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The Weekly Contrarian
Pick |
12/09/98 |
| ACNAF (Air
Canada [Non voting shares: ACNAF (NASDAQ), AC.A
(Toronto)]): |
Price:
3.125 |
52 week
range:
9.94-2.88 |
P/E
Ratio
8.9 |
Price/Sales
0.15 |
Price/Book
0.59 |
Institutional
Holdings
40.8% |
Industry
Airlines |
P/E to
Industry
43.9% |
Price/Book to
Industry
40.0% |
Profit Margin to
Industry
148.1% |
Montreal based Air Canada is the largest airline in Canada. The company's
fleet of 157
aircraft provide service to over 545 destinations worldwide. The company is
a member of
the Star Alliance of airlines (other members include Lufthansa, SAS, Thai
Airways Int'l,
Varig Brazilian, and United Airlines. All Nippon Airways, Air New Zealand,
and Ansett
Australia will be joining the alliance in 1999.). The company has suffered
through a
difficult
1998, and has seen its stock price plummet from over $9 a share at the
height of the
public's love for the airline sector in April to the present $3.38 .
The company lost $0.31 in the third quarter due to a 13 day long pilots
strike which cost
ACNAF $212 million. The strike caused revenues to decline by 17.9% during
the quarter.
The company expects to incur fourth quarter operating and net losses as a
result of the
strike, and will also report a loss for the year due to the strike.
The Asian economic crisis has hit the company hard this year. The Star
Alliance's large
exposure to the Asian market has hampered member airlines this year as
passenger and
cargo traffic have slumped noticeably. Air Canada's passenger traffic to
Asia and Britain
has seen reduced rates of growth this year, and its cargo operations have
suffered a 6.7%
decline in revenue ton miles. Cargo load factors in the airline industry as
a whole have
suffered recently as the full effects of the Asia/Russia/Emerging markets
collapse have
begun to be felt.
Air Canada is also suffering from a highly leveraged capital structure and
operating costs
that are growing faster than revenue growth. ACNAF's costs have grown by 10%
over the
past two quarters while revenues have increased by just 8%. The company
expects fourth
quarter revenue growth rates to be flat to down, while capacity will
increase by 5%. The
company has recognized the need to bring its cost structure into line with
revenue growth,
and is taking measures to address the problem. The company plans to delay
the delivery
of 5 Airbus aircraft and to make job cuts to bring costs down. Air Canada is
also planning
to retire older planes earlier than planned, and fly fewer available seat
miles as a means
to reduce costs.
We believe that ACNAF's cost cutting moves and a gradual recovery in Asian
markets next
year will enable the company to stage a turnaround in 1999. The company will
benefit
from any pickup in the Asian economies as its membership in the highly Asia
dependent
Star Alliance begins to bring increased traffic to the company's routes via
the numerous
code sharing agreements it has forged. An Asian recovery will put a halt to
the decreases
in cargo load factors that have plagued ACNAF this year as cargo volumes
pick up in
tandem with economic recovery. The Air Transportation Institute is expecting
overall
industry ridership to increase next year, and Air Canada will benefit from
any industry
recovery. Air Canada's earnings could surprise on the upside if Asian
economies recover
faster than expected.
The end of strike related losses, and the accompanying abatement of
strike-related
negative investor sentiment towards the stock, will enable the company to
return to profit
in 1999 and the depressed stock price to stage a partial recovery.
Throughout this year's
downturn, the company's domestic Canadian and U.S. operations have remained
strong.
We expect this trend to continue next year. The company produced strong
results in
October, with revenue passenger miles increasing by 8.4% and its load factor
increasing
by 2.7%.
Air Canada is currently undervalued relative to both its historical norms
and its
industry.
ACNAF is trading at 1.4 times cash flow, versus 2.3 times for the airline
industry. Other
valuation measures are equally undervalued: ACNAF trades at a trailing P/E
of 4.3, versus
an industry average of 9.5; ACNAF has a Price/Book ratio of 0.58, versus
1.01 for its
industry. We expect Air Canada's depressed valuation levels to return to
near the
industry norm as investors begin to put September's strike behind them and
start to focus
on the company's future prospects. An expansion of the P/E ratio to the
industry average
implies a price of $5 1/2 to $7 over the coming year. |
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