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As Air Canada (AC.TO) pilots vote whether to ratify a four-year agreement with the airline, some analysts say the company is “significantly undervalued” compared to its peers, and opportunity lies ahead for investors if the deal is ratified.
The impact of the agreement, reached right before the strike deadline, will likely weigh on the airline’s upcoming quarterly results due to higher costs if the deal if ratified, as well as an increase in the number of customers that likely turned away from the airline over concerns about a potential strike.
Still, TD Cowen analysts Tom Fitzgerald and Helane Becker wrote in a research note on Tuesday that the airline is “taxiing towards outperformance” and “remains significantly undervalued.”
The analysts lowered third-quarter and fourth-quarter earnings estimates for Air Canada due to expected pilot wage inflation and customers likely booking away from the airline because of fear of a pilot strike, but expect that margins “have bottomed this year” and will improve going forward. They have a “buy” rating on Air Canada’s stock, and a price target of $19 per share.
“Air Canada remains significantly undervalued on an EV/EBITDA basis versus other full-service carriers. We believe this valuation gap will close once pilot negotiations are in the rearview, shareholder returns are announced, and the recovery in long-haul Asia Pacific traffic continues to benefit Air Canada’s results,” Fitzgerald and Becker wrote.
“2024 has been a volatile year for the shares, but we expect margins to have bottomed this year and think the name is set up well against a lowered bar.”
Shares of Air Canada have struggled this year and are down about 12 per cent year-to-date. The weakness in share price performance is in part because of some of the earlier uncertainty surrounding the pilot deal. While post-pandemic pent-up demand helped fuel a travel recovery through 2023, there have also been broad industry concerns about air travel demand waning.
During the last quarterly conference call, CEO Michael Rousseau acknowledged the share price weakness, telling analysts that the airline was “disappointed with our stock performance year-to-date, especially coming off our record 2023, and having completely repaired the balance sheet.”
National Bank analyst Cameron Doerksen also trimmed earnings expectations for Air Canada’s third and fourth quarters due to “strike threat-related noise.” He maintains an “outperform” rating on the stock, with a $22 price target. He says the ratification of the pilot deal “would remove a key overhang on the stock,” and while yields have softened over the summer, industry capacity growth is expected to decelerate later this year, which could benefit the airline from a yield perspective.
“Much of the yield pressure that Air Canada has faced this year was the result of excess industry capacity, particularly to the U.S. and international sun destinations in the winter, as well as European destinations in the summer,” Doerksen wrote.
“Looking at Q4, however, capacity growth is decelerating which could help drive some yield improvement heading into 2025.”
Doerksen also expects lower jet fuel prices to help offset the impact of the strike threat.
But there remains a risk for the outlook for Air Canada – that the pilot union rejects the tentative four-year agreement.
Last week, the head of the Air Canada pilot union, Charlene Hudy, said she’ll step down if members opt to reject the deal. The contract, reached in late-September after more than a year of negotiations, averted a strike that would have seen approximately 670 flight cancellations and 110,000 passengers affected daily. While the agreement adds $1.9 billion in value for its membership, the deal has faced scrutiny from some pilots, particularly more recent recruits who are unimpressed with the ongoing pay gap between newer employees and more experienced colleagues.
Doerksen says that although the total pay increase of the tentative agreement is at the high end of expectations, he estimates the total cost increase for the airline will be around 2.5 per cent over the four years, something that is “manageable” for Air Canada.
“While there is still some risk that the recently reached tentative agreement with its pilots is not ratified, we believe the confirmation of a new deal would remove a key overhang on the stock,” he wrote.
Fitzgerald and Becker also note that other risks are that travel demand weakens in Canada, and that shareholder returns do not materialize as quickly as expected.
With files from The Canadian Press
Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.
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