After a remarkable recovery of 40% between May and July 2023, Air Canada (TSX:AC) stock fell 12.6% ahead of the second-quarter earnings. This selloff came, as the U.S. Fed increased the interest rate for another quarter to its 22-year high at 5.5%. While the Fed said that America can avert a recession, companies with high debt are feeling the pressure of rising interest expenses. Even though Air Canada reported strong second-quarter earnings and an improving balance sheet, the stock fell over fears of a slowdown.
Source: Getty Images
Why did Air Canada stock fall post-earnings?
Like all other airlines, Air Canada took a plunge during the pandemic, retired 33% of its old fleet, and replaced it with the new fleet as travel demand recovered. All these sudden traffic shocks created chaos in the airline industry. Air Canada accumulated significant debt and even raised equity capital to withstand the pandemic and spend on recovery.
This capital raising diluted shareholders’ interest. Hence, when Air Canada returned to its 2019 pre-pandemic fundamentals, the stock rose to its resistance level of $26 and fell. Let’s see how the airline improved its fundamentals in the first half (H1).
Air Canada’s improved fundamentals
| Air Canada’s fundamentals | 2018 | 2019 | 2022 | H1 2023 |
| Revenue | $18 billion | $19.13 billion | $16.56 billion | $10.31 billion |
| Net Income | $37 million | $1.47 billion | ($1.7 billion) | $842 million |
| Net Debt | $5.2 billion | $2.84 billion | $7.5 billion | $5.33 billion |
| Free Cash Flow | $1.32 billion | $2.07 billion | $796 million | $1.95 billion |
Air Canada saw a stark recovery in passenger volumes in premium and leisure classes. Moreover, fuel prices fell 9.4% from the June 2022 peak when the Russia-Ukraine war sent oil prices up to US$125. To add to the profit equation, Air Canada increased the airfare and did not see any impact on travel demand.
Higher fares, more demand for premium seats and falling fuel prices helped Air Canada turnaround from a net loss ($1.36 billion) in H1 2022 to a net profit ($842 million) in H1 2023. So, the 36% and 22.5% surge you see in operating revenue and adjusted earnings before interest, taxes, depreciation and amortization is because of a weak base year of 2022. In 2022, high fuel prices, rising interest rates, and rerouting flights from Russia affected its earnings. Air Canada has now returned to normalized growth.
On the debt front, Air Canada used the free cash flow (FCF) to reduce net debt to $5.33 billion. The airline saw this level of debt in 2018. In H1 2023, Air Canada achieved its 2018 debt levels and edged closer to its 2019 profit and FCF levels. The airline is fast accelerating its fundamentals.
During the 2019 recovery of its fundamentals, AC stock almost doubled throughout the year. If you had invested $5,000 at the end of 2018, it would be $9,517 at the start of 2020.
Is now a good time to buy airline stocks?
The pandemic has changed the world for airlines. AC stock has found resistance at a $26 price. For the stock to break this level, it has to reduce its debt. AC is still maintaining $10.55 billion in liquidity, as debtors require it as a cushion against credit risk.
Keeping such huge liquidity instead of reinvesting in the business or paying down debt shows that AC is still not out of the cloud. But signs are positive. Fitch improved the credit ratings outlook on AC from negative to positive.
AC stock could take some time to return to a growth rally as the market sentiment is bearish. The best time to buy Air Canada stock is when it trades near the $20 price, as it cannot sustain $26 because of its high valuation. You can buy the stock below $20, hold it for a longer term, and sell it above $35. It could reach the $35 price earlier if a recession is averted.
