Investing in top-quality stocks at a lower value than their intrinsic value can be a marvellous way to generate outsized long-term returns. However, finding value stocks in any market can be difficult. That’s because companies are priced based on their forward-looking prospects, with all available information used to discount future cash flows to the present.
For airline stocks, this has meant lower valuations in the near term. But given Air Canada’s (TSX: AC) rock-bottom valuation of only three times earnings, the question has to be whether this valuation makes any sense at all.
Let’s dive into whether Air Canada is a value buy, or a value trap, in this current environment.
Air Canada is cheap for a reason
Air Canada remains Canada’s largest airline, servicing more than 50 million customers every year in collaboration with its regional partners. The company reported revenue of $19 billion in 2019 — a figure that’s since improved drastically following the doldrums of the pandemic. This past year, Air Canada brought in $21.8 billion of operating revenue, roughly quadrupling its results year over year. Travel demand has come back with a vengeance, and Air Canada is clearly winning.
However, it appears to be the case that investors are pricing in some very dark storm clouds on the horizon. Given the issues with 737 jets and airline hesitancy picking up, as well as an indebted consumer, there are certainly headwinds that can take Air Canada’s recent numbers lower in the years to come. The question many are asking is: how much demand has been pulled forward, and what will things look two, three, or five years from now? That’s hard to tell.
Is Air Canada stock a buy?
From earnings and free cash flow perspective, Air Canada’s financial picture appears to be greatly improved. On a cash flow basis, the airline brought in $2.76 billion last year, a big jump from 2022’s number of $1.96 billion.
However, Air Canada’s large debt pile and the state of the Canadian traveller remain uncertain. It’s my view that this is certainly a value stock, but it’s cheap for a reason. In other words, while Air Canada may certainly represent a decent investment today, there aren’t really many catalysts that could lead to a sharp valuation increase aside from a continuation of current results for years to come.
Those looking to make that bet may do so, and I don’t think it’s necessarily a bad move. I just think the market is taking a very cautious view of Air Canada right now for a reason.
