Air Canada (TSX:AC) is one of Bay Street’s most hated stocks. Up just 13% over the last five years and down significantly year to date, it has underperformed the TSX Index over many timeframes.
It wasn’t always like this. If you’d bought the stock at its 2009 lows and sold at its early 2020 highs, you’d have realized a 5,450% return!
The questions are: 1. What has changed so dramatically with Air Canada in such a short period of time? 2. What can the company do about it? In this article, I attempt to answer those questions, ultimately concluding that investors are unjustified in their worries about AC stock.
Trump Tariffs
The biggest concern about Air Canada this year is the lingering impact of Donald Trump’s tariff policy.
Earlier this year, Donald Trump slapped 25% tariffs on many Canadian goods. Later, he increased the tariffs to 35%. These moves inspired Canadians to retaliate in several ways, including only buying Canadian groceries and boycotting travel to the United States. It was that latter move that likely got investors selling AC stock earlier this year. Industry reports claimed that Canada-U.S. travel had fallen as much as 70% by the second quarter. Air Canada denied the claims, saying the decrease was lower. However, its second quarter earnings release confirmed an impact.
The question investors want to ask here is, “Is Air Canada’s loss of Canada-U.S. travel demand really so bad?” In the second quarter, AC beat revenue expectations, with positive year-over-year growth. Earnings were a bit of a sour point, being off the expected amount by a few percentage points. However, the overall picture was pretty good. It looks like Air Canada made up what it lost in Canada-U.S. travel with other destinations.
Lingering COVID concerns
Another thing that might have investors worried about Air Canada stock is lingering fear of COVID-like scenarios emerging in the future. In 2020, Air Canada lost $4.6 billion due to COVID-related air travel disruptions. COVID lockdowns are long gone now, but it’s possible that investors fear similar travel restrictions emerging in the future. This point is quite speculative; I merely point out a possibility, not a confirmed fact here.
Performance
Air Canada has been performing pretty well in recent years. Over the last three- and five-year periods, its revenue has compounded at 25% and 9.5%, respectively. In the trailing 12-month period, the airline had a 6.6% net income margin, a 2.2% free cash flow margin, and a 99% return on equity. Overall, Air Canada is profitable and growing – though its margins are not huge.
Valuation
Last but not least, we should look at Air Canada’s valuation multiples in light of what we explored above. At today’s price, AC stock trades at:
- 9 times earnings.
- 0.29 times sales.
- 3.2 times book value.
- 8.2 times free cash flow (FCF).
These multiples are generally quite low, indicating that AC stock is cheap. The price/FCF multiple is likely to increase due to a massive capital expenditure (CAPEX) spree that Air Canada is undertaking. However, those expenditures will help the company increase its routes and will be complete by the end of 2027. So, by 2028, Air Canada should be earning healthy amounts of FCF yet again.
