Air Canada (TSX:AC) stock was one of the top performers on the TSX in the decade prior to COVID-19. Between the start of 2010 and the end of 2019, Air Canada stock rose by an impressive 3,500%, which means a $1,000 investment would have ballooned to $36,000 in this period.
However, companies in the aviation sector have been decimated since the pandemic struck. Air Canada stock lost over 80% in market value during the bear market in early 2020, and though it has since recovered, shares are still trading 56% below record highs.
So, a $1,000 investment in Air Canada stock at the start of 2020 would be worth $4,685 today. Does this mean the stock is an attractive contrarian buy, or will it remain volatile till the pandemic ends and normalcy returns?
Air Canada is likely to face several headwinds
The airline industry is a capital-intensive one, and Air Canada is burning millions of dollars each day as international traffic is still stuck in limbo. Further, there is a chance for business travel to change for good in a post-pandemic world, as the shift towards remote work has accelerated to a great extent in 2020.
According to investment mogul Warren Buffett, investing in airline stocks carries significant risks, as a competitive durable advantage has been elusive for several years now. Airline companies generate cash flows but have to reinvest capital to increase traffic routes and accommodate for an increase in passenger traffic.
So, while Air Canada and its peers will manage to increase sales over the long term, it will difficult to translate top-line growth into sustainable profits. The travel and tourism industry is also highly cyclical and is generally the last to recover during an economic recession.
The pandemic might be a once-in-a-lifetime scenario, but it has shown us the fragilities of investing in airline companies.
What’s next for investors?
Air Canada stock is valued at a market cap of $6.73 billion. This means it has a forward price-to-2021-sales ratio of 0.7. However, investors should note that the company is also expected to continue burning cash in the near term.
According to Bay Street analysts, Air Canada’s earnings are forecast to fall from $3.37 per share in 2019 to a loss of $12.7 per share in 2020 and improve to a loss of $2.88 per share in 2021.
If the pandemic worsens due to the new strain of virus found in the U.K., investors should expect Air Canada stock to correct significantly from current levels. The company has raised significant debt in order to boost liquidity amid the pandemic. However, it needs to increase revenue and earnings to make interest payments as well.
In the last six months of 2020, Air Canada is estimated to burn around $2 billion in a bid to stay afloat. Analysts tracking the stock have a 12-month price target of $26.72 for the company, which means its trading at a discount of 17% right now.
