While Canadian equities have lost 3%, Air Canada (TSX: AC) stock has lost 22% in the last 12 months. And the underperformance is quite evident, given the back-to-back challenges faced by the feeble aviation sector. The pandemic, record-high inflation, and now recession fears have weighed on it in the last few years. However, AC stock has suffered enough and will likely bring respite to investors later this year.
What’s next for AC stock?
In March 2020, when the pandemic was wreaking havoc, Air Canada management guided a return to profitability in three years. This is its third year, and we have already started seeing some green shoots.
In Q4 2022, Air Canada saw its bottom line turning positive after losses for 11 consecutive quarters. Strong travel demand and Air Canada’s stellar operational performance led it to profits last quarter. The airline reported a net profit of $168 million or $0.41 per share for the quarter that ended on December 31, 2022.
According to analysts’ estimates, Air Canada is expected to report total revenues of $4.3 billion in Q1 2023. That’s handsome 67% growth year over year. Air Canada has been seeing rapid revenue growth since last year. Canadian regulators opened the borders relatively late amid the pandemic restrictions compared to other countries. So, in the last six quarters, its revenues have grown by an average of 252%.
Strong operational and financial performance
Passenger load factor improved from 68% in Q4 2021 to 83% in Q4 2022, indicating increased demand. This is an important metric that shows the percentage of available seating capacity for passengers. Available seat miles, an indicator of passenger-carrying capacity, also grew by 59% to $22.4 billion in the last quarter.
After its stellar show last quarter, Air Canada management released optimistic guidance for 2023 and 2024. It expects adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) of $2.8 billion in 2023 and $3.8 billion next year. That’s an astonishing recovery Air Canada is eyeing.
Along with the profitability, Air Canada’s balance sheet also looks well-placed. At the end of Q4 2022, it had a net debt of $7.5 billion. If the guidance materializes, the leverage should not concern Air Canada investors. Passenger airlines carry a large amount of debt on their books as it’s a capital-intensive business.
AC stock has been trading in a narrow range for the last few quarters. It is trading at a 2024 EV (Enterprise Value)-to-EBITDA valuation of 4x and looks discounted. In comparison, the industry average is around 6x.
Risks
However, Air Canada’s road to consistent profitability will not be easy. Inflation will be a key risk, which will likely dent its margins.
The management has already guided that its cost per available seat mile (CASM) will be approximately 15% higher in 2023 than in 2019. Higher CASM will likely hamper its bottom line and could delay recovery. Fuel prices form around 30%–50% of an airline’s total operating costs, and will likely head higher this year, negatively impacting its bottom line.
Moreover, an impending recession could impact consumer discretionary spending, denting Air Canada’s top-line growth.
Investor takeaway
AC stock looks well-placed to recover even after these risks. That’s because these dangers seem already priced into the stock. Air Canada might not see a significant financial recovery in the upcoming quarter. However, the management guidance looks achievable, which makes AC stock more attractive.
