DBRS Changes Trend on Air Canada to Positive, Confirms Rating

DBRS Limited (DBRS) has today confirmed Air Canada’s (AC or the Airline) Issuer Rating of B and changed its trend to Positive from Stable. In changing the trend, DBRS recognizes that the action steps taken by AC in the past two years have led to noticeable improvements in cost efficiency, capacity management and profitability. These actions include the purchase of higher-density and more cost-effective aircraft, capacity expansion in the leisure market through Air Canada Rouge (AC Rouge, its low-cost carrier), increasing U.S.-based transcontinental passengers through Canadian airports and further growth in passenger-related fee revenues. DBRS believes that relief from substantial pension-related obligations, improved liquidity and reduced interest costs through debt refinancing and the recent ratification of labour contracts with its pilots have also materially de-risked AC’s operations. Sustained passenger demand and rational competition in the North American markets also supported the Airline’s earnings and cash flow.

Despite strengthened cash flow, the Airline’s adjusted debt level increased to $7.2 billion at September 30, 2014, from $6.1 billion at December 31, 2013, as the Airline financed delivery of five Boeing 777s (B777) and four Boeing 787s (B787). The increased borrowing offset the improved EBITDAR and cash flow, resulting in only moderate improvement in financial metrics, with adjusted cash flow-to-debt at 15% and adjusted debt-to-EBITDAR at 4.2 times for the last 12 months (LTM) ended September 30, 2014. DBRS considers these levels strong for its current B rating and, if sustained, could support of a higher B (high) rating. The Airline’s liquidity is acceptable, with unrestricted cash and short-term investments amounted to $2.5 billion as at September 30, 2014, or 19.4% of revenue for the LTM ended September 30, 2014.

DBRS notes that AC’s aircraft purchase program is sizable, and, therefore, even if operating cash flow continues as expected, the Airline will likely remain free cash flow negative in the medium term and the additional debt could constrain any further meaningful improvement in financial metrics. As reported in its Q3 2014 financial results, the Airline’s total committed and planned capex will aggregate to $7.8 billion between Q4 2014 and 2018.

DBRS could consider raising AC’s rating to B (high) in the next two quarters if the Airline maintains or improves its financial metrics from their current levels through the next one to two quarters, while sustaining its market position and cost reduction efforts. Conversely, DBRS could confirm the B rating and change the trend back to Stable if AC’s financial metrics materially weaken as a result of a decline in EBITDAR or cash flow. This could be caused by an industry down cycle, intensified competition or loss of market position.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Rating Companies in the Airline Industry and DBRS Criteria: Financial Ratios and Accounting Treatments – Non Financial Companies, which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.