The fortunes of Air Canada, the country’s largest carrier, could be on the mend, presenting investors with a high risk, high return trading opportunity.
Signs that something good may be happening are reflected in Air Canada’s advancing share price. Stock in the once beleaguered airline has been taking flight, changing hands recently at around $1.50 a share, nearly double the spring low of 78 cents.
Some pros contend the rise may only be the prelude to far sweeter gains. Analysts at two of Canada’s biggest banks – Tim James at TD Securities Inc. and Walter Spracklin at RBC Dominion Securities Inc. – have one-year price targets at $3, implying the shares could double again if the rally plays out as they hope.
To be sure, investors who are considering taking a flier on any airline should take a deep breath and ask themselves if they really want to go there. The airline industry has a reputation as a wealth destroyer. Carriers often go bankrupt, vapourizing investors’ money.
Air Canada restructured through insolvency in 2003 and, in the United States, American Airlines is currently under creditor protection, the most recent in a long list of carriers to avail themselves of bankruptcy proceedings.
Given the risks that airlines face, it isn’t surprising that the two analysts place Air Canada in their “speculative ” category of investments.
But the tradeoff for high risk is the potential for big gains, and that may be the case for Air Canada.
“It’s not often that I will be kind of pounding the table for an airline as an investment opportunity, but there are times when that investment opportunity can make some very attractive upside returns and this, we believe, is one of those times,” Mr. Spracklin says.
His Internet monitoring of Air Canada’s fare pricing has been showing a “very favourable” rising trend in recent months. The monitoring checks 1,000 domestic, cross border and international fares each week and provides an up-to-the-second survey of the carrier’s pricing power. “This is a sustained increase in fares and perhaps the most important trend that we’re seeing because it is the one that impacts profitability the most,” he says.
In a recent note to clients, Mr. James at TD praised Air Canada for its September traffic, which rose at its strongest pace since March. Another crucial metric, the airline’s load factor, or the percentage of seats with paying customers, improved to a record. “The strength was broad-based, with all regions posting strong traffic growth and load factor improvement.”
Air Canada also received good news from an arbitration ruling last week that went in its favour, lowering the cost of services provided by Chorus Aviation, its regional carrier better known as Jazz. Next year, the company could get further upside from the highly anticipated launch of a new, low cost subsidiary specializing in the leisure trade.
“We believe that recent developments at Air Canada demonstrate resilient demand and progress at reducing costs and improving efficiencies,” he said.
Air Canada does have knocks against it. One major long-term worry is its pension liability, pegged in the latest published figures at more than $4-billion. But recent contract changes to the plans have probably reduced the shortfall to a bit over $3-billion.
Like many pension plans, Air Canada’s has been hit by the sharp decline in interest rates, which reduces the return on investments in retirement accounts. The pension headache, however, would become far more manageable if and when interest rates rise back to more normal levels.
Investors should keep in mind the highly cyclical nature of airlines. If the economy tanks, so does airline profitability.
To be fair, a stronger economy has the reverse effect, leading to high returns. The added kicker for Air Canada is that any upturn strong enough to take interest rates higher will provide both pension relief and the likelihood of a strong boost to earnings.
Even Mr. Spracklin, the table-pounding bull, cautions that the carrier shouldn’t be viewed as a buy-and-hold investment. He calls the shares a “compelling trading opportunity” that is highly leveraged to an improving economy.
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