Air Canada (TSX:AC)(TSX:AC.B) stock has faced a bit of turbulence of late with shares pulling back nearly 9% from its all-time high reached in February. While the economically sensitive airline stocks are definitely not the type of investment you’d want to be caught holding in an economic downturn, I believe contrarian investors have an opportunity to snag shares at a nice discount if they’re not convinced that we’re headed into a recession.
As we saw late last year, recession fears were overblown beyond proportion. With more economic indicators flashing red lights, we very well could be headed south for the spring, despite the Fed’s backing off on further rate hikes. But like last year, investors may really have nothing to fear but fear itself.
With the airlines already priced with a high probability of a recession at some point over the medium term, there could be substantial value to be had for those gutsy enough to go against the grain at a time when it’d seem incredibly foolish to do so.
As you may be aware, airlines are the epitome of cyclical investments. And it’s these investments that stand to lose the most in the event of an economic recession. The airlines have a notorious reputation for crumbling like a paper bag when times get tough, but despite their troubled histories, there are many reasons to be optimistic on the airlines — Air Canada specifically.
Warren Buffett has despised the airlines for most of his investment career, and only recently (a few years ago) has he changed his tone. The airlines have not only become more investible through the utilization of more efficient aircraft and software systems, but they may finally have the stress relievers in place to survive the next inevitable economic downturn.
Despite the major advancements, most investors aren’t flocking into the airlines as Buffett has. Thus, dirt-cheap valuations are still available for those who are willing to take a leap of faith. Not only could the next recession be less severe and detrimental to the airlines, but a rebound could be much quicker with ULCC (ultra-low-cost carrier) arms and an in-house loyalty program, which aims to lower the sales decay in recessionary environments.
Of the two major Canadian airlines, Air Canada is the best bet at this juncture with the remarkable efficiencies and cost-cutting initiatives that’ll leave a long-lasting, positive impact to growth on the bottom line. The stock trades at eight times next year’s expected earnings and 0.5 times sales, which is ridiculously cheap, even for a seemingly economically sensitive company as an airline.
The top line has grown at 9.2% over the last year, and given initiatives in place that’ll result in higher margins moving forward, I think Air Canada may have a terrific risk/reward trade-off for those who aren’t already overexposed to highly cyclical stocks.
While Air Canada may not have the best operating track record in the world, one can’t help but be encouraged by the progress that’s been made behind the scenes over the past year. I don’t think the valuations fully reflect it, so I’d nibble the recent dip with more cash in hand to buy more should Air Canada be headed for a further tailspin.
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Fool contributor Joey Frenette has no position in any of the stocks mentioned.