Please ensure Javascript is enabled for purposes of website accessibility

Is Air Canada's Rally Set to Continue?

By Alexander MacLennan - Updated Apr 10, 2017 at 12:24PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

After tripling since last summer and recently topping its 52 week high, how much upside does Air Canada have left?

About a week ago, I discussed some of the reasons for Air Canada's (TSX: AC.B) strong stock performance over the past year. If the airline closed above its then-52-week high of $3.40, I promised I'd give it another look. Here's why that ended up happening sooner than I thought.

Industry rally
As stocks react to positive developments over time, or as investors pile in, sensing a move upward, many companies can rise on momentum-style buying. With shares up more than 22% since the beginning of September (as of Sept. 17), and up nearly 100% year to date, there is clearly an uptrend happening in Air Canada's stock. But what's driving this rally?

Airlines in general have been rallying this year, with United Continental Holdings (UAL -3.30%) and Delta Air Lines (DAL -2.26%) up 41% and 96%, respectively, year to date. These companies have benefited from a rebounding economy and disciplined capacity measures, both of which helped them post substantial earnings increases. Not only is the industry's situation getting better, but investors are also beginning to see a new perspective on airlines: stable profits fed by higher fares and load factors and reduced competition.

I don't see this perspective fully priced into airlines yet, however. Using Businessweek's earnings estimates and closing prices from Sept. 17, Delta Air Lines trades at only 7.8 times its 2014 fiscal year earnings, and United Continental trades for even less, at 7.3 times its 2014 earnings.

Although United Continental has missed estimates or lowered guidance in the past couple of years, earnings anywhere near these estimates would still leave the airline trading well below the broader market average. On Delta's side, the situation continues to improve. With its merger with Northwest Airlines now behind it, Delta is focusing on slashing debt, running its oil refinery, and even returning capital to shareholders through a dividend and buyback program.

When major players in an industry rally, their surging stock tends to place buying pressure on industry peers. In Air Canada's case, it has robust earnings to accompany its rising shares. The company's latest quarterly report solidly beat estimates, causing a pop of around 25% the day of the announcement, and setting the latest stage of its rally in motion.

Earnings forecasts point to an even brighter future ahead for Air Canada's earnings, with 2014 fiscal year consensus estimates of $0.96 per share. That makes the stock look extremely undervalued at less than five times its 2014 earnings.

Another index inclusion
The big news out of the U.S. airline industry last week was the inclusion of Delta Air Lines in the S&P 500, where it joined Southwest Airlines and became the only legacy carrier in the index. This helped Delta shares move higher in the days following, as the positive news was eaten up by investors who now view Delta as a safer investment. Its shares likely came under buying pressure from S&P 500-related funds as well.

Air Canada was also invited to the S&P/TSX Composite, however, which is much like a Canadian version of the S&P 500. Although there are not nearly as many S&P/TSX Composite funds as there are S&P 500 funds, Air Canada's presence in the index may increase some funds' willingness to add shares of the airline. Additionally, investors will now see Air Canada shares in the same index as WestJet shares, decreasing the perception of WestJet as the financially healthy Canadian airline, and Air Canada as the financially unhealthy one.

Turnaround at Air Canada
Although Air Canada is not the strongest player in the industry, its compelling valuation makes it my top pick in the airline industry. Through a combination of growing earnings, positive industry trends, and shifting investor sentiment, Air Canada shares have more than tripled off of their lows last summer. Despite this impressive rally, I view these factors as continuing drivers for shares going forward.

Possible risks to this rally include an economic slowdown, more aggressive capacity additions, or a spike in jet fuel prices. Barring any of these situations, I see Air Canada as an excellent value in an industry that is itself broadly undervalued. As with any company, however, investors should watch Air Canada and the airline industry as a whole closely for any positive or negative news that could affect their investments.

Alexander MacLennan owns shares of Air Canada, AMR, Delta Air Lines, and Gol Linhas. He is also long the following options: $22 January 2015 Delta calls, $25 January 2015 Delta calls, $30 January 2015 Delta calls, $17 January 2015 US Airways calls. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Delta Air Lines, Inc. Stock Quote
Delta Air Lines, Inc.
DAL
$34.54 (-2.26%) $0.80
United Airlines Holdings, Inc. Stock Quote
United Airlines Holdings, Inc.
UAL
$38.96 (-3.30%) $-1.33

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
402%
 
S&P 500 Returns
129%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/17/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.