CIBC: Pricing in too much negativity Our Conclusion
With AC having pre-released Q2 results and updated its 2024 outlook on July 22, its earnings were a non-event. That said, the results reaffirmed why we view AC as deeply discounted. We maintain our Outperformer rating and $25 price target. Key Points
While AC is seeing a normalization in travel trends as evidenced by softer
yields and load factors versus 2023 levels, we argue that last year’s unit
revenue KPIs were unstainable. As capacity returned, and we acknowledge
in certain markets too much capacity has been added, we expected AC
would face some Y/Y revenue pressures. That said, if we take a step back,
AC’s revised 2024 EBITDA guidance is essentially what the company printed
in 2018/19. We also note that AC acquired Aeroplan back in 2019 so the
quality of the company’s earnings today has improved. While investors are
concerned about the health of the Canadian consumer and what this means
for revenue growth next year – which has weighed on AC’s share price – this
concern fails to account for things AC can control. We note the following:
1. At the end of Q2, AC’s unrestricted liquidity was $10.2B, versus $10.0B
at the end of Q1. This includes $8.9B in cash, cash equivalents, shortand long-term investments and $1.3B available under undrawn credit
facilities. Net debt at the end of Q2 was $3.61B, versus $3.78B at the
end of Q1. Leverage ratio came in at 1.0x versus 0.9x exiting Q1. Even
with AC’s fleet investments in 2025-2027, its balance sheet strength puts
it in a position to reinstate a shareholder return program. We view this as
a positive medium-term catalyst. While the timing on this decision
remains uncertain, we now have AC buying back shares in 2025.
2. AC’s adj. CASM was up 1.7% Y/Y in Q2 and up 1.8% Y/Y in H1. If we
look at opex less fuel and labour costs, it is up around the same
percentage as ASM growth, suggesting unit cost inflation is contained
and AC is managing its cost structure well. We note that AC is accruing
for a new pilot contract in its adj. CASM guidance. This supports AC’s
view that 2024 should be the last year it sees elevated inflation and this
should moderate in 2025 onward. This bodes well for margin expansion.
The company still sees a high-teens EBITDA margin as achievable.
3. The Canadian airline industry is adjusting to the excess capacity hitting
certain routes. That said, we are also seeing industry participants
respond rationally. For example, AC’s capacity growth plan in 2024 is
down ~100bps from its previous outlook at the midpoint. The airline also
noted it is seeing capacity stabilize over the Atlantic in Q4. From that
perspective, recall TRZ revised its capacity growth plans for F2024 from
up 19% to up 11%-13%. We also note that while a number of Canadian
carriers have been adding capacity, AC’s domestic and transborder yield trends remain positive in Q2 and H1.
4. While concerns over the Canadian economy are weighing on AC’s outlook, we continue to view the company as well positioned to manage through a downturn. Its improving cost
structure and liquidity position provide a safety net. On the revenue side, AC’s diverse
portfolio gives it the flexibility to move assets to more profitable routes. For instance, as
Atlantic unit revenue trends were slipping, AC shifted capacity to the Pacific where
demand/supply conditions remain more favourable. As well, AC’s premium revenue and
loyalty program create a relatively stickier customer. In Q2, AC noted again that the
demand for premium products remained strong, with the Y/Y percent change in premium
cabin revenues outpacing the growth rate in economy cabin revenues by about two
percentage points. The increase in premium cabin revenues represented more than 60%
of the total passenger revenues increase in the second quarter.
5. In addition to point #4, during the Great Financial Crisis (GFC) AC’s revenue fell 8.1%
from 2007 to 2009 and its EBITDAR margin fell 600 bps over this same period. If we take
AC’s 2024 outlook as the current baseline and apply what we saw during the GFC, this
would imply downside EBITDA of ~$1.8B. We are currently modeling 2025E EBITDA of
$3.5B (consensus is $3.6B). The downside estimate implies a ~5.0x pro-forma EV to
EBITDA multiple. We do not view this as a stretched valuation on trough earnings. We
would make the case then that AC’s current share price is baking in a hard landing, which
is contrary to the consensus view. We argue that the other names we cover get the
benefit of a soft landing. We have also made the case that AC is in a better position to
help limit the downside than it was entering into the GFC.
We have adjusted our estimates and assumed a more moderate growth environment in 2025
but we assume AC begins repurchasing shares next year. Our 2024E and 2025E EBITDA
moves to $3.2B (from $3.3B) and $3.5B (from $3.6B) respectively.