TD: Forecast Update Forecast Update; Additional Risks to Short-term earnings
Event
We are lowering our H1/21 financial forecasts to reflect our updated assumptions regarding the impact of the second wave and recently introduced COVID-19 testing requirements on travelers entering Canada.
Impact: SLIGHTLY NEGATIVE
We are maintaining our BUY recommendation and $28.00 target. The requirement for a negative COVID-19 PCR test within 72-hours of boarding a flight bound for Canada (in addition to 14-day quarantine requirement) is already showing signs of significantly impacting Canadian air travel demand. WestJet announced plans this morning to operate 80% less capacity in February and March relative to 2020, a 30% reduction from previous plans.
Air Canada is trading at 4.7x 2022 consensus EBITDA and almost 30x adjusted EPS, unprecedented multiples for Air Canada. This valuation combined with Air Canada's modest share price response to extremely negative indications for short-term air travel demand suggests that the market is not concerned about short-term forecast revisions, and is either focused on 2023, or believes that consensus forecasts for 2022 are far too low (our view). Either way, we caution investors that with the share price appearing to focus on the long-term recovery potential without regard for what we believe will be weaker-than-currently expected financial results (by consensus) for Q4/20 and Q1/21, the stock could be susceptible to significant short-term volatility.
Despite short-term trends, we continue to believe that 2019 levels of air travel will be fully recovered in 2023. Our financial forecasts for 2022 and 2023 are significantly higher than consensus. Once we emerge from the current period of volatility, and what we expect will be downward revisions to short-term consensus expectations, we believe that our longer-term forecast margins and earnings will look increasingly realistic and ultimately take the share price higher.
TD Investment Conclusion
Air Canada is trading at an attractive valuation when considering its earnings potential in 2022 and beyond. 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.