The last few years have showcased the risks associated with investing in the airline sector. Typically, airline companies are debt heavy, as they need large amounts of funds to scale operations. Further, due to the lower margins, a competitive advantage remains elusive for companies in this industry.
Prior to 2020, airline companies enjoyed an extended period of lower interest rates and economic expansion, allowing them to deliver record profits and derive outsized gains to shareholders. However, in the last three years, airline stocks have trailed the broader markets by a wide margin due to the COVID-19 pandemic, rising balance sheet debt, an uptick in fuel prices, and interest rate hikes.
For instance, Air Canada (TSX:AC) stock surged 3,580% between the start of January 2010 and January 2020. However, since then, AC stock has fallen 52%. Despite the recent pullback, an investment of $1,000 in Air Canada stock in early 2010 would be worth over $17,300 today.
But historical returns don’t matter much to future investors. Let’s see if you should invest in Air Canada stock right now.
An overview of Air Canada
Air Canada is the largest airline and provider of scheduled passenger services in Canada. In 2019, it was among the top 20 largest airlines globally.
Air Canada sales fell from an all-time high of $19.1 billion in 2019 to $5.8 billion in 2020 and $6.4 billion in 2021. Its top-line growth more than doubled to $16.55 billion in 2022 due to the easing of travel restrictions.
However, the company’s operating loss stood at $187 million in 2022, compared to a loss of $3 billion in 2021. Air Canada ended 2022 with net debt of $7.5 billion, an increase of $542 million year over year. Comparatively, total liquidity fell to $9.8 billion from $10.5 billion in this period due to capital expenditures and debt repayments.
Air Canada claimed its Aeroplan program is key to retaining the loyalty of returning travelers. The plan continues to deliver solid results while providing Air Canada with an additional revenue stream, as it aims to expand total members to seven million.
Moreover, sales from Air Canada Cargo have touched $1.3 billion in 2022, up from $717 million in 2019. The number of freighters in service is expected to increase from three in 2023 to 12 in 2025, further diversifying its revenue base.
Is Air Canada stock a buy or a hold?
Air Canada is forecast to increase sales by 27.5% to $21.11 billion in 2023. Comparatively, its adjusted earnings per share might improve to $2.48 in 2023 compared to a loss of $2.76 per share in 2022.
Priced at 9.5 times forward earnings, Air Canada stock is quite cheap. But with $8.5 billion in cash and $16 billion in debt, the company is still exposed to interest rate risks. For instance, its interest expense almost doubled from $480 million in 2019 to $896 million in 2022. Its interest expense stood at $240 million in the first quarter of 2023, accounting for 20% of total sales.
Air Canada needs to de-leverage its balance sheet to improve profit margins and regain investor confidence. Analysts remain bullish on Air Canada stock and expect it to surge over 28% in the next 12 months.
