Air Canada T.AC

NBF: Expectations in-line with ours.

[Tempo1]

Investor Day - our key takeaways

 

Earlier today, we attended Air Canada's Investor Day in Toronto where the company reiterated its 2024 guidance and introduced guidance for 2025 while also providing long-term financial targets. Our key takeaways are:

• 2025 guidance consistent with our view and consensus. Management reiterated its 2024 guidance while also introducing guidance for 2025. For 2025, capacity growth is expected to be up 3-5% y/y (we currently forecast 4.5% ASM growth) with non-fuel CASM of $0.1425-$0.1450 (versus our current forecast for $0.1428), which relative to our 2024 estimate, would be a ~4.2% y/y increase at the midpoint. Recall that on its Q3 conference call, Air Canada indicated that it expected non-fuel CASM to be up 3-4%. The recent weakening of the CAD is an incremental headwind for costs next year. Full year 2025 EBITDA is expected to be $3.4-$3.8 billion versus our current forecast for $3.6 billion (consensus at just over $3.6 billion).
• Long-term financial targets mostly in-line with our expectations. The company is targeting revenue in 2028 of ~$30 billion and >$30 billion in 2030 (versus ~$22 billion expected in 2024) while the EBITDA margin in 2028 is expected to be 17%+, expanding to 18-20% in 2030 (versus ~16% this year with the 2030 target consistent with the pre-pandemic margin). We note that coming out of the pandemic, Air Canada management believed it could generate an EBITDA margin of 19% by 2024. In that context, the pace of margin improvement to the high-teens may be viewed as somewhat slower than hoped, but higher cost inflation (labour notably), engine-related aircraft groundings, and new aircraft delivery delays have led to elevated costs that will extend beyond 2025 before normalizing by 2028.
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• Revenue growth assumptions seem reasonable. From 2024-2028, Air Canada is projecting annual capacity growth of ~5-6% with revenue growth of 7-8% annually. Management notes that ~3% of the capacity growth over the period will come naturally through GDP growth as well as a full recovery of the network given that capacity today is still running below 2019 levels (we only expect a full capacity recovery in 2026). The remaining growth will come from new routes, particularly to international destinations (supported by demographic trends) as well as a continued focus on growing its sixth freedom connecting traffic with the U.S. Notably, management sees ~$900 million in incremental revenue from its sixth freedom franchise as it seeks to increase its market share on U.S.-international routes. In addition, growth in premium revenue will also contribute to the overall revenue growth with AC planning to increase premium seat capacity by 25%+ by 2028. Revenue growth does assume some annual yield improvement (~2%/year), but this improvement would largely just mirror CPI inflation. In our view, the revenue growth appears reasonable.
• Some near-term headwinds, but realistic margin target. Although Air Canada will face some margin headwinds in 2025, the company is targeting 17%+ in EBITDA margins by 2028 driven largely by increased scale (5-6% capacity growth but fixed cost growth of 3-4%), network optimization, fleet modernization and labour productivity. Management notes that new aircraft entering the fleet are expected to be 15-20% more fuel efficient, driving ~50 bps of margin expansion by 2028 while the company also seeks to increase labour productivity by 3%+ per year, representing another ~100 bps of margin expansion. Beyond 2028, management sees further margin expansion to 18-20% by 2030. We see the company's plan to expanding margins as realistic as capacity continues to recover and new, more fuel efficient aircraft are added to the fleet, allowing AC to further optimize its network. We note that the 2023 EBITDA margin was 18%, which we concede was helped by very strong yields coming out of the pandemic, but with notable offsets of a far less than fully-recovered network and higher jet fuel prices.
• Path to consistent FCF and shareholder returns. Recall that Air Canada will have elevated capex in the next few years as it invests in new aircraft. Indeed, the 2024-28 plan sees cumulative gross capex of $18 billion (net capex of $15 billion planned after sale leasebacks) with 50% of that going towards new aircraft for growth. Despite this heavy capex, Air Canada forecasts it will generate $4.0-$5.0 billion in cumulative free cash flow with the long-term goal to generate an FCF margin in 2028 (and 2030) of ~5%, which implies ~$1.5 billion annually by 2028. Air Canada will deploy excess cash towards share buybacks with a target share count of less than 300 million in 2028 versus 376 million at the end of Q3/24. Leverage is targeted to remain below 2.0x (was 1.0x at the end of Q3). Management expects to fully utilize its current NCIB authorization with ~15 million (or about half) already completed in the last two months. The key message from our perspective is that over the longer-term, management expects to generate consistent positive FCF while remaining within a guardrail of capex at less than 12% of revenue.

 

Maintain Outperform and $27.00 target

We maintain our Outperform rating and $27.00 target on Air Canada shares following the company's investor day with near-term and long-term targets largely consistent with our existing thinking. Air Canada will face some cost headwinds in 2025 (largely already factored into our forecast), but we see a realistic path to margin expansion and EBITDA growth through the 2028 timeframe with upside beyond. With the stock trading at just 3.2x 2025 EV/EBITDA versus its historical average of 4.4x and the U.S. peers at 5.7x, valuation remains compelling.

Our current Air Canada target implies only modest upside from the current share price, but we note that our valuation is based on applying a conservative 4.0x EV/EBITDA multiple to our 2025 forecast. Using a slightly higher (but still lower than peer group) multiple of 4.5x would result in a target of $32.00+, which would represent ~39% upside from the current share price.

[DrInvestor]

Using a slightly higher (but still lower than peer group) multiple of 4.5x would result in a target of $32.00+, which would represent ~39% upside from the current share price.   This $32 target is in my view more realistic. Another Outperformed rating.