Fitch Ratings - Chicago - 11 Nov 2024: Fitch Ratings has upgraded Air Canada's Long-Term Issuer Default Rating (IDR) to 'BB' from 'BB-'. The Rating Outlook is Stable. Fitch has also affirmed Air Canada's senior secured debt ratings at 'BB+' with a Recovery Rating of 'RR2'.
The upgrade reflects Air Canada's improving credit metrics and solid financial flexibility. Gross leverage has trended towards Fitch's prior upgrade sensitivity driven by debt repayment and healthy operating margins. Though Fitch expects leverage to tick up in the back half of 2024 on modestly weaker margins, further improvement is expected over time. Air Canada's financial flexibility is supported by a sizeable liquidity balance which provides protection in the case of a downturn and will allow the company to address upcoming maturities and capital spending needs.
Fitch expects FCF to be weak for the rating in 2025 and 2026 as capital spending steps up to address aircraft deliveries. Risks are mitigated by the company's currently high liquidity and optionality around financing decisions for the new aircraft.
Fitch has upgraded Air Canada's 2020-2 and 2017-1 class B certificates to 'BBB+' from 'BBB', primarily driven by Air Canada's IDR upgrade to 'BB' from 'BB-', supported by steady post-pandemic aircraft values. For similar reasons, Fitch has also upgraded Air Canada's 2013-1 class A and class B certificates to 'BBB+' and 'BBB-' respectively from 'BBB' and 'BB+'.
Key Rating Drivers
Balance Sheet Improvement: Air Canada maintains conservative financial policies, which Fitch views as supportive of the rating. The company achieved its prior net leverage target of 1.5x and continues to prioritize gross debt reduction. Total debt, including lease obligations, has declined by nearly CAD4.6 billion or 27% from peak levels, bringing Fitch-calculated leverage to 3.7x at Sept. 30, 2024, which is near our prior positive rating sensitivity.
Leverage is likely to tick up by YE but trend downward in 2025 and beyond. Fitch believes that the pace of future gross debt reduction may be limited by upcoming capital spending on pending widebody deliveries, which may drive financing needs and pending share repurchases. Nevertheless, total leverage is expected to trend downward in the coming years, reaching the low 3x or upper 2x range in 2026 or 2027.
Healthy Profit Margins: Fitch expects Air Canada's EBITDAR margins to stabilize in the mid-teens over the next several years. Though margins will likely remain below pre-pandemic levels, profits are expected to remain sufficient to drive healthy operating cash flows and allow leverage to trend lower. Improving yields and operating margins would be viewed as supportive of future positive ratings momentum.
Non-fuel unit costs have moved structurally higher across the industry in recent years. This will be pressured further by Air Canada's recent pilot contract. While unit revenues are also up, they have not fully kept pace. Fitch expects carriers to rationalize capacity to support unit revenues going forward. Recouping the full increase in costs through ticket prices may prove difficult given pressures on consumers, but we expect sustained demand for travel and premium products, in particular, to support stable margins overall.
Manageable Cost Pressure: Unit costs will likely remain a modest headwind over the forecast period, though Fitch expects pressures to be manageable in the current demand environment. The company recently completed negotiations with its pilots, which will drive wages materially higher, likely representing a low single-digit headwind to non-fuel unit costs. Rising airport costs, maintenance and supply chain pressures, and Canadian passenger compensation rules are all expected to drive higher expenses. Pressures should be partly mitigated by increased efficiencies as Air Canada achieves greater scale.
Solid Travel Demand: Fitch expects to see continued growth in Canadian air traffic over the next year as demand fully recovers to pre-pandemic levels. International demand has been particularly strong, creating a benefit for Air Canada's internationally focused route network. The company reports a solid level of bookings through the summer season, with healthy indications in corporate travel and demand for destinations in Asia. Like other network carriers, Air Canada is also seeing benefits from demand for premium products, which accounted for 28% of its passenger revenue growth in the third quarter.
Heavier Upcoming Capital Spending: Air Canada placed an order for 18 787-10s in September 2023, which will push up capital spending in the 2025-2027 timeframe and limit FCF generation. Fitch expects Air Canada to generate low single-digit FCF margins in 2024 before dipping negative in 2025 and 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.
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 CAD6.7 billion, a sizeable balance that can be leveraged in the case of future downturns. This value 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 CAD274 million for the remainder of 2024 and CAD1.1 billion in 2025 before stepping up to CAD2.4 billion in 2026 with the maturity of its USD1.2 billion senior secured notes. Fitch expects maturities to be managed via existing cash on hand and potential financing of new-delivery aircraft.