Air Canada (TSX:AC) has started gaining altitude since the airline revised its 2023 guidance in late April. And its first-quarter earnings proved that the airline is finally on the road to recovery from the dark clouds of the pandemic. There were many firsts in these earnings, but what made me turn bullish is the reduction in its net debt.
Air Canada sets the course to reduce debt
The worst thing the pandemic did to Air Canada was pile up a mountain of debt on its balance sheet. After all, the airline was burning cash and keeping its operations alive for the last two years on debt. It was the first time Air Canada’s net debt was reduced to $6.5 billion from $7.5 billion in December 2022. Even after repaying $1 billion in debt, the airline reported close to $1 billion ($987 million) in free cash flow thanks to advanced ticket sales.
The airline has adjusted to high fuel costs by passing on the cost to travellers. The advanced ticket sales show that travel demand is unaffected by higher ticket prices and a slowing economy.
The next step in Air Canada’s recovery
Air Canada has returned to its pre-pandemic operating efficiency with an 84.8% passenger load factor. It shows that almost 85% of all the seat miles are filled with passengers, which means the airline got paid for it. Air Canada is now looking to increase its passenger capacity by 23%. It is reportedly closing in on the purchase of up to 20 787 Dreamliners from Boeing.
Increasing capacity is a double-edged sword for an airline. Air Canada has to ensure that all those new planes are running to their optimum capacity and not lying idle in the hangar burning cash.
Air Canada is optimistic for 2023 and expects oil prices and the U.S. dollar to ease. While AC passed on the fuel cost to passengers, it bore the loss from foreign exchange ($732 million in 2022). This loss turned into a foreign exchange gain of $127 million in the first quarter as the U.S. dollar eased with the oil price.
The short-term headwinds
While Air Canada is on track for long-term recovery, a few short-term headwinds could pull down the stock price. The most pressing issue is WestJet Airlines’s pilot strike over pay.
Some Air Canada pilots have been receiving a 2% wage increase annually since 2014. They complained that they are underpaid as U.S. carrier Delta Airlines’s hourly pay rates are up to 45% higher. Such high pay scales are not feasible for Canadian airlines, as Canada has a high tax rate and a sparse population.
A pilot strike by WestJet could create a brief period of upside for Air Canada. But if Air Canada’s unhappy pilots go on strike, AC stock could fall.
Will a pilot strike affect the airline’s profits? That is unlikely. The grounding of planes during the pandemic was not in Air Canada’s control, but a pilot strike is in its control. The airline may resolve the issue, as it does not want grounded planes to haunt it in 2024.
Can Air Canada withstand a recession?
A recession could impact travel demand as consumer demand shifts to necessities. But it won’t bring a pandemic-like demand dip. A recession would also reduce crude prices, allowing AC to pass on the savings to passengers. A lower ticket price could keep travel demand alive in a recession.
The debt continues to remain a roadblock. But the management is accelerating debt repayment to free up more cash to fund its growth.
Should you buy airline stocks?
Air Canada stock is a buy below $22 as it is set to recover to the $40 pre-pandemic level in the next three to five years. But keep your portfolio diversified across other sectors, as airlines are always a bit rusty on the stock exchange.
