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  • Writer's pictureYoung Guns Capital Corp.

Invest in Airlines? Air Canada? Seriously?

Sometime in the early 1980s, Richard Branson, British entrepreneur and owner of the Virgin Records, was met with a cancelled flight. He was on his way to the British Virgin Islands to meet his girlfriend, when his American Airlines flight was suddenly cancelled.

Nothing was going to stop Richard that day so he marched to the back of the airport, gave them his credit card and hired a plane. He then borrowed a blackboard, wrote "Virgin Airlines one-way: $39 to the Virgin Islands," and filled up the flight with all the bumped passengers. The next day he called Boeing and said: "I've just had a bad experience and I'm thinking of starting an airline called Virgin. Do you have any secondhand 747s for sale?"

Fast forward to 2019 and Virgin Atlantic Airways revenue was almost 3 Billion in British pounds. It’s 37 aircraft flew roughly 5.6 million passengers around the world that year. What a business success story.

Airlines sound like a great investment so then why is he famously quoted saying:

“If you want to be a Millionaire, start with a billion dollars and launch a new airline.”

- Richard Branson, Virgin Atlantic Airways

Air travel remains a low-margin business because most travellers prioritize price above all else. Booking cheap flights online doesn't help the airlines. It is also capital-intensive. Modern aircraft, jet fuel and experienced crew aren’t cheap. Airlines are ultra-sensitive to things they have no control over, such as oil prices or a global pandemic that shuts down air traffic. I am looking at you Covid-19!

U.S. Airlines posted their 10th straight year of profits in 2019 and were preparing for even more growth in travel demand in 2020. Then Covid-19 started to spread. U.S. travel demand dropped 95% in 2020. Ouch.

The future of air travel looked bleak. In 2020, Richard Branson had offered his luxury island resort in the Caribbean as collateral to help get a UK government bailout of his stricken airline Virgin Atlantic Airways. I guess his quote does make a lot of sense now.

Warren Buffett, billionaire value investor, sold his entire positions in the U.S. airline industry. The prior stake, worth north of $4 billion in December 2019, included positions in United, American, Southwest and Delta Air Lines. In most cases, Buffett owned 10% of all outstanding stock in these airlines. That is a huge stake so it made headlines when he sold all his stock in airlines.

It’s 2021 and domestic and international travel is still discouraged by many levels of government because of Covid-19.

Airline stocks don’t do well over the long-term, except Westjet (now private company) and Southwest Airlines, they are meant to be traded like commodity stocks. Buy them when they are low and out of favour then sell them when the economy is doing great.

With all this information why would anyone want to buy an airline stock?

We think now is a good time to start a position. Stock prices are low and nobody wants them. That is the time to make money. We decided to buy $2,500 worth of Air Canada stock in our Registered Education Savings Plan (RESP). Our average cost price was $25 a share.

Normally, we would study a company's balance sheet, quarterly earnings and dividend before investing but in Air Canada’s case there is no point because international travel around the world was basically shut down in 2020. In the last quarter Air Canada was burning through about $14 million in cash a day. No real revenue but high fixed costs. It very expensive to have planes sitting around doing nothing.

Air Canada’s fortunes are tied to the reopening of domestic and international air travel (very profitable). People are tired of lockdowns and want to travel. If planes fill up quickly, Air Canada should be able to raise prices and boost profit margins.

Fuel accounts up to 20% of an airline’s expense so we will have to watch the price of oil which is has gone up significantly the past year. Brent crude is currently trading just above $60 a barrel.

Air Canada is also aware of this and are buying new planes to decrease its fuel costs. Air Canada ordered 33 Airbus A220-300s from the Airbus facility in Mirabel, Quebec. The Airbus 220 provides better fuel efficiency then its current aircraft. The Airbus 220 can fly farther on less fuel, averaging 20 per cent less fuel consumption per seat. This is huge for an airline.

On a bright spot Air Canada’s cargo division continues to deliver strong performance, with its revenue almost doubling from last year. No surprise because of the growth in e-commerce. Everyone is buying online at Amazon and the product needs to get shipped to your door. You probably travelled on this plane before it was converted to a cargo plane.

Many businesses across the globe have adapted to Zoom meetings and other ways of communication without traveling. Business travel is a profitable segment for airlines. If an executive needs to be in Toronto or New York next week for an important meeting then they aren't concerned about getting the cheapest flight, especially if the company is paying. All previous business travel may not come back. This is a risk.

Air Canada’s has a dominant position in the Canadian airline sector. The federal government recently gave the airline a $5.9 billion bailout deal which included low interest rate loans and equity investment ensure it survives the pandemic. The government bought $500 million worth of stock in Air Canada and has an option to acquire more than 14 million additional shares so the downside is limited. The Government of Canada won’t let it fail.

We made a $2,500 contribution to our RESP to purchase Air Canada stock so we will receive $500 Canada Education Savings Grant (CESG) from the federal government. This will further limit our downside risk. Employment and Social Development Canada provides an incentive for parents, family and friends to save for a child's post-secondary education by paying a grant based on the amount contributed to an RESP for the child. The CESG money is deposited directly into the child's RESP.

The stock was trading around $50 per share at the end of 2019. It currently trades under $25 now. We don’t know what’s going to happen to stock price in the short-term but we strongly feel the stock should provide us with double digit returns within the next three years.

Either we make money which will be used for our post-secondary education or we will learn some important investment lessons. We will win either way so this is calculated risk worth taking.

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