Air Canada T.AC

NBF: Talks impasse

[Tempo1]

Air Canada preparing for orderly shutdown as talks with pilots seemingly at an impasse

This morning, Air Canada announced that it is preparing to gradually suspend flights starting as early as September 15th as talks with its pilot union on a new contract are nearing an impasse. Talks continue, but either party will be in a position to issue a 72-hour strike or lockout notice as of September 15th. With a strike/lockout looking more likely, we note the following:

• An orderly shutdown the right move for Air Canada. If Air Canada does not begin shutting down operations ahead of a strike/lockout, it risks having aircraft stranded around the world making a re-start of operations much more challenging. As such, an orderly wind-down of operations ahead of a strike/lockout is the prudent course of action.
• Strike/lockout will have material financial implications, but Air Canada balance sheet in good shape. Air Canada's regional flights operated by Jazz and PAL could theoretically continue in the event of a mainline work stoppage, but these flights carry only ~20% of Air Canada passengers, a large proportion of which connect to mainline flights. As such, with the loss of most of its revenue, the financial implications of a work stoppage would be significant for Air Canada. The early days of the COVID shutdown are likely a reasonable reference point for the financial impact. In Q2/20, the first full quarter of travel restrictions, Air Canada lost ~$9 million in EBITDA per day, falling to ~$6 million/day in Q3/20 (for context, we forecast Air Canada will generate $3.1 billion in EBITDA in 2024). The company's balance sheet is well positioned to weather a shutdown with leverage at the end of Q2/24 sitting at 1.0x and cash and equivalents sitting at $8.9 billion.

• Wage increases manageable for AC, but still needs to remain competitive to Canadian peers. The sticking point in the negotiations appears to be largely around wage increases. It has been reported that Air Canada offered a 30% wage increase on average (higher for entry-levels) over a 4-year period, which would be higher than the 24% increase pilots at WestJet achieved in a new contract last year. However, the union, represented by ALPA, is insisting on wage increases that would make Air Canada pilots much closer to U.S. mainline peer group airline wage scales. We believe Air Canada is already accruing pilot wage costs that are something close to the increase WestJet pilots received, which would equate to a 1.5% increase to Air Canada's total costs over four years. At a 30% increase, we have previously estimated that Air Canada's total costs would increase by 1.8% over four years, which we would still view as manageable. However, wage increases materially beyond the 30% level would potentially result in Air Canada being at a significant cost disadvantage to its Canadian peers, and it is the Canadian peer group that should be the benchmark, in our view.
• Will the government step in? Given the Canadian government's recent intervention in the railroad work stoppage, as well as its intervention to try and prevent a shutdown at WestJet earlier in the summer, it would be reasonable to think the government would also step-in to prevent a lengthy shutdown at Air Canada. While a shutdown at Air Canada would not have the same economic impact of a shutdown at both railroads, we note that based on OAG scheduling data for Q4/24, Air Canada (and its regional partners) operates 43% of all industry domestic seat capacity, 43% of industry U.S. transborder capacity, and 36% of all international seats. Other airlines do not have excess capacity that can readily absorb the Air Canada traffic so any shutdown of more than a few days would be highly disruptive to Canada's transportation system.

Maintain Outperform, but expect some share price volatility in the near-term

We keep our Outperform rating and $24.00 target on Air Canada (based on a 4.0x EV/EBITDA multiple applied to our 2025 EBITDA forecast), but concede that the stock faces a period of volatility in the coming weeks as the risk of a shutdown has grown. With the stock trading at just 2.9x EV/EBITDA based on our 2024 forecast, we believe most of the potential headwinds are already priced in and that the resolution of the pilot negotiations with a reasonable outcome could be a positive catalyst for the stock.