Much ado about nothing: Capital Spend In 2023, AC generated $4.3B cash from operations and that was used to fund capex, pay interest, reduce debt and reduce leverage ratio (from 5 to 1.1). In coming years as capacity/demand goes back to 2019 levels, we will see higher cash flow from operations.
It’s all about consistent cash flow from operations and consistent FCF to deleverage, reinvest capital for better returns and return capital to shareholders. Make more money than you spend and if you can’t make more then don’t spend as much. Firm commitment to only a portion of fleet capital spend to stay flexible to respond. AC is well positioned in coming years to generate enough FCF even after capex.
Debt payments: Let’s get these out of the way first. Debt payments over next few years (even if large amount) are mute point as AC has billions of spare cash at hand which can be used to pay off debt in advance to reduce interest cost without impacting the leverage ratio and net debt. We saw the example yesterday by paying off USD 1.1B using cash and reduce interest cost.
LET’S UNDERSTAND THE SIZE AND IMPACT OF AC’S AIRCRAFT CAPITAL SPEND FOR NEXT 4 YEARS. FLEET ACFT ORDER Below table shows the fleet acquisition schedule of aircraft for next 4 years. In the MD&A these are all showed as purchases for calculating the capex amount. Many of these will be leased and for those only a portion of the capital amount (for leased acft) will go towards capex.
| 2024 | 2025 | 2026 | 2027 | Total |
| 787-10 | | 1 | 12 | 5 | 18 |
| 787-9 | 2 | | | | 2 |
| 767 F | 2 | 1 | | | 3 |
| 737 | | 5 | | | 5 |
| 330 | 1 | 5 | | | 6 |
| 321XLR – leased | | 4 | 6 | 5 | 15 |
| 321XLR-Purc | | | | 1 | 1 |
| 320 | 2 | | | | 2 |
| 220 | 2 | 10 | 10 | 5 | 27 |
| Total | 9 | 28 | 28 | 16 | 79 |
Above info is from MD&A. First 15 321XLR to be leased and next 15 to be purchased. AIRCRAFT PRICE Few points to understand:
- List price Vs actual: Usually large airlines pay 40%-60% lesser than list price for airplanes for purchases depending on demand and supply.
- Leased: As per new reporting law since 2019, leased airplanes value has to be added to debt. A portion of the aircraft value can be added to debt, let’s say 20% of the asset value and regular installments will go to income statement. 321XLR, 767F, 737 and 330s will be leased and others will be purchased.
- Used acft: 767F and 330s will be used aircraft (coming off lease) and will be of much lower value compared to new ones.
Below is the price/capital spend per acft (CAD) - Brand new aircraft @ 50% discount of the listed price (USD) @ FX given in the MD&A. 50% discount is a valid assumption.
- Used acft (767 and 330) are much cheaper.
- Leased acft: Using 20% of the asset value to be added to capital spend.
| | | | | | |
| | Aircraft
| List price for new acft (USD) M | Purchase Price for new Acft @50% (CAD)M | Approx. Cost for used Acft (CAD)M | % Added to debt for leased acft (20%) |
| New-Purch | 787-10 | $338 | $224 | | |
| New-Purch | 787-9 | $292 | $193 | | |
| Used-Lease | 767 F | $220 | | $80 | $16 |
| New-Lease | 737 | $122 | $81 | | $16 |
| Used-Lease | 330 | $250 | | $100 | $20 |
| New-Lease | 321 | $142 | | | $28 |
| New-Purch | 321 | $142 | $94 | | |
| New-Purch | 320 | $101 | $67 | | |
| New-Purch | 220 | $100 | $66 | | |
FLEET CAPITAL OVER NEXT FEW YEARS: based on new, used and leased acft and unit price from above table. | | Approx. price (CAD)M | 2024 | 2025 | 2026 | 2027 | Total |
| 787-10 | $224 | | $193 | $2,321 | $967 | $4,031 |
| 787-9 | $193 | $387 | | | | $387 |
| 767 F | $16 | $32 | $16 | | | $48 |
| 737 | $16 | $0 | $80 | | | $80 |
| 330 | $20 | $20 | $100 | | | $120 |
| 321 XLR | $28 | | $114 | $170 | $142 | $426 |
| 321 XLR | $94 | | | | $94 | $94 |
| 320 | $67 | $134 | | | | $134 |
| 220 | $66 | $133 | $663 | $663 | $331 | $1,789 |
CAPEX | Committed | $705 | $1,196 | $3,520 | $1,687 | $7,108 |
Uncommitted/
Planned | $108 | $332 | $498 | $472 | $938 |
| Total | $813 | $1,528 | $4,018 | $2,159 | $8,518 |
* Above does not include uncommitted capitalized mtce spend. Uncommitted/Planned spend covers non fleet category too. The projected capital spend in 2024 and 2025 includes advance payments for year 2026 high capital spend to make FCF even out over years, which is what investors like. CFO in his last analyst call had explicitly hinted towards this. We should see a plan for this in next investors day presentations.
FCF OVER NEXT FEW YEARS Below is the expected FCF based on capex spend as calculated above. We can see a very strong though uneven FCF generation till 2027. Thereafter, FCF will be even stronger. If in case, demand boosts and AC wants to exercise additional options to purchase 787s and others, we can expect additional capex. But all this will be profitable and efficient growth improving Revenue, EBITDA, NI and will generate incremental CFO.
| | 2023 | 2024 | 2025 | 2026 | 2027 | Total |
| CFO(M) | $4,300 | $4,300 | $4,600 | $5,000 | $5,500 | $19,400 |
| Capital(M) | | $813 | $1,528 | $4,018 | $2,159 | $8,518 |
| Net Interest (M) | | $250 | $350 | $450 | $400 | $1,450 |
| FCF (M) | $2,750 | $3,237 | $2,722 | $532 | $2,941 | $9,432 |
Optimized capital spend and FCF, in my opinion to produce consistent FCF, could be as follows: (by prepaying 2026 capex) | | 2023 | 2024 | 2025 | 2026 | 2027 | Total |
| CFO(M) | $4,300 | $4,300 | $4,600 | $5,000 | $5,500 | $19,400 |
| Capital (M) | | $1,813 | $1,528 | $2,518 | $2,159 | $8,518 |
| Net Interest (M) | | $250 | $350 | $450 | $400 | $1,450 |
| FCF (M) | $2,750 | $2,237 | $2,222 | $2,032 | $2,941 | $9,432 |
Main reasons for the difference in capital spend compared to MD&A are - Value of leased acft shown as capital spend and this will be lower amount when executed.
- Advance payment in 2024/25 for 2026.
It will be very normal in the airline world if some of the deliveries are moved from 2026 to 2027, further spreading the spend and allowing more FCF.
Even if we use projected capital spend (by AC) till 2027, we can expect $6-7$B FCF at a minimum. With leverage ratio already at target, all this FCF will be available to be returned to investors. AC ANTICIPATED STRATEGY GOING FORWARD REGARDING CAPITAL SPEND AND FCF AC will produce consistent CFO and FCF every year by streamlining their capital spend and be able to return capital to shareholders.
- CFO and FCF: In past 2 years in multiple communications (analyst call, investors presentations etc…) AC has stated that they would target EBITDA to be 19-21% of revenue in coming years (I am assuming 18.5% to stay conservative). CFO is roughly 7% higher than EBITDA. And in recent analyst call, Chief Financial Officer had categorically stated that they will be producing strong Cash Flow from Operations and FCF regularly. He also mentioned that 2024 FCF will be lower than 2023 and perhaps this is because of advance capex payments for year 2026. Advance payments will streamline FCF over the years and also avail discounts from OEMs.
- Capital spend and FCF: Key criticism airlines have faced in the past is the uneven FCF over years with peaks and valleys. Advance payments is a clear sign of leveling FCF over years. Ryan Air had achieved consistent FCF before COVID by regularly generating %age of revenue as FCF and %age as capital spend. They were able to fund their capex with CFO. AC has already achieved their LR target (<1.5) and will be even stronger (~0.9) at end of Q1. Going forward cash from operations will be used to purchase any new aircraft with cash and still produce FCF to return to shareholders. My estimates are:
- Consistent FCF of ~8% of revenue over many years. This would mean FCF ~$2.0B/year going forward. Some years could be higher, some lower within close range.
- Annual capital spend of ~10%. This would mean ~$2.5-$3.0B/year going forward. Ryan Air went through high capex period from 2015-2019 with 19% of their revenue spent on capital spending. And still, Ryar Air bought back shares worth €3.6B and paid dividend while maintaining cash and net debt levels.
- AC have had high capital spend period from 2015-2019 at a leverage ratio of 2.0+ and still bought back shares. This time AC is much stronger financially (LR ~1.0) and will be able to return capital to shareholders after paying for their new aircraft.
- As revenue will increase, target EBITDA %age (of revenue) will increase leading to higher CFO and FCF.
Even after financial success, AC should not splurge money on pilots or any other cost item inappropriately. Tight cost control is key to sustainable businesses. I am sure pilots don’t want to work for an airline, which is unable to grow because of ineffective capital spending. Once pilot negotiations are over, AC management will be able to talk about their strategy.
Is 3 digit sp in sight? It definitely is, with their current path of strong capacity and capital management. Had it been not for COVID, we would have seen it long back.