As a flag carrier of Canada, Air Canada (ACDVF) is willing to do whatever it takes to survive the pandemic. While several Latin American airlines have already declared bankruptcies and there’s a strong indication that some US companies will also go under, Air Canada has all the chances to recover once the pandemic is over. By laying off 20,000 of its 38,000 employees, the airline will be able to decrease its expenditures and preserve more liquidity. With C$7.5 billion in cash at the end of April and a relatively low debt burden, Air Canada’s recovery is a matter of time. The problem is that it will take years for travel and air traffic to return to pre-COVID-19 levels. While Q1 results were disappointing, as revenues were down 16% Y/Y, Q2 results will be even worse. As a result, Air Canada stock will likely be trading in a distressed territory for quite a while, until there’s a strong indication that its business is on track to recovery.
A Long Road to Recovery
Unlike other international flag carriers, Air Canada was better prepared to face this pandemic. When COVID-19 started to spread outside of China, the airline already had a strong balance sheet, which will help it to survive in this turbulent environment. When the global recession hit the Canadian economy a decade ago, the airline was in a worse financial condition than it is today. Since 2009, the major goal of Air Canada’s CEO Calin Rovinescu was to decrease the airline’s debt burden and quickly replace its old fleet. Under his leadership, Air Canada became one of the top 20 largest airlines around the globe with a fleet of more than 400 planes, and at the end of April, it had C$7.5 billion in cash and cash equivalents.
Like all the other airlines, Air Canada disappointed its investors in Q1, as its revenues were down 16%, while non-GAAP EPS were -C$1.49. With an EV/EBITDA of 4.24x, Air Canada trades close to its airline peers, as the industry’s median EV/EBITDA is 6.24x. At the same time, its operating and net margins are not as good in comparison to its North American peers.
Source: Capital IQ
Nevertheless, Air Canada is in a strong position to weather the current storm. According to the company, it will have around C$6.3 billion in cash at the end of Q2. As traffic slowly rebounds, it will be able to decrease its daily cash burn and minimize its losses for the time being. Air Canada already diluted its shareholders and injected more liquidity via a debt offering, and it should have enough cash for now to outlive the pandemic.
By being a flag carrier, it’s also very unlikely that Air Canada will go bust. While the airline is not interested in the bailout, it will most likely use the wage subsidy program in the upcoming quarters. The program states that the government of Canada will provide a 75% wage subsidy to all companies that lost more than 30% of their revenues. Considering that 70% of Air Canada’s revenue comes from international markets, the decline of its revenues in the current quarter will be even more than 30% and the airline will be eligible for the program. At the same time, by laying off 20,000 of its 38,000 employees and asking for a tax forbearance, Air Canada will be able to drastically cut its overall expenses in the upcoming months. Without fuel hedges, the airline will also benefit from the current low oil price environment, as the price for jet fuel is currently down more than 50% Y/Y.
There was also news that Air Canada could apply for the loan package program that Canada will soon offer to companies with over C$300 million in revenue. However, it’s unlikely that the management will decide to take a loan from the government, as it will make the stock an unattractive investment for the next couple of years. We believe that the application for the loan should be used only as a measure of last resort, since it will dilute all of the shareholders even more and forbid the airline from issuing any dividends in the foreseeable future.
With enough liquidity to survive the pandemic on its own, Air Canada’s long-term prospects look bright. However, several challenges make it hard to justify investing in the company even at the current price. Considering the uncertainty surrounding the reopening of different countries, it’s very unlikely that international traffic, which accounts for 70% of the overall revenues, will recover anytime soon. In its latest earnings call, company management said that it will take several years for the traffic to return to its pre-COVID-19 levels. At the same time, airlines like Air France-KLM (OTCPK:AFRAF) and IAG (OTCPK:ICAGY) share similar views and believe that in 2020 the traffic for the year will be down 50% to 80% Y/Y. Without full-year guidance, we believe that Air Canada stock will continue to trade in a distressed territory in the next couple of months until Q2 results are released. While in Q3 and Q4 the business should slowly recover on a quarter to quarter basis, it will still take a while for Air Canada stock to return to its January levels.
Considering the ongoing injection of liquidity into the markets, the airline industry will be one of the biggest laggards of the current recovery. As S&P 500 Index is on its way to set a new all-time high, Air Canada and all of its peers face too many issues that are outside of their control and, as a result, we believe that their stocks are unattractive even at the current prices. For that reason, we decided to avoid Air Canada, even though it will survive this pandemic, and focus on better opportunities with a much more favorable risk/reward ratio.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.