Air Canada (TSX:AC) has continued to drift lower this year as rising costs and investor skepticism continue to put pressure on its stock price. At face value, Air Canada stock looks very appealing, trading at a ridiculously low five times earnings.
Are investors missing something, or is Air Canada stock really that bad of an investment?
Air Canada’s costs and ticket prices rising
The first concern that I think investors have with regard to Air Canada is rising costs. This has been the trend in the last few years — one that has elevated the airliner’s cost structure significantly.
For example, 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.
Also, with oil prices remaining above $80, Air Canada’s biggest expense line is significantly higher than it was before the pandemic. This represents another big shift higher in the airliner’s cost structure relative to the pre-pandemic days.
Finally, Air Canada’s cost per available seat mile, or CASM, is more than 20% higher than pre-pandemic 2019 levels. CASM measures an airliner’s efficiency and is calculated by dividing operating costs by available seat miles.
In short, things are getting more and more expensive, and as a result, ticket prices are rising. So, the situation is bad on both ends, as rising ticket prices will eventually hit demand.
Air travel is at record highs, but can this be sustained?
Travel demand after the pandemic was favourably impacted by pent-up demand. As things returned to normal, air travel spiked as people booked their long-awaited travel plans. But today, even after this pent-up demand has been worked through the system, demand remains at record-breaking levels. In fact, Air Canada saw record demand in the last couple of quarters, as well as continued strength in advance bookings.
As is the case for many companies, immigration is a growth tailwind for Air Canada. I think that we cannot underestimate the impact that this increase in the population has on businesses. In Air Canada’s case, this fact has not gone unnoticed. As a result, the airliner is making strategic investments to capitalize on this, and will invest significantly in its fleet to support the company’s international travel growth.
This additional capacity will be costly, but it will be a driver of growth in the next few years. For example, Canada has seen a big influx of immigration from India in the last few years. This has motivated Air Canada’s plans for additional capacity deployments in Southeast Asia and North Africa.
The state of the consumer and its effect on Air Canada
Finally, I would like to spend some time discussing the state of the consumer. As we know, inflation and higher interest rates have pressured consumers. While the consumer has been more resilient than I would have expected, I think this remains a real issue/risk. The longer the cost of living remains at these higher levels, the more the pressure will build.
We are already seeing downward pressure on consumer spending, with discretionary spending being the first to fall. Travel is part of the discretionary spending pie. As such, I would expect that, in aggregate, this spending will fall. If and when this happens, the record travel demand will subside.
The bottom line
Air Canada’s stock price has continued to struggle to make a comeback. While the pandemic is over, the airliner is not the same as it used to be. It faces a higher cost structure and a consumer that is increasingly strapped for cash. Something has got to give.
As a result, I would stay away from Air Canada stock at this time.
