Revised Guidance Lifted Air Canada Stock but the Carrier Still Appears Undervalued

Any assessment of an airline stock, like Air Canada (CA:AC), must begin with two external factors: demand and fuel costs.

So when Canada’s leading airline updated its 2023 guidance on May 4, news that it expects higher adjusted EBITDA (earnings before interest, taxes, depreciation and amortization), increased traffic, and lower operating costs, should pique investor interest.

It did.

In the days leading up to the revised guidance after last Thursday’s close, AC stock was down on the week. On Friday, it finished up 11.6% on the good news. And it’s started off the week in the green, up a further 2.7%.

In fact, the flag carrier’s shares are up 9.9% year-to-date, outpacing air carrier exchange-traded fund US Global Jets ETF (US:JETS), which is up 7.1% in the same time frame.

Yet, despite these gains, Air Canada stock appears undervalued.

$1 Billion Earnings Bump

“The revised guidance for adjusted EBITDA reflects expected earnings resulting from an improvement in traffic and yield from a stronger-than-anticipated demand environment and lower-than expected fuel price,” stated the carrier’s press release.

The announcement boosted its adjusted EBITDA by $1 billion from $2.75 billion at the midpoint of its guidance to $3.75 billion. In 2022, its full-year adjusted EBITDA was $1.46 billion. (All figures in Canadian dollars, unless otherwise specified.)

Based on its current market cap, it’s trading at 5.0x its 2022 results and 2.0x its 2023 estimate. When Air Canada hit its all-time high of $52.71 in mid-January 2020, investors valued the company at 11.9x EBITDA. Over the past five years, it traded at an average of 14.3x EBITDA.

So, it’s cheap historically, and business is set to pick up over the remainder of 2023. Investors will know more when it reports first-quarter results on May 12.

Several analysts made changes to their Air Canada 12-month price targets on Friday.

CIBC upped its price target by $1 to $31, 52% higher than its May 5 closing price of $20.46. Other firms boosted expectations, with BMO Capital Markets’ target hiked to $33 from $29, Royal Bank to $22 from $20, and ATB Capital is now the highest in the group — to $38 from $31, or 86% higher than Friday’s closing price.

Of the 15 analysts covering Air Canada’s stock, 13 rate it ‘buy’ or ‘overweight’, with a median target price of $29.50. The remaining two analysts rate it as ‘hold’.

They’re Flying Again

Veteran portfolio manager John Zechner appeared on BNN Bloomberg on May 5 to discuss why he believes Air Canada provides investors an excellent buying opportunity at current prices.

“Air Canada did the smart thing as well in the downturn. They restructured, took out capacity when no one was flying; they did what they needed to do to bring costs in line, refinance the balance sheet and everything else so they’d be prepared when the skies opened up again,” Zechner stated.

He also pointed out that the competition has lessened in Canada. However, at the same time, demand has increased, providing the company with a significant opportunity to generate significantly higher profits without too much difficulty.

“They will price as high as they can without losing business. They still have that high load factor right now. So when you do that, and you don’t have a lot of empty seats, you can stick with the higher prices there.”

As we approach the summer, the biggest risk to Air Canada and all the other Canadian airlines is whether they’ll have enough labor to deal with the additional demand from passengers.

While Air Canada and WestJet say they are ready for this summer’s increase in traffic, others aren’t so sure.

“‘Everybody’s having trouble getting pilots,’ said David Gillen, transportation business professor at the University of British Columbia. The shortage will make it impossible for some airlines to fulfill their schedules and expand, he said,” The Globe and Mail reported.

This article originally appeared on Fintel

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