Rouge10 wrote: Leverage ratio target (by end of 2024) of 1.5 will be achieved 18 months in advance next week. AC is in much stronger and in advantageous position than all US airlines in almost all of aspects of business.
DEMAND Oct MTD passengers in US are +5% compared to 2019 and in Canada are +3%. Demand environment has been very strong since last 12 months and is still holding up as per airline CEOs. Passenger numbers are still increasing for both US airlines and AC. But there are clear differences.
Let’s see how: Revenue proportion for each airline: By proportion, AC’s has much lesser exposure to domestic business than US airlines. Numbers below are based on Q2 (AC) and Q3 for others.
United Delta American AC Domestic: 57%, 67% 69% CAN: 26%, US: 21% International: 43% 33% 31% 54% Atlantic: 25% 23% 17%
34% Pacific: 9% 4% 2%
12% Latin AM: 8% 6% 12% 7%
US airlines proportionately fly more DOM pax than AC. AC’s DOM market share has decreased over the last few years. It’s not by chance. AC continues it’s strong focus on high yield domestic and International business and lower yield domestic travel is left for LCCs, which will face high cost pressure in inflationary environment. While no one will be left unimpacted, AC will have created a buffer. At worse, AC might not need to add capacity and continue to fly with lesser than 2019 capacity.
Assuming both US and Canada experience similar market dynamics, AC will still hold their it’s yields stronger than US airlines. If you hear United CEO in his analyst call, he has clearly articulated how network carriers are going to outshine LCCs in the new market. In fact United will fare better than other US airlines and AC will even top United Next. In old operating model, during recession usually, LCC’s would grow by stealing market share from network carriers as passengers reduce their cost of flying. In new model, with strong loyalty models, focus on premium passengers and managed capacity over multi-year cycle, the outcomes will be more stable.
O
ut of all the markets, Atlantic (Incl Middle East, India) is experiencing the highest yield increases and is continuing. Compared to others, AC has highest proportion of high yield revenue market. This will allow AC to perform better. AC is very focused in further increasing international flying. While some of the markets might experience yield maturing, in 2024, China will continue to open up. Even with Russian airspace limitation, AC will add Chinese capacity from West coast. Sixth freedom traffic with aeroplan loyalty will steal passengers from US and European airlines.
All in all, even in case of some demand weakness, China demand will compensate easily. AC has been very disciplined in capacity allocation and utilization, allowing them to maintain higher margin/yields.
Railroads have started to see some return of volume and Q3 ’23 is first Q in a long time with improving Intermodal volumes. Usually, railroads and leading indicator of economy 2-3 Qs out.
United and Delta both mentioned that Business traffic is returning now that companies are mandating a return to office.
AEROPLAN/CREDIT CARD By now its well established that AP and credit cards are cash cows for the airlines. Aeroplan is the latest credit card program in industry and completed after lots of lessons learned. It has the best value for the airlines (AC) in 3 party contract. The increasing membership base caters not only to Canadians but also to Americans who prefer AC for 6
th freedom travel. Seven million members already and increasing. Math as follows:
Annual fee ranges from $90 - $600. With some approximations, annual revenue on the membership fee alone is $1.5B in 2024 for 7 million members. If discounts were offered in first year, all these will bring full value in 2024.
Annual spend assumption $40,000 per card. Total annual spend of $280B and @ 2.5% transaction fee, card txn based revenue is $7B. The spend could be higher as annual spend should be higher per card.
Total revenue from card starting 2024 will be > $8.5B (1.5+7). AC should get a major chunk of this. Let’s safely assume 40% and that translate into $3.5B. A lot of this is hidden in the regular cost/revenue line items of the balance sheet.
At 45% gross margin, one can expect $1.5B margin (45%*$3.5B) from the card business. And with 9M card holders this number will soon be $2.0B. My numbers are not the best case scenario.
See the link
https://www.altexsoft.com/blog/airline-loyalty-program/ to understand the details.
OIL PRICE: I have always maintained that balanced oil price is going to be in and around $80 on average. Price will always fluctuate though. For most part AC is basing their numbers on this assumption. E.g. today oil price is around $84 and has ranged between $68-$94 this year. YOY jet fuel price (and crack spread) is lower than Q4 2022 and with higher yields this year even Q4 is shaping out to be a record Q4.
Also AC’s has introduced dynamic pricing (changes daily) in response to changes in oil price and foreign exchange rates, which covers for higher fuel costs.
CAPACITY AC is currently at ~90% capacity of 2019 in a market, which is operating at 103% (Q3) pax volume (Canada) and have added 5+% population (immigration) since 2019. And expect another 2% increase because of immigration in 2024. Usually in recessions (except COVID), network carriers experience 10-15% demand destruction because of less business travel and/or lower yield. Currently, AC is already operating at approx. 10-15% lesser capacity than 2019. Why? Because of very disciplined focus on capacity, margin and yield.
Can AC get back market share from LCCs? Absolutely, but when the right time comes….. and the right time will come with right fleet, which will allow them to maintain yields.
CAPACITY/FLEET RENEWAL/CAPITAL SPEND/FCF:
As I mentioned before, US airlines are in the middle of their high spend, heavy fleet renewal cycle to replace their aging fleets. United and Delta more than American (but American has huge debt but younger fleet). Higher UAL and DAL capex will slow their ability to lower their leverage ratios. AC had prioritized fleet upgrading and up gauging from 2012-2020 and this is why AC never offered dividend in that time frame. US airlines postponed their fleet renewal but have to replace their aging fleet going forward. AC has lowered and smoothened out their capital spend curve and will avoid large capital expenditure peaks. And with current modern fleet, their unit cost (CASM) is continuously decreasing. It will continue to do so as additional B787-10s and 321-XLRs are added.
United Airlines’ three year (2023-2025) capital spend plan is $20B. Delta is not that far behind. This will limit their FCF for these years. American’s three year capital spend is less ($9B) (but their total debt is much higher to begin with). All three airlines will continue to see higher leverage ratios (2.5+) till 2025/26. Delta and United will achieve 10% operating margin this year but American will come at 7%.
For AC, three year capital spend is ~$4.5M. For facts, AC’s FCF for H1’23 is ~$2.0B. AC will fund its relatively small ongoing fleet additions with FCF (not current liquidity) and in the process, making its fleet even more efficient (less unit cost with less fuel cost, maintenance cost and more # of seats/acft). Even after that, AC will have billions left to accelerate debt repayment (if need be) and/or return $ to shareholders.
Pre covid, capital spend (as %age of revenue) was much lower for 3 US airlines than AC. Post covid, the trend has reversed. AC’s capital spend (As %age of revenue) is much lower than US airlines. This will increase the FCF (as %age of revenue) for AC than US airlines. FINANCIALS: Analysts are forecasting EPS as follows from https://www.marketbeat.com/stocks/TSE/AC/earnings/
Q1: -.53 Q2: $1.85 Q3: $1.77 Q4: .48
From above numbers, its clear that analysts are basing their numbers on past performance and high level analysis following US market. There is limited understanding of nuances between US and Canadian airline market.
Q3 will be huge beat like Q2 was. My estimate for Q3 is ~ $3.0. That will make 2023 EPS = $4.8. With 2019 valuation of PE=10, this will translate stock price into $48. At today’s share price = 16.X, the PE ratio is 3.33 (a discount of almost 70%). Yes, this is a TTM number and share price should be based on future earnings.
Current 2024 EPS estimate is $3.31 using the link above. Monday, we will see how conservative these estimates are. Even if we repeat 2023 earnings (given above reasons of under capacity, capacity management, focus on high income customer base, immigration, etc…), we can expect EPS of $5.0, as interest cost alone for 2024 (<$400M means less than 2% of revenue) will be much lower than 2023. In 2024, status will change to Investment grade and lower risk means higher share price.
Choose whatever valuation model you estimate. My EPS estimates for 2024 are higher than $5.0. The link above shows Q1 ’24 EPS estimate of 0.24 and if I replace this number with my 2023 estimates, we are looking at EPS of $5.5 in 2024.
QUICK VALUATIONS: Free cash flow: Expect AC’s full year 2023 FCF of ~$2.5B, which is ~ $7.0/Share. This will further reduce their leverage ratio to ~1.25 (@ FX =1.35), which will be industry best. Delta airline FCF has decreased to $2B ($3.2/share with revenue of over $50B). If we apply same valuation as Delta’s (current sp: 3.2*10= $32), AC sp should be at $70!! Just one way of looking at potential.
AC’s FCF as a percentage of total revenue will continue to be stronger than US airlines for coming years.
Net income: Delta’s estimated EPS for 2023 is around $6. Pre COVID that would have meant $6*10 = $60 sp. Today its valued at $32 ($6*
5.5). With same math, AC should be at, at least $25-27 (EPS estimate: $4.8) today. Comparing the two airlines, Delta’s FCF will be used up in funding fleet renewal and AC will have much larger FCF to be used for deleveraging and/or returning cash to shareholders. Technically AC will be valued more. We have seen this in 2019 and it will happen again over next few Qs.
CONCLUSION: No matter either which way you look at it, AC has very sound financial health and arguably one of the best in the world. Next Monday,
Air Canada will report its best Q3 ever, and with The Canadian airline market 12 to 18 months behind the US market from Covid, and with return of business travel,
expect forward guidance next Monday to continue to show strong demand and support for higher yields.