CIBC: Addressing FAQs We Get On ACOur Conclusion
We have had a number of questions on AC given the risks of a labour disruption and implications on its booking curve. In this report, we look to address these frequently asked questions (FAQs) as well as highlight other observations we have on the airline.
Key Points
What's The Risk Of A Labour Disruption?
On August 22, AC's pilot union, Air Line Pilots Association (ALPA), voted overwhelmingly to authorize a strike. On August 27, AC provided an update on its ongoing contract negotiations with the union. AC stated that significant progress has been made and the three-week cooling-off period gives the parties more than sufficient time to address any outstanding issues, and AC remains fully committed to bargaining meaningfully throughout the period. We note that the earliest a strike can occur is September 17. We would add that we saw the Canadian Minister of Labour step in and attempt to prevent a strike at WestJet in late June and, more recently, ask the Canadian Industrial Relations Board (CIRB) to impose binding arbitration between the Teamsters and the Canadian rails in order to end the work stoppage at the Canadian rails. We suspect both ALPA and AC are cognizant that the Canadian government has been willing to step in to prevent significant disruptions in the Canadian transportation industry. We suspect this incentivizes both parties to reach a negotiated settlement.
Will The Threat Of A Strike Impact AC's Near-term Booking Curve?
With a potential strike just under three weeks away, we would expect this to impact AC's booking curve in the near term as travellers book with other airlines. AC has implemented a goodwill rebooking policy that should help address some customer concerns. The policy allows customers holding bookings with travel between September 15 and September 23 to: 1) Rebook to any other AC flight(s) with the same origin and destination up to November 30, 2024, with change fees and other fees or fare differences waived, meaning such changes can be made at no cost for customers who choose to travel the same route in the same cabin; 2) Cancel their flight and retain the residual value on a future travel credit. Refunds will be available according to fare rules for customers with refundable tickets; for customers with non-refundable tickets, refunds will not be available as flights are scheduled to operate as normal; and 3) Cancel their flight and rebook travel for after November 30, in which case change fees will be waived but the customer will have to pay the fare difference, if any. We would note that Air Canada Express flights, operated by Jazz or PAL Airlines, are not operated by AC pilots and therefore will not be impacted by the end of the cooling-off period. We would note that the threat of a pilot strike at AC is occurring after the peak travel season. Using Radarbox data, we would note that the sevenday average daily Canadian flight activity falls by ~5% in the back half of September versus August when looking at 2019 and 2023 data
Should We Be Worried About The Health Of The Canadian Consumer?
We recognize investor concerns over the health of the Canadian consumer given the impact of inflation on household budgets. The BoC has begun its rate easing cycle, having already cut twice by 25 bps each time (moved from 5% to 4.5%). Our Economics team is forecasting another 75 bps in cuts in 2024 and 125 bps in cuts in 2025 with the overnight rate falling to 2.5% exiting next year. While we recognize the impact of rate cuts on consumer spending trends is not immediate, it has resulted in improving investor optimism on the health of the Canadian consumer with the TSX Consumer Discretionary Index up ~5% since late May. We would also note that looking back over the last year, the TSX Consumer Discretionary Index and the Canada 10-year yield have exhibited a -67% correlation.
Looking back the last 10 years and excluding the 2020-2021 pandemic-related time period, AC and the TSX Consumer Discretionary Index have exhibited a 70% correlation from August 2014 to December 2019 and a 58% correlation from January 2022 to October 2023. In 2024, the correlation is -49%. We recognize that uncertainty over the pilot labour negotiations and excess capacity on certain routes, which caused AC to lower its 2024 guidance in July, have weighed on its share price, but another major pushback we have 2.5 2.7 2.9 3.1 3.3 3.5 3.7 3.9 4.1 4.3 4.5 240 250 260 270 280 290 300 29-Aug-14 19-Sep-14 10-Oct-14 31-Oct-14 21-Nov-14 12-Dec-14 2-Jan-15 23-Jan-15 13-Feb-15 6-Mar-15 27-Mar-15 17-Apr-15 8-May-15 29-May-15 19-Jun-15 10-Jul-15 31-Jul-15 21-Aug-15 TSX Consumer Disretionary Index Vs. Canada 10-Yr Yield Correlation = -67% TSX Consumer Discretionary Index Canada 10-Yr Yield (RHS) Addressing FAQs We Get On AC - September 2, 2024 4 heard over the past year has been on concerns over the health of the Canadian consumer; namely, the view that a higher-for-longer interest rate environment would eventually impact travel demand. We view falling rates as an incremental positive. At this juncture, investor optimism over the health of the Canadian consumer has not flowed into AC's equity
FX And Fuel Have Become Tailwinds:
AC's 2024 full-year guidance assumes a US$/C$ FX rate of $1.36 and an average jet fuel price of $1.03/L. Over the past four weeks, we have seen jet fuel prices weaken and the C$ strengthen versus the US$. The New York jet fuel price has declined ~12% since July 31, 2024, and the C$ has strengthened from $1.38 to $1.35 over this same time period. While we recognize energy prices and FX are volatile, the recent moves in both variables should be a tailwind relative to expectations. For reference, we are forecasting a ~$1.38 US$/C$ FX rate and a jet fuel price averaging ~$1.05/L in H2/24 for AC. If we assume the current jet fuel price and FX environment hold, this would imply an average jet fuel price of ~$0.91/L in H2/24 and ~$0.98/L for 2024. All else equal, if we adjust our model to reflect this lower fuel price environment, it would yield approximately an incremental $350MM in operating income.