One of the most successful bets that Canadian investors made during the past five years was buying and holding the nation’s largest airline, Air Canada (TSX: AC)(TSX:AC.B).
During that time, the S&P/TSX Composite Index remained almost flat, producing 10% returns. Air Canada stock, however, surged more than 200%, and there is no comparison to make, obviously.
After such a massive rally of the past five years, the biggest question for investors now is to whether sell the stock and enjoy the New Year’s party, or remain invested, believing that the company’s impressive growth has still room to run.
In my view, this is a good time to take your profit and celebrate your success. The biggest threat to airline stocks, and more broadly for cyclical companies, is a possible recession in 2019. The risks of a recession have climbed as the nearly decade-long economic cycle ages, according to Pacific Investment Management, one of the largest bond fund managers in the world.
“The probability of a U.S. recession over the next 12 months has risen to about 30% recently and is thus higher than at any point in this nine-year-old expansion,” Pimco economist Joachim Fels and Andrew Balls, global fixed-income chief investment officer, wrote in an outlook released Thursday.
For airline stocks, such a scenario would be devastating. Discretionary travel is usually among the first that faces a cut during the times of distress, and Air Canada is not immune to this possibility. In the company’s latest earnings report, we’re already seeing signs of weakness, and that may worsen if the macro environment doesn’t improve.
On Oct. 31, Air Canada reported net income fell 63% year over year. Excluding one-time items, adjusted earnings decreased 39% to $561 million, or $2.03 per diluted share, from $922 million, or $3.33 per share, a year earlier.
Surging prices of fuel in that quarter played a big role in the airline’s dismal performance, but there is no visibility on that front either. Oil prices, after recording a more than 25% plunge since their October high, are moving up again as the oil cartel agrees to reduce the global output.
Bottom line
Beyond this macro picture, I really like Air Canada stock, which remains a good growth story following a very successful execution of its turnaround plan. But I believe in this late economic cycle, it’s a much better strategy to book a profit and move to the sidelines. You can always come back and buy Air Canada again once the dust is settled and we have a better understanding on the economy’s future direction.
