Although in the current investing environment, several stocks across many different sectors are trading undervalued, some of the cheapest stocks on the market continue to be airline stocks like Air Canada (TSX: AC).
Even airline stocks south of the border have struggled to recover to their pre-pandemic prices, despite an unbelievably quick resurgence in demand for the travel and tourism industry after pandemic restrictions were lifted last year.
Surging inflation and rapidly rising costs were some of the major headwinds airlines faced last year that impacted their profitability. And this year, higher interest rates have made debt more expensive after many airlines loaded up on debt during the pandemic just to stay afloat.
So you may be wondering if airline stocks are a good investment in this environment, whether or not Air Canada stock is the best to buy, or if you should look at other airlines, such as its largest competitor, WestJet.
Is WestJet a better investment than Air Canada stock?
If you’re considering investing in airline stocks due to how unbelievably cheap they look today, the first thing to know is that you can’t buy WestJet stock outright.
WestJet is now owned by Onex (TSX: ONEX), an asset manager with a market cap of more than $6 billion. Therefore, while you can gain exposure to WestJet, you’ll also gain exposure to all of its other investments as well as its asset management business.
Onex could be an excellent stock for your portfolio. However, if you’re looking specifically to capitalize on the recovery potential airline stocks have, Air Canada is a far better investment.
Not only is Onex’s portfolio considerably diversified, but the stock, in general, is nowhere near as cheap as Air Canada’s. Today, Air Canada is trading more than 55% below where it was when the pandemic hit, compared to Onex, which is down just 4.7%.
Therefore, Air Canada is certainly the top stock to buy if you’re betting on a significant recovery in airline stocks over the coming months and quarters.
How cheap is the airliner today?
Today, Air Canada stock is trading below $19 a share which, as I mentioned earlier, is more than 55% below where it was trading at the start of February 2020.
However, despite its stock price being down by more than 50%, from a valuation perspective, Air Canada stock is not quite as cheap.
Just prior to the pandemic, Air Canada traded at a forward enterprise value (EV)-to-(EBITDA) (earnings before interest, taxes, depreciation and amortization) ratio of roughly 4 times. And in the year leading up to the pandemic, it averaged a forward EV/EBITDA ratio of more than 3.6 times.
Therefore, with Air Canada stock trading at a forward EV/EBITDA ratio of just 3.3 times today, while it’s certainly cheap, it’s not as cheap as its share price might make it look.
In order for Air Canada to finally see a rally, its EBITDA is going to have to continue to increase as conditions normalize and the stock’s operations can fully recover.
Furthermore, Air Canada is going to need to pay down a lot of the debt it took on during the pandemic in order to both reduce its balance sheet but also improve its profitability.
So although Air Canada stock is certainly cheap in this environment, it wouldn’t be surprising if it took a bit more time until the share price starts to see a meaningful rally.
