Canada’s leading passenger airline company Air Canada (TSX:AC) reported its fourth-quarter (Q4) 2022 earnings last month. Although numbers indicated the light at the end of the tunnel, AC stock slipped 12% last month. It has notably disappointed investors recently, losing 20% in the last five years.
What’s next for AC stock?
Even if Air Canada exhibited a decent quarterly performance and highlighted a positive growth outlook, macroeconomic challenges might continue to weigh on its long-awaited recovery. Record-high inflation and rapid rate hikes will likely delay its profitability.
Air Canada has seen epic revenue growth in the last two years. Its revenue in Q4 2022 jumped 71% to $4.7 billion. However, operating expenses jumped in tandem, thanks to sky-high fuel charges, hitting its bottom line.
Apart from the top line, Air Canada saw a massive improvement in its profitability. It reported a net income of $168 million in Q4 2022 from a loss of $493 million in Q4 2021.
It’s been three years of consecutive losses and cash burn for Air Canada. Steep improvement in travel demand has notably improved Air Canada’s prospects recently. However, how the higher costs play out in 2023 remains to be seen.
For example, Air Canada management forecasted an adjusted cost per available seat mile will likely rise by 13-15% this year compared to 2022. So, higher costs might pull the profitability down. The same concern seems to have weighed on AC stock last month.
Despite the higher cost outlook, Air Canada has given rosy guidance for this year and next. It forecasts an adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) of $2.5-$3.0 billion in 2023, representing an 88% growth year over year. For 2024, the management expects an adjusted EBITDA of $3.5-$4.0 billion.
Air Canada balance sheet and leverage
Another concern is Air Canada’s leverage. Airline is a cyclical and capital-intensive industry. Due to interest rate hikes since last year, airline companies have seen a massive increase in their interest expenses. Air Canada has not been an exception.
Its net debt at the end of Q4 2022 was around $7.5 billion, implying a net debt-to-EBITDA ratio of five. That’s still higher compared to peers’ average of three. However, considering Canada’s late reopening after the pandemic, the leverage is justified. Plus, its guidance for 2024 makes the leverage looks manageable. The net debt-to-EBITDA ratio is an important leverage metric and shows how many years a company would take to repay its debt.
Risks
To add to the woes, an impending recession and ensuing cut in travel demand could notably dent Air Canada. A combination of rapid rate hikes and adamant inflation will likely lead to a recession. An economic downturn will result in lower discretionary spending, pulling its revenues sharply lower.
Conclusion
Air Canada is a fundamentally strong company, which drove its outperformance in the last decade. As macroeconomic challenges ease, probably later this year, investors can expect the flag carrier to return to glory and create considerable shareholder value.
