CA - Air Canada Can Fly High Again

2023-09-25 15:11:10 ET

Summary

• Air Canada stock has underperformed the broader markets with an 8.6% return compared to 14.6%.
• Rising oil prices and increased costs are impacting airline stocks, including Air Canada.
• Despite the underperformance, Air Canada stock is still a buy with the potential for strong gains due to efficient growth and undervaluation.

In 2022, I marked Air Canada stock a buy based on prudent capacity deployment plans. However, since then, the stock has underperformed with an 8.6% return compared to a 14.6% return for the broader markets. While the platform has grown used to analysts creating the impression they only find the big winners and outperformers, I think there should be a place for honest analysis and also highlight which picks did not perform strongly.

While the stock still booked a gain, it is undesired because just putting your money in a tracker would have resulted in better value appreciation. Investment in airlines in my view should only be considered with outsized returns, given the involved risks.

Why Is Air Canada Stock Underperforming?

When trying to figure out why Air Canada stock is down, I observed it was not something specific to the company. What many airlines are currently battling with is that oil prices have started rising again and that will impact the profits. Furthermore, the airlines have increased wages, and combined with higher fuel costs it means the overall costs are going up. That has caused many airline stocks to lose altitude since mid-July. While obviously in a different geographical area and a different model, Ryanair ( RYAAY ) ( RYAOF ) has hinted on demand softening this fall, which also does not help to improve the sentiment for airline stocks. It suggests there is pressure on the unit revenues while the costs are rising, thereby squeezing profits.

Is Air Canada Stock A Buy?

Air Canada stock peaked this year at $19.83 per share, which to me suggests that investors were pulling 2024 earnings in. If that still is what investors are aiming for, the fundamentals and forward projections for Air Canada show a 43% upside, including an 18% undervaluation with 2023 earnings in mind. As a result, I am maintaining my buy rating for the stock, which is in line with the Strong Buy rating from Seeking Alpha Quant and the Buy rating that Wall Street analysts have, putting the upside on 97%.

Hedging Against Fuel With Airplane Purchase

One thing that I like about Air Canada is the fact that the company continues to add to its fleet. The company is adding new fuel-efficient airplanes, including the Boeing 787, Boeing 737 MAX and Airbus A220-300. As oil prices rise, the commitment to order new fuel-efficient airplanes is one that I consider prudent. New airplane deliveries have an impact on the CapEx profile, but I consider it to be a very thoughtful long-term hedge against oil price fluctuations, as new airplanes tend to be 15 to 20 percent more fuel efficient than the airplanes they are replacing. It also allows for fuel-efficient growth of the airline. The recent purchase of 18 Boeing 787-10s that the plane maker announced is testimony to the efficient growth strategy. Air Canada recognizes that contrary to Delta Air Lines, which can buy older aircraft at good price points, it relies more on fuel-efficient jets to build a cost-efficient business.

Conclusion: Air Canada Stock Remains A Buy

While Air Canada stock has underperformed, I believe from a fundamental perspective - and on the condition it will be able to realize analyst expectations - the stock is a buy, probably even stronger than a year ago.

The downward pressure on the stock in recent months has primarily been caused by industry-wide concerns dragging the stock down. That is also the biggest risk I see for the stock. While the upside is evident, changes in investing sentiment and in the airline industry at all times can pressure the stock. Despite this, Air Canada stock remains a buy as the company focuses on efficient growth and its median valuation is significantly lower than the industry median, providing potential for even stronger gains than currently projected.

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