An Air Canada jet takes off from Trudeau Airport in Montreal, June 30, 2022. A sector-wide slump implies that soaring borrowing costs are stirring fears of a dramatic slowdown in consumer spending.Graham Hughes/The Canadian Press
Air Canada AC-T is generating strong profit growth amid surging demand from travel-hungry customers. But the stock is in a steep nosedive, suggesting that investors are growing increasingly worried about the future.
The share price fell to $16.50 on Monday – before gaining some ground on Tuesday to close at $16.73 – after the airline reported upbeat third-quarter financial results. It generated net income of $1.25-billion for the period ended Sept. 30, up from a loss of $508-million in the same period last year, yet the share price has slumped about 36 per cent since July alone.
The airline’s top executive couldn’t resist pointing out during a conference call with analysts that Air Canada’s stock appears out of line with its financial performance.
“Interesting to note that our equity value as of Oct. 20 has declined 12 per cent versus the same day in 2022 and is about 50 per cent of the same day in 2019,” Michael Rousseau, chief executive officer at Air Canada, said during the call.
To his point, the share price is close to its 2020 lows, when airlines faced enormous losses because of severe COVID-19 travel restrictions.
Air Canada has plenty of company in its current doldrums. The U.S. Global Jets Index, which includes American Airlines Group Inc., Delta Air Lines Inc., Southwest Airlines Co. and others, is down 32 per cent since July.
This sector-wide slump implies that soaring borrowing costs are stirring fears of a dramatic slowdown in consumer spending. Since mid-July, the yield on the 10-year U.S. Treasury bond – which underpins mortgages and other lending activities – has risen from about 3.8 per cent to a multiyear high of about 5 per cent last week.
These higher borrowing costs are affecting other economic readings. The U.S. Conference Board reported on Tuesday that its expectations index, which is an element of overall consumer confidence, remains at low levels that historically signal a recession within 12 months.
In Canada, gross domestic product showed no growth in August, falling short of economists’ estimates and signalling that activity may have contracted in the third quarter of this year.
For airlines, which are ultrasensitive to pullbacks in consumer and corporate spending, these latest economic indicators are bad news.
They also follow other headwinds that are gathering force. Pilot unions have been scoring big wage increases – 24 per cent over four years in the case of WestJet; 46 per cent in the case of American Airlines – putting pressure on expenses.
Jet fuel prices, though down from this time last year, are well above their recent lows in May. The World Bank warned this week that a disruption to oil output from a wider Middle East conflict could cause the price of crude oil to soar as much as 75 per cent, no doubt affecting jet fuel.
Air Canada believes it can get through these challenges. It has hedged 40 per cent of its exposure to fuel in the fourth quarter, leaving it less vulnerable to price increases. It has reduced its net debt by $2.1-billion since the start of 2023, winning a credit upgrade from Moody’s Canada in early October and giving it greater financial flexibility.
And executives believe that flying remains a priority for consumers as they spend more money on activities and services, rather than products.
“In terms of demand, it’s quite stable,” Mark Galardo, Air Canada’s head of network planning, said during a call with analysts.
If this operating environment persists, Air Canada’s stock could be a bargain. According to Konark Gupta, an analyst at Bank of Nova Scotia, the stock’s low valuation puts it in deep value territory.
He compares enterprise value (the total value of Air Canada, including debt) with estimated 2024 EBITDA (earnings before interest, taxes, depreciation and amortization) to get an EV/EBITDA ratio of 2.8.
That’s below the valuation trough seen before the COVID-19 pandemic, Mr. Gupta said in a note. He thinks a ratio of 3.75 is more reasonable, which leaves him expecting that the share price could rebound to $29 within a year.
The bearish case for the stock rests on the economy sliding into a recession. The bullish case, though, rests on the share price already reflecting grim days ahead.