Naturally, Air Canada (TSX:AC) was hit hard by the pandemic. Today, the airliner’s troubles are plenty, and Air Canada stock can’t seem to achieve lift-off. Why is the stock stuck below $20 while airline travel is at record highs?
For those of you considering buying Air Canada stock, here’s what you need to know before doing so.
Air Canada reported a net loss in Q1
Airline travel continues to be strong, as evidenced by the results of different airliners in the last few months. Air Canada has been no different, achieving record demand in the last couple of quarters and seeing continued strength in advance bookings.
Revenue in the first quarter increased 7% to approximately $5.3 billion. This is good and is a reflection of the continued strong demand that Air Canada is benefiting from. Yet, this strong demand was not enough to lift the airliner’s bottom line out of the red. In fact, Air Canada reported a net loss of $81 million, or $0.27 per share.
Air Canada’s rising costs
A troubling trend that I’ve discussed before is the significant increase in Air Canada’s cost structure. This makes it a fundamentally different business than it was in the pre-pandemic days when Air Canada’s stock was trading above $50.
In the first quarter of 2024, total operating expenses increased 6% compared to last year to $5.2 billion. Most notably, wages, salaries, and benefits expense, which accounted for more than 21% of total expense, increased a whopping 21% to 1.1 billion. This is consistent with what we have been expecting but it does signify a big increase in the fundamental cost structure of the airliner.
Thankfully, aircraft fuel expense declined versus last year as oil prices declined. However, this too has increased significantly over the years, as the price of oil continued to remain strong, between $70 and $80. Again, this represents a big shift in the airliner’s cost structure relative to the pre-pandemic days.
Finally, Air Canada’s cost per available seat mile, or CASM, measures an airliner’s efficiency by dividing operating costs by available seat miles. The lower this number is, the better. In the first quarter, CASM increased 1.6% versus last year and 4% sequentially to $14.76. Importantly, this is more than 20% higher than 2019 pre-pandemic levels.
Debt is falling, and free cash flow is skyrocketing
On the positive side, Air Canada is generating significant amounts of free cash flow. This is helping the company pay down its debt and dramatically improve its balance sheet. In the first quarter, free cash flow came in at $1.05 billion, 7% higher than the same period last year.
As a result of many quarters of strong cash flows, Air Canada’s debt level has decreased dramatically over the last year. In fact, Air Canada’s net debt currently stands at $3.8 billion, 42% lower than last year’s net debt balance of $6.5 billion. This is very important progress, as it lowers the company’s interest expense and risk profile significantly.
Air Canada stock
Finally, let’s take a look at Air Canada’s stock price. As I’ve mentioned, the stock was hit hard in the days of the pandemic. Since then, many investors have been anxiously awaiting a return to Air Canada’s glory days. But, as you can see from Air Canada’s stock price graph below, this has not happened.
The reasons for this include what I’ve already discussed in this article. But there are more reasons beyond this — investors are likely hesitant to believe in the staying power of the strong travel demand. Consumer debt levels are high, the cost of living has risen significantly, and the economy is in a shaky position at best.
In short, the future remains highly uncertain and riddled with risks. Travel is an expensive discretionary expense. It seems highly likely that consumers will have to reduce spending on this expense in the near future.
The bottom line
Air Canada trades at a very low five times this year’s consensus earnings expectation. It’s tempting for me to conclude that the stock is highly undervalued. Instead I think that the company’s earnings estimates are at risk.
