Air Canada (TSX:AC) has saw a significant spike in interest since the economy started opening back up. Since hitting lows in mid March of just under $13, the stock roared back to levels above $23 in under two months.
However, there are a few reasons I would highly suggest Canadian investors avoid Air Canada stock, and instead focus on another Canadian stock in the airline industry. Many investors learning how to buy stocks often are told to “buy low, sell high” and as such, a stock like Air Canada right now looks promising.
Commercial airline travel could be permanently damaged from COVID-19
When we think of an airline company like Air Canada and its ability to increase bottom lines, we often think of business travel. And if you didn’t think this way, you ought to start.
An airline company makes the bulk of its profits off business, not passenger travel. In fact, airline companies run extremely tight margins for the run of the mill passenger who grabs a $300 ticket from Vancouver to Saskatoon.
Between fuel, plane leases, employee salaries and the exorbitant amount of other expenses airline companies have, there just isn’t enough there.
They need business fliers. First class tickets, alcohol, meals, hotel bookings through Air Canada vacations. High margin items that are extremely popular among consumers who have the company’s credit card.
Looking back at Air Canada’s last profitable quarter, net profit margins hovered around 3.5%. There isn’t much room for error.
So, it’s concerning in a lockdown era due to COVID-19, businesses are starting to see that things the company used to pay a fortune for, like flying employers to in-person conferences and meetings, can be hosted at almost no cost. All the employee needs is a webcam and a microphone.
In fact, Shopify’s CEO was even bold enough to come out and say “The era of office centricity is over” suggesting that most Shopify staff will be permanently working from home.
As of right now, this is just a trend. However, if it catches on, Air Canada has the potential to take significantly longer to recover than some hopeful investors think.
The company already expects 3+ years to return to 2019 profit levels. I’m thinking that is overly optimistic.
So instead, why not focus on an airline company that has a large chunk of its coming from one of the heaviest spenders in the world, The U.S. Military?
Avoid a falling knife in Air Canada stock and buy Heroux Devtek (TSX:HRX)
Before the COVID-19 pandemic, Heroux Devtek (TSX:HRX) was one of the better performing stocks on the TSX Index over the last couple years. From December 2018 to February 2020, the stock had essentially doubled and there was a lot of optimism around the company.
COVID-19 obviously hit Heroux Devtek hard, as most would expect. The stock cratered by more than 55% as Canadian investors frantically bailed out of airline companies.
There is no doubt Heroux Devtek will be hurt by the lack of air travel from major companies like Air Canada. After all, it is the third largest producer of landing gear in the world.
However, the company has one client in particular that loves to spend money, the United States Military.
What investors didn’t pay attention to was the fact that more than 66% of Heroux Devtek’s backlog is comprised of orders for defense programs, and over 50% of revenue is expected to come from the United States this year, exposing them to a strong dollar. The company also came out and stated they expect very little disruptions to these orders.
To add to this, the company has a rock solid balance sheet to weather most storms, with over $225 million in working capital as of March 31st 2020.
There is no doubt Heroux Devtek’s stock price would take a hit due the COVID-19 pandemic. But I think the market overreacted when the stock dropped by over 55%.
Overall, there’s simply better options than buying Air Canada stock
Air Canada is going to be significantly impacted by COVID-19 for the next half decade, and its reliance on passenger and business travel is why.
There is money to be made in the airline sector right now, you just have to be looking at the right companies. Ones who’s revenue are expected to stay somewhat stable despite unprecedented headwinds, no pun intended.
Heroux Devtek is one of those companies, and could be a small-cap Canadian stock that provides investors with outsized gains in the future. It will be interesting to see how the company reports earnings moving forward.