Over the past three months, shares of Air Canada (TSE:AC) are up 27% while the one-year change is a whopping 149%
SmallCapPower | September 8, 2017: Aided by strong financial and operating performance, shares of Canada’s largest airline, Air Canada (TSX: AC), have run up sharply over the past year and currently trade at life-time high of $22.65. Over the past three months, shares of Air Canada are up 27% while the one-year change is a whopping 149%. Despite such a large move, valuations of Air Canada look attractive versus its Canadian and U.S. peers. With a robust outlook for 2017 and beyond on a favourable economic environment and growing international exposure, long-term investors could dabble at the stock at current levels.
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Investment Thesis
- Canada’s largest airline that continues to deliver strong operating and financial performance
- International expansion to drive future growth
- Stronger balance sheet and FCFs should support Capex plans
Canada’s largest airline
Headquartered in Montreal, Air Canada is Canada’s largest airline and ranks among the 20 largest airlines globally. The airline along with its Air Canada Express regional partners carried ~45 million passengers, offering direct passenger service to over 200 destinations on six continents. Air Canada has a fleet of 300 mainline and regional aircraft.
Increasing focus on international expansion
Leveraging its extensive and expanding global network along with faster service and lower rates vis-à-vis U.S. airlines, Air Canada continues to focus on selective international expansion. As part of this plan, the Company launched 28 new routes in 2016 and announced more than 20 new routes for 2017, including Toronto-Mumbai, Berlin & Belize; Vancouver-Taipei, Nagoya & Melbourne; Montreal-Shanghai, Algiers, and Marseille & Lima. Over 90% of projected capacity growth going forward is aimed at International markets. Air Canada notes that international traffic offers higher margins as incremental traffic is being flown at a significantly lower cost (B787s, increased seats on B777s, and Air Canada Rouge).
To support its aggressive international expansion, Air Canada is renewing its international fleet with fuel efficient Boeing 787 Dreamliners. The Company plans to operate 30 Boeing 787 Dreamliners by the end of 2017, including 22 larger Boeing 787-9 versions, with all 37 scheduled for delivery by 2019 year end.
In 2Q17, international passenger traffic grew at a much higher rate than domestic traffic. Compared to the domestic growth of 4% to $1.1 billion, U.S. transborder traffic grew 16.3% to $785 million, while TransAtlantic traffic grew 14.3% to $871 million.
Continued strong performance
Riding on an improving economic environment in Canada and overseas along with lower fuel costs, Air Canada continues to deliver strong financial and operating performance. The Company’s revenues increased to $14.7 billion in 2016, up 50% from the 2009 figure of $9.7 billion. EBITDA came in at a record $2.8 billion, or 18.9% of revenues, in 2016, a 1,200 bps increase over 2009.
The strong performance continued into 2Q17, with Air Canada reporting record 2Q17 EBITDAR of $670 million compared to $605 million in 2Q16. Adjusted net income for the quarter was $215 million, or $0.78 per diluted share, compared to $203 million, or $0.72 per diluted share, in the prior-year quarter.
Stronger balance sheet
As part of its plan to improve its balance sheet, Air Canada continues to lower debt and improve leverage ratios. Adjusted net debt at 2Q17 was $6,393 million, a decrease of $697 million from December 31, 2016, reflecting the impact of higher cash and short-term investment balances partly offset by the impact of a higher capitalized operating lease balance and higher long-term debt and finance lease balances. The Company recently completed a $1.25 billion refinancing, resulting in reduced cost of debt and the release of collateral.
Valuation and outlook
Despite a recent sharp run up in the stock price, Air Canada looks attractively valued compared to its Canadian and U.S. peers. As shown in the table below, Air Canada trades at an attractive P/E multiple of 7.46x versus its peer average of 11.0x. In terms of EV/EBITDA multiple too, Air Canada trades at a discount to the peer average. Strong financial and operating performance over the past several years along with robust guidance for 2017 (EBITDAR margin of 15%-18%, ROIC of 12% and FCF of $200-$500 million) and beyond should continue to attract long-term investors.
Source: Factset. *Marketcap of US-based companies in USD
Disclosure: Neither the author nor any of the principals at SmallCapPower, or their family members, own shares in any of the company mentioned above.
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