There aren’t very many stocks that are performing poorly this year. Ever since the markets walked off Donald Trump’s April tariff tantrum, it has pretty much been smooth sailing. Markets are once again up, and while some investors are celebrating, others are bemoaning the lack of undervalued stock opportunities.
One space that shows promise for investment today is airlines. Unlike other sectors, airlines are not rallying out of control this year. Instead, they are down for the count. In some cases, they are down by high percentages. In this article, I explore one Canadian airline stock that declined 12.2% yesterday for no good reason, and enjoys strong prospects in the year ahead.
Air Canada
Air Canada (TSX:AC) is Canada’s largest airline, and its only flagship airline. It transports passengers all around Canada, as well as to international destinations. Although AC faces considerable competition from WestJet and regional carriers in domestic routes, it is the only truly international Canadian airline serving lots of international routes. So, it enjoys a very good competitive position when it comes to transporting Canadians to international destinations.
Solid earnings
It’s somewhat surprising that Air Canada’s second quarter earnings release triggered a massive sell-off in the stock, because the release was by some measures ahead of estimates. Headline metrics included:
- Revenue: $5.6 billion in revenue, up 2% year over year (a beat by $78 million).
- Operating income: $418 million.
- Diluted earnings per share (EPS): $0.60 (miss by $0.12).
- Free cash flow: $183 million.
As you can see, the company missed narrowly on earnings, but showed positive revenue growth (2%) and positive free cash flow (it was negative the prior quarter). Additionally, it beat estimates on revenue. So, there were considerable signs of improvement in Air Canada’s second quarter earnings release.
Why Air Canada has been beaten down so much
Air Canada was not only beaten down in the markets yesterday – it has been getting a beating down for several years. In March and April of 2020, the stock tumbled all the way from $54 to $12.50, as the COVID-19 pandemic took much of its business away. With shelter in place orders keeping people stuck at home that year, few had any reason to fly. When the COVID vaccine was announced, AC stock rallied above $20. At that point, it was still deeply unprofitable. Since that time, the company’s stock has fallen to $19.35, despite now being profitable and growing. It’s hard to understand why the stock is still down from its post-COVID-vaccine-announcement level. So, it may be underpriced.
Valuation
Because of the five year beatdown it has suffered, Air Canada stock is very cheap. At today’s prices, it trades at:
- 10 times earnings.
- 0.4 times sales.
- 2.9 times book value.
- 1.9 times operating cash flow.
These are some truly rock bottom multiples. Yet Air Canada is hardly a failing enterprise. Boasting positive revenue growth, positive free cash flow (FCF), and long-term rising earnings, it appears to be thriving! Of course, the company’s fortunes could be impacted by Donald Trump’s trade attacks on Canada, and its FCF could be threatened by the capital expenditures the company is currently undergoing. In the long run, though, it should all work out.
