With the pandemic increasingly farther away in the rear-view mirror, travel has made a comeback. Air Canada (TSX:AC) stock, however, remains rangebound. Travel has certainly rebounded, but there are a multitude of risks that the airliner faces.
Let’s take a closer look in the hopes of determining whether to buy, sell, or hold Air Canada stock.
Consumer spending and the risk of recession
With interest rates at 20-year highs, consumers are feeling stretched. Gone are the days of easy money and, as a result, consumer spending is at risk. In this scenario, the first thing to be cut is discretionary spending.
Travel is among the biggest discretionary spending items. As the effects of higher interest rates accelerate with the passage of time, consumers will continue to cut their spending. This is a big macro risk that Air Canada and AC stock will be facing in the coming year.
For the time being, however, Air Canada has been staging a comeback from the depths of the pandemic. Strong demand has led to strong results for the airliner. For example, in the second quarter ended June 30, 2023, Air Canada reported strong demand, which led to a 36% increase in revenue to $5.4 billion. Also, its operating income increased by $1 billion to $802 million.
The risks to Air Canada stock remain plenty
On the second quarter conference call, the company said that the second half of the year has good visibility with $5.7 billion in advance ticket sales. However, the second half of 2023 as well as 2024 is likely to be much more difficult. The second quarter and the advanced bookings are backward looking. Unfortunately, I do not see such a rosy picture when I look ahead. This is because rising costs and increasing strain on the consumer are lurking in the background.
As you know, consumer spending is weakening at an accelerating pace. In fact, according to the Canadian Chamber of Commerce, real spending growth per person has been negative since March. In addition to this, we have oil prices, which have been rising again since July. Up 32% since the end of June, the cost of jet fuel is rising fast. This is by far Air Canada’s biggest expense. Therefore, this will surely hit the company’s upcoming results.
On the positive side, Air Canada has $9.6 billion in cash on its balance sheet, with $10.6 billion in liquidity and rapidly improving debt ratios.
Valuation
Air Canada’s stock price currently trades at a mere 5 times this year’s expected earnings. This obviously seems very cheap. However, investors are clearly skeptical of Air Canada’s recovery, I believe, for the reasons I outlined in this article.
In my view, investors are right to be skeptical. I think that there’s risk to Air Canada’s estimates and stock price going forward. If we are heading for a sharp slowdown in consumer spending, Air Canada stock is not a stock that we should own. The business is capital intensive, highly cyclical, and highly linked to oil prices, which have risen sharply once again. So, yes, the stock is cheap on a long-term basis but just be aware of these headwinds heading its way.
