Canadian airline stocks are like their peers everywhere else; cyclical and highly regulated.
It’s one of the sectors that causes a tonne of consternation among investors. Airlines, it is said, are blessed with the potential for huge growth but cursed in a number of ways, chief among them being their exposure to externalities such as the fluctuating price of oil, the constant to-and-fro-ing with labour unions and a highly competitive environment.
You can add to that mix some contemporary concerns such as signs of a slowing economy, the volatility created by the grounding of Boeing’s 737 Max jets and the ensuing capacity problems and spiking insurance premiums. Finally, for Canadian investors, a major shake-up this year in Canada’s airline space should be noted, with not one but two major deals emerging — Air Canada’s purchase of Transat and Onex’s deal for WestJet.
But, fear not, there is still money to be made in the sector. That’s according to the following three experts whose bullish opinions have been recently reviewed by Cantech Letter.
Air Canada (Air Canada Stock Quote, Chart, News TSX:AC)
To those of us who were prescient enough to buy up Air Canada in the early 2010s, back when the company was on the verge of collapse at the stock was essentially pennies, we salute your moxie. AC’s turnaround in recent years has been a sight to behold, going from debt-laden to fabulously profitable and lifting its share price to record highs this year.
But there’s still upside to the name, according to analyst Corey Hammill of Paradigm Capital. Hammill says that Air Canada beat his estimates in its latest quarter and pointed out that the Boeing 737 issue is just a little turbulence for AC.
“Despite the current headwinds resulting from the continued grounding of the Boeing 737 Max aircraft, we remain upbeat in our outlook for AC and believe that a multiple expansion is more than overdue. The Max grounding exemplifies how Air Canada’s business has been built to withstand various unforeseen shocks and still deliver strong profits,” writes Hammill in a July 31 report to clients.
“The current spread between AC and U.S. legacy carriers based on 2019 consensus EBITDA estimates is ~1 multiple point, with AC trading at ~4.5x and U.S. peers at ~5.5x. We estimate each multiple point is worth ~$14.00 per AC share. We are rolling forward our target price to 2020 (was 2019) while maintaining our 4.5x target EV/EBITDA multiple.”
Hammill maintained his “Buy” rating for AC but raised his target price from $44.00 per share to $54.00 per share, which at press time implied a return of 14 per cent.
Chorus Aviation (Chorus Aviation Stock Quote, Chart, News TSX:CHR)
One way to play the sector while trying to avoid the pitfalls of an economic slowdown would be Chorus Aviation, a regional airline specialist who earlier this year sealed up a new contract with Air Canada for its Jazz operations. Chorus’ leasing business, which includes international partners, offers the company a bit of a cushion when it comes to cyclicality, says Alex Ruus, portfolio manager for Arrow Capital.
“On the potential for a slowdown in the economy, usually airlines tend to do poorly in that environment because they’re a high fixed cost business. Chorus is a bit of an exception in that their business model is changing over time,” said Ruus, in conversation with BNN Bloomberg on August 27.
“I would characterize them as half-airline, half-aircraft lessor,” he says. “They provide service for Air Canada, and relative to other airline business it’s a much steadier, stable business and so they have very stable, predictable free cash flow and that’s why they’re able to pay big dividends.”
Chorus currently pays a dividend with a 6.5-per-cent yield and is up 33 per cent year-to-date and up two per cent for the past 12 months.
CargoJet (CargoJet Stock Quote, Chart, News TSX:CJT)
Another interesting approach to airlines is the overnight freight transport company CargoJet, which recently made headlines this summer through a new partnership with Amazon. The deal sees CargoJet effectively become Amazon’s carrier in Canada — an especially notable designation, seeing as Amazon has been more apt to develop its own logistics and transport network in the US — while potentially giving Amazon a 14.9 per cent stake in CargoJet.
Echelon Wealth Partners analyst Gianluca Tucci likes the deal, saying it validates CargoJet’s business model and reaffirms CJT’s status as the “Amazon of the North.”
“Amazon currently operates seven fulfilment centres across Canada with three more ready by the end of 2019 and one to be live in Q120,” writes Tucci in a client update on August 24. “In total, the seven current active fulfilment centres represent 3.6M square feet with the four planned fulfilment centres to add an additional 3.5M square feet of fulfilment space, effectively doubling Amazon’s current Canadian footprint. Cargojet is a direct beneficiary of this trend.”
With his report, Tucci reaffirmed his “Buy” recommendation for CJT and raised his target from $120.00 to $130.00, representing a projected 12-month return at the time of publication of 44 per cent.