Air Canada T.AC

Q2 and onwards

[Rouge10]

For any airline business to create value, following key (not complete list) factors are must to qualify no matter what the environment is

1. Strong demand environment, better if increasing (volume and premium)
2. Ability to generate cash flow from operations and free cash low sustainably.
3. Capital expenditure (Long term and esp near term) much lower than cash flow.
4. Decreasing adjusted net debt and debt servicing.
5. Decreasing outstanding shares (share buy back preferably at lower price)

As long as business is able to satisfy above conditions, you can expect positive impact to share price. Air Canada qualifies very well in the above criteria.
 

1. Demand: Demand picked up in 2^nd half of Q2 to ~50% (of 2019) compared to 1^st half at ~39%. April month pax volume in Canada is at 67% with highest day of 75% (of 2019) since March 2020. It is not even summer yet. Key points to remember
   1. Number of planes in air have not increased by this proportion; it means higher load factor (compensate for higher fuel cost directly). We can see 75%+ load factors this summer.
   2. Ticket prices went up suddenly from 15^th Feb substantially. Some of the summer market ticket prices doubled since Q1. These tickets were booked in high fuel price environment.
   3. Trusting AC’s management, expect summer to run at 80% of 2019 and all of 2022 at 75%.
   4. Even in severe of the recessions, demand destruction has not been more than 10-15% in the past. And we are not at 75% (of 2019) yet. If recession sets it, challenge won’t be to reduce capacity (which is more expensive option) but will be slower growth from today.

https://www.catsa-acsta.gc.ca/en/screened-passenger-data

2. Cash flow: Air Canada has been producing free cash flow since Aug 2021 (July was not a positive cash flow month as demand was just picking up), even with higher fuel price.
   1. In Q1, demand was very low ~39% (of 2019) in 1^st half and then it picked up to ~50% (of 2019) in 2^nd half.
   2. Ticket sales picked up around the same time the fuel price went above $100. 2^nd half was definitely positive free cash flow, even at a low load factor (~66% for Q1) to produce $59M free cash flow in Q1.
   3. Fuel price temporarily jumped to ~130 (like it did in the year 2008) and now hovering around $100. Like I said earlier, there are enough forces in the world to counter fuel price. Increasing demand at increasing load factor with higher fares will improve free cash flows further.
   4. Cargo, Aeroplan, Credit Card, higher load factor and higher ticket fares are going to produce strong free cash flow.

https://stockhouse.com/companies/bullboard?symbol=t.ac&postid=34493971
 

3. Capital expenditure: The link below is a bit dated. Since then AC has advanced some of their capital expenditure (aircraft purchase… to accommodate increasing demand and benefit from fuel efficiency). Still, they are at tail end of their fleet renewal (compared to US airlines). As per the Investors day, they are expecting to generate $3.5B free cash flow by 2024 after spending $4.5B ($1.5B*3) on fleet renewal. I believe this is a conservative estimate and AC will beat this substantially. AirlineInvestor has shared lot of intelligence on this topic.

 
https://stockhouse.com/companies/bullboard?symbol=t.ac&postid=34534796
https://aircanada.investorroom.com/investor-day-2022. Slides #94-#106
 

4. Adjusted net debt: Leverage ratio of 1.0 @ EBITDA of 19% @ 2024 revenue (~$20B approximation) means, adjusted net debt will decrease to $3.8B. This will be one of the lowest adj net debt numbers amongst North American airlines at that time, because other airlines have either higher debt or capital expenditures or both. They currently carry $5B of spare cash (more than min $5B liquidity requirement). Most of the long term debt is maturing towards late 2020s, leaving AC with lot of options to use their cash, viz. buy new planes with cash, share buy back, or other endeavours. Overall, they can continue to reduce their long term debt. 75% of their debt is at fixed interest rates thus protecting them from high interest rates. Debt servicing will stay within solid control for years to come.

 
https://aircanada.investorroom.com/investor-day-2022. Slides #94-#106
 

5. Outstanding shares: Yes, their outstanding shares have increased (~390M). And they can buy lot of those back if share price stays low. E.g. @$25 sp, they can buy back 100M shares for $2.5B only or @$50 sp, they can buyback 100M shares for $5.0B. Well, their cash position is strong ($5B spare) and will continue to improve with free cash flow of $3.5B from 2022-2024. Even after buying new planes with cash, they will have lot more to buyback shares. I will prefer more share buybacks if sp remains low due to whatever reasons.

And their pension surplus is $4.5B, one of the highest (if not the highest) amongst north American airlines.
 
Summary:
Leverage ratio of 1.0 and EBIDTA of 19% in 2024 means, adjusted net debt will be at $3.8B (down from today’s ~$7.0B). Long term debt and lease over next 3 years are ~2.8B.
 
Hence cash out flow is $2.8B (debt/lease)+$4.5B (capital) = ~$6.5B.
 
AC will generate billions in cash in 3 years to end up with free cash low of $3.5B, adjusted net debt of $3.8B and capital expenditure of $4.5B.
 
I believe, AC will surpass their commitments. We have not even considered the value AC can generate by selling Cargo or portion of Aeroplan. It is once again on track to be cash flow generating machine for years to come.