AC-Ability to generate cash– From 2010/2019 and 2021+ Air Canada transformation from 2010 to 2019 was much tougher than what it will be from 2021 onwards. The foundational difference is that in first journey Air Canada had major structural cost and structural revenue limitations and now they have to better manage their capacity while rebuilding their network.
2010-2019: AC had to deal with following structural problems at the onset of this journey:
COST: Tackling fixed cost (higher proportion) - Pension deficit: of up to ~$4.0B and this translated into $150M-$200M annual payments in addition to regular pension contributions due to govt restrictions.
- High debt and high debt servicing cost: Net debt of $6.0B (incl leases) and interest of approx. ~10% leading to debt servicing cost ~$400M annually.
- Maintenance: Older fleet. High cost heavy maintenance operations: AVEOS
- Fleet renewal: One of oldest fleet in the industry. It meant 10s of billions of $$ worth of capital spent in the following years (on 787, 777, some NB and overall fleet renewal and redesign). Need for $10-$15B for capital spend.
- Union negotiations: Tough union negotiations ahead with lot of uncertainty. 2012 strike.
- Oil/Fuel: Old fleet with high fuel consumption. Higher impact due to oil prices. Oil price varied between $50-$100 through out the decade. Hedges were designed to ensure certainty of oil spend.
REVENUE: Tackling the limited growth model - Low revenue growth: Minimal growth from 2004-2010 with no clear strategy for growth. Competition eating up market share. Dependency on domestic market. Lack of focus on International market
- Reservation system: Old reservation systems limited their product distribution potential.
- Product distribution: Dependency on travel agencies (Expedia in Canada, etc.) and limited potential of AC website. E.g. Payment methods limited to using North American/International credit cards only. It meant a potential customer with debit card in Europe could not buy AC ticket online unless he visited a local sales agent. But he could buy that on competition.
- Point of Sale: 90+% of sales originated in North America. Very limited POS outside North America.
- Suboptimal Fleet: Fleet at that time made few routes (Toronto-Del or Toronto -Brisbane) least/not profitable.
- Aeroplan: Very low value plan and that too outsourced to Aimia, which was locked till 2020. Air Canada was losing lot of value to Aimia and Aimia had failed to evolve. Very difficult to attract/lock repeat business.
- Credit Card: No ability to launch independent credit cards until 2019/20. Locked into Aeroplan credit card.
Before Air Canada could dream of being a financially strong international airline they had to transform their cost structure, which they did before the next recession (COVID - 2020). They sorted out their cost and revenue problems over the following 9 years, step by step.
How and when it happened is all available. While doing this they also spent $10-$15B on their fleet renewal (and others; like new reservation systems) while they reduced their net debt by about approx. $3B. In addition they also had bought back shares. All that came from positive cash flow (~$15B) in years with high cost and lower revenue (though increasing) structure). Cash flow was minimal in initial years but improved as the strategy unfolded towards the 2015-2019. All that without much impact of loyalty and credit card strategy (but were able to add one time payment of ~$1.0B-$1.5B from Visa/TD in 2019).
2020/21 – Air Canada strategy (2010+) was focused on renewing fleet and building a financially strong airline so that they never had to consider bankruptcy again. Hence, a severe recession was always built into their plan. Their handling of COVID-19 demonstrated that their strategy worked and now have very high liquidity (~$9.5B @ end of Q2). For comparison, Delta airline have $10.5B liquidity against total debt of $36B and net debt ($26B). Air Canada adj net debt is approx. $7.0B.
2021+ - With major cost transformation (pensions, fleet renewal, maintenance, etc..) and revenue transformation (International infrastructure, new reservation system, international POS, competitive product, Aeroplan and credit cards) behind them, their focus is on rebuilding the network. AC took 9 years (2010-2019) to go from ~$10B to ~18B airline but this time it will be much faster (2023/24) with much better positive cash flows and better ROIC that previous decade. Why? Because cost structure is much lower. Revenue will be little slower for now but will come back.
With positive cash flow insight, financial transformation is starting as we speak.
What’s different and what will help AC generate cash much faster than before? - Flexible cost structure with lesser fixed cost proportion.
- Lower unit cost at similar capacity utilization (repeat… capacity utilization). Will allow them to capture more market at lower pricing if need be.
- Major fleet renewal is over – remaining fleet focused on narrow bodies (A220/737). Most of the widebody is already done. Most of the US airline will need additional debt/cash as they are in middle of their widebody fleet renewal program.
- Tax rebates from losses.
- Most of the oil price is passed on in terms of fuel surcharges. Jet fuel spread is much lower than before (due to low demand) and hence jet fuel prices are similar to previous years. Though oil prices eat into profitability but its only ~20% of the overall cost and transforming the cost into flexible structure provides a better cushion from fuel price increase. (https://www.iata.org/en/publications/economics/fuel-monitor/)
- Full benefit of revenue strategy (Aeroplan, credit card, other initiatives)
- Enough cash on hand to focus on innovation or growth opportunities.
- Yes, interest cost is higher for now than before but will reduce in next 12-24 months as debt is paid off by cash generated and record liquidity on hand. Or if they choose to buy another airline (like airlineinvestor mentioned), that could generate even more cash.
Air Canada is on its way to be $100+ stock price in next 3-4 years.