Air Canada: Undervalued Stock with Positive Trends
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Many investors may wonder why I would recommend buying an airline stock; after all, most have huge amounts of debt, are exposed to volatile energy costs, and are in frequent conflict with their workers. While Air Canada (TSX: AC.B) (TSX: AC.A) is no exception these problems, the market appears to be taking a disproportionate bite out of the Canadian carrier's share price. When looked at in comparison to its rivals, a compelling valuation case emerges for Air Canada, and recent developments for the carrier point to an undervalued share price.
Airlines ca. 2009
When the economy was melting down in late 2008 and early 2009, airline shares were trading at bargain basement prices. Why? Because many believed most or all of the major airlines would be bankrupt by the end of the recession. But of the major carriers, only American Airlines (OTCBB: AAMRQ) went bankrupt, and it still took another two years for it to finally collapse. The rest of the airlines have made multi bagger gains for their investors since the bottom with United Airlines, now United Continental Holdings (NYSE: UAL), Delta Airlines (NYSE: DAL), and US Airways (NYSE: LCC) all surging out of the recession.
But what does this mean for Air Canada? It means airlines are prone to strong sell-offs and strong rallies based on the perceived state of the carrier. When the immediate threat of bankruptcy was removed from the major carriers in 2009, their share prices skyrocketed--yet Air Canada has been left behind. Solutions to the problems that remained at Air Canada, along with some profitable quarters, could be the catalyst this airline needs to takeoff (pun intended).
A winning streak
Looking at Air Canada, we see an airline with 2009 pricing but with improving prospects for recovery. Through a combination of arbitration rulings and carrier expansions, the airline's fortunes appear to be on the rebound.
It began in in July 2012, when a federal arbitrator sided with Air Canada in a long-running dispute with its pilots. By choosing Air Canada's final offer, the arbitrator prevents the airline's labor expenses from threatening the viability of the carrier, while at the same time removing uncertainty weighing on the stock price.
Also included in the July ruling was the go ahead for Air Canada to create a low cost carrier to more directly compete with low cost rivals in Canada. This is critical to Air Canada's success as an airline since discount carriers are becoming increasing popular in the current economic climate and parts of Air Canada's business could have been lost to Westjet's (TSX: WJA) new discount airline, Encore. Air Canada plans to have the discount carrier run by a separate management team but be wholly owned by Air Canada itself. The exact details of the low cost carrier are still being discussed, and Air Canada has launched a Facebook naming contest to name the new carrier.
The labor dispute was not Air Canada's only arbitration victory this year. In October, another arbitrator delivered positive news for Air Canada when it rejected the proposal set forth by regional operator Chorus Aviation (TSX: CHR.B). Chorus flies regional routes for Air Canada and receives a pre-determined markup for flying these routes, which Chorus has managed to turn into a fairly consistent 15% dividend for its shareholders.
It is not yet decided what the new markup rate will be, but it will not be as high as Chorus had asked for, and Chorus may even need to reimburse Air Canada for millions in previous markups. Air Canada should not be afraid of Chorus refusing to fly at the lower rates because it will still be profitable for Chorus, just less so. And Chorus relies on Air Canada for nearly all of its business, since it has been unable to establish successful partnerships with other carriers. All said, while this has caused a double digit decline in Chorus' stock price, Air Canada stands to benefit from yet another cost savings measure as it looks to become profitable next year.
Fresh off the most recent Chorus ruling, Air Canada has announced expansion plans in Western Canada as it tries to maintain market share against growing rival Westjet. Air Canada dominates the field of Canadian business travel, and the airline says the additional flights "reflect strong demand within Western Canada, the centre of the country's energy and resource industries." The airline plans to use new, more efficient Bombardier Q400 Next Gen aircraft with all leather seats to cater to the business segment, a move that should both reduce fuel expenses and draw more business travelers.
Buying like it's 2009
Through arbitration rulings and expansion plans both within the airline and with a new wholly owned subsidiary, Air Canada is showing positive signs of a turnaround. Already its stock price has more than doubled since June and the stock hit a new 52-week high at the close of Oct. 20. Analysts are also becoming more bullish on Air Canada shares, with a $2 price target from an analyst at UBS, a $2.50 price target with an outperform rating at BMO Capital Markets, and $3 price targets from analysts at TD Securities and RBC Dominion Securities.
Of course, like in 2009, risks to airlines still exist. Air Canada is still in the hunt to turn a profit, but expects to register one next year, and there is always the threat of another downturn in the already fragile economy. But at Air Canada the benefits appear to outweigh the risks, and while the stock does remain speculative according to most analysts, if Air Canada can pull off a turnaround, strong gains could be in store for the most risk tolerant investors.
TulipSpeculator1 owns shares of Air Canada. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.