ACDVF - Air Canada: Q1 Preview

2023-04-26 04:53:04 ET

Summary

• Air Canada is readying its Q1 earnings release for May 12, before market open.
• The stock has been mostly flat for the past 6 weeks, as investors have digested macro and industry earnings that have been mixed.
• Key things to look for in the upcoming earnings release include demand for summer travel/bookings and how the cost structure looks throughout 2023.
• Canada has lagged the U.S. in passenger arrivals via airports, as the U.S. has bounced back to 2019 levels. Longer COVID restrictions may have played a part, along with larger cuts to service from the top carriers (notably Air Canada and WestJet).
• All signs still point to consumers prioritizing travel, and an entry point in the high teens on the stock is worth a closer look. I reiterate my buy rating at a $30 price point over a 12-18 month term.

Introduction

Air Canada ( AC:CA ) is scheduled to release Q1 FY2023 earnings on May 12, 2023 ahead of market open. The company saw revenues increase dramatically last year, as restrictions started to abate nationally, and consumers used pent up savings to travel both domestically and abroad. Ahead of the earnings, I forecast a share price of $30 over a 12-18 month time frame, in line with my previous review two months ago. The company remains the leader in consumer aviation in Canada and is primed to rebound if travel demand remains elevated. This review showcases company and industry developments to keep an eye on heading into earnings season. Some key metrics to watch include upcoming inflation data, consumer spending on discretionary travel, reviewing recent earnings from leading U.S. carriers and linking different patterns on consumer spending can give us an idea of how the quarter may turn out. Bay Street analysts are mixed, with 3 analysts recently revising estimates in the past 90 days, ahead of not only earnings, but a more fulsome update of summer travel trends.

Will Demand Continue to Outstrip Supply

As COVID restrictions subsided in Canada throughout 2022, AC:CA revenues started to rebound quickly. Demand saw a bounce back after lockdowns, and many North American consumers indicated that they intend to increase their travel budget in 2023, which is double of home improvement spending. However, amid high inflation, and with many economists forecasting a slowdown , travel spending is usually one of the first discretionary items to be cut. Summer travel bookings will be a key metric to look for as a gauge to see if consumers are still willing to fly. Domestic flight prices are up 16% from last year in Canada and up 17% in the U.S. as of March.

U.S. competitors Delta Air Lines ( DAL ) and United Airlines ( UAL ) posted earnings that foreshadow strong summer demand, highlighted by UAL seeing revenue per available seat mile ((ASM)) rising 22% from a year ago. UAL is now guiding to Q2/23 ASM up ~19% Y/Y, revenue up 14-16% Y/Y, and reiterated its 2023 EPS guidance of ~US$10-US$12 versus consensus at the time of US$8.43. Delta also posted similar results, and expects ASM up 17% Y/Y. With AC:CA code sharing with UAL as Star Alliance partners, they are likely a good comparison for to review for the summer season. In terms of market share of flights run between Canada and the U.S., AC:CA has not ceded ground to new low cost carriers. AC:CA has continued to dominate the Transborder routes, while WestJet ( ONEX ), a key competitor, has seen share slide. If AC:CA can post numbers in line with US peers, and continue to grow market share on high margin routes, airline travel across the continent will likely remain strong throughout the summer and signals strength for AC:CA.

Another potential tailwind for AC:CA is the slower bounce back of air travel in Canada. While the U.S. saw passenger travel from Jan. 1-Apr. 15, 2023 eclipse the same dates in 2019 by ~500K passengers (0.2%), Canada was still lagging with just a 92.1% recovery rate, below estimates of 97% . In theory, this gives Canadian airlines more buffer to recover in time for the summer. Toronto had one of the strictest lockdowns in the Western world, which means that spending patterns may not perfectly match Americans, who have been able to travel for longer periods. Additionally, the strength of Canadian consumer may provide shock absorption in an upcoming recession. Canadian personal savings rates still remain above historical levels, while international travel spending in Canada also increased in the last quarter of 2022. If these trends can hold, both spell key tailwinds for consumers ability to spend on travel.

Meeting and exceeding expectations will also be critical to bust out of the stagnant trend the stock has seen recently. AC:CA last provided detailed guidance in February in their Q4 earnings release and if they can hit and exceed these goals, the stock has room to run. Hitting the high end of the $2.5-$3Bn adjusted EBITDA range and seeing ASM hit close to 95% would both be key catalysts to send the stock soaring. Costs will likely rise, as labor and oil prices remain sticky across the industry. The company also forecasts a leverage ratio of 1.5x by the end of 2024, so meaningful strides to cut the net debt is another area to closely watch, after a jump of $542MM in net debt in 2022. Other small items to watch include Aeroplan's penetration both in terms of more customers and more partnerships, and fleet updates, as large orders.

Model Shows Upside

AC:CA has seen their share price stagnate over the past couple months, as airline peers have announced mixed results and investors wait for the Fed to pause rate hikes. The company's cash position of almost $8Bn provides sufficient liquidity to fund current growth plans. The model forecasts a current WACC of 8.5%. The weighted average cost of debt of 5.3% and a net debt to EBITDA ratio of 5.1 sting, but a continued focus on cleaning the balance sheet should pay dividends later this year.

I forecast the continuing value of $14.3Bn, given a 19% revenue increase this year and blended revenue growth of ~7% for three years as choppy growth eventually flatlines. I anticipate adjusted EBIDTA next year to hit $2.44Bn, just below the guided range of $2.5Bn-$3Bn. I see margins holding steady into the end of the year and hold other cost ratios mostly in line with guidance. I see the load factor increasing over time toward 83%, and available seat miles to hit 93% of 2019 figures. Coupled with a terminal WACC above 8% and a terminal revenue growth rate of 2.1%, a $30 share price (see below) can be supported by fundamentals, but the stock will be volatile.

Conclusion

AC:CA remains the leader in the Canadian airline industry and is worth a buy at these levels ahead of Q1 earnings release on May 12, 2023. The company sports robust operations and continues to expand its service ahead of the summer travel season. Management has consistently delivered impressive returns on capital and the company has a history of strong CASM rates compared to top competitors . Despite the potential risk posed by fluctuating global oil prices, AC:CA has a promising future as there is still a high demand both domestically and internationally. Keep an eye on upcoming indicators on consumer savings strength, booking demand, CATSA passenger data, and results compared to prior forecasts. I anticipate a rebound in the stock price to approximately $30 within the next 12-18 months.

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