The Most Expensive Stock in Canada

Key Takeaways on Air Canada Stock

• Summer is usually a strong month for airlines
• Investors need to keep an eye on long-term risks
• Air Canada stock is trading at a 36% premium

Ruth Saldanha: Summer is here, along with summer travels, and while travelers might be frustrated with Air Canada (AC), the airline, Air Canada, the stock is flying high. The Air Canada stock is the most expensive stock in our coverage universe here in Canada, trading at a 36% premium to our fair value estimate, but why? Nic Owens covers the stock and he's here today to shed some light on this. Nic, thank you so much for being here today.

Nicolas Owens: Thanks, Ruth. Glad to be here.

Saldanha: So let's start with the basics. Is summer always a good time for airlines?

Owens: Generally yes. Airlines have spikes in traffic over the summer, it's more than 30% than they do in the winter and so summer is definitely the best part of their year.

Why Has Air Canada Stock Run Up So Much?

Saldanha: So why has Air Canada stock run up so much?

Owens: Well, airlines in general and Air Canada included are benefitting from a huge rebound in demand for travel after the COVID pandemic. There's two years worth of peoples plans and vacations and family visits that are back on, and also new patterns of work with sort of business travel and leisure travelers getting merged. And so the stocks are up because they're clocking record revenue, record profits and some investors believe as do I that even if there were some kind of general recession, airlines might skip this one because there's so much demand for travel.

Risks to Watch in Airline Stocks

Saldanha: So all of this sounds like good news. What are some of the risks that you're watching for this sector.

Owens: Well, this is why I think it's important to distinguish the short term versus the long term case. We agree that in the short term, even two or three years out, airlines should do pretty well if not very well. And that's being reflected in those stock valuations. Over the long haul there are a few key differences though, in the next, say, five years then from what we see from the five years prior to the pandemic. The airlines are in more debt than they were because they all borrowed a lot to make it through the pandemic. They will, ironically, they'll warrant taxes because they are suddenly more profitable. And most importantly perhaps, the cost of labor and some other costs have gone up. And that's a huge input for airlines and more or less labor is a fixed cost for them in our view. So for example, in 2019 labor was 17% of Air Canada's sales and in 2022 it was (20%). As a result, the temptation we think for an airline, any of the competitors or themselves to re-enter price wars or overspend to go after new routes is higher than it was before the pandemic. And so we see a risk there that what we might call the normal cutthroat economy of airlines is likely to return.

Why Air Canada Stock has No Economic Moat

Saldanha: The last thing I'd like to talk about is Air Canada in particular. Now, Air Canada is Canada's national carrier, but still you haven't awarded it an economic moat. What's up with that?

Owens: Well, in fairness, the only kind of moat I can imagine for an airline would be the national carrier, but one that was completely protected from internal and external competition. This is kind of like in some fictional country and where there would still be pressure on prices because the lower prices go, the more people fly. So there would still be that temptation, but at least it wouldn't have competitors. Air Canada competes for routes within Canada, connecting Canada countries all over the world and like all other airlines, it experiences the cost of fuel, the cost of labor, the changing of the seasons and the geopolitical risks equally to many competitors. So I'm afraid to say there's no moat there.

Saldanha: Great. Thank you so much for joining us with your perspectives, Nic.

Owens: Thank you.

Saldanha: From Morningstar I'm Ruth Saldanha. 

 Air Canada Stock Bulls Say

• Borders have reopened, which should allow increased international travel.
• Demand for leisure travel has recovered sharply from the pandemic. Pent-up travel demand could buoy air travel even during a recession.
• Air Canada has a solid track record of managing its debt load, and we don't see leverage as an imminent threat to its liquidity.

 Air Canada Stock Bears Say

• Air Canada’s business model is predicated on international travel, which has recovered more slowly than domestic travel.
• Ultra-low-cost carriers may enter the Canadian market and create fare pressure across the industry.
• As Canadian market share leader, Air Canada has the most to lose if a financially distressed rival were to lower prices to compete for passengers.