Air Canada: Still Climbing Out of Travel Restrictions; Fair Value Down to CAD 18.30 From CAD 27.00

We have taken a fresh look at North American airlines, and instituted an industry-based demand model for air travel, capacity, and airline revenue yields. As a result, we have lowered no-moat Air Canada’s AC fair value estimate to CAD 18.30 from CAD 27.00 per share.

We have tempered our view of the medium-term operating environment for North American airlines to include a return to normalized competitive dynamics after current supply constraints moderate, likely in a year or two. In many ways, we forecast 2023-27 as resembling the 2015-19 period before the pandemic, with declining fuel costs, a mostly consolidated industry, and robust demand for air travel. But three key differences temper this outlook: the industry piled on billions of dollars of debt to withstand the pandemic; the current period of high profitability will have erased tax shields that airlines all enjoyed in the previous era; and postpandemic labor agreements will add structural costs to airlines’ income statements. Although Air Canada may have the dubious distinction of enjoying its tax loss shields longer than some U.S. carriers, its leverage also constrains our valuation.

Our 2027 midcycle forecasts for Air Canada, with CAD 0.1709 passenger revenue mile yield, approximately 67% share of a growing pool of Canadian revenue passenger miles, and load factors approaching the high 80s, also incorporate nearly flat structural unit costs compared with prepandemic 2015-19. Our forecast also maintains the CAD 0.035 spread between Air Canada’s passenger revenue and nonfuel recurring costs before the pandemic, which allows for a return to approximately 8% operating margin over the next several years.

We reaffirm our view that there are no durable competitive advantages to be had in this industry, and that long-term investors should seek exposure to air travel elsewhere, such as with the wide-moat suppliers of airframes and jet engines, whose products airlines compete with one another to buy years in advance.