In early November, we posted an article entitled Is Air Canada’s Stock Ready for Takeoff?
Turns out the answer was an emphatic yes as the shares surged soon after by about 37 per cent on the back of news vaccines were coming.
The airline’s stock consolidated those gains and recently the shares have been jumping again largely on the concept that customers will flock back to air travel once the majority of people have been vaccinated against COVID-19.
Here are the reasons TD Securities believes Air Canada’s transformative change post-financial crisis has left it flush with cash and poised to thrive post-pandemic.
by Tim James and Shawn Levine
The Air Canada that exited the financial crisis in 2009 was facing a growing low-cost competitor that was eyeing the international market and had:
- Net debt (including off-balance sheet debt) of $5.7 billion.
- A pension funding agreement with the Government of Canada to shore up its massive solvency deficit.
- Cash-to-trailing-revenue of 14%.
- And an earnings before interest, taxes, depreciation, amortization, and aircraft rent (EBITDAR) margin of 7.0%.
Following the financial crisis, Air Canada developed, communicated, and implemented a strategy aimed at transforming the airline into a more competitive, financially strong, and sustainably profitable airline.
It renegotiated terms with key suppliers including its regional capacity supplier, maintenance providers and other key partners.
Air Canada began implementing revenue initiatives aimed at growing ancillary revenue, improving customer loyalty, offering more differentiated products and adjusting the fleet capabilities to align with the geographic dispersion and international travel demands of Canadian travelers.
A new low-cost leisure airline was launched in order to better compete with emerging low-cost competitors and provide a profitable use for older aircraft being replaced by newer aircraft in the mainline operations.
A wide variety of cost saving initiatives targeting every corner of the business were identified and executed.
In 2013, a process was started to reduce unit costs by 15%, a target which was subsequently increased achieved.
Why It Matters / Our Overall Investment Thesis
This strategy and what we consider its successful execution resulted in an airline that entered 2020 with a significantly strengthened financial position, and a more flexible and significantly reduced cost structure that provided it with the liquidity and ability to deal with the unexpected and rapidly escalating challenges presented by the pandemic.
In 2019, Air Canada’s Net Debt was $3.4 billion. The pension was in a surplus position of approximately $2.5 billion. Cash-to-trailing-revenue was 31% and EBITDAR margin was 19.0%.
Air Canada is trading at an attractive valuation when considering its earnings potential in 2022 and beyond.
Based on our assumptions regarding the impact from COVID-19, we believe Air Canada’s strong liquidity, capacity cuts, and debt repayment requirements will allow it to navigate this challenging environment and reward investors who decide to ride out the current volatility and elevated risk.
Air Canada’s strong financial position prior to the pandemic has been crucial to its ability to raise $6.8 billion in liquidity without the assistance of the Canadian government and including two equity issues.
This has allowed the airline to keep $8 billion of liquidity at its disposal through nearly the entirely of the pandemic.
In addition, it has been able to rapidly remove and defer $1.7 billion from its cost base and capital commitments, which combined with its cash raising initiatives, have largely kept it comfortably ahead of any bankruptcy risk.
This is all despite a downturn in air travel demand that is far in excess of any scenario modeling and the most stringent government-imposed travel restrictions of any country.
Why It Matters
Air Canada’s strengthened balance sheet, cost structure, and free cash flow (FCF) has provided it with the ability to minimize cash burn as demand evaporated, secure financing at attractive terms, and continue to selectively acquire next generation aircraft that will be key tools to rebuilding its earnings as the recovery takes hold.
It has not been forced to take high cost government financial support or sell valuable assets, both of which would have degraded its competitive position while impairing its earnings and FCF power.
In addition to the issuance of debt capital, Air Canada raised common equity and convertible notes in order to reinforce its financial position and avoid excessive leverage in its capital structure.
We believe that its quick and aggressive action on costs during the pandemic will lead to a return to previous peak margins despite the potential for lower volume and a less profitable mix of business versus leisure travel.
Disclosure: TD Securities has provided investment banking services to Air Canada within the past 12 months.
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