Air Canada vs. Southwest Airlines: Which Stock Is a Better Buy?

Air Canada and Southwest Airlines trade significantly below all-time highs. But which airline stock should you buy right now?

Aditya Raghunath

Aditya Raghunath joined the Motley Fool Canada team in 2019 and has close to seven years of experience in covering publicly-listed companies. With a post-graduate degree in finance, Aditya aims to educate and engage Canadians by writing extensively about growth, dividend, and value stocks. If you are considering investing in the stock market, he recommends reading The Intelligent Investor by Benjamin Graham before taking the plunge.

Published July 24, 2024 8:00 pm EDT

Airline stocks trading in the U.S. and Canada are among the cheapest companies in 2024. Most airline stocks trade significantly below all-time highs due to higher interest rates, a debt-heavy balance sheet, inflation, volatile oil prices, and slower consumer spending.

However, with interest rate cuts on the horizon, there is a chance for beaten-down, undervalued airline stocks to gain pace and stage a rebound in the next 12 months. So, let’s see which airline stock, between Air Canada (TSX: AC) and Southwest Airlines (NYSE: LUV), is a better buy right now.

Is Southwest Airlines stock a good buy?

Valued at US$16 billion by market cap, Southwest Airlines has returned less than 4% in dividend-adjusted gains to shareholders in the past decade. Trading almost 60% below all-time highs, LUV stock has burned massive shareholder wealth since the COVID-19 pandemic.

While Southwest reported record sales of US$6.33 billion in the first quarter (Q1) of 2024, it missed analyst revenue estimates of US$6.42 billion. Its loss per share of US$0.36 was also wider than estimates of US$0.34 per share.

During the Q1 earnings call, Southwest warned investors that Boeing’s aircraft delays will hamper its top-line growth in the near term. For instance, it expects to grow capacity by 4% in 2024, lower than its previous estimates of 6%. Southwest Airlines said it expects to receive just 20 Boeing 737 Max 8 planes, much lower than initial estimates of 46 planes. This will force the airline company to delay retiring older Boeing aircraft.

To shore up profit margins, Southwest has embarked on a cost-saving journey by offering its employees voluntary time off and shutting down operations at some airports.

Wall Street expects Southwest Airlines to report adjusted earnings per share of US$0.72 in 2024, down from US$1.57 per share in 2023. So, priced at 38 times forward earnings, LUV stock trades at a hefty premium to other airline peers.

Out of the 19 analysts covering Southwest Airlines stock, 16 recommend “buy,” and three recommend “hold.” The 12-month average target price for LUV stock is $27.18, which is marginally higher than its current trading price.

Is Air Canada stock undervalued?

After rising over 3,000% in the decade prior to COVID-19, Air Canada stock trades 68% below all-time highs. In the March quarter, Air Canada reported an operating revenue of $5.2 billion, an increase of 7% year over year. Its adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) rose roughly 10% to $453 million, indicating a margin of 8.7%.

A widening earnings base enabled Air Canada to report $1 billion in free cash flow. The Canadian airline giant used its free cash flow to reduce net debt by $786 million to $3.78 billion in the last three months. Air Canada ended Q1 with a net-debt-adjusted EBITDA multiple of 0.9 times, resulting in a credit rating upgrade to “BB” by S&P Global.

In the last four quarters, the company’s free cash flow totalled $2.82 billion. Priced at 2.2 times trailing free cash flow, Air Canada is extremely cheap and trades at a 35% discount to consensus price target estimates.