Many TSX stocks have still not recovered from the massive hit they took during the pandemic. Stocks like Air Canada (TSX:AC) are still trading at a fraction of what they were trading at before the pandemic. Clearly, the damage was so great that there is no easy fix.
In this article, I will discuss Air Canada stock. After another 16% drop in the last three months, is it time to buy?
Demand has recovered nicely but Air Canada’s costs have risen
So, let’s see where we sit today with Air Canada stock. As I said in the introduction, it’s been hit hard and remains depressed. In fact, Air Canada stock is currently trading 63% lower than in March 2020, before the pandemic really hit.
Understandably, the stock was quick to nosedive back then. But after a prolonged shut down and years of weak travel demand, things are looking up. In 2022, Air Canada is experiencing strong demand. This translated into free cash flow of $800 million and adjusted EBITDA of $1.5 billion. While revenues were not quite back to pre-pandemic levels, they’re sure coming close. In fact, 2022 revenue was 87% of 2019 revenue.
This is good. But the post-pandemic environment is different from the pre-pandemic environment. For example, costs are much higher. Costs such as fuel have risen sharply, and inflation in all areas have brought costs in general higher as well. This is obviously impacting profitability. The magnitude of this impact is reflected in Air Canada’s stock price and in management’s changed guidance.
Back in March 2022, management’s guidance for cumulative free cash flow during 2022 to 2024 was $3.5 billion. Today, the guidance is for cumulative free cash flow of $2.5 billion. A big difference. It highlights the magnitude of the hit that rising costs are having on the business. Recall, fuel alone makes up more than 30% of Air Canada’s operating cost.
On top of rising costs, Air Canada is also facing a more competitive environment post-pandemic. Essentially, four new players have launched low-cost carriers into the domestic space. For example, low-cost carrier Play Airlines recently announced new services in Canada. The airline services destinations such as Barcelona, Brussels, Iceland, Lisbon, and more. At a time when Air Canada has been increasing fares to combat inflation, this cannot be seen as anything but negative.
Similarly, Air Canada is also expanding. Since international margins are higher than domestic margins, Air Canada has been focusing on international flights. In addition to this, Air Canada has been investing in its cargo business. While relatively small, this is a high margin business that offers Air Canada diversification and a departure from its typical seasonality.
Air Canada’s balance sheet
Lastly, I would like to cover Air Canada’s balance sheet. This is a capital-intensive business, and without the backing of a strong balance sheet, it gets too risky. At this point in time, Air Canada does not have investment grade status. Yet, before the pandemic, it easily achieved and maintained investment grade status.
Along with a deterioration in the company’s free cash flow guidance, Air Canada has also relaxed it debt reduction plan. In short, rising costs have prohibited the aggressive debt reduction that was initially planned. Despite this, Air Canada does have ample liquidity of over $9.8 billion as of December 31, 2022.
Motley Fool: The bottom line
The Air Canada story is still riddled with a lot of uncertainty, as well as real obstacles. This is reflected in the AC stock price, which has languished over the last two years despite the recent sharp recovery in travel.