TD: Airlines preview AC target at 25$ (down 2$)Q2/20 Canadian Airline Preview
Focus Remains on Liquidity and Cash Burn
TD Investment Conclusion
Canadian airlines will start reporting calendar Q2/20 results on July 31. Having observed capacity plans, financial results from select U.S. airlines, and other data, we believe that our assumptions regarding the impact of COVID-19 on air travel and the 2020 and 2021 financial results of our coverage group remain appropriate. We have made changes to our assumptions, including updated fuel prices and FX, resulting in downward revisions to our forecasts and target prices for those companies with exposure. Our target price for Air Canada decreases by $2.00 to $25.00, and for Transat A.T. by $0.50 to $11.50. Our Chorus Aviation target price is unchanged at $6.00. Our BUY recommendations for Air Canada and Chorus, and TENDER recommendation for Transat, remain unchanged.
We believe that investors should focus on capacity plans, and revenue and cash flow expectations from airlines. Several U.S. airlines have reported Q2/20 results, indicating that the gradual recovery in demand has met resistance due to the rise in COVID-19 cases in many states. Regardless, expectations are that this resistance will dissipate and the travel recovery will continue, albeit at a pace that remains highly uncertain. Results have been consistent with our assumptions that the impact of COVID-19 will gradually lessen in Q3 and Q4, and that a recovery to pre-COVID-19 levels of demand could take 2-3 years.
Air Canada is trading at an attractive valuation when considering its earnings potential beyond 2021. Based on our current assumptions regarding the impact from COVID-19, we believe that Air Canada's strong liquidity, capacity cuts, and limited debt-repayment requirements will allow it to navigate this challenging environment and reward investors who decide to ride-out the current volatility and elevated risk.
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Details
Air Canada Focus and Outlook Air Canada has already announced that it expects to end the quarter with at least $9 billion of liquidity. This liquidity, relative to 2019 revenue, is at the higher-end of the range when compared with U.S. mainline airlines. We believe that the company’s access to additional liquidity is important, but we do not believe that Air Canada will require it based on a range of recovery scenarios, including ones which reflect a slower recovery than what we forecast.
Although we expect management to note a gradual improvement in passenger demand for travel based on growing consumer confidence in its safety and decreasing barriers for domestic and international travel, we believe that there is a risk that the recent pick-up in daily new cases in Canada could lead to a note of caution. Strengthening demand should provide additional confidence and allow management to provide insights into the potential for further cash burn reductions in Q3 and Q4 relative to the $20 million per day anticipated for Q2/20.
We view Air Canada as one of the best-positioned airlines globally to withstand the downturn, given its significant liquidity cushion, reasonable financial leverage, and pandemic containment progress in Canada. We believe that there could be an upward bias to our forecasts and valuation multiples within the next 12 months, depending on the duration of the negative news and contraction in industry revenue. We continue to believe that Air Canada’s long-term value is above our 12-month target, but that in the current environment, our target represents a reasonable risk-adjusted expectation for investors.