CIBC: Target up at 30$ ( from 27$)Countercyclical Recovery
Our Conclusion
AC reported solid Q3 results despite broader macro concerns facing the economy. We would note that the concerns weighing on airlines are twofold: 1) whether air travel demand will ease exiting a strong summer and 2) broader concerns over a recession. AC’s strong Q3 results, along with results from the U.S. peers, highlight that the sector is uniquely positioned this time around even in the face of a broader economic slowdown as airlines benefit from a continued recovery coming out of the depths of the pandemic. We maintain our Outperformer rating and the price target goes to $30 (from $27).
Key Points
Healthy Demand Profile: Q3 adj. EBITDA came in at $1,057MM versus consensus expectations of $825MM, driven by a healthy demand profile and a strong load factor, which came in at 86.5% on a consolidated basis. For reference, the average load factor in the third quarter between 2016 and 2019 was 85.7%. Load factors across the network achieved mid- to high-80s across all geographies. The airline carried 11.5MM passengers in the quarter, which is 78% of Q3/19 passengers. The momentum continues into 2023 as AC noted that leisure and sun demand is trending above 2019 levels. While corporate recovery lags, AC continues to see sequential improvement in corporate travel, especially past the Labour Day weekend. AC also noted that booking curves are lengthening and customers are booking flights further out than during the pandemic. This highlights consumers’ increasing comfort in getting back to travel. Net-net, we would argue that the Q3 performance and the trends AC is seeing for winter and early 2023 support our view that the pent-up demand was not satisfied by one strong summer. We believe that the pent-up demand for travel provides AC (and the broader airline industry) a unique countercyclical offset even with a slowing economy.
Strong Yields
Across The Board: Q3 consolidated average yield was 21.8 cents, up 5.4% Y/Y and ahead of expectations. Looking at the domestic network, Q3 yield was 27.4 cents, the highest we have seen over the past decade-plus outside of some of the anomalies we saw on this metric during the pandemic. While we recognize stage length impacts unit revenue metrics, we view the strong performance in yields as also being attributable to: 1) pent-up demand in the market, which has given the airline sector more pricing power to offset inflationary pressures; 2) a shift in consumer spending from goods to services, resulting in travellers paying up for premium services that carry better yields. AC noted that premium economy revenue has increased four times Y/Y, ahead of business; and economy cabin revenue has increased three times Y/Y; and 3) revenue management initiatives including Aeroplan, which provides yield upside. AC also noted that looking out to Q4, it is not seeing a softening in yield action or demand destruction as fares have increased.
Path To Strong FCF Generation – Equity Upside From Deleveraging:
The current demand/yield environment benefitting AC gives us increasing confidence in its ability to hit its 2024 targets, suggesting a significant amount of FCF generation over the next few years. We already see AC benefitting from improving cash conversion as its revenue recovers. Q3 CFO came in at $290MM, and this is the fifth CFO-positive quarter for the airline since the pandemic hit. We estimate that AC will generated ~$4B of FCF over the next three years, which highlights the significant upside to AC’s equity value from the debt to equity shift within its enterprise value (EV). In addition, while our price target is based on a 4.5x EV/EBITDA multiple on our 2025E, generally in line with where AC traded prior to the pandemic, its U.S. peers traded at ~6x. We continue to argue that AC’s multiple has an opportunity to trade up to where its peers are, given its financial targets/metrics. For reference, a point turn in our target multiple would add another ~$9-$10/share to AC’s equity value.