Air Canada (TSX:AC)(TSX:AC.B) stock looks ridiculously cheap after suffering a 50% peak-to-trough drop. With no signs of a bottom in sight, Air Canada is one of the fastest falling knives amid the coronavirus sell-off.
A dangerously risky proposition, despite low valuation multiples
With panic over the coronavirus (COVID-19) continuing to mount, people are taking a raincheck on flights. Nobody wants to stay inside an enclosed metal structure that’s been recirculating air for hours. Most of the fear has been amplified with the cruise line stocks, with Norwegian Cruise Line leading the downward charge. It is off 75% from its highs. The cruise ships have undoubtedly been receiving most of the attention from the mainstream media for carrying huge masses of newly infected.
But in terms of volume, the airlines are arguably a more significant vector of disease transmission. With the U.S. implementing travel bans (Canada will probably follow suit), the airlines could be due for a cruise-line-like decline over the coming weeks. I guess you could say they’re cruising for a bruising.
Air Canada has already shed half of its value. That’s excessive, to say the least. But don’t think for a second that it can’t halve again, as Norwegian has. The next thing you know, a slew of international travel restrictions could turn into a ban on domestic flights should community spread start becoming a major issue. If that ends up happening, the airlines may be seen as the unrecoverable crashes waiting to happen, as they were prior to the 2007-08 financial crisis.
The airlines are better positioned to weather future recessions compared to 2008
Any other time, the airline stocks would be a pound-the-table buy on the dip. Many of them have profoundly improved their ability to survive through harsh economic environments. Air Canada has done wonders for operational efficiencies over the past five years. Gone are the days where Air Canada (or other airlines) are insolvencies waiting to happen in the next recession.
The airlines are undoubtedly better seasoned to ride out the next cyclical downturn without a government bailout. However, it’s up for debate as to whether or not they’re ready to deal with a biological crisis. A global pandemic puts Air Canada among the most vulnerable firms. As times get uglier, all eyes will be on the balance sheet.
In a way, Air Canada is being put to the test after years of substantial investment in improving operational capabilities. But I don’t care how much more efficient operations have become. If nobody is going on flights for fears of getting sick, you’re not going to get your bottom-line numbers where they need to be with a severe decline in the ticket sales, and I don’t care how much better margins have become.
It’s going to be tough to keep the lights on with high fixed costs without some sort of stimulus like interest-free loans granted by the government. The company has a considerable amount of debt (around $8 billion in long-term debt) sitting on the balance sheet, and while it’s not at the level reached during the financial crisis (around $14 billion in debt), one could argue that being at the forefront of a pandemic is a worse situation, since it’s not just belt-tightening that could hurt business, but fear for one’s wellbeing.
Nobody knows when the pandemic will come to an end. It could last a lot longer than expected, and if that’s the case, Air Canada could see its bill rack up very quickly. For now, I’d steer clear or Air Canada stock, as the stock is likely to continue on its tailspin.
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Fool contributor Joey Frenette has no position in any of the stocks mentioned.