What Is Keeping Air Canada (TSX:AC) Stock From Soaring?

Air Canada (TSX:AC) stock is testing investors’ patience, trading below $24, even when international borders opened.

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Did you buy Air Canada (TSX:AC) stock for around $26 during its rally in March in hopes of quick gains? But now you are stuck with a stock that has dipped below $24 and is showing no sign of recovery. You are losing patience, as you’d expected the stock to rally past $32 and reach $40 by the end of the year. Well, guess what? There are still 2.5 months to the year-end, and it only takes the stock a day or a week to make a new high. 

What’s keeping Air Canada stock from rallying? Once you know the answer, it will probably make the holding period bearable.

What is keeping Air Canada stock from rallying?

Air Canada’s stock price rally faded when it received the $5.9 billion government bailout. Before the bailout, the stock was rallying over the anticipation of one. After the bailout announcement on April 12, the stock dipped almost 14% in six trading days. 

The bailout gives the government up to a 10% stake in Air Canada through equity warrants; 50% of warrants will vest when $4 billion worth of credit facilities are implemented, and the remaining 50% will vest as and when the airline draws these credit facilities. 

The problem with the government stake is that it dilutes the interest of shareholders. Moreover, no private business wants too much government interference, as the latter’s objective is the affordability of the service rather than profits.

Is 10% government stake enough to keep Air Canada stock gravitated to $24? 

As it is, Air Canada is sitting on a huge debt pile (net debt of $6 billion), burning cash, and facing on and off demand due to virus mutations. The only thing that kept Air Canada stock running in this unstable environment was investors’ trust in the management to turn the tides when skies reopen.

When investors hoped for a government bailout, they were expecting a low-cost loan and not an equity arrangement. The equity gives the government voting rights and a say in the working of the airline. Moreover, when the government converts equity warrants into shares, more shares will release in the market and dilute shareholders’ interest. Shareholders find a 10% equity stake more expensive than a loan at 9% interest. 

The need of the hour is flexibility. Air Canada will have to make tough choices to get the airline back to profits. While the government won’t interfere much with the airline’s operations, it might prevent the airline from making difficult decisions. 

Air Canada’s management is working out the math and trying not to draw much of the bailout money to keep the government stake to the minimum. In its second-quarter earnings, the management mentioned that they might decide whether or not to draw $2.47 billion in unsecured debt. 

What should you do?

In all this, you might be wondering what you should do with Air Canada stock. I’ve kept saying you should buy the stock at $24 or below, and I stick by this recommendation. The airline stock is at crossroads and is trading near the bottom. If it surges, it could cross the $32 mark, and if it falls, it could dip to $20. To put it the other way, there is 15% downside but 36% upside.

I am optimistic about Air Canada’s short-term rally and expect it to come before July 2022. Air Canada is not a fundamentally viable stock for the next five years. Hence, there is limited upside from the pent-up demand. 

So, if you own the stock, hold it till mid-next year. If the stock crosses $32, book some profit by selling a portion of your shares. If the stock falls below $20, then booking losses would be better, as you can put that money in another stock and recoup losses. 

Air Canada is an active investment, so stay abreast.  

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Puja Tayal has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

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