Fitch Upgrades Air Canada to 'BB-'; Outlook Positive
Fitch Ratings - Chicago - 18 Dec 2023: Fitch Ratings has Upgraded Air Canada's long-term IDR to 'BB-' from 'B+'. The Rating Outlook is Positive. Fitch has also upgraded Air Canada's senior secured debt ratings to 'BB+'/'RR2' from 'BB'/'RR2'.
The upgrade reflects Air Canada's improving credit metrics and sustained efforts towards de-leveraging. Solid operating margins thus far in 2023 have allowed the airline to pay down debt while maintaining liquidity. Fitch expects Air Canada to end the year with gross leverage around 3.8x, with continued improvements thereafter.
Air Canada's 'BB-' rating is supported by its solid liquidity balance, which provides protection in the case of a downturn. Cash and revolver capacity remain healthy relative to peers, positioning the company well to address upcoming debt maturities and spending needs. Air Canada also retains significant financial flexibility from unencumbered assets, including its loyalty program, to support capital raises if needed.
Fitch has upgraded Air Canada's 2017-1 class AA certificates to 'AA' from AA-' and 2020-2 class A certificates to 'A' from 'A-'. Fitch has also upgraded Air Canada's 2020-2 class B certificates to 'BBB' from 'BBB-' and affirmed its remaining enhanced equipment trust certificate (EETC) ratings. The upgrades are driven by increasing collateral coverage along with support from Air Canada's improving credit profile. Stable and improving 777 aircraft values also benefit certain transactions.
KEY RATING DRIVERS
Deleveraging Progress: Air Canada maintains conservative financial policies that Fitch views as supportive of the rating. The company maintains a public net leverage target of 1.5x by YE 2024, and has prepaid more than CAD$1.2 billion in debt in the first three quarters of 2023. Fitch believes that normalized post-pandemic profitability will drive further de-leveraging over time. Fitch expects Air Canada to end 2023 with gross leverage of around 3.8x, an improvement over the prior forecast driven by debt repayment and better than expected profitability this year. Fitch anticipates that leverage will trend toward 3x over the next 2-3 years, though further capacity to prepay debt may be limited by upcoming capital spending needs.
Improved Profit Margins: Growing demand and supportive unit revenues combined with more moderate fuel prices have driven margin performance above Fitch's prior expectations this year. Fitch's forecast includes consistent EBITDAR margin generation remaining roughly stable in the mid-teen range through the forecast period. Margins will face headwinds from rising labor rates and domestic competition. Challenges are likely to be offset by efficiencies gained as Air Canada continues to expand capacity, achieves benefits from its fleet renewal, and continues to grow its loyalty program.
Air Canada is currently in negotiations with its pilot's union, which is likely to result in significant pay increases as pilots push for similar improvements gained by other unions this year. Canadian competitor WestJet recently reached a deal with its pilots that included a 24% pay increase over four years. A similar deal would likely create a headwind to unit costs in the low single digit range. Canadian low-cost carriers also continue to compete aggressively; however, they remain relatively small and their long-term viability is uncertain.
Positive Demand Trends: Fitch expects to see continued growth in Canadian air traffic in 2024 as demand fully recovers to pre-pandemic levels. After initially lagging the U.S. in traffic recovery, Canadian traffic improved significantly in 2023 with daily passenger counts now typically down in the single digits compared to 2019. International demand has been particularly strong, which benefits Air Canada's internationally focused route network. Fitch expects that demand in the Atlantic region may slow next year from elevated levels in 2023, but traffic to Asia remains low and has further room to recover. Longer-term international demand is also supported by a large immigrant population settling in Canada, which benefits Air Canada as the country's leading international carrier.
Heavier Upcoming Capital Spending: Air Canada placed an order for 18 787-10s in September 2023. This will push up capital spending in the 2025-2027 time frame and limit FCF generation. Fitch expects Air Canada to generate mid-single digit FCF margins in 2023, modestly positive FCF in 2024 and 2025, and negative FCF in 2026 when capital expenditures peak. Fitch views capital commitments as manageable in light of Air Canada's healthy liquidity balance, prospects for improving cash flows from operations and the finance-ability of the aircraft. Limited FCF is balanced by the efficiencies to be gained as the 787s replace aging widebody aircraft, reducing fuel burn and maintenance requirements. The 787 order is part of Air Canada's ongoing fleet modernization efforts, which include replacing older A320s and A321s with efficient A220s and A321 XLRs.
Solid Financial Flexibility: Fitch views Air Canada's financial flexibility as supportive for the rating. The company reports that recent aircraft debt prepayments have brought the value of its unencumbered assets to CAD$6.7 billion, a sizeable balance that can be leveraged in the case of future downturns. This val ue excludes Air Canada's loyalty program, which other airlines have successfully tapped to raise significant capital. Upcoming debt maturities are also manageable. Scheduled principal maturities total CAD$378 million in 2024 and CAD $1.1 billion in 2025 before stepping up to CAD $2.4 billion in 2026 with the maturity of its $1.2 billion senior secured notes. Fitch expects maturities to be managed via existing cash on hand and potential financing of new-delivery aircraft.
EETC RATINGS
Class AA Upgrade: Fitch has upgraded Air Canada's 2017-1 class AA certificates to 'AA' from 'AA-'. Fitch's 'AA' level stress LTV for the class AA certificates improved to 85% from 88% in the prior review, providing a sufficient amount of headroom within the rating category. Fitch rated the transaction at 'AA-' in previous reviews, partly reflecting pandemic-related risks which have since subsided. High quality collateral pool including the 737 MAX 8 and 787-9 and Air Canada's improved credit profile also provide support to the rating.
Class A Upgrade: Fitch has also upgraded the 2020-2 class A certificates to 'A' from 'A-'. Fitch's 'A' level stress scenario LTV for the class A certificates modestly improved to 83% since the last review. While LTVs has been steady, qualitative factors including stabilization of the 777 values and Air Canada's stronger credit profile in the 'BB' category drive the rating upgrade.
Class A Affirmations: Fitch has affirmed Air Canada's 2017-1 and 2015-1 class A certificates at 'A' and the 2013-1 class A at 'BBB'. The 2017 and 2015 class A certificates continue to pass Fitch's 'A' level stress with significant headroom at 86% and 78%, respectively, a moderate improvement since last review. Although the 2015-1 pool consists entirely of 787s, the transaction's strong LTV and the high quality of the aircraft mitigate the lack of diversification, supporting the 'A' rating.
Fitch has also affirmed Air Canada's 2013-1 Class A certificates at 'BBB'. The 2013-1 class A certificates fail to pass Fitch's 'BBB' level stress scenario due to the depressed 777 values. Fitch rates the class A via a bottom-up approach which is typically applied to subordinated tranches. Class A benefits from a 4-notch uplift from Air Canada's 'BB-' IDR for a strong affirmation factor (+2), a presence of liquidity facility (+1) and strong recovery prospects (+1).
Stress adjustment: In Fitch's analysis for the 777-200LR and 777-300ER, Fitch has adjusted downward their base values used in its EETC models to account for one appraisal firm with values that were notably above estimates provided by peers. The adjustments account for a 3% to 9% decrease in 777 values from appraised values.
LTV Summary:
AC 2020-2 class A: Base Case - 61%, 'A' Stress Case - 83%
AC 2017-1 class AA: Base Case - 52%, 'AA' Stress Case - 85%
AC 2017-1 class A: Base Case - 69%, 'A' Stress Case - 86%
AC 2015-1 class A: Base Case - 62%, 'A' Stress Case - 78%
AC 2013-1 class A: Base Case - 81%, 'BBB' Stress Case 113%
Subordinated Tranche Ratings: Fitch notches subordinated tranche EETC ratings from Air Canada's 'BB-' IDR based on three primary variables: 1) the affirmation factor (0-2 notches) 2) the presence of a liquidity facility, (0-1 notch) and 3) recovery prospects (0-1 notch). As per Fitch's criteria, as the airline's IDR moves up to the 'BB' category from 'B', the affirmation factor notching reduces by to 0-2 notches from 0-3 notches.
Class B Upgrade: Fitch has upgraded Air Canada's 2020-2 Class B certificates to 'BBB' from 'BBB-', reflecting a four-notch uplift from Air Canada's 'BB-' IDR. Despite recovery prospects well above 91%, Fitch has historically restrained from assigning recovery uplift to the transaction due to uncertainties around aircraft values, especially the 777 through the pandemic, and Air Canada's 'B' category corporate credit rating. As aircraft values have stabilized and concerns around Air Canada's credit profile reduced, Fitch has applied a +1 uplift for recovery prospects, bringing total notching to +4 (with +2 for high affirmation factor and +1 for a liquidity facility). The 2020-2 holds approximately 9% of Air Canada's widebody aircraft which are important to Air Canada's international and leisure markets, supporting the transaction's high affirmation factor.
Class B Affirmations: Fitch has affirmed Air Canada's 2017-1 class B certificates at 'BBB'. Fitch rates the transaction at the same level as the 2020-2 class B and two notches higher than the 2013-1 class B, reflecting stronger recovery expectations for the 2017-1 and 2020-2. The 2017-1 class B benefits from a four-notch uplift from Air Canada's 'BB-' IDR, including +2 for a high affirmation factor, +1 for a liquidity facility and +1 for strong recovery prospects. High affirmation factor is supported by high quality collateral that includes a good amount of young and strategic 737 MAX 8s and 787-9s
Fitch has also affirmed the 2013-1 class B certificate at 'BB+'. The rating is achieved by a 2-notch uplift from Air Canada 'BB-' IDR. The uplift consists of +2 for a high affirmation, +1 for a liquidity facility and -1 adjustment for poor recovery prospects due to depressed values for the 777s. Fitch maintains a high affirmation factor for the transaction as the 777-300ER is strategically important as it is currently Air Canada's only option for serving high density, long-haul routes. The five 777s in the 2013-1 transaction also represent some of the newest and most attractive in AC's 777 fleet.
DERIVATION SUMMARY
Air Canada's 'BB-' rating is one notch above peers American Airlines and United Airlines. Air Canada's financial metrics compare favorably to American's, with gross leverage and fixed charge coverage ratios both favorable to American's. United's leverage metric is currently modestly below Air Canada'; however, this is offset by Fitch's expectations that United's FCF profile will be weaker than Air Canada's through our forecast period. Air Canada remains two notches below Delta Air Lines, which benefits from better leverage metrics, along with beneficial size and scale. Air Canada's market position in the duopolistic Canadian market is favorable to the heavily competitive U.S. market.
EETC RATINGS
The 'AA' rating for the class 2017-1 AA certificates is generally stronger than those in comparable United Airlines transactions due to United exposure to 777-300ERs. The 'A' ratings on Air Canada's class A certificates are similar to transactions issued by United, American, and others that all feature sufficient levels of overcollateralization to pass Fitch's 'A' level stress scenarios.
Air Canada's class B certificates are generally rated higher than comparable transactions in United's EETCs. Air Canada's transactions receive higher affirmation factors than United's because a large portion of United's fleet is tied up in a single EETC transaction, which limits the affirmation factor for its remaining EETCs. Air Canada's fleet planning is also relatively gradual compared to United's aggressive fleet upgrade plan. Air Canada's transactions, except for 2013-1, receive recovery uplift from higher recovery prospects as they are less exposed to the 777s.
KEY ASSUMPTIONS
Fitch's base case assumes:
--Air Traffic continues to grow in Canada in 2024, rebounding from pandemic lows.
--Capacity grows 20% in 2023, in line with management's public projections, bringing FY 2023 capacity to just under 90% of 2019 levels. Capacity grows by another 8% next year, bringing 2024 capacity to within 5% of 2019 levels. Capacity growth thereafter is in the low single digits.
--Load factors remain steady in the low to mid 80% range.
--Yields increase in the mid-single digits in 2023 reflecting results through the first nine months. Thereafter, yields rise in the low single digits annually reflecting general inflationary influences on ticket prices.
--Jet Fuel prices in 2023 at 118/litre, equivalent to the mid $3.30/gallon range in the U.S., which would reflect Brent crude prices in the 80s. Jet declines to 100/litre over the forecast period, remaining elevated above historical levels.
--Non-fuel cost per available seat mile (CASM) rises by 1.5% in 2023, in line with management guidance. CASM ex is roughly flat next year as cost headwinds are offset by efficiencies gained as the company restores capacity.
--Operating margins rebound to near historical levels over the next two years.
--Capital spending reflects management's forecast.
EETCs
--Key assumptions within the rating case for the issuer include a harsh downside scenario in which Air Canada declares bankruptcy, chooses to reject the collateral aircraft, and where the aircraft are remarketed in the midst of a severe slump in aircraft values. An Air Canada bankruptcy is hypothetical and is not Fitch's current expectation as reflected in the airlines's 'BB-' IDR. Fitch's models also incorporate a full draw on liquidity facilities and include assumptions for repossession and remarketing costs.
--Fitch's recovery analyses for subordinated tranches utilize Fitch's 'BB' level stress tests and include a full draw on liquidity facilities and assumptions for repossessions and remarketing costs.
--Fitch's analysis incorporates a 6% annual depreciation rate for Tier 1 aircraft, a 7% annual depreciation rate for Tier 2 aircraft and 8% annual depreciation rate for Tier 3 aircraft.
--Value stress assumptions utilized in Fitch's models:
777-300ER: A level - 35%;
777-200LR: A level - 45%
737 MAX 8: AA level - 40%, A level - 20%;
787-9: A level - 25%;
787-8: A level - 30%;
A321-200: A level - 25%.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
--Adjusted debt/EBITDAR trending below 3.5x;
--FFO fixed-charge coverage trending above 3x;
--EBITDAR Margins sustained in the upper teens or better;
--Neutral to positive sustained FCF;
--Maintaining or increasing financial flexibility evidenced by increasing unencumbered assets.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
--Adjusted debt/EBITDAR sustained above 4.5x;
--FFO fixed charge coverage sustained below 2x;
--EBITDAR margins declining to the low teens or below.
EETCs
Factors that could, individually or collectively, lead to positive rating action/upgrade:
--Ratings for the class AA and A certificates are primarily based on a top-down analysis based on the value of the collateral. The ratings could be upgraded if collateral coverage continues to improve as the debt amortizes.
--2013-1 class A certificates and other transactions' class B certificates ratings are based off of the underlying issuer rating. The ratings could be upgraded if Air Canada's IDR is further upgraded.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A negative rating action for the class AA and A certificates could be driven by an unexpected decline in collateral values.
--The 2013-1 class A certificates are rated based on a bottom-up approach. A negative rating action for the 2013 class A certificates could occur if an unexpected decline in 777 values drives recovery prospects below 91%, if Fitch downgrades Air Canada's IDR, and/or if Fitch's assessment of the transactions' affirmation factors change.
--Subordinated tranche ratings are based on Air Canada's underlying airline IDR of 'BB-' and are sensitive to a change in the airline's corporate rating. The ratings are also subject to recovery expectations in a stress scenario and changes in Fitch's view of the affirmation factors for the underlying collateral.
LIQUIDITY AND DEBT STRUCTURE
Solid Liquidity: Air Canada ended the third quarter with CAD$8.3 billion in cash and short-term investments and full availability under both its US$600 million revolver and CAD 200 million revolvers. Total liquidity is more than 40% of LTM revenue, putting Air Canada above U.S. peers by this measure. Liquidity remains well above pre-pandemic levels despite the company pre-paying some debt as an improving operating environment allowed the company to generate positive FCF. Fitch considers Air Canada's liquidity balance to be more than sufficient to cover near-term obligations. Upcoming debt maturities are manageable at CAD378 million in 2024 and CAD 1.1 billion in 2025 and $2.4 billion in 2026.
Air Canada's debt stack primarily consists of CAD 6.7 billion in debt secured by its slots, gates and routes (SGR) credit facility completed in mid-2021. The facility consists of CAD 2 billion of secured notes due in 2029, $1.6 billion of notes due in 2026, a $3.1 billion TLB maturing in 2028 and a $600 million revolver due in 2025.
The company also has CAD 1.05 billion outstanding on a credit facility provided by the Canadian government that was utilized to issue refunds for flights cancelled during the pandemic. The credit facility is unsecured, has a seven-year term, and has a 1.21% coupon.
The remainder of the company's debt primarily consists of aircraft secured EETCs and other aircraft financings.
ISSUER PROFILE
Air Canada is Canada's largest airline, serving more than 200 destinations with a fleet of 354 aircraft (mainline and regional).
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
RATING ACTIONS
ENTITY / DEBT
RATING
RECOVERY
PRIOR
Air Canada
LT IDRBB- Upgrade
B+
senior secured
LTBB+ Upgrade
RR2
BB
Air Canada Pass Through Trust Series 2020-2
senior secured
LTA Upgrade
A-
senior secured
LTBBB Upgrade
BBB-
Air Canada Pass Through Trust Series 2017-1
senior secured
LTAA Upgrade
AA-
senior secured
LTA Affirmed
A
senior secured
LTBBB Affirmed
BBB
Air Canada Pass Through Trust Series 2015-1
PREVIOUSPage
1
of 2
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Additional information is available on www.fitchratings.com
PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer’s available public disclosure.
APPLICABLE CRITERIA
Aircraft Enhanced Equipment Trust Certificates Rating Criteria (pub. 22 Jun 2023) (including rating assumption sensitivity)
Corporates Recovery Ratings and Instrument Ratings Criteria (pub. 13 Oct 2023) (including rating assumption sensitivity)
Corporate Rating Criteria (pub. 03 Nov 2023) (including rating assumption sensitivity)
Sector Navigators – Addendum to the Corporate Rating Criteria (pub. 03 Nov 2023)
APPLICABLE MODELS
Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).
Corporate Monitoring & Forecasting Model (COMFORT Model), v8.1.0 (1)
Enhanced Equipment Trust Certificates Model, v2.2.2 (1)
ADDITIONAL DISCLOSURES
Dodd-Frank Rating Information Disclosure Form
Solicitation Status
Endorsement Policy
ENDORSEMENT STATUS
Air Canada EU Endorsed, UK Endorsed
Air Canada Pass Through Trust 2013-1 Pass Through Trust EU Endorsed, UK Endorsed
Air Canada Pass Through Trust Series 2015-1 EU Endorsed, UK Endorsed
Air Canada Pass Through Trust Series 2017-1 EU Endorsed, UK Endorsed
Air Canada Pass Through Trust Series 2020-2 EU Endorsed, UK Endorsed
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