Air Canada (AC) Earnings Call Transcript & Summary

Thank you, everybody, for joining us again at our Annual Leveraged Finance Conference. My name is Doug Karson, I cover aerospace and transportation. And we're so pleased to have Air Canada with us today, very great story. We're going to spend about 30 minutes in a fireside chat format. So please feel free to send some questions in for me, and I'll be sure to ask them. With us today, we have Pierre, who's the Vice President and Treasurer of Air Canada and Valerie Durand, Head of Investor Relations and Corporate Sustainability. So thank you very much for joining us today.

I'd like to maybe start the fireside chat with just a discussion about the recovery we're seeing in the industry. In the third quarter, operating revenues were about $2.1 billion, almost 3x above last year. If you could just maybe tell us a little bit what you're seeing in the industry and maybe talk about how your capacity set for this growth that we're seeing or rebound, let's call it.

So I could start with that one. I would say in terms of -- can you hear me? Yes? Yes? Okay.

Yes, I can.

Okay. In terms of what we are seeing, so as travel restrictions eased during the third quarter, we saw a pickup in demand. So our operating capacity for Q3 2021 was increased 87% year-over-year. And when we compare to Q3 2019 it's a lower capacity from about -- of about 66% lower. So when we look forward in terms of capacity guidance for Q4, we're looking at an increase of 135% compared to 2020 -- Q4 2020 and a drop of -- a decrease of about 47% compared to Q3 -- Q4 2019, excuse me. So I would tell you that how things are shaping up? I mean -- and when we look at this change over the third quarter compared to Q1 and Q2, it definitely translated into the results. As you've pointed out, we were a positive EBITDA for the first time in Q3 2021. And that's obviously the results of -- from operations and the ease of restrictions and the seasonality of the demand, I would say. So as we get into the fall season, that booking curve is consistent with the seasonal challenge -- the seasonal change that we typically see. And then as we look into the holiday and into early Q1 2022, we're seeing the demand ramp up again similar to the seasonal pattern that we typically see. So I mean, the key difference here is obviously the business travel remains a little bit soft. But on the flip side, as we have done so at the onset of the pandemic, we entered the leisure and VFR markets quite quickly. And we were able to focus on capturing premium leisure opportunities for the premium cabin. So we always expected the recovery to be led by VFR, we call that VFR, we love our acronyms that visiting friends and relatives, and leisure. And geographically speaking, we always expected it to be led by domestic followed by transporter followed by Transatlantic and what we're seeing aligns with those expectations. So as we look ahead going into the holidays and early 2022, for some markets we're seeing very strong demand and very healthy demand for Europe 2022. I would say if we look at it geographically, where it becomes a little bit of a softer or unknown is on the Pacific as restrictions are still in place. And obviously, now there is only Omicron, although it's a little too early to tell at this point whether that will have an impact or not. So as you can appreciate, your question was how is it going? So we've been quite nimble. We've been adjusting as the situation evolves. When the restrictions eased, we were ready with capacity to respond in the market. So we continue to evolve as the situation -- we continue to adjust as the situation evolves, I would tell you. And another good sign of our recovery is that we are -- we have recalled more than 10,000 employees up to date, and we are hiring as well. So -- and we are in a very strong liquidity position.

I would add that -- if I may, I would add that our recovery is very much tied to the restrictions the government put in place being removed. But -- and as you know, these restrictions were much more stringent than they were in the U.S. So we lag what's happening in U.S. by probably 6 to 9 months.

Exactly.

The Canadian government has removed a number of restrictions which had been very helpful. Unfortunately, yesterday, in the wake of Omicron, they've added some requirements when we come back to Canada other than from U.S. to test. So that's putting some additional restrictions in place that we need to deal with. But other than that, we're trending in the right direction, and we look forward to an environment where there are less restrictions obviously, which will be helpful overall to Air Canada.

That's helpful. If I can maybe expand on that first question. if you can maybe help investors the sort of leisure versus business travel? And Valerie mentioned that you're able to get some premium cabin demand. Can you maybe talk a little bit about your mix? That would be helpful. So leisure versus business and then some of the price points.

So yes, it's a question I get all the time, and it's a little bit difficult to answer because we don't ask people why they travel. So -- and presumably, yes, you have business travelers in the front cabin, but you obviously have some traveling in the economy cabin as well. So what I would tell you in terms of business travel, if I could give a bit more color on this is, is that the business travel, as you know, remains a little bit soft right now. And that's because office policies have shifted to the right a little bit. And I would say that, that's more for the larger corporates because when we look at certain industries, it has been resilient, like take, for example, the construction industry, mining industry, a lot of resiliency there as well as the SMEs, the small million -- small or medium enterprises, they've been hustling through the pandemic and have been traveling over the pandemic. So there is some resiliency there. Now what we are hearing from our customers, our corporate customers was definitely a desire to travel again. And I said this on the previous call, I've never been so happy to take a business trip in my life when I did so the first time. So I think many of us feel that way. So as those office policies reopen up, that's when we expect business travel to return. And as I've said before, in terms of aircraft configurations, we are very well configured to capture the market. We have very efficient locus, and we have been capturing some good revenue with respect to premium travel on the VFR markets, on the leisure markets. And the other way we do that is with Aeroplan, which is a game changer for us and allows us to do those targeted offers and sell up when we need to.

That's helpful. Maybe we're kind of on the operating performance. I think in each of the last 2 months, in the third quarter, you showed positive EBITDA. Is there anything you could help us frame like what would be a reasonable kind of path to recovery on the EBITDA?

Yes. So I mean, I would tell you, path to recovery to EBITDA, stay tuned for Investor Day. We'll have an Investor Day in March 30 in Toronto next year. But you're right, EBITDA improved $487 million compared to the third quarter of 2020. So that's a negative EBITDA of $67 million in the third quarter of 2021, with the last 2 months being -- generating positive EBITDA. So that's, as I said before, results from operations and obviously driven by the seasonality factor that I talked about. We always see a pickup in demand in the summer, good demand in the summer. And then keep in mind, I would say, particularly for Q3 of this year, it is over that quarter gradually that we saw in the ease of restrictions. So it began in July for Canadians, then in August for American citizens and U.S. residents and then in September for international travelers. So the positive effect happened gradually over the quarter as restrictions eased. And then when you combine that with our cost discipline and the efficiencies we expected to see with the ramp-up. That's a little bit of the color I can give you on the positive EBITDA of the quarter and then stay tuned for Investor Day for more longer-term targets.

That's great. And hopefully, I'll be able to travel. I'll get out there to see if they'd be fun. Pierre mentioned a strong liquidity, I pulled out a press release recently that due to improved liquidity, you withdrew from further Government of Canada financial support. So liquidity is really strong. If you could just refresh us on exactly what the dollar amount of liquidity is? How much you kind of need safely to run the business? And then maybe I'll touch on some other balance sheet items for bondholders.

Sure. So you're correct. We did recently terminate our credit lines with the Government of Canada, roughly $4 billion. At the end of the third quarter, I think we were around $14.5 billion of liquidity, which included that $4 billion, assuming on a pro forma basis, we're down to $10.5 billion of liquidity. If you recall, when we -- just prior to COVID, we had one of the better balance sheets in -- for our size in the airline industry, we held somewhere north of $7 billion of liquidity. And at that point, we thought we had too much liquidity, and we're looking for ways to make use of those funds. Obviously, in hindsight, we're very happy that we had excess liquidity, which helped us get us through the most difficult times in our history. So even if you assume pro forma, we're at $10.5 billion and we're currently a much smaller airline than we were prior to COVID and we expect to be smaller for some period of time. One can argue we have excess liquidity. Now we are in a much riskier environment. And so we're not about to start thinking a more normalized environment. But once we get to that point where we feel we're more normalized, $10.5 billion is too much liquidity for the size of the airline and who we expect to be. So to the extent we can hold on to that liquidity and things get more normalized, you would think that we would use that excess cash to delever, which was one of the big strategies we employed prior to COVID to get us to the point where we were 1 notch below investment grade. We spend a lot of time on cash on deleveraging. And you should expect us, as we go forward and things improve that, that's what we're going to focus on before returning more to our shareholders.

What's the right leverage for the company kind of roughly in a range to stay kind of conservative, but yet leave some flexibility for equity investors?

Yes. I mean if we go back to pre-COVID again, we were net leveraged under 1 or around 1 and that got us to where we were with respect to almost investment grade. I don't think we're going to be there anytime soon. But certainly, as we move forward, you should expect us to employ the same strategy as we did before and that were very successful. And so we have the same people in place with the same mindset. So you should expect a much lower net leverage as we go forward. Whether it's 1, it's hard to say at this point. There's so many factors, so many unknowns at this point. We're still rebuilding the airline. So the focus is more over short term right now. Valerie did mention we're having an Investor Day. So we'll -- our goal is to provide longer-term ratios and goals at that point. But -- and hopefully, we'll be able to give some guidance on leverage at that point also. But right now, it's a little early in the game.

Very fair. Very helpful. If I can maybe touch on cash flow. If I've got this right, I think net cash flow is $153 million. It was $520 million higher than the midpoint of the guidance. First of all, am I right on that -- on the cash flow being positive?

For Q3?

Yes.

Yes. Cash flow was positive in Q3. Despite we had guided to a negative or cash burn, negative cash burn, but we ended up having actually cash flow positive for third quarter. A lot of it to do with Valerie, what Valerie already mentioned was all the -- a number of restrictions were removed by the government, which played into a lot of pent-up demand being people going and buying tickets at that point. So it was mostly led by advanced ticket sales that provide a lot of cash flow because people all of a sudden saw the opportunity that that they needed to have easier travel and we're willing to book. And so that definitely helped Q3 cash flow. And to some extent, it should help Q4 also. But yes, we did have a very good cash flow quarter in Q3.

Yes. On the -- cash generation of $153 million compared to what we had expected of net cash burn of between $280 million and $460 million.

Yes. That's helpful. You probably talked about this in your Investor Day, but how do we think about capital allocation priorities bringing on new aircraft versus paying down debt? And maybe give me a little color of like how your capacity and fleet is set up right now for this, which I think will be a slow recovery, but definitely it's coming.

Yes. So yes, you're correct. We will give you more color on our Investor Day, sorry. In the meantime, we continue to take aircraft deliveries. We have taken A220s throughout the pandemic, those are financed by ADC. So from a cash flow perspective, it was never an issue for us. The MAXs with all their issues only started redelivering to our Canada this past September, so only a few -- a couple of months ago. And so we're starting to take those given our liquidity position and our desire to start thinking about deleveraging, we actually are paying those with cash at this point. Whether or not we decide to finance those will depend on how things play out over the next few months. So we're finding ourselves time to see how the market evolves, whether any variance caused significant concern and whether we need additional liquidity. And hopefully, things will continue to improve and therefore, we don't have to finance those. And therefore, the easiest way to delever is to never lever up to begin with. So that's the sort of a thought process with respect to the MAX. And so from a capital allocation perspective, those are really the only -- with the addition of some 787s 3, I think, those are really the only things that's committed with respect to aircraft. And obviously, we have other things that matter as we go forward in terms of maintenance and other things. But whether or not we commit to other aircraft in the future, time will tell. But at this point, that's really the only thing that we're focused on. And with respect to whether -- what do we do with the free cash flow as we go forward, we hope, of course, there will be free cash flow sooner than later. But as I said earlier, it's really all about deleveraging. And as you recall, prior to COVID, in the first few years of us getting close to investment grade, we were focusing entirely on deleveraging. Only towards the end did we start looking more into share buybacks. So you should expect sort of the same dynamic as we go forward. It's more focused on deleveraging. And then once the company gets a more solid footing with respect to its balance sheet, then we'll look at other things, including what we can do with the shareholder. But that's down the road. There was a -- sorry, there was another part of your question, Valerie, that maybe was more for you. You were asking -- I forget the end of their first -- the question.

I think it was regarding your capacity versus debt reduction. I think you've covered it.

Yes. That's what I thought.

Is investment-grade, would it be super helpful? Is -- it would be nice to have? It would impact the business a whole lot about just the markets and a lot of liquidity?

Yes. We had this question before when we were actually close. I'd say that with respect to our ability to finance ourselves, we're pretty much investment grade to begin with, given the WBC. And so to become investment grade, I wouldn't say is a huge benefit. But since we were right at the doorstep, well we're not going to say no, if that's what for core. But is it a target of ours today? No, a target of ours today is to improve our balance sheet, delever. But at a certain point in the future, we expect our credit rating to move towards the same area that we were prior to COVID. How long that takes, who knows at this point. But as we get closer to investment grade, we'll start thinking about it more seriously, and we -- and if effort to get there is reasonable, then for sure we'll do it. But it's not some big goal we have at this particular moment.

Okay. That's helpful. I've got a question that came in from an investor. I mean we'll kind of roll some of those questions in. There's been a pretty tight labor market in a lot of the industries that I cover. How has the labor been in Canada? Has it affected you? Has it impacted the cost at all? Just being curious on the labor side.

Yes, that's a great question. And as I said, we've already recalled more than 10,000 employees year-to-date. One thing that's important to keep in mind as you compare us to our U.S. peers, is that we have long-term agreements in place with our major unions. And those represent all areas of work force. So these provide that long-term stability in terms of costs, but also frame the recall conditions of our colleagues, which manages expectations for all. So to give you an indication in terms of wage increases, it's basically inflation at around 2% for those agreements. So we're not seeing the same challenges as some of our U.S. peers may have shared. And we've also started hiring new employees as well. And I mean, look, it's true. There's no secret that the labor market is quite tight in that we are competing with the Amazons of the room. But we're confident that with our competitive product, our brand, our culture, our brand is -- we have a top employer brand. We've won awards in this respect year-over-year. We are still able to attract top talent.

That's good. I'm happy to ask the question because that's a different environment that we're seeing here in the U.S. labor market.

Yes. I would add on the pilot side. One key differentiator for us at least is many, many years ago, we established a bit of a, I'll call it, a farm system, our pilot flow-up system with our regional carriers. So take, for example, our regional carrier Jazz, they are very active in recruiting in the pilot academies and specialized schools. The pilots will fly with Jazz for a couple of years and then have the opportunity to flow up to Air Canada. So in terms of how we are structured, we are structured down the line to ensure an efficient recruitment cycle, if I may, which is a little bit different than what you may see in the state as this has been established for several years now. Is that what you wanted to add, Pierre?

Yes, but I was going to add that from a pilot perspective, we hardly laid off any pilots through the pandemic. What we did is basically just reduced their flying hours, which was the more efficient way to do it. So in terms of our ability to have pilots as our capacity is put back in place, it's relatively easy. We're not seeing any issue with respect to -- on the pilot side, which is -- which was strictly the bigger issue with respect to airlines.

Yes. And with respect to labor, generally, sorry, it's like a 10 is not here. But I mean, now we've recalled more than 10,000 employees. But as we ramped up, one of the efficiencies that we saw is that we had to make the difficult decisions and lay off some of our colleagues, at least 50% -- approximately 50% of our workforce. But if you look at our capacity, it was much lower than that. So we actually kept 50% of our workforce in place, which, as we ramped up, allow for some efficiencies, which obviously translate into the cost side as well.

We got a question coming in on oil prices, and that's always a big topic. How is fuel affected your operations, obviously, it's been a very volatile market for that. Maybe just talk to me a little bit about your ability to pass some of those costs on and where you're at on that?

Sure. For quite a while, price of oil at jet fuel really wasn't much of an issue internally given how we will fly. So yes, as we started ramping up, it's been accompanied by higher fuel prices. It's been down a bit lately given Omicron and other things. But we remain unhedged, but at the same time most of our peers, if not all our peers in North America are on hedged. And so the fact that oil and jet prices may be going up, we're all in the same boat. So we all have the incentive to react in a manner to offset those costs in a rational way, and there's a bit of a comfort level being in the same boat. If we decided to go and hedge, there's a cost to that. And to the extent there was no reason edge that our cost structure looks unfavorably against other airlines. And so you could be wrong, you can be right when you hedge. We think being unhedged at this point makes sense, even though there is some pressure for prices to go up. But as long as our peers remain unhedged, we think that's a reasonable place to be. At the same time, we are in an inflationary environment. And in that environment, you should expect to be able to raise fares to offset some of those rising costs. And therefore, that's what we've been seeing. And our expectation is we'll be able to do that to the extent fuel prices go up from here. But overall, our cost structure is still in very good shape, as Valerie was mentioning, from a labor perspective is very much under control given the contracts we already have in place and other things that are in place. So the main element is what you mentioned is oil, and we certainly are focusing on that. But at this point, it's not something that's overly of concern.

That's great. I have another question coming in on the Aeroplan question. We've certainly seen how successful lucrative loyalty programs can be. Can you talk to us about the newly revamped Aero program -- Aeroplan program. And is it different than before? Is that a fair question? I want to throw it out there.

Yes. So I mean, in terms of Aeroplan, as you know, we acquired the program back in 2019, and we have transformed it. We actually launched the Transform program in November 2020. We just didn't do a big hoopla around it because of the context. So really, we haven't really had the opportunity to really flex the muscle in terms of that program. So in terms of what that means for us, buying and transforming is really the game changer for us that we now own the data. We have the data. So we basically took out the middleman and are able to get in touch directly with our customers. So that program allowed us during the pandemic to keep engagement with our customers. And then when we relaunched the program last year, we made a commitment to earn our way into everyday lives, if I may say. So we've announced several partnerships to work towards that objective. We've announced a partnership with Starbucks, with Rocky Mountaineer, with Uber. And for those of you who are in Ontario with LCBO, which is the the liquor store in Ontario, so I don't know about you Doug, but for me, there's no -- for some people, they might not get more everyday life than the LCBO. So we actually won an excellence in management award for recognizing the strategic -- the excellence in the strategic transformation of the program. And so in terms of the results of the program, I mean we -- over the third quarter, we achieved very strong results, driven by the gross billings of points sold in the quarter. Those increased 50% year-over-year. Growth in member enrollment and credit card engagement is strong. In fact, the average card spend and the new card acquisitions are both higher than the prepandemic levels. So with the improvement that we are seeing not only with the Aeroplan redemption but with the yields, it is exceeding our expectations. But we're starting to see the off, but that will come over time as elements of the transformation are rolled out and more opportunities come up. So more to come on on Investor Day, but I would close by saying that Aeroplan is key for us in terms of customer engagement, but also revenue diversification it's a key strength compared to our competitors. It is quite a unique program.

That's very helpful. So that wraps up our time. Thank you so much, Valerie, and Pierre. I'm looking forward to the Investor Day. I think it will be very interesting and a great update. Thank you for everyone joining us today. And without further ado, we'll conclude the presentation. If anyone has any questions, feel free to e-mail me at my e-mail work. And thanks so much, Air Canada, a great presentation. Thank you.

Thank you.

Thank you, everyone. Take care. Bye.