Special report from CIBCAC Well Positioned In The Post-pandemic World
Airline Traffic Monitor – December 2022
Key Points
In our last Airline Traffic Monitor for the year, we discuss why we consider AC a well-positioned airline in the post-pandemic world. While we recognize airline equities face a challenging environment given the growing concerns that the economy is headed towards a recession, as we note in our 2023 Industrial / Transportation Outlook (link to note), we foresee significant upside in AC’s equity value as we see air travel still benefitting from a multi-year recovery. AC remains our preferred aviation name for the following reasons:
Commercial Aviation – Countercyclical Recovery: We continue to expect the Canadian airlines to benefit from pent-up demand to travel. Historically, there has been a strong correlation between GDP and air passengers (95% between 2004-2019 in the U.S.) and we believe the North American airline industry is positioned to benefit from a countercyclical recovery this time around in the face of a slowing recovery. Currently, air traffic in the U.S. and Canada is down ~10% from 2019 levels. If we assume that the relationship between GDP and air traffic holds ($24,433 of GDP per one passenger enplaned in Canada and US$21,199 per one passenger enplaned in the U.S.), then absent the pandemic, air traffic in the region should be up 3%-5% from 2019 levels. This suggests that there is still a ~15% gap to make up for, which we think should counter some of the cyclical concerns and highlights the pent-up demand for travel. AC is well positioned amongst North American carriers given its market positioning in Canada.
Corporate Travel Demand – Don’t Need A Full Recovery In The Near Term To Hit Margin Targets: We continue to observe positive signs of ongoing recovery in corporate travel demand, though a number of KPIs we track may reflect a plateauing. That being said, our view remains that the airline industry need not experience a full recovery in corporate travel to post a full recovery in profitability. In our report titled Canadian Airline Industry: Can The Sector Return To Pre-pandemic Profitability? (link to note), we highlight that upon exiting the Global Financial Crisis leisure travel took two years to recover versus five years for corporate travel in the U.S. Even with this headwind, profitability rebounded faster than the recovery in business travel, reflecting a more rational market place as airlines sought to rebuild their balance sheets. This creates a more favourable environment for the incumbent carriers.
Yield Environment Is Favourable: While corporate travel continues to lag in the recovery, we expect AC, and the broader airline industry, to lean on other yield-enhancing strategies. A look at average air fares in the U.S., for example, shows they are tracking above pre-pandemic levels as airlines look to combat inflationary pressures. Average load factor for North America is also back to pre-pandemic levels with below pre-pandemic capacity. This is also creating a favourable yield environment. We continue to see signs of how travel has changed emerging from the pandemic, including an increase of blended business and leisure trips and an increased appetite for premium economy products, both of which are yield enhancing. North American airlines have noted that premium cabin recovery has been outpacing that for economy cabins. AC noted that premium cabin revenues were 11% higher in Q3/22 than in 2019. A survey conducted by Conde Nast Traveller noted that 33% of respondents booked a blended trip in 2022 and 32% booked just business trips, pointing to the growth in “bleisure” travel. AC’s yield strategy is aided by the company’s Aeroplan program, which helps it to reach its target audience with premium offers and is capable of driving ancillary revenues.
AC – Why It Remains Our Preferred Name: AC is targeting 2024 capacity to reach 95% of 2019 levels. Against this backdrop, we conservatively assume 2024 revenue is at least equal to that for 2019, with the lower capacity offset by higher yields, cargo revenue growth, and Aeroplan upside (note, we forecast 2024 revenue of $20.3B). Applying a 19% EBITDA margin and using a 1.1x leverage ratio, to which the company is guiding, we infer an equity value per share of ~$40 using a 5x EBITDA multiple (about a one point discount to where AC’s U.S. peers traded pre-pandemic). This reflects a ~100% upside from current levels. Every one-point change in multiple implies a ~$10/share equity pick-up. AC also noted that the margin is expected to be closer to 20% once the A321XLRs come in, representing further upside.