RBC chops price target on Air Canada

RBC Capital Markets analyst James McGarragle lowered his target on Air Canada (Air Canada Stock Quote, Chart, News, Analysts, Financials TSX:AC) to $28.00 from $37.00, citing continued pressure from high fuel prices, but maintained his “Outperform” rating following stronger-than-expected third-quarter operating performance.

In an update following the Montreal-based airline’s Oct. 29 results, McGarragle said Air Canada’s ability to increase revenue and manage costs despite rising fuel expenses supports his positive view of the shares.

“Q3 results demonstrate Air Canada’s operational excellence in a challenging fuel environment,” McGarragle argued. “While fuel volatility remains a key risk, and we admittedly have no visibility on when or if it moderates, the risk-reward at current levels is compelling.”

Air Canada reported record third-quarter revenue of $6.98-billion, up 21% year-over-year, supported by stronger passenger demand, higher fares and growth in cargo operations. Passenger load factor increased 2.6 percentage points to 89%, while passenger yields rose 11%. Total unit revenue increased 14%, and cargo revenue grew 33%. The airline generated Adjusted EBITDA of $936-million and operating income of $261-million, despite a $906-million year-over-year increase in fuel expenses. Air Canada said fuel prices were 10 cents per litre higher than it had anticipated for the quarter.

Chief Financial Officer John Di Bert said pricing, capacity management and cost controls helped offset some of the additional expense.

“Decisive pricing, capacity and cost actions helped mitigate the impact of a $906 million year-over-year increase in fuel expense,” Di Bert said.

However, the continued pressure from fuel prices prompted Air Canada to reduce its full-year financial guidance. The company now expects 2026 Adjusted EBITDA of $2.4-billion to $2.7-billion, down from its previous forecast of $2.9-billion to $3.2-billion. It also lowered its free cash flow outlook to approximately break-even, within a $150-million range in either direction, compared with its previous expectation of $200-million to $500-million. Third-quarter free cash flow was negative $440-million, despite operating cash flow of $266-million.

McGarragle said the company’s operating performance demonstrates its ability to generate stronger cash flow if fuel prices moderate.

“Strong execution increases our confidence in management’s ability to deliver meaningful free cash flow inflection if fuel eases, while the recent sell-off limits downside if fuel stays elevated,” he said.

Air Canada also strengthened its balance sheet during the quarter, using proceeds from an Aeroplan transaction to repay $1.7-billion in debt and complete an $800-million substantial issuer bid. The share repurchase reduced shares outstanding by approximately 10%, leaving 252.7 million shares at quarter-end. Net debt stood at $4.22-billion, while total liquidity reached $8.02-billion.

McGarragle believes the reduced debt burden and lower share count could improve shareholder returns when operating conditions become more favourable.

“We see meaningful upside in a fuel normalization scenario, with contained downside given how much the shares have come off,” he said.

His revised $28.00 target reflects the challenging fuel environment, although he continues to view Air Canada’s valuation as attractive relative to its longer-term earnings and free cash flow potential.

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