Air Canada could still reward investors with hefty returns, despite the recent labour turmoil and rising expenses from pay hikes.ANDREJ IVANOV/AFP/Getty Images
Canadians are hopping mad about oligopolies, and the reason is clear: Many stocks within this cozy group of protected companies have been stumbling.
Railways, telecoms, big banks, grocers and, yeah, Air Canada AC-T, typically enjoy limited competition because they must adhere to tight regulations and serve a domestic population spread across six time zones, which tends to keep out interlopers.
Consumers might grumble about high fees and dismal service here, while looking forlornly at the paradise of American capitalism to the south – wink wink – where competition is fierce.
But investors have long recognized that there is another side to Canadian oligopolies.
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As large, stable businesses, they tend to generate loads of cash and distribute attractive dividends. And because they are spared intense competition on their home turf, they don’t need to sacrifice profits in search of market share or survival.
For all these advantages, though, a number of key companies have left investors with a lot to think about.
Air Canada has tarnished the public’s view of oligopolies after a labour disruption left thousands of travelers stranded this week without access to alternative carriers.
One solution that may be gaining traction: Increase competition by giving international airlines access to domestic Canadian routes.
Beyond airlines, telecoms face the twin threat of regulators who want lower prices for mobile communications and a government that has scaled back immigration – once a major factor in driving customer growth.
BCE Inc.’s BCE-T decision to slash its quarterly dividend this year has focused attention on the telecom sector’s enormous debt levels and weak growth prospects, undermining the buy-it and forget-it approach that has long attracted investors.
Similarly, railways – whose long-term returns have easily outperformed major indexes – are also falling out of favour because tariffs are threatening to disrupt North American trade.
Canadian National Railway Co. CNR-T and Canadian Pacific Kansas City Ltd. CP-T are down 27 per cent and 14 per cent, respectively, from their recent highs last year, in contrast to the benchmark S&P/TSX Composite Index, which rose to a record high earlier this month.
Though grocers have been performing well, they were vilified for price hikes in 2022 after inflation spiked, leading to calls for greater competition that could chip away at their competitive armour.
And banks, which have also gained ground this year, face a troubled housing market and a weaker domestic economy that could slide into recession, making them vulnerable to a downturn.
Is the poor oligopoly doomed?
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Full disclosure: I own units in an exchange-traded fund that holds the Big Six Canadian bank stocks. I also own shares in CN, BCE and Telus Corp. T-T
While that might make me look like an oligopoly fanboy, the fact of the matter is that stocks that fit this description have a lot going for them.
For one: Size. Eight of the biggest 20 companies in the S&P/TSX Composite Index are banks, railways and grocers – more if you include pipelines and life insurers – which contributes to stability.
What’s more, they can be ideal for income-hungry investors. Just 15 oligopolies from four sectors generate a whopping 35 per cent of all dividends in the index, according to a report from CIBC Capital Markets this month.
Though not infallible, these stocks tend to beat the market over time, too. Most of the 15 stocks have outperformed both the TSX and the S&P 500 over the past 30 years, according to the CIBC report.
Air Canada isn’t part of this esteemed group: It’s much smaller than typical oligopolies, it doesn’t pay a dividend and, let’s face it, airlines have a rocky history. Air Canada’s share price, though up nearly 50 per cent from a recent low in April, is 60 per cent below its prepandemic high.
Nonetheless, its oligopoly status can’t hurt – and some observers are now arguing that the airline can emerge from the recent labour turmoil, along with rising expenses from pay hikes, and still reward investors with hefty returns.
Air Canada's unionized flight attendants reached an agreement with the country's largest carrier on Tuesday, ending the first strike by its cabin crew in 40 years.
Reuters
“While we recognize that Air Canada’s brand has taken a hit during these last few days as customers were forced to cancel or reschedule their travel plans, we have not assumed any longtail impact on Air Canada’s demand outlook,” Kevin Chiang, an analyst at CIBC Capital Markets, said in a note.
He expects the airline’s share price can rally to $24 within the next 12 months, implying a gain of 27 per cent from Wednesday’s price.
James McGarragle, an analyst at RBC Dominion Securities, thinks the stock can rally to $25.
Despite a strike-related hit to its third-quarter profit, the analyst expects the airline will generate significantly more free cash flow after management proved itself capable of navigating a rocky economy in the first half of the year.
Sure, ticket holders will continue to grumble. But that’s the beauty of oligopolies for investors: We complain about airlines, banks and telecoms – and then remain loyal customers.