RE:RE:RE:RE:RE:RE:US peer Delta bleeding badly Good Afternoon logicandinertia,
Both OTB and Fraudhunter are bang-on in their comments. Thought I would add my two cents worth to hopefully address your concerns, which are italicized and in bold below.
Any insight welcomed. Struggling with this one - could be a great short or long from here. Almost impossible to invest , which explains the trading. Not sure what you mean by “which explains the trading.” OTB has mentioned this in previous posts and I agree with his comments that large hedge funds (they
are US-based) and likely some Canadian funds are buying up Air Canada shares. Super-Algos are at work here, and the buying began early this year. Just watch the bid/ask changes in the hour prior to market open and the shorting that occurs at open (to steal shares, stop losses, etc) and throughout the day to keep the price within a specific trading range. Day and bank traders are just playing off the algos. Lot’s of small retail investors getting their shares stolen. Net accumulation is the goal. What I see now is that volume is beginning to dry-up (so the algos have to work much harder) as more and more shares are bought up by the new owners.
After mkt today, Delta announced they were cutting capacity by 90 percent and burning $60mm a day. That is almost half a billion every 8 day. So not a bad proxy to use. Actually, it’s a poor proxy to use. At the end of last year, Air Canada’s cash/cash equivalents as a percentage of total revenue was 33.5% while Delta’s was only 6.2%. Air Canada’s total liquidity was $7.380 billion while Delta’s was only $6 billion, an airline ‘about 2.5x bigger than AC.’
Delta is about 2.5x bigger than AC and has slightly higher profit margins in 2019. Did you account for the MAX grounding? For most of 2019, Air Canada operated with 9% of their fleet grounded resulting in a much higher CASM (both adjusted casm and fuel casm). Delta does not operate the B737 MAX. Delta flew its planned capacity in 2019. Air Canada did not due to the MAX grounding. Again, comparing apples to oranges here.
The industry has done a fine job of turning itself around , but the dynamics remain the same. Use debt/lease financing to buy assets, while using a decent portion of cash flow to reduce the equity float (Ac bought back $373 million last year). The percentage of shares bought back over the years pale in comparison to Air Canada’s U.S. counterparts. Air Canada focused on fleet renewal and debt reduction. They took the pain up front. This is the opposite of what Delta did. Delta’s focus was on achieving investment grade, operating an older fleet, buying back shares and paying a dividend. Going into this crisis, Air Canada’s leverage ratio was 0.8x, the lowest of all NA legacy carriers, and when the 50 MAX and Airbus A220 are in the fleet, and the older less fuel-efficient aircraft, mostly leased, are removed, the airline will have the youngest mainline fleet in NA. All aircraft to be delivered this year were to be paid for in cash, or form part of the Boeing in-kind settlement. Furthermore, Air Canada has moved away from aircraft leasing. Recent changes to accounting rules involving leases resulted in a notable decrease in Air Canada’s leverage ratio while its U.S. legacy counterparts all saw their leverage ratio increase, one significantly.
Curious as to what fixed income instruments they own in the pension and how they will have fared as the removal of pension overhand really accrued to the equity value over past several years. Air Canada has a pension surplus (see below). Moreover, over the last number of years, Air Canada has successfully immunized its pension plans, to a current level of about 87.5%. This means that the plans are significantly less sensitive to changes in interest rates. Delta, on the other hand, has a significant pension deficit. Each year part of its free cash flow is directed toward the underfunded plan. Given Delta’s management stated reduced scope of operations on the other side of this crisis, expect less annual funding to their pension plan.
From Air Canada’s latest MD&A:
“As at January 1, 2019, the aggregate solvency surplus in Air Canada’s domestic registered pension plans was $2.5 billion. The next valuations to be made as at January 1, 2020 will be completed in the first half of 2020. As permitted by applicable legislation and subject to applicable plan rules, amounts in excess of 105% on a solvency basis may be used to reduce current service contributions under the defined benefit component or to fund the employer contribution to a defined contribution component within the same pension plan.”
“As at December 31, 2019, approximately
87.5% of Air Canada’s pension assets were invested in fixed income instruments to mitigate a significant portion of the interest rate (discount rate) risk. Air Canada may continue to increase the percentage of fixed income products matched to pension liabilities, subject to favourable market conditions.”
With just 263 million shares outstanding , big swings in cash flow /burn have a dramatic impact to equity value. We saw that in a positive way from 2010-2019, and we are seeing it the other way in past 4 weeks. Even the dated National Bank piece expected AC to burn thru almost $3 billion in first six months of this year. The projected cash flow burns assumed labour cost reductions were less than what is being achieved and did not consider non-refundable ticket holders given 24-month credits for cancelled flights, the Federal government’s recently announced wage subsidy boost to 75% and, importantly, Boeing’s agreed to compensation for the MAX grounding. In previous posts I estimated total settlement cost to exceed $1.1 billion, with an estimate cash settlement this year exceeding $600 million as well as other in-kind consideration (e.g., MAX aircraft at no cost).
Holders of the debt expect to be paid back every penny with interest , and refinancing of existing debt will require higher interest costs. That is what the debt pricing is telling us. So what gets adjusted in the capital structure to account for the free cash flow burn and higher debt costs? The equity value, and with just 263 million shares out , it doesn't take much to impact the valuation . And recognize that cost of capital for all industries (but especially for airlines) is going up , and rolling over debt will become pricier . The easy credit days are behind us, as the owners of airline debt will want a margin of safety. That is already happening. Please read my post (A Matter of Interest) from early December on Enhanced Equipment Trust Certificates (EETCs):
https://stockhouse.com/companies/bullboard/t.ac/air-canada?postid=30442752 To summarize:
IN SIMPLE TERMS, enhanced equipment trust certificates (EETCs) are corporate debt securities, typically issued by airlines. EETCs are
secured on the aircraft operated by the airlines and are structured through special purpose companies (SPVs) created specifically to own the aircraft and "enhanced" by elements such as debt tranching, availability of liquidity facilities and over-collateralisation.
Given the current low interest rate environment, use of EETCs with aircraft as security, and fewer new aircraft deliveries after the crisis, is it not unreasonable to anticipate more competitive rates on EETCs going forward? No shortage of money looking for a home. Just wondering.
this is tricky, as to what will be left over for the equity holder, and does the government take a big equity slab at these low prices , creating dilution concerns. Historically, the Canadian govt has never warmed-up to the idea of bailing out airlines with large sums of money, unlike the U.S. government. That said, Air Canada has the financial wherewithal to financially navigate its way through this crisis. Make no mistake about it.
Wednesday and Thursday, Berkshire sold 20 percent of their Delta position and 4 percent of Southwest, after saying he wouldn't be selling discounted airline shares when asked last month… won't help the N/T sentiment for this beleaguered sector. Things are not always as they seem. Buffett has always been upbeat on the U.S. economy, and he no doubt views the current crisis as an opportunity to employ much of BRK’s unused capital. I agree with OTB’s comments on BRK’s announcement last night (discussed in this thread). If Buffet were only going to invest in two U.S. airlines, the airlines would be Delta and Southwest - no if ands or buts. It is noteworthy that Buffet owns 18% of AMEX, the credit card company that is partnered with Delta (loyalty program).