Air Canada (AC) Earnings Call Transcript

Good evening, ladies and gentlemen, and thank you for standing by. Welcome to Air Canada's Third Quarter 2026 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Amanda Murray, Vice President of Financial Planning, Strategy & Investor Relations. Amanda, please go ahead.

Thank you, Christa. Hello. [Foreign Language] Welcome to Air Canada's Third Quarter 2026 Earnings Call. Thank you for joining us today. With me today are John Di Bert, our Chief Financial Officer; and Mark Galardo, our Chief Commercial Officer and President of Cargo. Other members of our executive team are also here for the Q&A. Rob Fyfe, who represents the Board of Directors, is with us as well. Before we begin, a reminder that today's discussion may contain forward-looking information about Air Canada's outlook, objectives and strategy. Actual results could differ materially due to various assumptions, risks and uncertainties. Please refer to our Q3 2026 earnings release, our 2025 annual MD&A, our third quarter 2026 MD&A and other filings available on aircanada.com and on SEDAR+. With that, I'll turn the call over to John.

Thank you, Amanda, and good evening, everyone. [Foreign Language] I'll start with the headline. This quarter showed the resilience of Air Canada. Strong commercial execution delivered solid results despite higher fuel costs. Operating revenues grew 21% to $7 billion with passenger revenues growing at the same rate. Even taking into account last year's labor disruption in Q3, this quarter showed the strength of our commercial strategy, almost 6% more capacity and 89% load factor up nearly 3 percentage points and yields up 11% year-over-year. So more seeds, fuller planes and higher fares. That translated into adjusted EBITDA of $936 million, essentially in line with last year while absorbing a $906 million of higher fuel costs, driven by 68% higher fuel prices year-over-year. Adjusted EBITDA margin of 13.4% declined from 16.6% last year. I want to thank our employees who delivered a safe, consistent and caring service to our customers over a very busy summer period. Their focus and professionalism are within our plans into results quarter after quarter. Our recent recognition as the best airline in North America at the 2026 Skytrax World Airline Awards the tenth time we received this honor since 2010, reinforces the strength of our offering and our commitment to our customers. [Foreign Language] Allow me to step back from the quarter for a moment. Over the last couple of years, we have made meaningful progress in strengthening Air Canada. We've reduced leverage, further strengthened our balance sheet and substantially lowered our share count. We have also built on our solid commercial foundations and reached new agreements with all employee groups. The skill of our hubs, the breadth of our global network, premium products and the strength of our plane give us differentiated customer proposition and support more diversified revenue streams. Together, these achievements give us resilience and financial flexibility to keep investing in our fleet, network, our customer experience and our people, while creating lasting value for our customers, employees and our shareholders. We are building a stronger, more resilient airline, focused on structural and sustainable value creation. Mark will begin with our commercial performance, and I'll follow with our financial results and outlook before we open the lines for questions. Mark, over to you.

Thank you, John, and good evening, everyone. [Foreign Language] I'd like to start by thanking our employees for their continued focus on operational excellence, and our customers with loyalty, we greatly appreciate. Our third quarter results represent another consecutive quarter of record revenue for Air Canada and values the continued resilience of our commercial model. They demonstrate the strength of our foundation and the importance of our diversified revenue streams, our far-reaching global network in our higher-yielding customer segments. Q3 operating revenues and passenger revenues reached a record $7 billion and $6.3 billion, respectively, both up 21% year-over-year. Importantly, for the first time in our history, all months of the third quarter produced passenger revenues above $2 billion. Both total and passenger unit revenues increased 14% year-over-year. With more than 1/3 of our quarterly sales made before April 1, passenger unit revenues increased the most in our North America markets. And this is where a closer booking window enabled us to better reflect higher fuel prices at the time of booking. On almost 6% more system capacity we capitalized on persistent demand strength to deliver leading load factor performance amongst North American peers in this more leisure-oriented period. Today, our hubs are some of the best connected international gateways in North America. Leveraging the scale our Sixth Freedom revenues were up 16% year-over-year despite the longer booking window, driven by a stronger year-over-year performance on the Pacific and Lat Am corridors. Turning to our customer segments. Air Canada remains well positioned to capture premium demand, and premium cabin revenues increased 19% year-over-year. Even in December period, corporate revenues performed well, up 22% year-over-year. A core strength of Air Canada's commercial strategy is our ability to offer a competitive product for every type of customer with a value proposition no other Canadian airline offers, the breadth of our global network, our premium products and Aeroplan. Aeroplan continues to play an important role in our commercial ecosystem, especially in premium segments and rewards our customers for their loyalty and engagement with us and our partners. Our customers consistently engage strongly with third-party gross billings collected year-to-date totaling $1.6 billion, an 11.5% increase year-over-year. These billings represent amounts charged to Aeroplan program partners for points issued. Lastly, Cargo revenues grew 33% year-over-year, driven by higher yields and favorable freight pricing, while other revenues increased 11% on higher Air Canada Vacation ground package revenues and higher Aeroplan non-air revenues. Looking ahead, revenue quality continues to strengthen as our pricing actions increasingly reflect higher fuel costs. However, given the timing of the recent fuel increase in the booking curve, we do not expect to fully recover the incremental costs in the fourth quarter. For Q4, at this point, we are seeing sustained yield strength with load factors broadly flat year-over-year. For context, this is against a very strong fourth quarter last year when we reported record profitability and Q4 PRASM growth versus 2024. Beyond that, we are actively reviewing capacity and revenue against conservative forward fuel expectations. To date, we have proactively removed more than 2 points of planned capacity from the first quarter of 2027 and and we will continue to proactively adjust capacity and fares to protect margins over the course of the year. Winter demand remains resilient across most geographies despite some pressure in the domestic market. Air Canada Vacations bookings are an important barometer of leisure demand, and we're encouraged that early bookings for Sun markets are outpacing capacity growth and generating stronger revenues. Our new international routes are booking well and we are pleased with the initial results of our Airbus A321XLR. This aircraft has a fuel burn per ASM below comparable wide-bodies, which is a real advantage in this current fuel environment. Supporting a better supply/demand balance in these markets, the XLR is delivering a more favorable margin profile than other aircraft types on comparable routes. As always, we retain the flexibility to allocate aircraft and capacity to areas of strength and mitigator exposure to less favorable conditions. As we move into the shoulder months, an important part of our commercial strategy is reshaping our seasonality around less commoditized periods. This is where demand from premium and corporate customers the strongest and where our structural advantages matter most. And as that demand strength in the shoulder period, we continue to adapt our schedule and commercial strategies to capture the growing opportunities in spring and fall. More broadly, we continue to accelerate a number of core commercial priorities to support revenue generation into 2027. We've enhanced our offering with more preferred seats on our high-density 777s and the launch of branded fares in premium cabins. In late August, we unveiled our new Summer 2027 routes generating considerable excitement amongst our customers and Aeroplan members. And earlier this month, we launched Embark, our platform for small- and medium-sized businesses, which are the bedrock of the Canadian economy. To close, the third quarter was another quarter of solid commercial performance against a volatile backdrop and another validation of the resilience of our commercial platform. We have the agility and flexibility to manage through a volatile environment and are confident in the opportunities ahead. We remain focused on leveraging our structural advantages as we execute on our 2027 plan. Thank you. [Foreign Language] Over to you, John.

Thank you, Mark. Third quarter adjusted EBITDA was $936 million for an adjusted EBITDA margin of 13.4%. These results demonstrate the underlying strength and the resilience of our [indiscernible]. They were achieved despite fuel prices being significantly higher than we had originally planned and reflect the actions we took throughout the year to improve fuel recovery, through pricing, capacity management. Our new product provide some additional context. Mark already discussed our solid commercial performance, driving a 21% decrease in revenue. Operating expenses were 22% higher than in the third quarter of 2025, driven by a $906 million increase in fuel expense, which was driven by a 68% year-over-year rise in fuel price per liter. At our Q2 call, our Q3 assumption for fuel was CAD 1.38 per liter or USD 3.70 per gallon. Our actual fuel price averaged CAD 1.48 per liter in the quarter, approximately USD 4 a gallon. That's an intra-quarter $140 million headwind and it includes the benefits of fuel hedging gains of $22 million in Q3. In all, we recovered 46% of incremental fuel expense, below our original expectation of 60%, primarily due to the significant increase in fuel prices experienced in September. We expect our recovery rate to improve to 70% in Q4. Fuel recovery remains a question of timing, not demand. When fuel spiked in September, approximately 50% of our fourth quarter bookings had already been sold, creating a natural lag before our pricing actions could be fully reflected in fares. Our commercial actions continue to offset a meaningful portion of higher fuel costs and our recovery rate will grow as those actions work through the booking curve. Our objective remains to achieve full fuel recapture over time. While fare increases remain the primary tool to offset a higher fuel environment, we will also pace our growth to protect unit revenues and margins through 2027. Turning to costs. Unit cost performance was broadly in line with our expectations. Adjusted CASM increased 3.3% to $0.145. The increase mainly reflected higher labor costs, higher sales and distribution expenses and higher depreciation of the new aircraft into service. This was partially offset by the lower other operating expenses and our 6% capacity growth. With new 4-year agreements concluded with IAM and Unifor, the labor agreements reset cycle is now largely reflected in our cost structure, allowing us to focus on productivity and cost containment initiatives as we grow the airline. Unit cost performance in the quarter was also favorably impacted by the timing of maintenance and other costs, which we expect will materialize in Q4. Below the operating line, adjusted pretax income was $328 million. Adjusted net income attributable to shareholders of Air Canada was $214 million, and adjusted diluted EPS was $0.75. Turning to cash generation. Third quarter free cash flow usage was $440 million, largely reflecting lower operating cash flow, including the seasonal unwind of advanced ticket sales and higher capital expenditures. Year-to-date, we have generated $1.3 billion in positive free cash flow, including approximately $500 million in proceeds from sales and leaseback transactions. Turning to our balance sheet. We ended the quarter with net leverage of 1.3x, comfortably below our target of 2x or less. Our liquidity was $8 billion at the end of Q3, a healthy 32% of trailing 12-month revenues. Our capital allocation priorities remain unchanged, maintain financial strength and flexibility; invest in the airline; and third, return excess capital to shareholders. Our financial flexibility is a pillar of our resilience and a true competitive advantage. That strength matters amid volatility and enables us to look through near-term pressure on earnings when assessing leverage. In August, we used the proceeds from the Aeroplan transaction to repay a USD 1.2 billion bond maturity. As a result, we have no material corporate debt maturities until April 2028. Turning to investment in the airline. Fleet CapEx will step up through the end of 2026 and into 2027 as deliveries ramp up. New aircraft improve our customer value proposition, open network opportunities, deliver efficiencies and lower our unit costs over time. The A321XLR is an early example. On a comparable transatlantic stage late, is burning roughly 15% to 20% less fuel per ASM than a wide-body aircraft on a comparable route. This is meaningful in any environment, but it matters even more in this current fuel environment. Scheduled aircraft deliveries in the fourth quarter include 6 A321XLRs our first 2 787-10s; and 7 A220s. We expect these aircraft to generate attractive returns and support long-term value creation. Finally, consistent with the commitments we made at our Investor Day, we returned capital to shareholders through the completion of an $800 million substantial issuer bid in September. The transaction reduced our shares outstanding by approximately 10%, 252.7 million shares outstanding as of September 30, 2026. It's our lowest share count since 2009 and well below our 2028 target of under 300 million shares, 2 years ahead of schedule. We do plan to renew our NCIB program in November, but we'll remain opportunistic in repurchasing shares. Now let's turn to the Aeroplan. For the rest of 2026, our commercial trends remain strong, and we expect them to extend into the winter season. We have narrowed our capacity and our cost ranges to reflect limited variability in the fourth quarter while keeping room for fuel volatility. Fuel remains the largest variable in our outlook. At this time of the year, we anticipate about 1/2 of our Q4 fuel needs to be exposed to the fuel price volatility. We are planning for a Q4 all-in fuel price of CAD 1.72 per liter or about USD 4.60 per gallon compared to CAD 1.29 per liter or USD 350 per gallon in our August outlook. This higher fuel assumption is the principal change for our full year outlook and is driving the adjustment to our expected profitability and cash generation. We now expect full year ASM growth of approximately 2.75%, aligned with the midpoint of our prior guidance. We expect adjusted CASM to increase 5.5% to 6% versus 2025. While the timing of certain costs that shifted from Q3 to Q4, affecting the year-over-year comparison, we continue to expect adjusted CASM growth to be lower in the second half of 2026 than in the first half. Over time, we expect our fleet renewal and the benefits of scale to support, decelerate -- to support decelerating our unit cost trajectory. We expect adjusted EBITDA to be between $2.4 billion and $2.7 billion, which is approximately $500 million below prior guidance at the midpoint. The change reflects our higher fuel assumptions for the fourth quarter. We now expect breakeven free cash flow plus or minus $150 million compared with our prior guidance range of $200 million to $500 million. Year-to-date, we have generated $1.3 billion of free cash flow. Our guidance continues to assume approximately $1 billion of sale leaseback transactions in 2026, which is supported by signed definitive agreements. Though we are not yet providing guidance for 2027, we are planning for fuel to stay elevated. On that basis, we still expect to reach pre-pandemic capacity levels, but we are carefully reviewing the pace of capacity growth to protect unit revenues, margins and returns while retaining flexibility to respond to demand. Our diversified earnings streams, our strong balance sheet and our financial flexibility to support our long-term strategy, and they give us confidence in our ability to execute as we head into 2027. We remain well positioned to play both offense and defense. To conclude, our priorities are clear and unchanged. One, manage their controllables, including commercial actions, capacity, cost and operational performance; two, protect our margins, returns and cash generation while maintaining the strength of our balance sheet; and third, continue advancing the value creation framework we set out in new frontiers. With that, back to Amanda for questions.

Thank you, John. Christa, please open the line for questions from analysts.

[Operator Instructions] And your first question comes from Konark Gupta with Scotiabank.

My first question, I guess, is on the fuel here. So I mean, it's understandable that the fuel prices have run up a lot. So the fuel recovery rate has to come down in Q4. But can you help us understand some of the moving parts in that fuel absorption rates, John? I mean what kind of fares are you underwriting these days on fuel price? And are you expecting the fuel price to kind of taper off from here? Or this is an ongoing assumption for the next, call it, 6 months as well?

Yes. Good evening, Konark. I think, first and foremost, we take the world as it is, right? So you've got fuel running in the 170 to 180 range pretty constantly right now. So our posture is that, that is with us for at least the foreseeable future. We continue to price -- we had expectations of 140 to 145 kind of fuel pricing recovery as we went into the quarter. We had a spike. So we'll be looking to continue to push pricing actions in a particularly as we look into Q1. And with respect to fuel prices, we don't -- we won't make any speculation other than the fact of of taking the world as it is today. Maybe Mark has some comments on the pricing environment.

Yes. So Karit took us several weeks not months to kind of level up with in the fall with fuel prices that were closer to $1.40, $1.50 liter. And going into Q4 had fuel state at that level, we would have covered most of the incremental fuel bills, not all However, since kind of early fall, it's run up to $1.70, $1.80 and then moved up pretty quickly. So at this point in time, certainly, we are trying to push further increases in market, but it will take some time before the market fully levels up with where the fuel price is today.

Okay. That's great color. And then maybe on the transborder side, while I have you, Mark, the market seems to be in a structural decline here for some time. Do you guys expect -- or how are you guys, I would say, building capacity again in anticipation of demand coming back potentially? Or are you just playing on a spot basis?

So Konark, if you look at our Q3 results on transborder, they were excellent. Our revenue growth was quite good. Our yields were quite solid and our [indiscernible] continues to grow. On transport, you've got a couple of structural tailwinds that are helping us on the strength of the U.S. dollar. Secondly, we've got a pretty favorable supply-demand balance and the profitability levels that we're enjoying on the U.S. market right now, the margins are slightly higher than they are on domestic. And as I look forward, I see much of the same for Q4 and for Q1. So I've got no reason right now to be concerned about the state of the transborder market.

Your next question comes from the line of Atul Maheswari with UBS.

Can you maybe double-click on the portion that you mentioned about fourth quarter bookings. Could you give us some sense of how -- what kind of trends you're seeing by various geographies? And then any color on how early 1Q bookings are taking out would be helpful.

Sure. So what you're going to see overall right now for the fourth quarter is load factors are generally flat year-over-year. As I mentioned in my script, our fuel recovery and therefore, yields are higher in North America because the booking window is much closer in, whereas the international typically books further out. So given that backdrop, we should expect that North America has the highest yields with obviously flat load factors year-over-year in international trailing a little bit.

Your next question comes from the line of Fadi Chamoun with BMO Capital Markets.

Mark, just on come back to the demand resiliency, like as you look at the progression month-to-month since the fuel started to kind of rise materially in late August and kind of into the fall period, have you not seen impact like from a load factor perspective, I guess you've called out Q4 flat load factor, but we've seen much stronger performance before that? Like are you starting to see any resistance on the demand side? I'm just trying to think if you're going to next year and your plan to grow capacity, how should we be thinking about the market's ability to kind of absorb what you have planned from a capacity perspective given where fuel prices are today?

Yes. Thanks, Fadi. So obviously, we saw a very strong end of Q3 with September and October, which I called out previously being quite strong. The demand overall to from within Canada still remains relatively stable kind of up a little bit. What we've seen is the market -- the growth rate is decelerating a little bit, whereas in prior quarters, we would have seen market demand growth between 4% or 5%. We're now seeing demand market growth between 2% and 3%. But certainly, what's helping us is how diversified our network is. Certainly, the sixth [indiscernible] portion of our network is also helping as we're tapping into new traffic sources. So that's kind of helping us offset a little bit. Going into Q1, much of the same. Our current booking posture for Q1 has a flat load factor build so far.

Your next question comes from the line of Savi Syth with Raymond James.

I know you're not kind of ready to talk about capacity growth for next year, but if I look at your fleet plan, just overall seats are growing high single digits, and it sounds from your commentary that you might be if fuel prices stay high, maybe in that kind of low to mid-single-digit range probably capacity growth. But curious on how you achieve that and what we should think about in terms of the impact on unit costs as a result of that.

Savi, we're looking at a bunch of scenarios right now in terms of flexibility and agility of how we deploy capacity. Our focus right now is really the first half of '27 because that's where we anticipate that fuel prices will continue to be relatively high. So we removed 2 points out of Q1. We are looking at the more marginal flying reduction, so that would be midweek cancellations on certain routes. We're going to be looking at reducing utilization somewhat. And as you can see by the suspension of our Singapore route, we're also kind of reevaluating the ultra long-haul part of our business as that's a bit more exposed to the higher fuel prices. So right now, we're still very much contemplating a variety of scenarios. What we can say definitively is for Q1, we removed 2 points of capacity and we'll leave it there.

And maybe just I'll take the back end of your question on CASM. So we have a 5.5% to 6% range for 2026 on CASM both year-over-year. Yes, for sure, had we had the higher single-digit capacity growth in 2027, we would have been expecting a very favorable impact to CASM. I still think that as we get through the plan cycle here, we'll see the benefits of newer aircraft continued scale improvement even at lower rates of growth. And that should still produce a decelerating CASM growth year-over-year. So we'll work through that as we get into '27 guide, we'll talk through it, but expectations are still that we're going to get -- start to have a curve to the downside on the year-over-year growth in CASM.

That's super helpful. And just if I might follow up on the kind of the demand question earlier. Curious what you're seeing on the corporate side? And if maybe some of that slowing, is that more leisure and being kind of low price sensitive? Just curious how corporate is doing here.

No corporate continues to evolve very favorably into Q4, it's a double digits kind of in line with Q3.

Your next question comes from the line of James McGarragle with RBC Capital Markets.

I just had one quick follow-up here on that capacity planning on 2027. So just to confirm, is that -- would you be deferring any of your new planes or potentially retiring any of the old ones. I just want to make sure I'm modeling any adjustments to potentially CapEx or free cash flow correctly into 2027?

Yes. So for '27, I think the new fleet remains an advantage in the sense that they are more cost effective, more fuel efficient, and they'll provide better service and some premiumization. So I think we'll be looking more at utilization on the older fleet. And as Mark said, reducing some of the marginal flying at the same time, utilization on older aircraft or aircraft that needs specific high-cost maintenance. So we'll try to balance all of that. No significant change in the expectation other than as every year has been for the last couple of years it will be some movement with delivery schedules and timing, but we'll deal with that as it comes.

And just in terms of your balance sheet, obviously, it's in really good shape right now. Can you just give us an update on how you guys are thinking about capital allocation into Q4 and into 2027? And I'll turn the line over after that.

Yes. I think thank you. We've been very consistent with capital allocation. First and foremost, we work to protect the balance sheet. Work that we did in Q3 is further proof of that. We have no maturities through April 2028. So that's in good shape, high liquidity relative to last 12 months of revenue over 30%, so it gives us a lot of flexibility. We're going into a CapEx cycle, and that's been kind of planned and telegraphed for a long time now, and that starts with quite a few deliveries in Q4 and then through 2027. That will start to normalize past that in '28, '29. But for now, I think it's -- keep the balance sheet strong. So grow responsibly with that, invest in the airline, so we can create the value -- the platform for value creation for the long term, which we're confident continues to be our main objective here. And then thirdly, returning shareholder value. But I think on that one, we've achieved a lot, right? We're at 252 million shares outstanding. We feel very good about the share count. We've deployed now probably almost $2.5 billion of cash over the last few years. We'll be very opportunistic with the NCIB, and we'll see how '27 evolves as well with fuel and cash flow. So all those things will be considered.

Your next question comes from the line of Jamie Baker with JPMorgan.

I'm John. I got interrupted. So I'm hoping you didn't already address this, but a question on leverage. How do we think about the cadence of where leverage heads next Obviously, next year is a bit intense from a CapEx perspective. You've got the buyback plans. Just kind of curious how you're, I guess, triangulating between leverage in your IG aspirations?

Yes. And I think the math is going to be the math. We're going to have probably a couple of lighter quarters as we go through higher fuel environment if it stays as it is. We'll see as that moves through. But I think my comment would be through that, that we built the airline to be very resilient, strong liquidity from an overall strength of the balance sheet, nothing changes. The math, obviously, given the earnings and the pressure that comes from some of these spikes on fuel is going to take its toll over the next couple of quarters. We'll see some pressure on the leverage ratio. My expectation is that we work through that. But our aspirations for investment grade were really all about converging our '28 and 2030 objectives, and I think that those remain intact. And so the work here is to get their responsibly and put ourselves in a position to have both cash generation and investment-grade opportunities as we kind of work through the next probably 12, 18 months.

Okay. That helps. And then second, for Mark and sorry to beat a dead horse here on fuel recapture and I realize the calculus might differ between airlines. But the 70% estimate for the fourth quarter is a little bit lighter than what we've heard from others. You've got factors like the pace of domestic fare increases. You mentioned the booking curve in your prepared remarks. I guess my blunt question is whether there's any elasticity component baked into the 70% assumption. Any thoughts there?

Yes, absolutely. Great question, Jamie. One of the items that differs between Air can and kind of our American peers is the composition of our network. We're almost 60-40 long-haul to short-haul. Our American peers typically 30-70. And the close-in booking window for North America allows a higher recaptures, just basic math. We have a much longer kind of tail for international long-haul bookings. And as a result, once those bookings are in, it's hard to recapture because the bookings are made and we typically have a strong base of bookings basically 2 months out. That's really a contributing factor as to why our recapture rates are a little bit lower.

Your next question comes from the line of Cameron Doerksen with National Bank.