Air Canada (AC) Earnings Call Transcript & Summary

Good afternoon, everyone. Thanks for coming to the afternoon sessions with Air Canada. We have their Chief Financial Officer, John Di Bert with us. And John is going to start off with a brief presentation here.

Okay. Fantastic. Well, thanks, and great to see you, Andrew, and good to see all of you as well. So maybe what I thought I'd do is, I'll just really glide through, very quickly, on a couple of just background chart so that you guys can get familiar. I'm sure many of you are following the story, but nonetheless, get you up to speed and then pleasure to take some questions. So coming out of the box here, just the first quarter. So you can see we had, I think, a good start in terms of just building up the capacity. We've been looking to grow year-over-year, $5.2 billion of revenue. And I would say that across the board, pretty solid performance from the business in terms of bringing that capacity on. And really within the expectations we had for the first quarter. We talked a little bit more about it on the call, earnings at $453 million. I think we had in there a $20 million charge that we took for some restructuring of some agreements we had in the cargo business. And really, that's a kind of a onetime charge. So from an ongoing perspective, really more like a $475 million plan target or I should say, delivery from Q1. And we feel pretty good about the way we kicked off the year overall, so not really widely off any internal expectations we had. From a cost point of view, $14.76. So that's up 1.6% year-over-year. And I think what you see in there is, on the one hand, you see some productivity gains, some efficiency from the capacity growth. And then you see some of the cost pressure from just wages. We had some cost increases for maintenance, getting ready for the summer season. And we're also making big investments in IT as we modernize the airline, and that also goes through our CASM. But overall, we felt pretty good about the 1.6% year-over-year, and we'll talk about the guidance, but kind of supporting the full year. Solid quarter on cash. So we're still building advanced ticket sale cash flow, which is very positive on working capital. And I would say that as we go through the year here, it's going to be nice to carry comment that $1 billion of free cash flow generation in Q1. Really, the big CapEx here is coming in '25, '26, '27. So feel pretty good about the full year in terms of just cash flow generation. Obviously, off to a good start here. Talking about cash and cash flow. I think in a nutshell, easy way to look at this, we added about $4.5 billion or so of net debt through the pandemic to the balance sheet. We started off just below 1x leverage. So very well-capitalized balance sheet and it's in good shape, pre-pandemic, ramped up in order to have liquidity, in order to be able to navigate through, that was complete and done well. And as we started to see the recovery manifest itself largely end of '22, but mostly through 2023. We've been deploying a lot of cash as we're earning and generating it. So all the cash flow we generated by and large, dollar for dollar, has gone to drive down debt. And we've done so both at the aircraft financing level, but also on the corporate debt, and we just did something over the last quarter, which was, repriced our Term Loan B and also take down half of the outstanding debt. So feeling good about where we are today, $3.8 billion of net debt and sitting just under 1x leverage. We recently also were upgraded across the board from our rating agencies. And so stand at a BB rating across the 3 agencies. Just to close off on that, I mean, right now, as we speak, all things considered end of the quarter, $10 billion of liquidity. We have a $1.3 billion revolver. So the rest of that is real cash on hand. We just mentioned, we paid down $1.1 billion in March. That felt good. It also -- we took down the cost of that capital by about 100 basis points. And then on a net debt basis, under [ 4 ], which is really off the last 12 months or 4 quarters of earnings less than 1x and better than our pre-pandemic or just around the pre-pandemic, [ 0.8 ]. I won't spend too much time here, but just very simply, strategically kind of big picture, Air Canada. It's really well funding in the future, but it's also about growth. We have tremendous opportunities. We believe that the airline can continue to access markets and grow the overall traffic well into the 2030s. At the same time, we want to have a great product, and so we're investing in technology, in Aeroplan, in branded offerings, in the cabins of our aircraft and making it a great experience. And then finally, really through our whole network and our employees and also our own role in Canada, the Canadian community, we think we're a great partner for the corporations we serve, the communities we bring together through our regions and our network, and frankly, the opportunities we create for our employees. To fund our future component of it, again, not to get too philosophical here, but really fundamentally behind that statement is the fact that we will be prudent and we will manage with discipline when it comes to the financials of the company, always keeping an eye on cost, making sure we have the right balance sheet and we manage risk very well. We believe in innovation, and we need to execute for that growth. And so we will continue to innovate in how we operate the airline, the technology we bring in and how we grow the fleet and look for commercial opportunities and revenue manage. And then finally, just making sure that we deploy capital well and deploying capital to, one, the fleet to grow, and to modernize it and to create returns for investors and then to be able to allocate capital to investors. '24 guidance. So this is what we set out when we launched the plan for 2024, and we talked about this at our Q4 call, 6% to 8% in terms of the overall fleet capacity. And we feel good that we're continuing and able to deliver on that. We had a good start. The next couple of quarters, we'll add not at the same rate that we did in Q1, probably mid-single digits and then move through the end of the year here and hit that 6% to 8% capacity uptick. And that will lead into more growth into 2025 as we come back to 2019 levels. On the cost side, 2.5% to 4.5%, we talked about on our Q4 call, the fact that we had some natural tailwinds from productivity, from efficiency, from just getting the airline back to those more efficient operating capabilities that we had pre-pandemic. Investments in technology are helping. But at the same time, we do have some headwinds, and those headwinds come in the form of labor agreement we're updating, obviously, with our pilots and the fact that we have some airport infrastructure and we believe some APPR passenger rights costs that probably are some headwinds through the system. And through all of that, we have the normal assumption for inflation, whatever that might be 3% or so. And then, of course, on the earnings, that's the drop out of those assumptions. Probably a flattish yield environment is our going-in assumption, maybe a little bit of pressure there, but by and large, holding and then the ability to generate the capacity and hold cost will get us $3.7 billion to $4.2 billion on the full year. So I'm sure we'll have questions and we'll dive into this further, but I think what I'll say here and suffice to say is I think that there's some very unique structural opportunities for Air Canada in terms of growth. And in a nutshell, you have GDP growth, which is true for every airline, so call it 2%, 3% your normal macroeconomic driver. But on top of that, what is, I'd say, dislocated a little bit from just the normal GDP and macroeconomic backdrop that an airline will face in any jurisdiction or any region. We also have some things that are unique to Air Canada and to Canada. Number one is that we have about 0.5 million new Canadian entrants per year on a 40 million citizen country. That's not an immaterial number. And a large part of that immigration is coming from India, China, North Africa, Middle East, Southeast Asia. And that fits perfectly into our network. And really, we have a fantastic global network that accesses all of those regions. And that is just a demographic driver that is generational. So at 0.5 million per year and it's been going on for many years and potentially for several more, that creates a generational structural opportunity for delivering travel to those new entrants for business, for pleasure, for going back home, visiting family and friends and then just a higher propensity from those new entrants to travel in the first place. Number two, we have a fantastic Sixth Freedom franchise. And really, there's an opportunity for us to continue to take international U.S. traffic into both transatlantic and transpacific. Geographically, where Canada is, we've got three major hubs, one in Montreal, the other is Vancouver and of course, the global mega hub is Toronto, shortest routes across either ocean. And most oftentimes, if you're going to make a connection, the fastest route is going to be a connection into Montreal into Europe or a connection into Vancouver into Asia Pacific, and Toronto can service from both sides, frankly. And there's a great opportunity for us to continue to grow that franchise. When you think about 40 million Canadians and you think about 400 million Americans, the largest, most affluent travel market, 1% of that traffic is equal to 10% addressable market growth for us. And so just continuing to power those flows and how our fleet is being built and our connections and the way we actually transit passengers from U.S. transborder into a Canadian hub and out is seamless. You don't pick up bags, you don't -- you go through customs, you're in the same terminal. So it's actually a great experience and often the best option, and we can talk about -- more about that. As far as recovery, I alluded to it before, but getting back to 2019 levels. So in many cases, airlines are kind of at 100% or 110% of 2019 traffic. We're still -- at the end of '23, we're about 90%, 99 billion ASMs and 112 billion that we produced in 2019 versus '23. And I think that we'll make up some of that gap in 2024 and then probably by '25 -- 2019 levels are better, hopefully. So there's one thing that is true today that probably has never been true is the strength of all of the assets we have and the platforms and the brands. And we can talk about the global hubs, I can touch on that later. The way we've built them out, the Sixth Freedom franchise, I think a little bit more about that probably as we speak. Air Canada Vacations is a fantastic brand. Aeroplan is probably the single most powerful transformation and tool that we've put into the asset mix over the last few years in 2019, we reacquired it. And it's doubled in size. Today, there are some 8 million members for Aeroplan. And it's -- for me, a staggering statistic anyway that about 10% of all consumer transactions flow through an Aeroplan member participation. So whether that's credit card or it's consumer products with brand associations we have. So a very powerful set of platforms. The cargo business is a fantastic way to leverage our belly freight network, and we've introduced a handful of cargo jets to be able to drive freighter traffic directly into that network. Routes that we would not normally fly for passengers, we load up freight and bring them through what is our best and biggest asset in the network. So here it is. This is Aeroplan. Like I said, 2x the size that it was when we first took it over, tremendous partnerships, major credit card holders. An interesting statistic is we have about 1 million members that are U.S.-based members. So that also speaks to the Sixth Freedom traffic. It also speaks to the appeal that we have outside of Canada with the program. And then finally, what I would say is that we've made a lot of investments and efforts in technology and customer experience, and we continue to do that between launches, between technology, between the capability to interact with us through your mobile device. And frankly, just focused on customer service experience and we track many different projects and programs to enable it. One of the things that we are doing is actually empowering our frontline to make more decisions and be more empowered to solve customer challenges and issues on the spot. One chart here that's interesting, I know for many of you, you see a bit of a peakiness on CapEx. So we have an important CapEx program over the next 3 years for sure. And what is really strategically important about that CapEx program is that you're bringing in A220s, which are a fantastic transborder machine. We can talk more about that, superefficient, 135, 140 passengers, same seat cost as a narrow-body, 737 or a A320. On top of that, 321XLRs. So these are great machines to -- for us to go long range in Montreal, you can fly deep into Europe, similarly Toronto, given the distance. And so that can allow you to expand the network to fly all year round in routes that you would otherwise put a wide-body, not be able to fill the full capacity in low season, 321XLR can fly the same distances but take a much better load factor. And there are also -- the 787-10 is the other major investment we're committed to, and that is squarely to grow the international network footprint, particularly to service some of those longer-range routes into the Middle East and into India and abroad. Finally, obviously, our people. We have -- I think we've done a very good job of ramping down the airline but also ramping it back up. And we create an incredible work environment for all of our members. And ultimately, that's recognized through many different awards that we received in Canada. And so it's an important part of us being able to ramp up that airline, continue to train people, continue to deliver that customer experience and have the available staffing across all of the different disciplines. I'll leave you on this, and then we'll turn it over for 15 to 20 minutes of questions. But I would say we got off to a good start in Q1, continue to see pretty good 2024 intact. We're expecting to generate cash in the year, which is important to overall, I think, the financial strategy of the company, never had a stronger set of assets between hubs, Aeroplan, the fleet plan to grow. And I think we've built a balance sheet to be able to navigate through a lot of growth, but a lot of opportunity as well and still be resilient to risk, which I think is always important. And Air Canada has shown an ability to execute over the last 2 decades as we rebuild the airline into what is a world-class global carrier from Canada. So with that, maybe I'll take a seat and get some questions.

Great, John. Thank you for that. Appreciate it. Certainly, a few things to maybe unpack from the presentation, but maybe touch upon -- maybe start with, I guess, your 2024 guidance. You mentioned in terms of the -- with your capacity, flattish type of yield assumptions for this year is within your guide. Can you maybe walk us around the globe and kind of what you're seeing in each of the regions, just in terms of maybe pressure points and kind of tailwinds in terms of revenue right now?

Absolutely. So I would say that -- I'll start with the market that has kind of seen the biggest growth and has, I think, still strong potential. Back end of last year, we made a decision to pivot a lot of our growth towards -- or to have the highest rate of growth in Asia Pacific. And you see from our Q1 numbers, we had over 30 -- I think it was 37% year-over-year growth in capacity. Yields have held up nicely there as well. Last year, we were running load factors sometimes in the 90s, and we knew we needed to add. There's still a bit of a deficit in capacity in that segment. And so it's done very well for us, and we continue to see that as being a solid performer all year. When you look at -- and when you look at the system level, right, we talked 6% to 8% system-level capacity growth. I would say that Asia Pacific probably grows at 2x the rate of the entire system. When it comes to, I would say, the transatlantic franchise, last year, I would say is it was an optimal set of circumstances. And obviously, we and the other airlines were able to do well through that. We like what we see in transatlantic this year in 2024. But I think we had a good sense that it was going to be hard to replicate year-over-year, that kind of performance. And so we're seeing good growth, I would say, if you take that 6% to 8%, probably the upper end or maybe slightly higher than the top end of that range is the transatlantic capacity we've put out there. I think that yields flattish maybe a bit of a pressure on the full year. We'll see how the summer kind of evolves here, but I feel generally very good about the franchise, and it's still a great, great piece of our business, frankly. Domestic. If you're going to kind of a bit of the inverse is true as well on the domestic side, where 2023 was not the greatest domestic year and probably because a lot of Canadians were getting out to travel after being in Canada for a long time. And so '24, we're actually seeing that get better. And so we're seeing some good traffic growth and decent yields in domestic traffic. So again, nothing that we didn't expect or plan for, but it's kind of holding up very nicely, which is nice. And then transborder is -- it's a very important market for us. I think the Sixth Freedom franchise continues to grow quarter-over-quarter. Transborder is an important part of it, but also a Canadian is left to go to the U.S. And so that traffic continues to stay fairly healthy. And I would say also, we do get a little bit of -- there are some downsides, we get a bit of a benefit from the FX on the transborder traffic, particularly coming up.

Got it. You mentioned in your presentation the Sixth Freedom side of everything, last night when we were at dinner [indiscernible] regards to that demand channel. Can you maybe help us understand what percentage of that market you are, where you think it can go and what the true opportunity for that demand channel is?

Yes. I would say that -- you kind of -- you have to take a step back for a second. So I mentioned just a little bit of just the basics, right? So you've got 400 million Americans, 40 million Canadians. Just think about 1% of that market, 4 million representative travelers, passengers against the 40 million domestic sized addressable market. So every point is like a 10% addressable market expansion, which is very powerful for us. The geography of it is [indiscernible] to it. But we've done more. And we've done that over the last decade, right? So this is not an overnight thing where we've streamlined the hub experience that you come in from whatever Austin, Texas to Toronto and you go to Athens or you come in from Minneapolis and go to Rome through Toronto or St. Louis, Montreal and into Barcelona. Those kind of opportunities, we've made that experience very seamless over time. And it's been a lot of work to make sure that you don't have to check bags. There's no custom checks, you're basically in the same terminal. And if you're -- lounge access, it's a very nice. And we synchronize the whole schedule so that the transborder schedule is synchronized to the international schedule. And the same would be true for Vancouver, Asia Pacific, right? So that's the backdrop. And so the opportunity now is when you look at our fleet, the additions are we're going to go from 33 220s to 60 220s, 27 additional 220s. It's a perfect machine to bring that traffic up very efficiently and also be able to access the most U.S. cities from Canada for any airline, frankly, and to drive those hubs and the traffic through it. So the 321XLR is another great example. You can create all year around routes that fly 220 passengers where you had to kind of sustain a plane that had 350, 360 passengers on a widebody that may be too much capacity to carry. But now you can fly outside of peak season. So the reliability of those routes to that Sixth Freedom franchise is also going to be enhanced. And so when all those pieces come together, plus an Aeroplan program, plus penetration in U.S. travelers using the Aeroplan program, I think that addressable market expansion is kind of -- like it's a really big accelerant for the business. And I think we're naturally built to acquire it. And really, the competition is against the other international carriers. It's not the Big 3. The Big 3, that's their traffic, and they'll have a rightful ownership of it. It's going and challenging those international carriers that are taking traffic through Europe or Asia on their carriers. And it's much better to make that connection here and then go direct. And we have a lot of direct. I think Montreal might be the #3 or the #4 transatlantic hub in -- on the continent. So think about that. I mean it punches above its weight for direct connections to Europe as an example. And similarly, we just had a flight from Vancouver to Singapore, it's the longest flight we carry, whatever it was, 14 -- I think it was 16 hours. And so we opened up a route to Bangkok. I think we have the only direct access from North America to Bangkok. So there's a lot of great opportunities that we create for those U.S. travelers to come through.

I would think it's not only U.S., right? I would think at some point, Sixth Freedom could be also taking someone from Sao Paulo, wanting to go to Japan and transfer their hub -- go through Vancouver. So when I think about the U.S. as a percentage of your Sixth Freedom traffic, is it something like 90% plus number? Or is it -- is U.S. 60%, 70% of that business?

Yes, it's a good question. I won't volunteer number here, but it's also -- the inverse traffic is also true. Europeans and Asians coming into the U.S. will often also take that same set of connections and routes. So to your point, it's probably some distribution. But those are the flows that are the most meaningful ones.

Fair enough. Maybe moving on to the domestic market. Last week, Transat, pure leisure carrier spoke a little bit about some softer unit revenues that they were seeing lower margin guidance for the year. Did that surprise you? Kind of maybe talk a little bit about what you're seeing domestically and how maybe your model is a little bit different than Transat.

Yes. I mean I won't comment much on Transat. I think in the end, everybody makes their plan based on their view of what's coming. I think for us, we've seen a solid domestic market. We've not seen -- I think we had some challenges last year with the regional network in terms of just pilots and availability of pilots and we kind of worked through that. So that got our regional Jazz network up and running. We plan for aircraft availability and capacity and try to be, I think, as realistic as we could be. I think if you would have asked me on capacity and traffic at the end of last year, I probably would have volunteered in a number higher than the 6% to 8%, but we've kind of managed that. So maybe these are factors that either they looked at differently or made different calls on. I would say that, by and large, the Air Canada Vacations had a solid quarter in the first quarter but a lot of that traffic points out. So any excess capacity would have been pointed that way. And as we go into the summer season, I think transatlantic is important for all of the Canadian carriers, that -- also Transat being one of them. And I mean, we'll see how that all develops and maybe they had different yield assumptions, I'm not sure.

Fair enough. I guess when I speak to investors on Air Canada, probably the big -- one of the bigger holdups is just concerns around the Canadian consumer. You obviously have a lot of card data, you see a lot of spend. What's your take on the health of the Canadian consumer right now?