Canada’s flag carrier Air Canada (TSX:AC) depicted a strong recovery in its fourth-quarter (Q4) 2022 earnings last week. However, the stock has fallen more than 13% in the last three trading sessions, continuing with its long-term bearish trend.
What’s next for Air Canada?
Many businesses and stocks have passed beyond their pandemic blues and are making new highs. However, Canadian aviation has been relatively slower to recover, thanks to its stringent restrictions till last year. Since March 2020, AC stock has not created any meaningful shareholder value, notably underperforming broader markets.
For Q4 2022, and even for the entirety of 2022, Air Canada stood strong and reported solid numbers all around. Superior demand and contribution from cargo and other segments played well for its financial growth last year.
Total revenues came in at $16.6 billion in 2022, marking a stellar 160% growth compared to 2021. Its net loss narrowed to $1.7 billion in 2022 versus a loss of $3.9 billion in the earlier year.
Why did AC stock fall last week?
The loss came in wider than expected, leading to a stock price drop. Moreover, markets also did not like the cost outlook Air Canada management provided for the current year.
In 2023, Air Canada expects adjusted cost per available seat mile (CASM) to be 13-15% higher than in 2019. CASM is an important metric among airlines that measure their efficiency. It is calculated by dividing an airline’s operating cost by available seat miles. Higher CASM indicates declining profitability.
But it’s not just Air Canada. This is quite expected in the inflationary environment. The higher CASM is seen across the industry. For example, aircraft fuel charges, which form a major component of an airline’s expenses, have gone through the roof lately. To be precise, Air Canada reported $5.3 billion in fuel charges last year, which were 235% higher than in 2021.
Rising interest rates also dented its bottom line negatively in the reported period. Air Canada’s interest expenses were $909 million last year — 21% higher than in 2021.
Despite higher costs, Air Canada has furnished an optimistic outlook for 2023 and 2024. It expects an adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) of $2.5-$3.0 billion this year, indicating an 88% increase year over year. For 2024, the management aims to achieve an adjusted EBITDA of $3.5-$4.0 billion.
Travel is rapidly rebounding in Canada and will likely continue at an accelerated pace. In 2021, Air Canada operated 162,000 flights and carried 13.7 million passengers. But since June 2022, it has operated 217,000 flights and carried 25 million passengers.
However, broader economic conditions and a potential recession will be an important driver for Air Canada’s top-line growth in 2023. Consumer discretionary spending has a direct correlation with economic cycles and, thus, will drive travel demand. So, even if Air Canada has highlighted a strong recovery and a visible road to profitability, the path will most likely be thorny.
Despite the near-term pressures, AC stock looks attractively placed. It is currently trading at a forward enterprise value-to-EBITDA valuation of five, which is in line with peers’ averages.
Higher costs and recession fears will likely keep dominating Air Canada stock, at least for the next few quarters. However, we might see meaningful improvement in its profitability later this year or next. Its manageable leverage and expected free cash flow growth will likely drive considerable shareholder value for patient investors.