The answer to our headline question is evidently, yes. Air Canada was trading around $20 share when we initially published this article.
The stock rose around 40 per cent as news of effective COVID vaccines hit the market.
TD Securities has updated its view of Air Canada, keeping a “buy” recommendation on the shares and a $30 target price, which implies nearly 15 per cent upside over the next 12 months.
But TD has reduced its earnings forecast for the airline to reflect the still difficult period all airlines have to get through before returning to any type of pre-pandemic traffic levels.
Here’s a summary of TD’s update followed by the original article based on TD and RBC research:
We are maintaining our BUY recommendation and $30.00 target price.
We are reducing our short-term forecasts due to the anticipated impact of the second wave of new cases of COVID-19 on air travel restrictions and demand.
Our increased caution is supported by recent travel indicators which suggest that the recovery has stalled and/or temporarily reversed during Q4.
We will be revising our Q4/20 Air Canada forecasts again before Q4 reporting, but at this time, we highlight the fact that we are well below consensus for the quarter.
We caution investors that with the share price appearing to focus on the long-term recovery potential without regard for what we believe will be weaker-than-currently expected financial results (by consensus) for Q4/20, the stock could be susceptible to significant short-term volatility.
However, despite the historically modest upside to our target, we believe it is prudent to wait for the year-end outlook before revisiting our recommendation.
Despite short-term trends, we continue to believe that 2019 levels of air travel will be fully recovered in 2023.
Our financial forecasts for 2022 and 2023 are significantly higher than consensus. Once we emerge from the current period of volatility, and what we expect will be downward revisions to short-term consensus expectations, we believe that our longer-term forecast margins and earnings will look increasingly realistic and ultimately take the share price higher.
TD Investment Conclusion
Air Canada is trading at an attractive valuation when considering its earnings potential beyond 2021.
Based on our current assumptions regarding the impact from COVID-19, we believe that Air Canada’s strong liquidity, capacity cuts, and limited debt-repayment requirements will allow it to navigate this challenging environment and reward investors that decide to ride out the current volatility and elevated risk.
Here’s the original story:
We got a taste of the appetite for out of favour stocks inordinately affected by the pandemic after Pfizer said its COVID vaccine was more than 90 per cent effective.
So-called “garbage stocks” took off, the possibility of which we flagged in our article on October 21.
The rally is unlikely to be sustainable and there are many questions unanswered about the vaccine and how quickly it could be distributed.
But if you’re looking for a company ripe to benefit in the lead up to what we hope is a post-pandemic environment, Air Canada is at the front of the queue.
To get a better idea of the airline’s current status following its third quarter earnings report, we turn to summaries of analyst research reports from Tim James and Shawn Levine at TD Securities and Walter Spracklin and Ryall Stroud at RBC Capital Markets.
Let’s start with TD:
Rating: Buy
Price Target: $30, up from $26.
Projected 12-Month Return: 48%
Impact: Positive
Company Profile
Air Canada is Canada’s largest domestic and international full-service airline, operating a fleet of nearly 400 aircraft, inclusive of Jazz, to nearly 200 destinations worldwide.
Primary hubs are located in Toronto, Vancouver, and Montreal. Air Canada is also a founding member of the Star Alliance network.
Air Canada reported Q3/2020 EBITDA of -$554 million vs. TD/consensus at -$578 million/-$488 million.
Net cash burn per day was $9 million vs. our estimate of $16.6 million and original guidance of $15 million-$17 million.
The increased target is due to the positive implications for valuation period net debt from a stronger-than-expected outlook for cash flow due to cost reductions and lower than previously assumed capital expenditures.
Air Canada’s cost reduction initiatives appear to be yielding better-than-anticipated results, the impact of which is expected to offset the slight reduction to our forecast revenue.
While passenger revenue in Q3/20 was below our forecast, it does not impact our view and expectations for the trajectory of the recovery which assumes that passenger revenue returns to approximately 66%, 91%, and 98% of 2019 revenue in 2021, 2022, and 2023, respectively.
(Editor’s Note: Outgoing Air Canada CEO Calin Rovinescu has said it will likely take three-to-five years for the airline to get back to its pre-pandemic passenger traffic levels.)
We believe that this expectation is well supported by travel data trends and expectations for an eventual loosening of travel restrictions, vaccine distribution, and a better consumer understanding of the actual health risks related to commercial air travel.
We believe that Air Canada’s early actions aimed at ensuring the long-term viability of the business have been successful, and that investors will be rewarded in 2021 as the market prices the stock based on the underlying fundamental value of the business, which, we believe, is significantly higher than the current share price.
Although yesterday’s encouraging vaccine development news is positive for sentiment towards travel stocks, we caution investors that the current wave of new COVID-19 cases and its potential impact on Q4 travel demand could limit share price upside in the short term.
TD Investment Conclusion
Air Canada is trading at an attractive valuation when considering its earnings potential beyond 2021.
Based on our current assumptions regarding the impact from COVID-19, we believe that Air Canada’s strong liquidity, capacity cuts, and limited debt-repayment requirements will allow it to navigate this challenging environment and reward investors that decide to ride out the current volatility and elevated risk.
And now a summary of RBC’s outlook on Air Canada:
Upside Potential Despite Uncertainty
Rating: Outperform
Price Target: $23
Projected 12-Month Return: 14%
Air Canada has material upside return potential long term.
We believe the measures taken to reduce costs has the company well positioned to weather COVID-19.
Furthermore, we see another stage of cost reductions that has yet to be implemented, on top of significantly lower jet fuel prices—which, if sustained, could provide investors another valuation leg higher.
Transformation still at the early stages. Having achieved a groundbreaking labour deal that gave management the tools and flexibility to completely restructure operations, Air Canada remains in the early stages of executing on this transformation.
The result is an opportunity to reduce per-unit costs by as much as 21% or more in a normalized environment. Our view is if management is successful in achieving this, the share price upside potential is considerable.
Of particular interest is that this cost realignment comes on the back of internal actions (i.e., fleet reconfiguration) that have been made possible by the flexibility achieved under new labour agreements.
Upside Still Intact
Despite unprecedented industry conditions, Air Canada should still be able to unlock value for shareholders through:
(1) Disciplined industry capacity growth and a “new normal” in the competitive dynamic.
(2) Lower jet fuel prices and a return to profitability.
(3) Gradually improving traffic growth. However, we do not expect share price appreciation to be linear, and we expect some share price volatility despite a positive bias.
Disclosure: Both TD Securities and RBC Capital Markets have provided Air Canada with investment banking and other services within the last 12 months. And Kathleen P. Taylor, the Chair of the Board of Royal Bank of Canada, is a Director of Air Canada.
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