DBRS Confirms Air Canada’s B (high) Rating and Stable Trend

DBRS Limited (DBRS) has today confirmed Air Canada’s (AC or the Airline) Issuer Rating of B (high) with Stable Trend. In confirming the rating, DBRS acknowledges AC’s sustained improvements in cost efficiency, product offerings and labour relations. Favourable operating conditions also helped the Airline generate noticeably stronger cash flows and earnings and propelled its financial metrics in 2015 to levels considered strong for the rating. However, DBRS notes that AC’s sizable committed capital expenditures (capex) of $8.2 billion as at June 30, 2016 (of which $1.9 billion are scheduled for 2017 and $1.7 billion for 2018) could cause material increase in adjusted debt. Whether the Airline can avoid deterioration in financial metrics will depend on its ability to grow cash flow and earnings at a similar pace. DBRS expects AC to remain exposed to possible weakening in passenger demand, increase in fuel prices and price competition, which are beyond its control.

Firm passenger demand and proactive capacity management have helped AC maintain a load factor in the low 80% range despite a 23% increase in available seat miles (ASM) since 2013. The Airline has benefited from rational competition, increasing U.S.-based transcontinental passengers through Canadian airports and expansion in international routes. AC has also reduced operating expenses per ASM by 14% since 2012 through cabin reconfiguration to increase density, expansion of the lower-cost Air Canada Rouge, renegotiations of commercial and capacity purchase agreements and lower fuel expenses.

With operating cash flow and EBITDAR at record levels, AC’s financial metrics have meaningfully improved: adjusted cash flow-to-debt increased to 23% in 2015 from 14% in 2013, while adjusted debt-to-EBITDA reduced to 3.5 times (x) from 4.3x during the same period. This was achieved despite higher debt levels and the translation impact of a weaker Canadian dollar to its predominantly U.S. dollar-denominated debt. The metrics weakened to 22% and 4.0x, respectively, in the 12 months ended (LTM) June 30, 2016, as aircraft purchased for 2016 were all delivered in the first half. DBRS expects the metrics to improve moderately by year-end 2016 with no more delivery in the second half. AC’s liquidity further strengthened with unrestricted cash and short-term investments of $3.1 billion as at June 30, 2016, or 22.5% of LTM revenue.

RATING DRIVERS
The Stable trend reflects DBRS’s view that, despite noticeable improvement in operating efficiency and cash flows, heavy capex could constrain AC’s deleveraging effort, and its ability to meet the leverage target will largely depend on continued favourable conditions and its cost and capacity management discipline. AC has an internal leverage target (net adjusted debt-to-EBITDAR) of 2.2x for 2018 (2.7x in LTM June 30, 2016). DBRS could consider positive rating action if AC maintains its financial metrics similar to their 2015 levels after capex peaks in 2017. Conversely, material deterioration in financial metrics could pressure the rating.

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 (February 2016) and DBRS Criteria: Financial Ratio Definitions and Accounting Adjustments – Non-Financial Companies (April 2016), which can be found on our website under Methodologies.

The full report providing additional analytical detail is available by clicking on the link under Related Research at the right of the screen or by contacting us at info@dbrs.com