NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings for Air Canada at 'B' and maintained a Positive Rating Outlook. Fitch has upgraded the ratings for Air Canada's second lien senior secured debt to 'BB/RR1' from 'BB-/RR2' and assigned a rating of 'B-/RR5(EXP)' to Air Canada's proposed $300 million unsecured notes. Fitch has also affirmed the existing ratings for Air Canada's Pass Through Trust Series 2013-1 as detailed at the end of this release.
KEY RATING DRIVERS:
The ratings are supported by Air Canada's improving operating results, its strong market position in Canada, and adequate liquidity position. The Positive Outlook is supported by the company's reduced pension risks, efforts to improve its cost structure, and an improving debt structure.
While Fitch believes that Air Canada's credit profile is improving, notable risks still remain. Concerns include significant upcoming aircraft deliveries that will pressure free cash flows (FCFs), heavy competition from WestJet, uncertainty remaining around the ultimate success of rouge, and a fluctuating exchange rate.
Positive Operating Trends: Operating trends have been largely positive over the past year, and should continue into 2014 given Fitch's expectations for modest macroeconomic growth. Unit revenues may come under pressure in 2014 as the company adds capacity. However, unit costs are also expected to decline, which should provide room for margins to expand barring an unexpected spike in fuel prices or significant deterioration in the value of the Canadian Dollar.
Air Canada's EBITDAR margin expanded by 70 basis points (bps) to 11.6% in 2013. This remains at the low end of its North American peers. Fitch expects margins to expand modestly over the next one to two years.
Air Canada expects to add between 6.5%-8% additional capacity in 2014, the bulk of which will be aimed at further international expansion. Importantly, a significant portion of this growth is the result of upgauging as opposed to adding new routes. The company's five high density 777-300ERs which arrived in 2013 will be in service for the full year 2014 on high demand international routes. The first of AC's 787s arrive this year replacing 767-300ERs (251 seats vs 211). Seats added as a result of upgauging will come at a low incremental unit cost, meaning that Air Canada should see improved profitability on routes where the new aircraft are flying.
For 2013 revenues were up by 2.2%, increasing across all geographies, led by a 7.1% increase in revenues across the Atlantic. Systemwide capacity was up by 1.9% while load factors remained flat. Yields increased by 0.5% for the year.
Improving Cost Structure: Air Canada has publicly stated a goal of reducing unit costs by 15% over the next five years when compared to 2012 levels. CASM ex-fuel was down by 1.5% in 2013 reflecting the benefits of the cost initiatives taken over the past year including its new pilot contract and lower maintenance expenses.
Unit costs are likely to trend downward again in 2014 as the company gets the benefit of a full year of flying its higher density aircraft and due to significant additions to capacity. Added capacity will push salaries and wages higher, but costs are expected to increase by a smaller margin than capacity, bringing unit costs down. In addition, the 787s that Air Canada will begin to receive in 2014 will feature attractive operating economics compared to the 767s that they will be replacing.
Some of Air Canada's expected cost savings will come from the continued expansion of rouge, the company's lower cost, leisure focused subsidiary. Fitch notes that early results at rouge have been positive, but much uncertainty remains over rouge's ultimate success. As rouge grows it will begin to contribute meaningfully to Air Canada over the next several years, however, its fleet will not reach its full size until 2017.
Heightened Domestic Competition: Continued heavy competition from domestic rival, WestJet, presents a concern in the near term. WestJet launched its Encore regional product in February of 2013. WestJet is now quickly adding new routes to directly compete with Air Canada in smaller domestic markets. WestJet expanded ASMs by nearly 9% in 2013, and expects to add another 4%-6% in 2014.
Despite the added competition, domestic yields held up relatively well in 2013 aside from the fourth quarter when WestJet engaged in some heavy fare discounting. Fitch would view Air Canada's ability to sustain or grow domestic yields in the near term to be a credit positive given the added competition.
Financial Risks Remain: Air Canada remains highly leveraged, though total adjusted debt/EBITDAR has decreased to an estimated 5.0x from 5.2x at year-end 2012. The company will have limited ability to pay down debt over the intermediate term due to high capital commitments. Fitch expects leverage to remain stable or potentially increase modestly (depending on the direction of fuel prices and the CAD/USD exchange rate) over the next year. However, continued operational and margin improvements should allow leverage to come down from current levels over the longer term.
Heavy upcoming capital requirements related to new aircraft deliveries also present a concern. Air Canada expects cap ex to total $1.3 billion in 2014, up from $962 million in 2013. Aircraft spending is likely to be higher still in 2015. As a result, Fitch expects FCF to be pressured for the next several years. FCF was negative in 2013 and may be minimal or negative again in 2014 and 2015.
The increase in cap ex is primarily the result of taking new 787s which are scheduled to begin to arrive this summer. Air Canada is expected to take six 787-8s this year in addition to the one 777-300ER delivered in the first quarter. In 2015, the company will take four 787-8s, two 787-9s, five A320s and five A321s.
Total liquidity as a percentage of LTM revenue at year-end 2013 was 19%, which Fitch considers adequate for the rating. Liquidity consisted of $2.2 billion in cash and equivalents plus AC's fully undrawn $100 million revolver. Upcoming debt maturities total $312 million in 2014 and $613 million in 2015, which Fitch considers to be manageable. However, Air Canada could need to access the capital markets to refinance its maturities if operating results are weaker than expected.
Fitch views the improved status of Air Canada's pension plan as a notable credit positive. Based on preliminary estimates AC estimates that its pension plans are in a small surplus position as of year-end 2013 compared to a deficit of $3.7 billion a year ago. The improvement is the result of a higher discount rate, solid asset returns, and incremental contributions made through the year. The company is required to make contributions averaging $200 million/year based on its current agreement with the Canadian government. However, if the pension plans remain fully funded, Air Canada will be able to exit this agreement, potentially as early as 2015, which would significantly reduce required cash contributions.
Fitch also notes that Air Canada made significant improvements to its balance sheet in 2013 by refinancing much of its existing high yield debt and moving out the largest of its looming debt maturities. The company issued $1.3 billion in new debt in September of 2013, paying down its 9.25% notes and 10.125% notes due in 2015 and its 12% senior second lien notes due 2016. The refinancing provides meaningful improvements to cash interest obligations in the coming years and leaves Air Canada with a manageable maturity schedule.
Recovery Ratings: Fitch has also upgraded the recovery ratings for Air Canada's second lien secured notes to 'BB/RR1' from 'BB-/RR2'. Fitch's recovery analysis reflects a scenario in which a distressed enterprise value is allocated to the various debt classes. The upgrade is based on a higher estimated distressed enterprise value based on Air Canada's improving EBITDA generation. Fitch has also assigned a rating of 'B-/RR5(EXP)' to Air Canada's proposed $300 million unsecured notes. The 'RR5' recovery rating reflects an expected recovery at the high end of the 10%-30% range driven by the notes' subordinate position within Air Canada's debt structure which primarily consists of secured obligations.
Future actions that may individually or collectively cause Fitch to take a positive rating action include:
--Better than expected operating performance leading to neutral or positive FCF despite elevated capital expenditures.
--Continued adjusted leverage reduction to around or below 4.5x.
--Successful cost control efforts leading to EBITDAR margins to approach 15%.
--Further evidence that rouge is contributing positively to the business.
Future actions that may individually or collectively cause Fitch to take a negative rating action include:
--Weaker than expected operating performance causing FCF to be notably below Fitch's expectations.
--Significant weakening of yields, particularly in domestic markets due to increased competition, causing EBITDAR margins to drop below 10%.
--Adjusted Leverage increasing and remaining above 6.0x.
Fitch's senior tranche EETC ratings are primarily based on a top-down collateral analysis. Since the ratings were previously reviewed, collateral values for the 777-300ERs in the pool have not deviated from Fitch's expectations; therefore, the rating has been affirmed at 'A'.
Subordinated tranche ratings are linked to Air Canada's IDR, and therefore the ratings have been affirmed at 'BB+' and 'BB-' for the B and C tranches respectively.
Subordinated tranche ratings are adjusted from Air Canada's IDR based on three primary factors; 1) affirmation factor, 2) presence of a liquidity facility, and 3) recovery prospects. Fitch considers the affirmation factor for this collateral pool to be high resulting in a +3 notch adjustment (maximum is 3) for the B tranche. The B tranche also features an 18 month liquidity facility, providing a further +1 notch adjustment. No adjustment has been made for recovery, resulting in a rating of 'BB+', +4 notches above Air Canada's IDR. The two notch differential between the B and C tranche reflects the C tranches subordinate position.
Fitch has affirmed the following ratings:
--Long-term IDR at 'B';
--Senior secured first-lien debt at 'BB/RR1'.
Air Canada Pass Through Trust Series 2013-1;
--Class A certificates at 'A';
--Class B certificates at 'BB+';
--Class C certificates at 'BB-'.
Fitch has upgraded the following ratings;
--Senior secured second-lien debt to 'BB/RR1' from 'BB-/RR2'.
Fitch has assigned the following ratings;
--$300 million senior unsecured notes, 'B-/RR5 (EXP)'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013);
--'Recovery Ratings and Notching Criteria for Nonfinancial Corporate Issuers' (Nov. 19, 2013);
--'Rating Aircraft Enhanced Equipment Trust Certificates' (Sept. 12, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Rating Aircraft Enhanced Equipment Trust Certificates