Air Canada (TSX:AC) stock has been taking a beating in recent years. In 2020, in the early months of the COVID-19 pandemic, the stock fell all the way from $54 to $12, as the travel restrictions in that period caused the company’s revenue to decline 80%. The company’s stock later rallied when the first COVID vaccine was announced, but subsequently gave up the gains for reasons that are less clear.
Today, Air Canada is in a much better place than it was in 2020. It’s profitable. It has repaid much of its debt. Its revenue has recovered to its pre-COVID level and then some. Nevertheless, at around $19, AC stock is still nowhere near its pre-COVID stock price. What’s going on here?
There are a few lingering issues for Air Canada that have investors worrying about the stock, even though the underlying company is in a much better place than it was before the crash. The question is, why the apparent discrepancy? In this article, I will explore the reasons why Air Canada stock is still at a relatively low level and why I think it will be at a higher one in five years’ time.
Source: Getty Images
Capital expenditures
One reason why some investors are concerned about Air Canada is because of the large amounts of capital expenditures (CAPEX) the company is undertaking in the next three years. CAPEX refers to spending on fixed assets like property, plant and equipment. In the case of an airline, it mainly refers to spending on new aircraft.
Air Canada expects $3.4 billion in CAPEX in 2025, $4.3 billion in 2026, and $4.9 billion in 2027. After 2027, the CAPEX spend is expected to decline.
The amounts of CAPEX above are fairly large. Notably, they exceed the company’s past amounts of free cash flow, seeming to imply that Air Canada will be cash flow negative in the years ahead.
Is this CAPEX such a big risk for Air Canada?
In my opinion, no. Airplanes tend to be in service for decades, meaning that a lot of CAPEX now does not mean a lot of CAPEX in the future. Also, Air Canada’s revenue has far surpassed levels seen in past years, so unprecedented CAPEX does not necessarily mean chronic cash burn. Overall, I don’t think Air Canada’s CAPEX is going to ruin the company.
Trump tariffs
Another reason why people are concerned about Air Canada is because of Donald Trump’s trade wars. Earlier this year, Trump slapped a 25% tariff on Canada, ostensibly to counter the flow of fentanyl into the United States. In response, many Canadians pledged to cancel vacations to the United States. Later, data collection firms reported that Canada-U.S. air travel did decline — one story claimed by as much as 70%. Air Canada said that it saw an impact but denied that its U.S. travel hours went down by 70%.
Again, this strikes me as not that big of a risk. Canadians are most likely replacing U.S. travel with inter-provincial travel and overseas travel. Air Canada’s most recent earnings release confirms this: revenue was stable year-over-year, and free cash flow was positive. On the whole, Air Canada looks like a bargain at 8.8 times earnings and 1.6 times operating cash flow. I think it will be worth more in five years’ time than it is today.
