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Air Canada Stock Slipped 7% After Earnings: Is it a Deal — or Danger?

Plane on runway, aircraft
Image source: Getty Images.

Written by Puja Tayal at The Motley Fool Canada

Air Canada (TSX:AC) stock fell 6.5% after the airline released a stellar 2023 earnings. Everything from revenue to profits to free cash flow showed strong growth, while its net debt was reduced significantly. Air Canada chief executive officer Michael Rousseau called 2023 “a very successful year,” as the airline fully recovered from the pandemic loss and became profitable again. While the fundamentals were strong, the stock continued to trade at the pandemic level of around $18. Why so? Is it a good time to buy the stock? Let’s find out.

Air Canada’s 2023 earnings highlights 

  • Operating revenue surged 31.8% to $21.83 million as the airline increased its number of international flights and hiked fares, particularly for routes that crossed the Atlantic and Pacific oceans.

  • It turned its 2022 net loss of $1.7 billion into a net profit of $2.27 billion as easing fuel prices and higher airfare offset an increase in salaries.

  • Air Canada reduced its leverage ratio to 1.1 from 5.1 a year ago as it repaid $2.9 billion in debt and increased its adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) by 170% to $3.98 billion.

  • Lower debt and higher profits increased its free cash flow by 2.5 times to $2.75 billion.

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Air Canada expects to see strong demand for international flights and moderate demand for domestic flights. All these fundamentals suggest that Air Canada is back in business and is ready for growth. It has also increased its liquidity to $10.3 billion to withstand any macro crisis.

When everything is going well for Air Canada, why did the stock fall?

Why did Air Canada’s stock plunge 6.5% post-earnings? 

The biggest challenge for airlines is maintaining cost efficiency. Running an airline is expensive. Fuel and wages make up for almost half of the operating expenses. AC’s salary expense increased by 21% as it hiked wages and added 3,200 employees. And this will increase further as it is negotiating a wage hike with nearly 5,300 pilots. The industry is highly competitive. Its North American counterparts increased pilot wages by 34-50%. Then, the airline is increasing its fees, and changes in customer compensation rules will add to the cost.

If you join the dots, the cost angle doesn’t seem attractive for Air Canada. Yet, the airline forecasts the cost per available seat to surge only 2.5%-4.5% in 2024 from 4.1% in 2023. Despite rising costs, it expects to maintain its 2024 adjusted EBITDA at the 2023 level, hinting that it will pass on the higher costs to customers through higher fares.

Looking at the current market environment, Air Canada is being cautious with capacity expansion while other airlines are expanding rapidly. It aims to boost flight capacity by 6-8%, lower than the analysts’ estimate of 10%. It is a wise decision on the part of Air Canada’s management. Most of the time, airlines suffer from overcapacity, which leads to losses. Air Canada has shown a remarkable recovery from the pandemic, and it continues to prioritize efficiency.

Should you consider buying the stock now? 

2024 could be a weak year for the stock as it absorbs the high cost. However, the airline stock could see seasonal growth mid-year as the demand element remains strong. On the valuation front, the stock is trading at 5.8 times its forward earnings per share at $18. This valuation is higher than its American counterparts, trading around 4.3-5.0 times. This is because Air Canada dilutes shareholder earnings by raising equity capital during the pandemic.

The $18 price point is still an attractive buying proposition, as you could see AC stock rise to $22-$24 in the seasonal rally. But it will take a little longer for Air Canada to break its upper range of $26 due to equity dilution. It is a good stock for the short term. But if you are looking for a long-term growth opportunity within the aerospace sector, Bombardier is a good stock to buy and hold, as it is steadily growing profits and free cash flow.

The post Air Canada Stock Slipped 7% After Earnings: Is it a Deal — or Danger? appeared first on The Motley Fool Canada.

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Fool contributor Puja Tayal has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

2024