down.
Even the prospect of a settlement may be weighing on sentiment toward the airline, given that rising labour costs are already weighing on profits. In its first quarter financial results, released on May 2, Air Canada said that its operating expenses increased by 6 per cent from the same period in 2023.
The gain was partly due to higher operating capacity and traffic, as more travellers took to the skies. But expenses related to labour, maintenance and technology also rose, chipping away at the airline’s quarterly earnings before interest, taxes, depreciation and amortization. When EBITDA missed analysts’ estimates, Air Canada’s share price fell 8.4 per cent on the day of the report.
The third challenge: Potentially wavering consumer demand. Though Air Canada’s revenue and free cash flow both increased by 7 per cent in the first quarter from the same period in 2023 – suggesting a rebound in travel – the gains haven’t reassured investors worried that high mortgage costs, slower economic activity and a rising unemployment rate won’t temper demand for plane tickets in the months ahead.
At the Bank of America Transportation, Airlines and Industrials Conference in mid-May, Air Canada’s chief financial officer acknowledged that the carrier remains vigilant on consumer health.
“We have a strong balance sheet for those reasons,” John Di Bert said.
But investors have to consider whether the beaten-up stock is already reflecting a gloomy future – and if it’s poised for a rebound should the gloom lift.
Kevin Chiang, an analyst at CIBC Capital Markets, believes that the shares are pricing in a hard landing, a scenario where high interest rates send economic activity into a recessionary tailspin. That could mean that the downside risks are low.
“Not to sound like a broken record, but we view Air Canada as a deep value name,” Mr. Chiang said in a note in late June.
The case that the stock is cheap rests on a valuation that trails its peers in the airline sector and is close to lows witnessed during dramatic selloffs that have followed steep economic downturns.
The enterprise value to EBITDA ratio, for example, which compares Air Canada’s total market value to its profits over the past 12 months, currently sits at 2.8, according to S&P Global Market Intelligence. That’s well below the historical average of about 3.5.
A rebound to a normal valuation could send the share price rising to $28 or higher. Matthew Lee, an analyst at Canaccord Genuity, expects that a rebound will drive the share price to $32.
That’s not such an outlandish bet. Though airline stocks are notoriously volatile, careening at the first hint of bad economic news, they can also deliver swift gains when the economy improves.
Consider that Air Canada’s share price rallied a total of 390 per cent over the four-year stretch between 2016 and 2019, before the pandemic struck.
As well, the shares gained more than 80 per cent over a seventh-month rebound from November, 2020 through May, 2021, when COVID-19 fears were easing and inflation hadn’t yet emerged as a problem.
Are we on the cusp of good times? Maybe not. But with inflation subsiding and the Bank of Canada starting to ease up on its key interest rate, perhaps the gloom encompassing Air Canada shares is about to fade.