Tighter Climate Regulations And High Debt Will Crush Margins

Key Takeaways

• Rising regulatory and environmental pressures are increasing costs and threatening brand reputation, complicating Air Canada's competitive position globally.
  
• Shifting travel patterns, financial constraints, and cost disadvantages risk eroding premium revenue and limiting growth opportunities.
  
• Expansion of international routes, operational efficiency upgrades, and loyalty program growth are driving margin improvement, customer retention, and greater financial flexibility.

Catalysts

Provides domestic, U.S. transborder, and international airline services.

• Increasing regulatory scrutiny on climate impact, including anticipated carbon taxes and stricter emissions requirements, is likely to impose significantly higher operating costs on Air Canada in the coming years, directly eroding future net margins and making price competitiveness more challenging in international markets.
  
• The persistent trend towards remote work and the resulting structural decline in business travel threatens Air Canada's lucrative premium and corporate travel segments, raising the long-term risk of sustained weakness in high-margin passenger revenue and limiting rebound in total earnings.
  
• The company's high leverage, pandemic-era debt burden, and the ongoing need for elevated capital expenditures to modernize and replace aging aircraft will constrain financial flexibility and raise interest expenses, putting pressure on free cash flow and reducing the capacity to invest in growth opportunities.
  
• Slowing adoption of sustainable aviation fuels across the airline industry puts Air Canada at risk of elevated fuel expenses and potential regulatory penalties in major markets, undermining both earnings growth and brand reputation with increasingly climate-conscious consumers.
  
• Cost disadvantages compared to ultra-low-cost carriers, especially on price-sensitive domestic and transborder routes, could result in further market share loss and compress yields, leading to persistently pressured net margins and limiting the company's ability to sustainably grow revenue.

Air Canada Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Air Canada compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Air Canada's revenue will grow by 4.5% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 6.6% today to 2.4% in 3 years time.
• The bearish analysts expect earnings to reach CA$604.9 million (and earnings per share of CA$2.53) by about August 2028, down from CA$1.5 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 10.5x on those 2028 earnings, up from 4.0x today. This future PE is lower than the current PE for the CA Airlines industry at 16.3x.
• Analysts expect the number of shares outstanding to decline by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 11.02%, as per the Simply Wall St company report.

Air Canada Future Earnings Per Share Growth

Risks

• Strong expansion and demand in Air Canada's international network, coupled with a resilient and diverse route mix, are fueling growth and supporting higher premium cabin revenues, which help reinforce long-term revenue and net margin stability.
  
• The strategic focus on the Aeroplan loyalty program, premium products, and sixth freedom connectivity is broadening high-yield customer segments and increasing customer retention, which can drive higher recurring revenues and more predictable earnings.
  
• Fleet modernization through the addition of fuel-efficient aircraft such as the A220s, 737 MAX, and incoming A321XLR and 787-10s is lowering operating costs and enabling profitable network expansion, improving operating margins and supporting long-term earnings growth.
  
• Robust capital allocation and balance sheet management, including significant debt reduction, share buybacks, and high liquidity, are strengthening financial flexibility and returning value to shareholders, potentially lifting earnings per share and share price.
  
• Continuous investment in technology, operational efficiency, and customer experience-demonstrated by improvements in on-time performance, digital platforms, and cost control initiatives-positions Air Canada to capture secular growth trends in air travel, supporting stronger revenues and sustained improvement in net margins.

Valuation

• The assumed bearish price target for Air Canada is CA$19.43, which represents two standard deviations below the consensus price target of CA$25.74. This valuation is based on what can be assumed as the expectations of Air Canada's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$32.0, and the most bearish reporting a price target of just CA$18.1.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be CA$25.5 billion, earnings will come to CA$604.9 million, and it would be trading on a PE ratio of 10.5x, assuming you use a discount rate of 11.0%.
• Given the current share price of CA$19.77, the bearish analyst price target of CA$19.43 is 1.8% lower. The relatively low difference between the current share price and the analyst bearish price target indicates that the bearish analysts believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.