TD Waterhouse Comments on AC this morningTDW sees AC in strong position to weather the storm. AC strength will benefit Chorus.
Below are TDW comments.
Air Canada
(AC-T) C$16.03
Highlights from AC Management Call
Event
Yesterday, TD hosted a conference call with Michael Rousseau, Deputy CEO
and CFO, to discuss Air Canada's positioning and initiatives for dealing with the
COVID-19 pandemic.
Impact: POSITIVE
We are maintaining our BUY recommendation, $28.00 target, and forecasts. The
call confirmed our view that Air Canada has sufficient liquidity to meet financial
obligations. The company is responding quickly to the crisis in adjusting its cost
structure without sacrificing its ability to ramp-up operations once the recovery
begins. We believe that there could be an upward bias to our forecasts and valuation
multiples within the next 12 months depending on the duration of the negative news
and contraction in industry revenue. We continue to believe that Air Canada's longterm
value is well above our 12-month target, but that in the current environment,
our target represents a reasonable risk-adjusted expectation for investors.
Assuming that the impact of COVID-19 has started dissipating by the end of 2020,
we believe Air Canada's share price will be higher in 12 months (notwithstanding
the potential for more downside in the meantime). We believe that Air Canada has
the financial strength to sustain itself through a crisis that continues well beyond
H1/20. Air Canada management has extensive experience to facilitate navigating
this unprecedented event. The conservative approach to how the balance sheet was
managed prior to the downturn is benefiting the company today, and management
is working towards exiting this crisis as strong as the company entered it.
Liquidity
Air Canada had $7.3 billion of liquidity (cash, cash equivalent, short- and longterm
investments) as at mid-March, including drawdowns on its U.S.- and Cdnbased
revolving credit facilities.
TD Investment Conclusion
Air Canada is trading at an attractive valuation when considering its earnings
potential beyond 2020 and 2021. Based on our current assumptions regarding the
impact from COVID-19, we believe that Air Canada's strong liquidity, capacity cuts,
and limited debt-repayment requirements will allow it to navigate this challenging
environment and reward investors who decide to ride-out the current volatility and
elevated risk.
Details
Liquidity (cont'd)
· Management believes that the company has one of the strongest liquidity
positions among airlines globally, a view that we share. Regardless, the company
is adding additional layers of liquidity insurance to protect against a much more
prolonged impact than expected. This should not be viewed as liquidity that is
required based on the company's current assumptions and planning.
· Air Canada has $5 billion in unencumbered assets that can be used to secure
additional liquidity. Approximately 60% is aircraft. Cash and liquidity is well over
30% of trailing revenue.
· The company is in discussions with the federal government regarding support.
Given the stage of discussions with the government, there were no details
regarding specific potential sources of assistance. However, we believe flexibility
on fees related to aviation infrastructure, and access to liquidity (loans/loan
guarantees) are likely outcomes.
· Not surprisingly, there will be a reduction in liquidity in the short-term as certain
fixed costs and capital expenditures continue. The company estimates that its
cash burn (operating cash flow before working capital) is 40-50%, which implies
that for every $1 reduction in revenue, operating cash flow will decline by $0.40-
0.50.
· The normal seasonality in cash generation from working capital in the first half of
the year and a reversal in the second half could be reversed in 2020. Air Canada
(and other Canadian airlines) have secured regulatory relief regarding customer
deposits for non-refundable fares for flights that have been cancelled. At the end
of Q4/19, the deposit liability was $2.9 billion. The relief means that the airlines
can retain a portion of those deposits and provide affected travellers with a 24-
month credit for future travel. As a result, cash outflows related to the burn-down
and return of deposits will be less significant than they would be if this relief was
not provided.
· As at Q4/19, Air Canada planned $2.4 billion in capital expenditures for 2020,
approximately 50% of which is for aircraft (17 A220s and six 737 MAX). The
company still plans to accept delivery of these aircraft, and has debt already
secured for the A220 purchases. Assuming the 737 MAX grounding is lifted, and
Air Canada takes delivery, we believe financing will be secured. The remaining
50% of originally-planned capital expenditures have been reduced by several
hundred million dollars, implying that cash usage for capex in 2020, after
deducting financing inflows will be below $1 billion. Our forecast is for the
equivalent value to be approximately $850 million.
Outlook
· Management expects the eventual recovery in air travel demand to be more Ushaped
than V-shaped.
· Excluding fuel and D&A, approximately 50% of its operating expenses are
variable. The timing of labour expense reductions is dependent on the underlying
employment contracts. Air Canada has announced layoffs of more than 5,100
cabin crew members. Pilot layoffs must be managed with a view to the
requirement to ramp-up flying as the recovery gains momentum due to the
regulatory requirements for pilot training. As a result, Air Canada has sought to
reduce the minimum number of hours for pilots as opposed to layoffs. Other
variable costs can be reduced in less than a month.
· The company extended A320 and E190 leases last year to backfill the lost
capacity from the grounding of the 737 MAX. There is some flexibility to return
those aircraft to lessors this year if demand results in the need for further capacity
reductions.
· Regional partners have been very receptive to necessary actions and represent a
source of reduced costs with regional capacity generally coming down in-line with
mainline.
· There is a significant amount of incoming interest in cargo services.