Air Canada (TSX:AC) stock has been underperforming the TSX Composite for quite some time. Since January 17, 2020, AC stock has fallen 60.5% in price, while the TSX Index has risen 24.74% plus dividends. It has been a period of marked underperformance for Canada’s flagship airline.
Curiously enough, the company’s actual performance has not been so bad in this four-year timeframe. 2023 revenue was $20.327 billion, up 13.2% from 2019, the last full year that Air Canada reported before the COVID-19 pandemic hit. Its net income increased 54% in the same period, while free cash flow declined only slightly. On the whole, it appears that Air Canada, as a business, has fully recovered from the damage it took from the COVID-19 pandemic.
An interesting fact about Air Canada is that its stock price largely hasn’t recovered to its pre-COVID levels. It is up some 65% from its March 2020 low ($12.15), but it still hasn’t gotten anywhere to its pre-COVID high. As mentioned previously, AC’s revenue and earnings have surpassed their 2019 levels, but free cash flow remains down a little bit. Perhaps it is not warranted for AC to re-take its all-time highs just yet, but it should at least be higher than the level it was at in early 2019 ($30) when 2018 was the last full year reported. AC’s revenue, earnings, and yes, even free cash flow are all up massively from 2018.
If Air Canada stock was valued correctly in early 2019, then its shares are undervalued today. In this article, I will explore several factors investors need to consider before deciding whether this apparent valuation discrepancy is something they want to invest in.
The background story
The reason why Air Canada stock got beaten down in 2020 is because the COVID-19 pandemic practically destroyed its business. International routes were cancelled, inter-provincial travel was heavily discouraged, and people just generally stayed home. It was not a formula for big revenue gains at airlines. It should come as no surprise that airline stocks performed poorly in 2020. From the top to the bottom that year, Air Canada declined 72% in price.
Recent earnings
It was understandable that Air Canada’s stock plummeted in 2020. The pandemic was seemingly obliterating the business, and at the time, nobody knew how long the restrictions would last. I avoided Air Canada stock all that year for these reasons. However, by 2022, it was clear that Air Canada stock was recovering. By 2023, the recovery was obvious. That year, the company delivered the following:
- $21.8 billion in revenue, up 32%
- $2.2 billion in operating income, up from -$200 million
- $2.2 billion in net income, up from -$1.7 billion
- $5.96 in diluted earnings per share (EPS), up from -$4.75
For comparison, in 2019, the last full year before the COVID-19 pandemic hit, AC did
- $19.19 billion in revenue;
- $1.65 billion in operating income; and
- $47 million in net income.
Overall, 2023 earnings were much better than 2019 earnings, yet Air Canada’s stock is still down from its late 2019/early 2020 levels.
Valuation
As you might expect, Air Canada’s business/stock price discrepancy has produced a rather cheap valuation. At Monday’s closing prices, Air Canada traded at the following:
- 3.3 times earnings
- 0.33 times sales
- Nine times book value
- 1.66 times operating cash flow
It’s shockingly cheap. On the whole, I would be comfortable earning Air Canada stock today. Higher jet fuel prices are a concern, but they will not produce a 2020-style disaster. It is unlikely that Air Canada will keep underperforming the TSX forever.
