Air Canada Evaluation

Executive Summary
Air Canada is a full service airline company with the largest market share in the Canadian market making it the largest airline in Canada and 15th in the world.
I don’t recommend lending Air Canada due to: * Weak industry conditions * Poor historical performance/financial health * Risk factors assessment * Poor credit ratings
Summary of Main Points
The airline industry is a very volatile industry with a lot of uncertainties. Based on Porter’s five forces, companies in the airline business are faced with challenges such as threat of new entrants, high buyers power, high suppliers power, availability of substitutes, and intense competition.

Historical operating results are poor. The company has been having continuing losses since 2008. Also, financially it is not healthy. Air Canada leverage ratio is very high, and obligated to significant debt due to pension fund, employees’ benefit, and orders of new crafts. Labor strike is a major risk factor. Recently, the company was faced with several strikes that caused many flights delays or cancelations. Negotiation is taking place between the company and labor unions. Outcome this negotiation might result in higher labor cost preventing the company from enhancing its cost structure.

According to S&P, Air Canada credit rating is B-, which is a non-investment grade. Also, Moody’s downgraded the company from B3 to Caa1 due to its debt obligation and high leverage.

Company Overview
Air Canada is the largest full-service airline in Canada and the 15th in the world. With fleet consisting of 350 aircrafts, it serves more than 180 domestic and international destinations with 1,470 scheduled fights daily carrying over 32 million passengers yearly. Air Canada provides scheduled passenger services in the Canadian market, the Canada-U.S. transborder market, and in the international market to and from Canada destinations. It also, offers full range of leisure travel packages including cruises, tours, car rentals and excursions through Air Canada Vacations. Air Canada Cargo provides cargo services to over 150 destinations.
The following chart is a breakdown of 2011 revenues:

Established in 1937 under the name Trans-Canada Air Lines, and changed its name to Air Canada by 1964. Air Canada is a founding member of Star Alliance, the world largest airline-alliance group. Today, Montreal-based it operates a fleet of approximately 204 aircrafts under the Air Canada name and approximately 158 aircrafts under the Air Canada Express brand, and it employs 26,000 people.
Current Focus/Strategy
The company has been following strategy of profitable growth and sustainability to create value for shareholders and to lower the overall risk profile of the company. To do so, Air Canada continues improving its revenue performance by increasing productivity and improving cost structure. Currently, the airline focuses on leverage its strengths internationally, enhancing customer services and products with the focus on business travellers, and transform corporate’s culture.
Competition
Air Canada has a leading share in all markets. Based on 2011 revenues, its market shares in the domestic market, transborder market, and international market are 55%, 36%, and 37% respectively. In the domestic market, Air Canada main competitor is West Jet Airline, which holds 35% of the domestic market share. However, it competes against numerous competitors in the transborder and international market. Recent News
According to a report on June 1, 2012, An Air Canada flight was delayed for more than three hours after flight attendants, fearing for their safety left the plane due to a stench in the cabin.
Air Canada spokeswoman, Angela Mah, said to reporters “The delay was due to a report of an unpleasant odour in the cabin, typically associated with oil in the ventilation system, which does not impact the safe operation of a flight” Another recent incident happened on May 28, 2012, when a flight had to conduct an emergency landing amid reports that hot chunks of blackened metal were falling from the sky and damaging cars in Mississauga. In March of this year, a private company, Aveos, that maintains many of Air Canada's aircraft filed for bankruptcy protection. Aveos said it was forced to shutdown because of not enough work volume. Air Canada reported it would shift its routine maintenance to other suppliers in the United States and Canada where maintenance is cheaper.
In addition, Air Canada recently encountered several issues with different labor unions to reach new contracts that led to strikes. The company negotiations with mechanics’, ground workers’, and pilots’ representatives failed to reach to an agreement resulting in many delayed and canceled flights.

External Analysis
Threat of New Entrants
Threat of new entrants in the airline industry is very high due to absence of new entrants barriers. Difficult regulations were obstacles preventing new carriers from entering the market. However, sine the start of deregulation in 1987, the number of airline companies in Canada grew significantly. Next, the availability of financing options through leasing companies or airplanes manufacturers reduces the initial capital required. Also, with no brand loyalty and switching cost, new carriers can easily gain market share. Therefore, many airlines offer frequent flyer programs. Such programs attract many travellers and establish customers’ loyalty to discourage new entrants. Finally, airports’ limited capacity is a major entry barrier that in busy airports new carriers might do not find spaces. On the other hand, new entrants find that using smaller less busier airports attract some travellers. Overall, threat of new entrants has been seen as a very high threat.
Buyer Power
Customers in the airline industry are considered to have a strong bargaining power due to the following. With low switching cost and very little differentiation making brand loyalty very weak, customers buy their ticket based on price. Resulting in, price sensitive customers. Today, the Internet provides to the customers an easy access to all carriers’ prices and information giving them the advantage to easily find the cheapest tickets. On the other hand, carriers deal with large number of buyers with small volumes instead of one large buyer. Dealing with large number of customers reduces customers’ pressure and power. Nevertheless, buyers’ are considered to have a strong bargaining power
Supplier Power Suppliers are described to have a large impact to affect carriers’ margins and profitability. There are few suppliers of certain products and switching to another one is costly. For instance, there are only two large airplane manufactures in the world, Boeing and Airbus. Switching from one to another requires intensive work such as pilots and operators training. Airports are considered a very important supplier that without it an airline company cannot operates. Slow growth in airports’ capacities and size made access to them very limited. Furthermore, since the airline industry is heavily unionized, unionized labors are a major source of threat that it is an industry has been known for encountering many workers’ strikes. Finally, suppliers tend to be more profitable than carriers. In short, suppliers have a strong bargaining power on airline companies.
Threat of Substitutes Flying has been the most convenience transportation method in North America. However, the availability of other transportation methods such as railways is a threat for airline companies. Improvement in technology and communication devices is another source of threat. With the availability of high quality video calls, nowadays, business travellers can conduct their meetings from their offices specially that many corporates are trying to reduce travelling expenses because of the economy condition. Yet, threat of substitutes in the airline industry is perceived as a moderate threat.
Rivalry
The airline industry is a highly competitive industry with low returns and high fix cost due to several reasons. First, the number of carriers has increased over the past few years. Airline companies are facing competition as some companies are increasing their capacity. Also, consolidation in the industry has increased competition that some carriers have engaged in either merge or acquisition. Furthermore, many players in the market are about the same size with very little differentiation in products and services. Lastly, the airline industry is considered a mature industry with very little growth that companies can only grow by stealing customers away from competitors. In conclusion, rivalry in the airline industry is very intense.

SWOT Analysis
Strength
Air Canada is widely recognized with strong position in the market. It has well-established routs and destinations around the world and Star Alliance partner. Such network helps the company to protect its market share. In addition, Air Canada brand value has noticeably enhanced in recent years. According to J.D. Power and Associates’ 2011 report, Air Canada ranked second in North America in the traditional network carrier (see Exhibit 1). The association rank is based on in-flight serves, cost, and fees measures. Moreover, in 2011 Air Canada won many awards and titles such as Best In-Flight Services in North America by Business Traveler magazine.
Weakness
Even though, it has strengthening its brand image by improving services and meeting customers’ expectations, critics are accusing Air Canada for not providing enough incentives to their customers to gain their loyalty over its international rivals. Poor financial performance is another weakness Air Canada is facing; hence financial performance details will be discussed in the financial section of this report. Unlike its competitor WestJet, Air Canada fleet is considered very diversified consisting of aging inefficient aircrafts developing a higher cost structure.
Opportunity
Leveraging the international network by expanding its services in the international market. Well-positioned in major hubs, Toronto, Vancouver, and Montreal, which are attractive gateways for global connecting traffic. Furthermore, restructuring cost structure by including new efficient aircrafts into its fleet to enhance profitability by reducing operating cost.
Threat
First of all, heavily unionized industry with many labor issues that could harm Air Canada’s reputation and customers’ satisfaction. Such issues might negatively impact operations resulting in flight delays or cancelations. For example, in March 2011, the government legally restricted Air Canada workers from stinking; however, 12 pilots called in sick at the same time, and ground crews left their jobs at Pearson International Airport resulted in delaying and cancelling over 100 flights. Fluctuations in fuel prices affect operating cost and profitability. In 2011, the company’s revenues reached $11.6 billion; Air Canada paid around $3.4 billion on fuel, which is about 29% of total (see Exhibit 2).
Corporate Level Strategy
Air Canada is focusing to achieve a strategy of profitable growth and sustainability to create value for shareholders and to lower the overall risk profile through the following points: * Leveraging the international network * Adapting competitive cost structure * Increasing customer satisfaction levels and growing the airline’s premium customer base * Enhancing the corporate culture and developing a strong employee brand
Business Level Strategy
Leveraging the international network
In 2010 and 2011 Air Canada’s capacity growth in the international market grew by 10.0% and 6.6% respectively. In 2012, the company continues to focus on strengthening its international market share by advantaging from its well-positioned hubs for international connecting traffic.
Adapting competitive cost structure
Pursue sustainable reductions in its cost structure without compromising customer experience and to leverage opportunities for revenue growth. In 2014, Air Canada is scheduled to receive its first Boeing 787 Dreamliner. At the same time, Air Canada will be removing many Boeing 767 from its fleet, which are more expensive to operate. The change in fleet will allow the airline to reduce operating cost through fuel and maintenance savings.
Increasing customer satisfaction levels and growing the airline’s premium customer base
Air Canada’s goal is to continuously meet and exceed customer expectations by delivering consistently friendly, professional and “best in class” service. The airline has achieved a noticeable improvement in its services. As mentioned previously, in 2011, it earned several awards.
Enhancing the corporate culture and developing a strong employee brand
Build a culture that encourages and promotes, leadership, accountability and entrepreneurship to achieve a competitive advantage.

Financial Assessment
Income Statement The airline industry is characterized by high fixed cost and low return. The following two tables show Air Canada income statements:

In Millions of CAD | 2008 | 2009 | 2010 | 2011 | Total Revenue | 11,082 | 9,739 | 10,786 | 11,612 | Gross Profit | 3,847 | 3,475 | 4,253 | 4,223 | Operating Income | (164) | (316) | 278 | 179 | Net Income | (1,025) | (24) | (33) | (255) | In Millions of CAD | 2012 1st Q. | Revenue | 2,962 | Gross Profit | 1,025 | Operating Income | (93) | Net Income | (211) |

Historical performance indicates that the company has been experiencing ongoing losses since 2008. The tables above indicate that Air Canada cost structure is very high with some operating expenses that are out of its control, which explains why revenues don’t reflect net incomes. For example, revenue in 2011 increased by 7% from previous year, yet it reported greater losses. Operating expense, fuel expense, and wages increased by 8%, 27%, and 4% respectively from 2010 The company announced that its first quarter loss is due to increasing fuel cost, strikes, and Aveos collapse. Fuel bill rose 20% in the last quarter. Also, the quarter faced a challenging environment with several labor strife. In addition, it reported that last quarter loss, ($211) million, included $120 million charge stemming from the collapse of Aveos.
Balance Sheet The following table illustrates Air Canada balance sheet: In Millions of CAD | 2008 | 2009 | 2010 | 2011 | Total Assets | 11,364 | 10,406 | 10,153 | 9,633 | Total Debt | 5,354 | 4,522 | 4,595 | 4,330 | Total Liabilities | 10,602 | 8,960 | 11,587 | 13,718 | Total Equity | 762 | 1,446 | (1,434) | (4,085) |

We can see that in 2010 and 2011 equity were significantly devaluated. This was due to negative retained earning with accumulated deficit of ($2.3) billion and ($4.9) billion respectively. Increase in liability was mainly due to low interest rate that resulted in higher pension fund and other benefit liabilities. Moreover, reduction in assets was largely due to the impact of depreciation expense of $668 million.
Cash Flow

In 2011, cash from operating activities decreased $347 million. This is because of a decline in net cash flow from operations. Also, Air Canada made capital expenditures investments. The company made payment for new aircrafts, Boing 787. Financing activities reported debt repayments of $608. We can see the cash has been shirking since 2009, which raises liquidity concerns in the future. The following table shows Air Canada cash flow:

In Millions of CAD | 2008 | 2009 | 2010 | 2011 | Cash from Operating Activities | (102) | (167) | 933 | 586 | Cash from Investing Activities | 190 | 838 | (965) | (400) | Cash from Financing Activities | (116) | (55) | 7 | (428) | Cash & Short-term Investment | 1,333 | 1,450 | 2,192 | 2,009 |
Key Ratios We can see in the following table that the carrier’s liquidity has been enhanced since 2010 to reach almost one, indicating the company is able to meet its current obligations. Liquidity Analysis | 2008 | 2009 | 2010 | 2011 | Current ratio | 0.65 | 0.88 | 1.07 | 1.06 | Quick ratio | 0.62 | 0.84 | 1.02 | 1.00 |

Next table illustrates Air Canada debt ratio and leverage ratio. We can notice that debt ratio has been around 44% over the past four years. On the other hand, leverage in 2011 increased significantly. This is due to pension fund obligations and purchases of new aircrafts.

Debt Analysis | 2008 | 2009 | 2010 | 2011 | Debt ratio | 47% | 43% | 45% | 45% | Leverage ratio | 93% | 86% | 114% | 142% |

This part of ratio analysis focuses on profitability. The following table shows us that the company has not been profitable since 2008. This is mainly due to increasing operating cost. Profitability Analysis | 2008 | 2009 | 2010 | 2011 | Gross profit margin | 35% | 36% | 39% | 36% | Oprt profit margin | -1.48% | -3.24% | 2.58% | 1.54% | Net profit margin | -9.25% | -0.25% | -0.31% | -2.20% | (ROE) | -134.51% | -1.66% | -2.30% | -6.24% | (ROA) | -9.02% | -0.23% | -0.33% | -2.65% |

Risk Assessment Airline industry is a weak industry with significant volatility and uncertainties. Because of its nature, it is considered the least profitable industry in North America. As mentioned earlier, carriers are faced with difficult challenges.
In 2003, the company filed for bankruptcy protection. Besides, it has been experiencing losses since 2008. Air Canada ability to generate positive earnings is dependent on its ability to change its cost structure, which is challenged with number of difficulties such as labor cost and fuel cost.
Recently, Moody’s downgraded Air Canada from B3 to Caa1 probability to default. Moody’s action was due to concerns regarding the company’s ability to absorb higher capital expenditures for new planes and additional funding requirements for its sizeable pension shortfalls beginning in 2014.
According to the rating agency, Air Canada leverage is 8x. In 2014, it will start taking delivery of Boeing 787 aircraft, which will substantially increase capital spending.
Moreover, Moody's estimates Air Canada's current pension solvency deficit to be in excess of $4 billion, which could result in a material increase of its cash funding obligations at the same time that rising capital expenditures are further stressing the company's credit metrics.
S&P rating for Air Canada is B-, which is considered a non-investment grade. Such low grade raises concerns and possibility that the company wont be able to meet its financial obligations.
Air Canada is facing a substantial pressure from labor unions that might result in increased labor cost. This would make Air Canada unable to achieve the desired cost structure reductions.
Forecast
As mentioned earlier, the airline industry is a mature industry with minimal growth driven by cargo traffic, airline traffic, number of passengers, and world GDP. The following charts illustrates growth percentages in each area:

Emerging markets with high GDP such as China and India are driving the economic growth. Air Canada strategically is focusing on leveraging its international network. Figures indicate that the company capacity for international market grew in 2010 and 2011 grew by 10% and 6.6% respectively. Thus, fleet modernization and improved services have been attracting customers. Air Canada is planning to continue its fleet modernization. In 2014, the company is scheduled to receive its first Boeing 787 Dreamliner. Such modernization will enhance customers experience with Air Canada. Also, last year, it won several awards for its services and is committed to sustain its services quality. In 2011, Air Canada revenues grew by 7% and average of 2.90% over the past five years. Therefore, when looking at market outlook and historical growth, Air Canada is assumed to maintain its growth. Revenue is projected to grow by 7% in 2012 and in 2013. Since the industry is very competitive and other carries are enhancing services and fleets, growth is estimated to slightly decline to reach 2.90% by 2016. The following table demonstrates the forecasted income statement: Figures in millions | | | | | | | Growth Rate | | 7.00% | 7.00% | 4.00% | 3.50% | 2.90% | | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | Revenues | 11,612.00 | 12,425 | 13,295 | 13,826 | 14,310 | 14,725 | Gross profit | 4,223.00 | 4,519 | 4,835 | 5,028 | 5,204 | 5,355 | Operating income | 179.00 | 192 | 205 | 213 | 221 | 227 | Net Income | (255.00) | (393) | (292) | (304) | (314) | (323) |

Note, 2012 net income includes $120 million loss from Aveos bankruptcy. Net incomes are negatives due to cost structure. The company is planning to make several reductions in its cost structure; however, due to external factors and industry conditions, operating cost is projected to continue at 2011’s levels.
Recommendation
After analyzing and conducting: * External Factors * SWAT Analysis * Corporate Strategy * Historical Financial Performance * Risk Factors * Revenue Projections
Air Cana is not a suitable company for us at the present time; therefore, I don’t recommend lending Air Canada.

Exhibit 1

Exhibit 2

Source: Air Canada Annual report 2011

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[ 1 ]. Air Canada Profile, Yahoo Finance, http://finance.yahoo.com/q/pr?s=AC-A.TO+Profile (Accessed May 24, 2012)
[ 2 ]. Corporate Profile, Aircanada.com, http://www.aircanada.com/en/about/acfamily/index.html (Accessed May 24, 2012)
[ 3 ]. From Annual Report 2011, Air Canada, Page 9
[ 4 ]. Road Show 2012 Presentation, Air Canada, Page 5
[ 5 ]. Flight attendants fear for safety, leave Air Canada flight due to stench in plane: Reports, The Star, http://www.thestar.com/news/canada/article/1204756--flight-attendants-fear-for-safety-leave-air-canada-flight-due-to-stench-in-plane-reports (Accessed June 1, 2012)
[ 6 ]. Air Canada plane makes emergency landing at Pearson amid reports of falling debris, The Star, http://www.thestar.com/news/article/1201852--air-canada-plane-makes-emergency-landing-at-pearson-after-reports-of-falling-debris (Accessed May 29, 2012)
[ 7 ]. Air Canada maintenance firm gets bankruptcy protection, CBC News http://www.cbc.ca/news/canada/story/2012/03/19/aveo-layoffs-air-canada-monday.html (Accessed May 30, 2012)
[ 8 ]. Air Canada First Quarter, Bloomberg, http://www.bloomberg.com/news/2012-05-04/air-canada-first-quarter-loss-widens-on-aveos-fuel-costs.html (Accessed May 24, 2012)
[ 9 ]. North America Airline Satisfaction Study, http://www.jdpower.com/content/press-release/g0q0zHi/north-america-airline-satisfaction-study.htm (Accessed May 30, 2012)
[ 10 ]. From 2011 Annual Report, Air Canada, page 11
[ 11 ]. How to Fix Air Canada: Look to Porter, But Start with Labour Changes, Toronto Standard, http://torontostandard.com/business/air-canada (Accessed May 30, 2012)
[ 12 ]. From 2011 Annual Report, Air Canada, page 10
[ 13 ]. Ibid., page 9
[ 14 ]. Ibid, page 10
[ 15 ]. Ibid, page 11
[ 16 ]. Air Canada First-Quarter Loss Widens on Aveos, Fuel Costs, Bloomberg http://www.bloomberg.com/news/2012-05-04/air-canada-first-quarter-loss-widens-on-aveos-fuel-costs.html (Accessed May 30, 2012)
[ 17 ]. Annual Report 2011, Air Canada, page 38
[ 18 ]. Ibid., page 39
[ 19 ]. Ibid., page 41
[ 20 ]. Air Canada downgraded by Moody's, CBC News, http://www.cbc.ca/news/business/story/2012/04/03/air-canada-downgrade.html (Accessed May 30, 2012)
[ 21 ]. Ibid.
[ 22 ]. From Boeing Current Market Outlook 2011, page 8.