Air Canada (TSX:AC) was among the best-performing TSX stocks in the decade before COVID-19. During that period, Air Canada and its peers enjoyed an elongated period of economic expansion and low interest rates, enabling them to grow earnings and cash flows at a healthy pace.
In 2020, the global airline sector was decimated as countries shut their borders due to the COVID-19 pandemic. As the airline sector is extremely capital intensive, airline companies were forced to increase balance sheet debt to offset their cash burn rates.
While Air Canada stock rose by more than 3,000% between 2010 and 2020, it currently trades 62% below all-time highs, allowing you to buy the dip. Let’s see if Air Canada stock can finally recover in 2024.
The bull case for Air Canada stock
Despite an uncertain macro environment, Air Canada reported record revenue of $21.8 billion in 2023, up 32% year over year, as air travel demand remained strong. Its annual operating income stood at $2.3 billion, compared to a loss of $200 million in 2022. Further, Air Canada’s adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) more than doubled to almost $4 billion.
Air Canada transported 46 million passengers in 2023 as it continued to focus on operational improvements amid headwinds such as inflation and supply chain challenges. A widening profit margin allowed Air Canada to strengthen its balance sheet, reduce debt, and effectively navigate cost pressures.
Air Canada’s total debt rose from $7.1 billion in 2019 to $13 billion in 2021. Currently, it stands at $10.5 billion. Rising interest rates and higher debt have increased Air Canada’s gross interest expense to $944 million in 2023, up from just $515 million in 2019.
Air Canada reported operating cash flow of $4.3 billion and free cash flow of $2.8 billion in 2023, indicating it spent $1.6 billion on capital expenditures. Given its free cash flow, the Canadian airline giant has the flexibility to lower its debt and interest expenses in the near term.
Finally, Air Canada has seen its membership in its loyalty program, Aeroplan, double to eight million in the last five years. An increase in the number of loyalty members should translate to higher engagement rates for Air Canada over time.
Is Air Canada stock undervalued?
Analysts tracking Air Canada stock expect sales to rise by 3.1% year over year to $22.5 billion in 2024. Comparatively, adjusted earnings per share is forecast to narrow to $3.65 in 2024 from $4.56 in 2023.
Priced at 0.3 times forward sales and 5.4 times forward earnings, Air Canada stock is really cheap. Analysts remain bullish on Air Canada and expect shares to gain 40% from current levels.
Air Canada is a debt-heavy company that is struggling with elevated interest expenses and a sluggish macro economy. The cyclical nature of the airline sector makes Air Canada stock a high-risk investment today. However, if interest rates move lower and global economic growth recovers in the next 12 months, Air Canada should deliver outsized gains to shareholders.
