Air Canada has been delivering a lot of surprises this year: It bumped a 10-year-old boy from a flight to Costa Rica during March Break, and in July a plane nearly landed on idling jets in San Francisco.
The airline has been surprising investors as well – but in a good way.
Earlier this month, its second-quarter profit sailed past analysts' expectations, sending the shares on a 10-per-cent one-day rally that kept going. The share price is now up 70 per cent this year, which raises a question: Are investors starting to think differently about this notoriously volatile sector?
To be sure, this is hardly a shunned sector. Over the past five years, Air Canada shares have surged more than 2,100 per cent, WestJet Airlines Ltd. shares are up more than 50 per cent and Delta Air Lines Inc. is up more than 400 per cent.
The gains follow what many observers believe is a new era for airlines, which were once bankruptcy-prone. Following a round of consolidation in the United States, airlines have become much more disciplined about staying competitive without giving up profitability.
They have also become more efficient. According to a recent report by Oliver Wyman, a global consultancy, U.S. airline costs fell in the second quarter of 2016 to 11 cents per available seat mile – a common measure used by the industry to gauge efficiency. That's down from 11.5 cents in the same period in 2015, or a 4.1-per-cent decrease.
At Air Canada, the trend has been moving in the same direction. Its costs, excluding the impact of foreign exchange and fuel, have fallen 17 per cent since 2012. WestJet, too, has ratcheted up its efficiency over this period.
The better environment for airlines has even attracted Warren Buffett, the legendary and influential investor who swore off owning airline stocks years ago but has taken a recent shine to them. Mr. Buffett's Berkshire Hathaway Inc. is now the largest shareholder in Delta and United Continental Holdings Inc., and it is among the top shareholders in American Airlines Group Inc. and Southwest Airlines Co.
Given that Mr. Buffett is a long-term investor, his move into the sector suggests that he sees potential here beyond the recent rallies.
Mr. Buffett doesn't own Air Canada shares, but the airline's second-quarter results, released on Aug. 1, appear to support his bullish views on the sector.
Air Canada reported a profit of $300-million or $1.08 a share in the second quarter, up from 66 cents a share in the same period a year ago. After subtracting things such as currency gains and employee benefits, adjusted profit was 78 cents a share, which was well above the 36 cents that analysts had been expecting.
The same day, WestJet reported second quarter profit of more than $48-million, or 39 cents a share after adjustments, also handily beating expectations of 27 cents a share.
In both cases, the better-than-expected results were driven by strong demand for tickets, the airlines' ability to squeeze more dollars out of each plane seat, and ongoing efficiencies that help offset a stronger Canadian dollar and rising fuel costs.
But even with the pleasant surprises and subsequent rallies, valuations remain low. This suggests that the market is still unwilling to accept the argument that today's airlines are better equipped to handle cyclical downturns without seeking bankruptcy protection.
Air Canada shares trade at less than seven-times reported profit. WestJet's price-to-earnings ratio is 11.5. Among U.S. stocks, Delta's P/E ratio is 9.3 and United Continental's is 7.7, at a time when the S&P 500 has a P/E ratio close to 21.
Using another measure, Canadian airline stocks are cheaper than their U.S. counterparts, which only adds to the argument that there is still a skeptical cloud hanging over them.
According to Fadi Chamoun, an analyst at BMO Nesbitt Burns, major U.S. airlines trade at 5.3-times their enterprise value to EBITDAR (or earnings before interest, taxes, depreciation, amortization and rent), a metric which gets around whether an airline rents or owns its planes.
By comparison, Air Canada trades at just 3.9-times EV/EBITDAR.
Air Canada shares have enjoyed a surprisingly good run. But if the airline continues to report upbeat results, it may have one more surprise in store: It will defy the skeptics as a long-term investment.