Written by Daniel Da Costa at The Motley Fool Canada
The last three years have been a rollercoaster ride for airline stocks like Air Canada (TSX:AC), and that may be putting it mildly.
The pandemic not only impacted the revenue that these stocks could generate for more than two years, but it also caused these stocks to take on huge amounts of debt just to weather the storm.
Even after an unbelievable recovery that strained the travel industry for months, Air Canada stock, which is now generating more revenue than it did prior to the pandemic, continues to struggle to rally.
Furthermore, adding to the consistent ups and downs Air Canada has faced is the significant inflation we’ve seen in the economy that sent costs soaring over the last year. This has not only hurt the profitability of the airline stock, but it’s also what’s led to rapidly rising interest rates, which is also making debt more expensive to service.
Given where the stock trades today, in the mid $16s, down roughly 70% from its pre-pandemic price, there is a lot of optimism about the potential for Air Canada stock when it can finally see a full recovery.
However, since the pandemic hit and Air Canada began trading this cheaply, investors have anticipated a recovery that’s never materialized. Is Air Canada actually worth $30 a share, or is Air Canada in for a lot longer of a recovery than many hope and expect?
Why is Air Canada stock still trading where it did at the start of the pandemic?
To see Air Canada stock trading roughly 70% off where it was prior to the pandemic is quite shocking, especially since it’s been three-and-a-half years since the pandemic first hit.
In my opinion, though, what’s even more shocking is that Air Canada trades only slightly higher than its lowest closing price since the start of the pandemic of $12.15.
Over the last few years, it’s had minor rallies, only for a new headwind or worsening economic environment to cause the stock to sell off again. So, what’s preventing Air Canada stock from seeing a sustained rally?
There are a few reasons for that, including a worsening economic environment and uncertainty in the stock market, making a stock like Air Canada seem a lot riskier. In addition, one of the biggest reasons is due to all the debt that I mentioned before that Air Canada has taken on.
For example, at the end of 2019, just prior to the pandemic, Air Canada stock had just under $5.2 million of long-term debt and $3.3 billion of net debt.
Meanwhile, in its most recent update at the end of the second quarter on June 30, 2023, Air Canada has roughly $11.6 billion in long-term debt and roughly $6.2 billion in net debt.
This increase in debt is not only impacting Air Canada’s valuation, it’s also impacting its profitability. For example, in the last quarter of 2019, it paid just $113 million in interest.
By mid-2021, when it actually had slightly more long-term and net debt than it does today, its quarterly interest expense was $159 million.
And now, after several interest rate increases, Air Canada’s interest expense in its most recent quarter has climbed to $235 million, more than double what it was at the end of 2019.
Is the airliner really worth $30?
The significant increase in debt since the pandemic has also caused Air Canada’s enterprise value to increase. Although its stock is down by roughly 70% from its pre-pandemic price, if you look at Air Canada’s enterprise value of $12 billion today, it’s only 26% lower than where it was prior to the pandemic, showing it’s not nearly as cheap as it seems.
Therefore, for Air Canada to see a significant rally in the next year and hit its current average target price of $29.88, it will need to continue to improve its revenue and profitability while paying down as much debt as possible.
However, even if Air Canada can continue to improve its operations until we see a significant improvement in regard to the uncertainty in the stock market, Air Canada will likely have a difficult time seeing a sustained recovery in its share price.
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Fool contributor Daniel Da Costa has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.