Airlines are acting woefully.  The US airlines are not far from their March lows, and Air Canada just reached its lowest point since early April.  Interestingly, AC remains 60% higher than its March lows, which can be taken both positively (for bulls who believe in differentiation and “it’s different for AC”) and negatively (for bears who believe it will revert back to industry group performance).  But what isn’t arguable is that volume on AC over the past week has been falling (not good), and makes rallying ever tougher.  Why?  Thinking logically, everybody who has bought and held Air Canada’s stock since mid 2017 except for a week in early April 2020 and 10 days in March 2020 is now underwater.  With the overhang of the Buffett news and the poor performance of the industry group (JETS ETF looks awful), as AC tries to rally, it faces walls of sellers.  Because many investors are loss averse, and when they get back to close to break-even, they get an itchy trigger finger.  This is simply resistance.  When the industry is in an upturn, equity holders benefit from falling debt, lower debt servicing, positive incremental operating leverage, and new highs on the share price with no resistance above them.   It makes for a good time had by all.  And it was deserved by Air Canada.  This has changed.

There is considerable work ahead.  Once the CEWS program is finished, Air Canada will likely be downsizing its employee base, which will require a considerable cash cost for employee severance.  Of the 32,900 employees (wage bill of $3.2 billion) with AC at end of December 2019, and with plans to retire 79 aircraft and CEO thoughts that 2019 revenue and capacity won’’t be reached for “at least three years”, some tough union negotiations lie ahead.  How would AC management address this downsizing? 

If one assumes that 15-20% will be downsized, the question is what path AC would proceed down.  Focus on newer, younger employees, which would mean less severance due to tenure, but less of a drawdown in salary costs going forward as they make less.   Or a blend including offering older employees packages to bring down permanent salary costs, which would also cost more up front.  I would bet on the latter, but the terms laid out by the company and approved by the respective unions won’t be cheap.  At 15-20% of the employee base, along with the backdrop of Canadian employment law and strong unions, this may be in the range of $250-350mm in cash restructuring costs.  This potential downsizing will be political and certainly play into management’s thinking regarding any government aid, given the blowback firings would cause.   Canada learned the hard lesson in 2008/2009 with the auto industry bailout which ultimately saved very little (the move to Mexico and tax-attractive southern US states continued unabated).  So making a further deal (beyond CEWS) with the government may be a poisoned chalice. 

At $22 million per day, Air Canada burns thru $1 per share in equity value every 13 days.  Because the debt has to be paid back, this cash burn weighs on the back of the equity holder, not the debt holder.  And it will be a considerable time until Air Canada is generating positive free cash flow.   So the share price feels a natural weight on it, or gravity, that can only be overcome by a dramatic change in its near-term fortunes.  To anybody following the trading patterns of the airlines, this is noticeable. 

The industry debt is also trading horribly, with quotes and charts from UAL, LUV, AAL, and DAL below.  Note that these are samples of the unsecured debt offerings.  The secured debt is trading slightly better. 

Good luck.