July 12, 2024 10:58 PM

Air Canada: A bargain stock for the contrarian investor?

As borders have closed and passengers have been confined, airline revenues have tumbled. The crisis in the airline industry has caused share prices to crash as investors prepare for the worst. Some airlines, however, have managed to set themselves up on a solid foundation for weathering the crisis. For the contrarian investor, this presents some opportunities to buy at a dramatic discount.

/ Published 4 years ago

This picture show an Air Canada plane.
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Airlines have felt the full brunt of the global health crisis more than most other industries. Amongst those hardest hit, Air Canada (AC.TO) has seen second quarter revenues and passenger volumes tumble to just under 5% of the equivalent 2019 period.

This fall in passenger traffic has been reflected in its share price. Now trading in the $15-17 per share range, it has tumbled 60-70% from the $45-50 range in which it was being traded during the earlier months of this year.

Recent months have seen the price stabilize after the initial crash, which briefly saw the $10 per share level being tested. It now appears that investors have settled on a $16 support level for the time being, with only a brief dip into the $15 range being seen at the beginning of this month.

Even with the recent stability, for the risk averse investor now is not the best time to be buying into Air Canada. There is still a lot of uncertainty over the situation with the COVID-19 pandemic. Even if there is progress being made on the vaccine front, the opening of some borders and a flattening off of the infection rates, the future of the crisis is purely hypothetical.

For the contrarian with a greater appetite for risk, however, buying into Air Canada could be a solid long term play. The company has taken several measures to help it weather an enduring crisis and has also seen its cargo business undergoing rapid growth. Embracing the assumption that air travel will begin to make a recovery in 2021, Air Canada shares are currently trading at a significant discount.

Air travel will make a recovery

The current consensus held amongst airline industry analysts and professionals is that air travel will begin its slow recovery next year. Many estimates for a full recovery predict that 2023 will be the year passenger traffic returns to normal levels, with 2024 being predicted by the more pessimistic. Of course, this is not a certainty and, if a significant worsening of the pandemic were to eventuate, recovery time could blow out by several more years.

This uncertainty over the global evolution of the health crisis has caused investors to be wary, holding down airline stocks as they wait for more certainty. This uncertainty has not been ignored by airlines either, and many have adjusted their strategies to deal with an enduring pandemic.

Measures taken to increase liquidity

Acknowledging the state of the situation, Air Canada has made drastic efforts to free up cash within its business. With $5.1B worth of cash and cash equivalents on its books by the end of Q2 2020, it has increased this figure by approximately 220%, or $3.5B, over the $1.6B being held at the end of the same quarter last year.

They’ve also taken other measures to increase cash flow within the business. Steps taken here include raising $5.5B through new equity offerings, debt and aircraft financing. The end result of these efforts is a current total liquidity of over $9B. This puts it in a strong position to survive an enduring crisis, giving it a cushion to deal with the inevitable cash burn that will eat into profits for several more quarters to come.

Dealing with the cash burn problem

Airlines are not designed to lay dormant, having high operating costs that don’t just disappear by grounding its fleet. Dealing with its cash burn problem, Air Canada has begun to implement several measures to reduce losses.

The first of these measures, already underway, is a reduction in its workforce by 50% in an effort to slash its $700M+ per quarter wage bill. There are also initiatives in place to retire up to 75 of its aircraft (30% of its current fleet), saving ground fees, maintenance and depreciation costs, and is preparing to cancel new aircraft orders if the situation requires it.

With these measures in place, Air Canada is set to reduce its Q2 2020 cash burn of $1.7B down to as low as $1.35B by the end of Q3. While losses should still be expected in the near future, the initiatives to reduce operating costs and increase its liquidity put Air Canada in a good position to come out of the crisis in a strong position.

Air Canada set to make a strong recovery

Prior to the onset of the outbreak of the COVID-19 pandemic, Air Canada had recorded 27 consecutive quarters of year-on-year revenue growth. This is a strong level of achievement for any business, and a particularly impressive one in the fiercely competitive airline sector. Given its track record of success and the strong position it has placed itself in to weather the duration of the crisis, there’s no reason to expect that Air Canada will not make a phenomenal recovery in the next 3-4 years as the crisis situation improves.

This stable position is further bolstered by the sharp uptick seen in their cargo business, with Q2 revenues on this front increasing 52% over Q2 2019, rising from $177M to $269M this year. Further growth should be expected for this side of the business as consumers increasingly depend on online shopping for their retail needs, unless a rapid improvement in the global situation occurs. Of course, were this to happen, Air Canada’s passenger business would be on track to make a quick recovery.

All of this has not yet been reflected in the share price of the company, however. Investors are still toey as they wait for progress on the Coronavirus front and this has suffocated Air Canada’s share price, holding it down at current levels for months, despite its solidifying its position. This presents a fantastic opportunity for the contrarian looking to take advantage of a possible strong recovery by Air Canada, and is one that will disappear the moment any confirmation of a vaccine or a global recovery from the pandemic is released.


(Featured image by Yan Gouger via Wikimedia Commons / CC BY-SA)

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