While the stock is approaching insanely cheap territory with shares sporting a mere 2.3 times trailing earnings multiple, I’d urge investors to proceed with caution. Not only is Air Canada one of the fastest falling knives in the market right now, but it’s also a name that some think could face bankruptcy in a worst-case scenario.
Aren’t the airlines more recession-resilient this time around?
The 2007-08 Financial Crisis proved to be a disaster for airlines that were on the verge of bankruptcy. Air Canada stock crumbled like a paper bag, and many investors lost a tonne of wealth, as the stock took a ridiculously long time to recover. Heck, the stock had only recently recovered from the damage brought forth by the Financial Crisis, and sadly, the stock could be headed to the lows seen in 2008.
Prior to 2007-08, Air Canada and many other airlines weren’t as efficient as they are today. Air Canada invested a tonne of cost-saving efforts, operational efficiency initiatives, and with more fuel-efficient aircraft in the fleet, one would think the airlines would be able to hold their own come the next market meltdown.
All the cost-saving efforts paid off over the last few years. The airline was capable of better weathering another cyclical downturn, and that inspired the “paradigm shift” in the airlines that Warren Buffett probably bought into.
While the airlines are far better than they were prior to the Great Recession, they could still be on the brink amid the pandemic-driven downturn. You see, the airlines are better positioned to ride out a cyclical, structural downturn, but not a pandemic-driven crash that puts the airlines in the dead centre of the bear’s cross-hairs.
Had this been a structural decline, I have no doubt that the airlines wouldn’t be in need of a bailout this time around. But boy, a pandemic is an entirely different beast. Instead of reduced demand for seats, international and transborder flights were shuttered to slow the spread of the deadly disease known as COVID-19.
Nobody knows when the COVID-19 pandemic is going to subside. Airlines are one of the few businesses with high operating costs, and the longer things drag on, the more dire the consequences become. The company made a tonne of investments to improve operations over the years, but it’s left its balance sheet in a tight spot amid the pandemic.
Is Air Canada at risk of bankruptcy? And could the stock be worth $0?
Air Canada has a fair share of debt on its balance sheet, but it’s not drowning in debt like during the Financial Crisis. In a worst-case scenario, there’s no question that Air Canada could, in theory, be at risk of going under. But I don’t think the federal government will sit around and let it happen, given Air Canada is one of those few “essential businesses” that’s needed for an economy to thrive.
Air Canada isn’t too big to fail per se, as the company only sports a $3 billion market cap. However, I see the company as “too essential” to fail. As such, I don’t think Air Canada will go under, even though it’s theoretically possible should the pandemic continue dragging on.
The airline became such an efficient operation, even though it may not seem like it now. As such, it’s in the best interest of the government to keep the company alive, as it navigates through turmoil that wasn’t its fault to begin with.
I don’t see Air Canada ever falling to zero, even under a worst-case scenario. But that doesn’t mean it’s safe to jump aboard amid this pandemic. The stock has already dropped 75%, meaning it halved twice, so don’t think for a moment that the stock can’t halve again. And again.
Foolish takeaway on Air Canada
I see immense value to be had in the stock after its decline to $12, as I just don’t see the company going bankrupt.
The stock is a falling knife, however, and should be nibbled on gradually rather than bought in full at one instance in time. Shares could be on the way to the single digits, so you’re going to want to have more dry powder to buy on the way down!
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Fool contributor Joey Frenette has no position in any of the stocks mentioned.