Jun 25, 2021
[7 min Read]
In my analysis today, I will be discussing Air Canada and why I think it's severely undervalued at its current trading price. I will be bringing up financial information taken from their 10K and most recent 10Q, as well as 2 investment theses' pertaining to their economic factors.
If you enjoy my analysis on AC, look at the rest of my portfolio and analyses here and give me a follow to be updated on my next one!
Air Canada (TSX: AC) is the largest provider of scheduled passenger services in the Canadian market, the Canada-US transborder market and in the international market to and from Canada. It offers scheduled passenger services under the Air Canada Vacations and Air Canada Rouge brand name and provides air cargo services under Air Canada Cargo.
COVID-19 Mitigation and Recovery Plan
Revenues - Total revenues FY2020 was $5.9M representing a 70% decrease from the previous year primarily due to the system-wide negative impact of the pandemic, including government-regulated travel restrictions. Of total revenues, passenger revenues accounted for 75.1%, cargo revenues accounted for 15.8% and 9.1% was from others. FY2019, prior to the pandemic, 90.1% of total revenue was from passenger-related, 3.7% was cargo, and 6.2% was other. The change in each operating YoY was -75%, +28% and -55%, respectively.
Expenses - FY2020, operation expenses decrease by $7.9M or 45% from 2019 that was significantly made from managing variable costs and reducing fixed expenses
Cash and Cash Equivalents - With their cash and cash equivalents sitting at $7.5M as of the annual report, and most recently $6.0M from their 1Q2021, I think that their cash position will sustain them for the remaining of this year if revenues continue to be low and stagnant.
The household saving rate in Canada increased to 13.1% in the 1Q2021 from 12.7% in 4Q2020 and had a high 10 year high of 28.2% in 3Q2020 (Refer to picture). Further analysis revealed that Canadians saved approx. 5 times more of their disposable income (DI) in 2020 compared to 2019 and translates to estimates of $2,701 in just one quarter of 2020 compared to $296 for a quarter in 2019. This increased DI comes from government COVID-19 support programs such as Emergency Wage Subsidy and Canada's Recovery Benefit which are expected to end later this year. These elevated savings can lead to pent-up spending due to the increased consumer purchasing power on goods such as international travel.
But how much is DI really spent on travelling? Well, a study from the U.S Travel Association reports that travel and tourism was the second most popular choice for DI- despite this being a U.S stat, it's not hard to say that Canada may be similar. To sum it up increased savings = increased DI = increased purchasing power = (potentially) increased travelling
With Canada easing up on some travel restrictions as vaccination numbers increase, Canadians may be more willing to travel- whether that's domestically or internationally. A key change coming into effect in early July is that Canada will be lifting most international travel restrictions for Canadians and permanent residents who are fully vaccinated and therefore allowing them to travel with more ease. This includes non-essential reason travel and no costly government-authorized hotel quarantine.
With over 20% fully vaccinated, the government is setting its sights on getting 75% fully vaccinated where we can then see more loosened safety measures at borders. At this 75% mark, Canada will also begin welcoming fully vaccinated tourists that can boost AC's revenues since AC also operates as a large provider of flights coming to Canada.
Air Canada has a significant amount of financial leverage, and there is no certainty that the company will be able to satisfy its debt, lease, and other obligations. AC's high financial leverage can incur greater levels of debt than current levels. Prior to and during COVID-19, AC has been focusing on reducing debt levels and improving leverage ratios, but this can continue to be a problem and have a significant impact on their future operating performance and refinancing.
Beyond the upcoming year, if revenues from operating activities don't increase, AC might not be able to obtain sufficient funds in a timely way to provide adequate liquidity and to finance necessary operating and capex. AC's liquidity levels are impacted by many factors, and an effort to put forth their business strategy requires a lot of liquidity and ongoing operating capex. The decreased demand thus far from the pandemic has already had a significant impact on AC's business.
Increased fuel prices will have a negative impact on AC's business and operations due to increased expenses. Fuel costs are one of AC's largest operating cost and given fluctuations in the price of fuel and the competitive nature of the airline industry, AC may not be able to pass the increased fuel prices to its customers by increased passenger fares without losing customer loyalty or customers in general to another airline business.
At its current trading price, I think it's trading at a discount and can present significant upside. Given that their share price is primarily due to their business operation and financial performance, I believe that as travel begins to pick up and revenues increase, shareholders will see the value of the company reflected in the share price.
Looking at past chart data, it was previously trading at a high of $51 in January 2021 prior to the pandemic. The real question here is when will it return to that level? Thing is, we don't exactly know but surely airline travel is not going anywhere and being that AC is the largest provider of passenger flights in Canada, and is heavily supported by the Canadian government, the company itself won't be going anywhere either.