Air Canada (AC) Earnings Call Transcript & Summary

Session here. We have folks from Air Canada and their EVP and Chief Financial Officer, Amos Kazzaz. Amos, thanks for being with us today.

Good morning, Andrew. Great to be here. Nice to see a few faces in the crowd here.

Great to be back in person. I probably haven't seen you face-to-face in a number of years now. I think this is the first time.

Definitely since pre-pandemic.

Yes, absolutely. A lot has happened since a lot has transpired since the last time we saw each other in person. Maybe for those in the room and on the line that maybe don't know the Air Canada story that well. The -- I'd say the pandemic was probably a bit different for you than it was for a lot of the U.S. airlines that people are a bit more familiar with. There was no PSP program for you. You only got -- you got some low interest loan money for some customer refunds, but that was about it. But you were able to emerge from the pandemic in relatively good shape, certainly for an airline. Maybe take a few minutes or so to maybe explain to folks how Air Canada reacted during the pandemic from kind of a cost network perspective and how you thought about the balance sheet over that time because I think those are some differentiating factors for Air Canada.

Yes, definitely, it's a good place to start. Certainly, the last couple of years have been challenging to say the least and probably a little bit more so in Canada. We entered the pandemic with liquidity about -- unrestricted liquidity about $7.4 billion. And with a leverage ratio of just under 1, one of the strongest balance sheets in against the -- across the industry relative to our size. And then pandemic hit, but we are now sitting at liquidity a little bit under -- a little bit over $10.2 billion, so you're right. The Canadian government did not offer us any sort of support package like the U.S. did. And it's interesting that if you sort of look back, it's almost a year ago now and a year into the pandemic when the Canadian government did provide some support package in the form of $500 million in equity, $4 billion in secured and unsecured credit facilities and $1.2 billion facility for the refunding of nonrefundable tickets.

Refundable or nonrefundable tickets.

Nonrefundable tickets. Interesting proposes, but that was part of the package with the government. So then we moved into -- concluded them about a year ago. When we went into August, we completed a series of financings that essentially raised about $7.1 billion in gross proceeds. We then, in November, exited the [indiscernible] facility and only left in place the $1.2 billion refund facility, and that's a 7-year term and 1.2% interest. Given that the Canadian government did not support us in the efforts until later on, and then again, we didn't tap into that, we had to work on our own. And so we end up raising in essence, 2/3 debt and about 1/3 equity because we didn't really want to destroy the balance sheet with all debt. So that was important to us to be able to leverage ourselves coming out. So then that was sort of the financial balance sheet side. And then we look at what we have to do. So from a network perspective, we essentially then had to rapidly size down. The Canadian government essentially closed orders. And so we took it upon ourselves to resize the airline. We retired 79 aircraft, a combination of 767s, 320s, 319s, E190s and that accelerated our move into our fleet transformation of fuel-efficient maintenance cost efficient, MAXs and -- and so that then said, we need to resize the airline to bring down the rest of the cost structure, so we began attacking fixed costs to be able to take fixed costs out, resize the airline and then reduce our breakeven point. So that sort of culminated the activities on the fleet side, balance sheet, financing. And now we see demand coming back strongly. We're at the point now of calling ourselves perhaps Air Canada 2.0, the transformed Air Canada with essentially, we did all this work really, based on the culture we have built over the last decade and the strong resilient CEO, the team, the efforts sort of worked together to ensure that we were going to come out of pandemic in a ability to recover and recover quickly.

Great. So maybe -- so you got through it well, you reshaped the -- you reshape the airline for kind of the new world. And now we're sitting here in the recovery, right? We have -- we track the checkpoint data kind of through Canada. I think what we're seeing is kind of 70%, 75% recovered back to pre-pandemic levels, I believe, of late. Can you maybe speak to where Air Canada sits in the recovery in terms of both kind of your domestic network restoration and how you're thinking about the international network restoration?

Yes, it is really nice to see that this whole notion of pent-up demand. The U.S. saw it earlier, we finally saw it. And so it's nice to see that pent up demand and the traffic has begun coming back and is keeping up with the capacity that we're putting out there. And certainly is more led by VFR traffic and leisure traffic. If we look at first quarter, we're basically 55% of 2019 capacity. If you look at traffic in the first quarter, it was double triple digits really across all segments. It was led by U.S. Trans border, Atlantic and Pacific. But then again, keep in mind that where we came off of 2021, where essentially the borders were still somewhat restricted and locked down. As we now look into Q2, we continue to put up capacity -- accelerating our capacity recovery will be in the second quarter, 73% of 2019. And then as we look out to the summer, we'll be at 80% of 2019 capacity. We've launched 34 routes international across Atlantic and Pacific. And when you then dial down into that, that will put the Atlantic at about little over 90% capacity in the second half of the year. So continue to see really strong traffic growth, and that's essentially how we're seeing the build back in traffic and capacity. So for the year in total, we'll be at 75% of 2019 capacity. Again, that's with the impact of Q1, which was a slower build-up.

Yes. How are you thinking about, I guess, the Asian network in particular, obviously, places you fly within Asia, but probably in China probably a bit slower recovery, but other areas might be a bit stronger. How do you think about Asia and when -- with your ability to kind of move your assets around in the region, how do you think about the timeline? Or how long is it going to take to kind of fully restore that network if it gets restored back to 2019 levels?

And that's a good question about, will it get restored back because I think it really, for us, it depends on China. And China, we don't believe will start recovering until 2023. However, we saw the rest of the Pacific, we saw Korea strong, Japan, fairly strong, but where we have additional capacity where we've rebuilt in the Pacific is South Pacific with Australia, New Zealand, sort of coming back on. And then what has ended up replacing China for a large extent, is India. India has been a strong point for us. We were flying India out of Montreal, Toronto and Vancouver. We've had to back off of Vancouver most recently because of the aerospace restrictions over Russia. But nonetheless, we see India as a growing market and perhaps all in all, replacing China or a good portion of China. So when we look out into 2024 capacity and services, we think we'll be recovered across the regions, albeit may be made up by different mix. And that's the beauty of having your planes because you can pick up your factory and you can move it quickly and target the next opportunity.

So I guess we see a lot of similarities in the recovery that's now transpiring in Canada versus what kind of we've seen in the U.S., right? You spoke earlier about things starting out with kind of leisure VFR travel. I think you spoke on the call about beginning to see some small- medium-sized businesses getting back out on the road. That's basically exactly how kind of the U.S. recovery played out. So it seems like you got -- Canada is about a quarter to kind of behind the U.S. as fast forward to this earnings season, and we -- at least in the U.S., we've seen like the biggest surprise was just how powerful the corporate recovery has been here. I guess, where does the corporate recovery stand for Air Canada today? And kind of what green shoots are you seeing from a corporate perspective? And kind of how do you think about the rebuild?

Yes. It's an interesting dilemma in Canada. I think it's much slower to recover, essentially, it's been based on return to office policies and have not evolved as fast as they have certainly in the United States. I mean it wasn't actually until today or yesterday when the mask mandate was lifted in Quebec. And so getting back to offices, I think, has been one of the key drivers that has held back corporate travel. Now that said, what we are seeing, and we had mentioned on our first earnings call -- first quarter earnings call, that we see traffic on corporates, specifically the SMEs down by about 50%. Now what we've seen now in terms of May and June bookings building up, we're seeing that, that will probably move up to down 40%. And then the big push for corporate travel will be in post Labor Day because essentially summer is somewhat off. All I will say, though, that we are seeing now some corporate activity in a nontraditional period, we're seeing meetings being planned in July to frame, which is unusual. But for us another good sign. So I think once we get post Labor Day, the biggest market, business market is North America, the trade transborder business that come Labor Day, post Labor Day, we should see it down 30%, down 20% and probably fully recovered in 2023. So still, again, a little bit behind but catching up now that restrictions are eased, sure it's coming back.

My next question was going to be in the -- I think you're guiding to 8% to 11% EBITDA margins this year. I guess, how do you think about the kind of the corporate recovery and the contract of that margin guide? Because I would think corporate is just a lot more -- probably a lot more profitable for you than the leisure VFR travel.

On an all in, all in basis, yes, it is. But the one thing that we've been seeing now the recovery on VFR and leisure is premium cabins, and we're seeing strength in premium cabins by leisure -- by leisure travelers. So that's been a nice addition as we move through this. But I think all in all, as we look at our EBITDA margin guide, it really reflected a view that sequentially, you would basically be seeing down 50, down 40, down 30, down 20 as the quarters went by. Now baked also into that is then -- is the view on all the other aspects of our business. And -- but one can take a view of our premium cabins, and we look at our premium cabins and if it doesn't come back as strong, we have a smaller footprint. We have a smaller premium cabin, which we're able to, I think, manage somewhat effectively through the leisure traveler, if you will, and demand on premium cabins from that side of the business.

I mean, you're not the only one to speak about this premium -- kind of the premium leisure business. Have you surveyed your customers? Like what do you think is the driver behind that like how sustainable do you think that is?

That's -- we haven't surveyed particularly on this question, but we certainly see the benefit that we have of finally having Aeroplan in-house and having the data and being able to engage with customers and that Aeroplan is paying is playing a large role in that in terms of the offerings and ability to redeem, but more targeted offerings towards leisure travelers as well. And so I think as we go forward, and we're really exercising Aeroplan now that it's come back on digital transformation that we've done, the everyday partners, the attractiveness of the program that it's building members, and we find that as an opportunity now to help fill the leisure cabin until -- can help fill the premium cabin with leisure.

With -- I guess, can you maybe talk about how you revamped the Rouge fleet in the pandemic? Can you maybe talk to a bit kind of how the economics of the fleet change given all the kind of the recent retirements that you had? And if you can kind of give us some construct in terms of kind of how much of your business was leisure pre pandemic and kind of how the economics of that -- how you improve the economics of the leisure business over the past few years.

And I have to almost start out by saying, I don't really know how many of leisure versus business because really don't ask that. We simply don't ask that question. But that said, we've seen, again, the recoveries we talked about is being led by leisure by VFR and leisure traffic. So with Rouge, specifically then, we did retire all the 767s. So now Rouge is a narrow-body A319, A320, A321 product. It's lower cost than mainline. It's still a very important competitive tool for us, and we use Rouge primarily focused on Eastern Canada to leisure destinations. Now at the same time, also Rouge has been somewhat of a utility player in that we use it in regional networks where we need additional capacity, and we also use it as competing against LCCs. Part of that simplification is moving to a single, to a narrow-body fleet has also made the product simpler, it is taking some costs out and also more importantly, reduce the seasonality we had when we had the 767s in there, and we swung them from Europe to leisure to some markets. And so in that sort of swing now we don't have that large because it changed the capacity. So the 767s then, we're serving the secondary markets for Rouge, European markets. And now essentially, what we're doing is hub-to-hub flying with 787s, A330s, 777s, and there are other markets there that we're also serving with mainline such as Athens with high-density 777s, efficient locos, again, for that type of a market. So we have the specific aircraft type that sort of helped in terms of replacement of Rouge on that. And then to get to the secondary European city, we work with them basically within the Star partners, and they're flying that second leg. And then we sort of combine all that effort with the joint ventures that we have, then that also opens up additional points of distribution strength, point-of-sale strength to support leisure and the premium business segment. So when we then think, okay, well, leisure has been leading the recovery, having an in-house specialist, we have Air Canada vacations, and they are basically a great extension to be able to partake and participate in the growing vacation market business. It certainly helps support our Canada brand. It's an additional element there that gives us the opportunity to earn margins on the land portion of vacations and ancillaries that are driven out of there. So Air Canada Vacations has very strong relationships with the tourism boards and other partners. So participating in that part of the leisure market is made possible combination you have Rouge, you have Air Canada vacations. And then lastly, I'll throw in again is Aeroplan. Aeroplan being able to directly market to the leisure customers, which we didn't really have before.

Yes. Yes. Before I move on to another topic, is there any questions in the room? We can -- if there's ever a question, just raise your hand, happy to get a mic over to you. If not, I've got 2 pages here I can go through. But I guess, kind of when I think about Air Canada pre-pandemic, I think of growth opportunities like your sixth freedom traffic, Aeroplan growth, we're always focused on cost controls. I look at you today, and I don't think much has really changed, right? Obviously, you're a bit smaller, but you're focused on cost controls during the pandemic, I think Aeroplan is still a big opportunity for you. I think based on the last earnings call, still highly focused on sixth freedom traffic. So maybe on those points, can you speak about your hub strategy today and how you kind of plan to continue to drive that sixth freedom growth.

Okay. Well, it feels like nothing has changed. It feels like a lot of -- it's an interesting perspective. But you're right, we still focus on the same key strategies that have built to our success before. So in terms of our hub strategy, we have 3 geographically advantaged hubs in Vancouver, Montreal and Toronto. And then we have a fourth Mid-Continent hub in Calgary and what we've been doing is...

It is sort of a new strategy versus -- I never heard you talk about Calgary years ago, right?

That's true. Calgary has sort of become a new focus for us as well is it does help sort of connect the rest of network there and there are opportunities out in the West that Calgary certainly affords us from a network perspective. But if we -- coming back to -- if you look at the rankings, in North America of hubs, basically North American transatlantic hub rankings, you see that Toronto and Montreal are the third and fourth largest probably surprise to many people. But what we've been doing deliberately is building that traffic, that building the segments, building the network into feeding all those hub with multiple routes. And so much so that come this summer, we will have added 94 routes to basically use connecting traffic to Atlantic and Pacific, but more specifically towards Atlantic where the demand is right now. And those 94 new routes create essentially 1,000 city pairs when you look at it in total on Transatlantic from U.S. over Canada. So that part of building that sixth freedom is important to us. We see very strong demand now through the summer and carrying through into Q3 as well. So sixth freedom. We were the largest foreign carrier in the U.S., flying to the U.S. and we are rebuilding back the network there. And again, sixth freedom traffic has been key to growing then our international network and supporting international growth.

Got it. On Aeroplan, I guess, one of the things that came out of the pandemic was the big U.S. airlines use their loyalty programs to raise cash, right? So we got a quick glimpse into some of the economics of their loyalty plans. Generally, I'd say they contribute directionally 1/4 of the firm's EBITDA. I pretty much know the answer to this, but I have to ask you anyway. Are you in and around that -- is Aeroplan in and around that ballpark, I would think at this point, is probably lower than in terms of contribution, but anything you can say there?

Well, a couple of things. So see you right there. You know the answer of that question.

I have been trying for years.

Well, I'll see if I can give you a couple of reference points to make that work. So I think going back when we had acquired Aeroplan, and we said, here's what the economics of be, we said, look, it's about $2.5 billion NPV over the term of the financial partners that we have with the banking terms relationships. Then we said the other reference point, was it to look back at what Aeroplan did under EMEA, it produced EBITDA of about $250 million. So again, we say, well, it's not quite the same. But -- so we look at our sales compared to the U.S. carriers, we have longer duration, opportunity for growth, and we just acquired and launched it in the pandemic of all times. You know the pandemic, we sit below that 25%. But nonetheless, it's very important for us. It will contribute. Now we've eliminated that middleman of EMEA. We have a direct relationship with our customers. We're engaged with them. We have the data. And essentially, this whole digital transformation that we've gone through with EMEA -- I'm sorry, with Aeroplan and adding our everyday partners, we're now sort of back on the path of attracting new members. In the first quarter, actually, we had the highest new member acquisition that we've had in a similar first quarter period and even so much that pre-pandemic, we saw that the growth in members for each of the card issues with the 3 banks exceeded pre-pandemic levels. So very happy to see that. Certainly, we lost a couple of years in the pandemic, but we'll be back on target here of growing our membership -- members by 40% by 2024 and then offering some more higher-margin products as we build out Aeroplan. So not quite there, but it is a strong contributor to Air Canada.

I guess are there any limiting factors within Aeroplan, whether it's agreements with your banking partners or what have you that would kind of prevent you from generating whether it's similar margins or similar contribution over time, and with very long timeframe? Are there any limiting factors that would prevent it from maybe reaching the size that these programs are in the U.S.?

Yes, I think there is one key element, and that's interchange rates or swap fees depending on how you want to call them. Certainly, in the U.S., it is a very different regimen than it is in Canada, and Canada has gone through a period where the government mandates to some changes in interchange fees. So under that regimen, we'll not be able to be at the levels of U.S. because of the interchange dynamic here.

That's good context. I did not know that. I guess maybe moving on. Labor issues have been a big topic here in the U.S., particularly around pilots. I asked Mike on the earnings call about this, but do you see any pilot issues in your ranks, any bottlenecks? And is there anything from a pilot or a labor perspective that might not allow kind of your network restoration plan to go as expected. Anything to think about there?

No, that's actually one of the points that is -- we're very different from the U.S. carriers and that we don't have a pilot shortage issue, we built the capacity. If we look at pilot headcounts, pre-pandemic, post-pandemic now, it's roughly the same other than retirements and all. We have -- in Canada, it's a little bit different in the perspective. We have a good program, good flying programs. There's a lot of capability to produce pilots, then they go up through [ Jazz ] or to the regionals and then flow up into Air Canada. Air Canada has a wide-body aircraft, makes an attractive place to come to. So we're not seeing that and the ability to build in back to 2024 as capacity goes on, we just are not experiencing or seeing that in Canada. So it's an advantage for ourselves right now.

How many pilots do you have? Because I know the fleet is smaller, how many pilots do you have today versus pre-pandemic or do you think has it changed on a per plane basis or anything?

No, it really hasn't changed on a per plane basis because for the most part, during the pandemic, we didn't furlough all of pilots. I mean, essentially, we kept as many as we could on and kept them trained. And so we want to be able to recover quickly and not have that bottlenecks in terms of training. So roughly same sort of numbers, but I haven't disclosed that. I'm not sure I can start here.

Understood. I guess, so not many labor issues. I guess, speak a little bit about inflation in other areas of the business here, landing fees, obviously, a lot -- pretty much you kind of go through the P&L, right? And there just seem to be areas of inflation, areas of hyperinflation. And look, we all know where fuel is, right, that we can track every day. But kind of what are you seeing in some of the nonfuel or I guess, nonlabor cost lines, right? Because you still have -- you're pretty much still your labor agreements still have some -- a number of years left on them, right? So how do you think about kind of the inflation that everybody else is seeing?

Yes. No, it's a good comment -- a good question right now in this inflationary environment that we're in. And certainly from our long-term labor agreements, that's one item that we can sort of look at that line of P&L. We're pretty well protected as we have agreements going through 2024, all the way through 2029. And so basically about a 2% type increase -- average increase. During the course of the restructuring or call during the course of resizing the airline, we renegotiated maintenance contracts. And so for the largest providers, we're fairly well protected. We have caps on inflation. And when you get to hyperinflation, a sharing of that. I would say, though, we are seeing pressure on some spare parts in terms of inflationary pressure. Food is another category. I think we sort of hit the grocery stores, and we see that in Food. Airport user fees, they're going up, but again, not at hyper rates. It's sort of more of an inflationary from what we've seen so far. And then the other cost categories we've addressed for the regional lines, technology, and again, we negotiated those contracts during the course of the pandemic. So I think for us, we'll see more of it as they roll off in the next couple of years. And then by then, you hope that you're in a position where inflation has tamped down and the like. So we have the ability to manage through this with essentially the growing -- with our revenue management tools that we have, technology investments we've made there, Aeroplan we've talked about cargo sort of generating additional revenue and all, all this really help offset any other inflationary pressures that we see.

So we have a couple of minutes left. Last question that I had for you and probably one you like talking about as CFO. But what I've been impressed with, like you've -- even with revenues down 50%, 60% from pre-pandemic you've managed to eke out a small amount of free cash flow over the last few quarters. At Investor Day a couple of months ago, right, I think you guided to $3.5 billion of cumulative free cash flow, $22 million to $24 million. It's actually only a bit behind what you did, I think, in the 2016 kind of 2019 time frame. So you spoke earlier about, I think, north of $10 billion of cash and liquidity. How do you manage this cash?

It helps me sleep at night. I'll say that. It's comforting from that perspective. But look, we're very happy to -- we'd be able to see the -- able to generate good, strong cash flow as you talked about our guidance out there. And for us, my priority right now is to delever and to fund our investments. This basically has been fleet. So right now, we've reset our view in terms of minimum cash that we want to hold and we pegged that at $5 billion, but that includes undrawn lines of credit. So cash asset basically is being able to be both an offensive and a defensive tool for ourselves, so defensive for the unknowns and then offensive for making strategic investments we have with the 321 XLRs, additional couple of traders, dedicated freighters, new freighters and 787s. So for us, that's the way to manage the cash and then we'll see how it progresses.

Great. Well, that brings us to the end of our time. Amos, thank you very much. Appreciate it.

Thank you very much, Andrew.