Air Canada (TSX:AC) was once on top of the world. In 2012 the stock was valued at $1. By 2019, shares surpassed $50.
But there’s a catch: the coronavirus pandemic has crushed the company’s prospects. Today, the stock is only worth $15. The rapid decline has caught the eye of value investors. Some analysts believe the share price could double in 2020.
Just be careful. Last week, executives released a bombshell revelation that should be heard by all investors, not just Air Canada shareholders.
Get ready for this
Airline investors have been wondering what to do. The stock of nearly every airline is down at least 50%. Some companies have seen their share prices decline by 80%. There has never been a better time to buy, many argue. But is that true?
The problem is that we have almost no clarity on what the future holds. When will the coronavirus pandemic subside? When will business and leisure travel return to normal? No one knows.
Uncertainty crushes the valuation of any stock it touches. In this case, it could ultimately lead to 100% downside. Many airliners are struggling to survive. Delta Air Lines is reportedly losing $50 million every day. Air Canada is almost certainly bleeding cash too.
Last month, the news hit that Warren Buffett could be exiting the industry entirely, even though he was a top shareholder of four different airlines at the start of the year.
What do Air Canada executives think? Last week, on the company’s first quarter conference call, we got our first glimpse.
“The pandemic and its fallout will materially impact both customer demand and our liquidity in the short and medium term,” management began. “Moreover, while the duration of the pandemic and its fallout remain unknown, it is our current expectation that it will take at least three years to recover to 2019 levels of revenue and capacity.”
Three years until a return to normal! But it gets worse.
“We expect that both the overall industry and our airline will be considerably smaller for some time, which will unfortunately result in significant reductions in both fleet and employee levels,” they concluded. Next quarter, the company will reduce its booking capacity by 85%.
Time to buy Air Canada?
I recently covered why airline stocks were such a great investment last decade. The cause was simple: industry consolidation. Decades ago, dozens of airlines competed over a single route. Today, only a few players compete in any given region. The U.S. is down to just four major carriers, while Canada only has two.
Whichever airlines can survive the current rout may eventually see brighter days. Lesser-financed competitors will exit the market. New entrants will be limited. These factors will boost profits for incumbents.
But the road to this bright future is unclear. According to Air Canada, it will take years. Over that time, emergency funding measures will be taken, and it’s unclear how that will happen. There are few buyers for costly assets like planes, and government bailouts will likely result in heavy share dilution.
It’s tempting to buy beaten-down airline stocks like Air Canada, but the uncertainty is just too high. That seems to be Warren Buffett’s conclusion as well.
