In the coming week, Canadian airliners will be reporting their fourth quarter and year-end 2018 results.
With Air Canada (TSX: AC)(TSX:AC.B) stock up in the last year and WestJet Airlines Ltd. (TSX:WJA) stock down 18%, investors are undoubtedly wondering if they should buy on these stocks.
Let’s explore.
First of all, let’s keep in mind that for airliners, jet fuel cost is the single biggest expense.
What this means is that your view of oil prices is the most important variable to consider when deciding whether these stocks are good buys today.
Last quarter
With crude oil hovering in the $70 range in the third quarter, airliners saw huge increases in their biggest cost: jet fuel.
This drove a 50% increase in jet fuel cost for both airliners and a 65% reduction in EPS for WestJet. While Air Canada more than offset this through pricing increases, strong traffic, and efficiency gains, the company’s return on invested capital expectations were reduced.
In fact, its focus on return on invested capital, which has hit as high as 15% and has been key to its performance, has started to trend downward in this new environment (most recent guidance has come down to 12% from previous guidance of 13% to 16%).
Upcoming fourth quarter results
In an environment of rising fuel prices, airline stocks will usually underperform.
And while oil prices are down on a one-year basis, they remain extremely volatile, with investors unsure of their ultimate direction.
In the fourth quarter of 2018, average crude oil prices were at least $10 per barrel lower than in the third quarter.
Accordingly, we can expect strong fourth-quarter results for the airliners.
With regard to the stock prices, in my view they will trade based on investors’ expectations for crude oil prices and the health of the consumer, and while Air Canada’s transformation is far more than just those two variables, they are nonetheless, still big variables.
Up until now, demand has remained quite healthy, and the Air Canada is still generating ample cash flow.
If we hear cracks in this narrative, we may see a selling off of the stock.
While the company’s strategy to transform itself has only just begun, with a focus on and investment in fleet modernization, international expansion, network diversification, and the rollout of Rouge, the macro environment is undoubtedly getting more difficult.
Let’s not forget that Air Canada and WestJet are still highly cyclical companies that will not fare well if consumers reign in their spending as a result of higher interest rates and heavy consumer debt loads.
And this, coupled with rising fuel prices, will continue to be headwinds for the stock.
