Air Canada (AC) Earnings Call Transcript
May 18, 2023
Earnings Call Speaker Segments
Good morning, everyone. Thanks for joining us today. Our next presenters are -- the folks from Air Canada, happy to have Amos Kazzaz here, EVP and Chief Financial Officer of Air Canada. And I didn't get to say this on the earnings call, but congratulations on your retirement from what I hear today. This is sort of your last hurrah in front of investors?
It's my farewell tour of that. Andrew, we get to spend it with you, so I'm very happy to do that.
Excellent. Well, thank you for that, and certainly wish you the best of luck in retirement. I guess -- just looking back at last year, the discussion then was all about the reemergence from COVID. I'd say today, it's probably more about the new normal, right? I think the biggest concern up until the last couple weeks and say after you updated your guidance, right, the biggest investor focus, I'd say, over the course of this year has been on the cost side, right? Raise costs kind of February, you did raise them again kind of -- in your recent update. Like I know there's been a lot of inflation out there and U.S. airlines have been like where there's rampant inflation. But I guess, from your perspective, why have costs been so difficult to forecast? And then like you maybe bucket the areas within your P&L, where you've seen the most inflation and have been most kind of, I guess, surprised by over the past year or so?
Well, good question to sort of start off with the morning here. Sort of what's been difficult to forecast. And we said this a little bit in the commentary when we missed guidance, we were 1 point above guidance for full year on the CASM side. And what it is where we've had actually difficult time forecasting is the passenger side is the recovery, the passenger recovery, the recovery in the business. We talked about it -- in your comments at the beginning were a new normal. We think we're getting to a new normal. But in fourth quarter and where we missed sort of guidance and as we updated guidance this year, it's been that revenue line. So when we see the strong revenue, we don't underlying -- we don't -- we haven't been caught up with the forecast from perspective of cost of sales. Because that revenue comes in and you got to pay credit card discount fees and you've got commissions and you've got GDS fees, et cetera so all of that has been difficult. We haven't sometimes talked to our network planning guys and revenue management of, I don't want to say sandbagging us.
Sure.
But sort of sandbagging the revenue side. And so as we saw, we thought the recovery was going to take us through -- the end of 2024. We're not going to be until 2025 when we got back into sort of full recovery. And now we're seeing that move in a year earlier so that's sort of 1 element. 1 of the big buckets of -- has been difficult to forecast. I think now that the booking curves and we'll get to that perhaps a little later on, have better line of sight on now how we see the demand profile coming back in stronger and gives us a better sense of forecasting those particular line items that come off of the revenue pile. Then when you get into the other areas, as you've heard from U.S. carriers and all, you go down the line buckets of expenses. You hit some of the big ones where we were faced with food catering cost inflation there. We had contracts were up for renewal and we had forecasted -- assumption of this level of inflation and then tying it up for a 3-year contract. And then we said no, we're not going to do that for a 3-year contract. We'll do it on a 1-year contract because we believe food inflation will come down in terms of catering costs. Along those lines, you hit the service costs. We have ground handled across the world. And there you have the impact of labor and tight labor markets. And so pushing up that labor component of cost and then bringing in the whole sort of service contract. And again, we're trying not to have signed long-term contracts in 2022 and into 2023, until we sort of see inflation coming down. So what we've now been doing about it is, these contracts are now coming up for renewal. We have some relief of the inflationary pressures, which then will give us a better handle on forecasting expenses going forward. And so that's been the efforts there. And on the revenue side, distribution costs. Finally, there is the rollout of NDC, and sort of a bad name for it, but it's a -- New Distribution Capability, which is letting us take a little bit more control over content and bring down some of the distribution costs or help on cost of sales. So those sort of the buckets there. There's obviously a little bit on the technology side, on IT. Again, contract renewals, different sort of focus on that, but again, bringing that back in, adding additional scope to projects, added some costs there. But at the end of the day, those technology investments and additional costs we're seeing in IT will provide benefits down the road here.
You mentioned NDC creating a lot of articles about that these days. I know our GDS analysts have written about it. Yes maybe -- can you expand on this like with this new distribution capability, what do you take more control of? How does that influence your cost structure?
So I think what we have been able to do and this has sort of been a little bit of discussion back and forth with the providers out there with the big GDSs is, is controlling your content, It's our content, how we display it, our ability to then bundle, create opportunities to purchase on up into the value stream of the products and services that we have. And so having that control and then bringing that display into our internal channel rather than those external channels. So it's not we're taking all the content -- will disappear off of the other channels will still be there, but we get additional content being provided that will hopefully then bring people into our channels and then lower distribution costs. So that ultimately is where the say the Big Bang is from that perspective.
Okay. More sort of basically more direct bookings.
More direct bookings.
Got it, got it. And just lastly, on the kind of cost structure, what are you seeing from an MRO perspective. I know the U.S. airlines kind of time lines there are extended. So aircraft out of service longer, obviously, maybe a little bit more costly than some think. Where do you stand there?
Yes, it was also 1 of the elements in the buckets the earlier one of expanded MRO times. But again it comes back to that labor, they too were sort of struggling with getting labor and then some of the supply chain in terms of the parts and materials that went into the overhauls, got more expensive, delayed coming in. But now as our discussions with the MROs and what we've contracted out for the next few years, we're in good shape with them and have negotiated good contracts.
I know on last Investor Day, right, you put forth this kind of, I guess, it was a $1 billion cost restructuring program. All of that probably gets masked in all this inflation that we've just been talking about. But where does that stand, is everything that you kind of identified in that program out there implemented? And I know you're retiring in July, your successors here in the room kind of thoughts on what is to come?
Yes, we'll give out a shout. My successor, John Di Bert, is here in the second row. So John is looking forward to taking this and I don't want to create any new expectations for him as he steps into.
You already set a pretty -- high bar for him after the recent guidance entry?
Yes, I think I set him up for that, and he's ready for it, he understands. So we actually -- we reached success on our $1 billion target that we had there. So it went into a lot of the items that we spoke back then and trying to bring down the fixed costs in that. And then there was a second element that we had brought in after we had -- as we were wrapping up the $1 billion in savings is another $400 million on the regional side. There we had consolidated carriers there. Sky Regional was brought into the -- into Jazz. So now Jazz has all of the regional flying and that $400 million of savings is over 15 years, but about $50 million of it was front-loaded each year. So we're seeing those savings there. So that $1 billion program, check that box. We did that, but then point all that's good part of that or some of that got not a good part, but some of that got lost in the whole inflationary -- uptick of what we saw in the sort of the last 1.5 years, but that doesn't stop us. We still are focused. Our DNA is cost, cost control and -- sure that we continue to identify opportunities and improvements in productivity, efficiency and the technology investments we're making to really continue to, by the way, at the cost structure.
Pilots. I know they have a reopener provision in their contract. I think it's later this month where negotiations can get started earlier. The U.S. labor inflation has obviously been high. How do you think about that when it comes to your -- the U.S. labor cost, how is that influenced the way you're thinking about contract with negotiations with your pilots? I'm just curious, how do you factor that into your current outlook?
Well, let's talk about the pilot situation. It's a topic -- current topic certainly with what's going on at WestJet there. So from our perspective, as you mentioned, on some specificity around it on May 29, so in a couple weeks from now, the pilots will be able to deem whether we have met the benchmark under the 10-year framework that we have with the pilot agreement. And if they say we have not met the benchmarks, then the contract is reopened in September 29 of 2023, so this coming year. So if that's the case, then we will lay out a timeline and a schedule to go through negotiations. And we sort of pride ourselves over the last 10 years having…
What are the key benchmarks that they'll be looking towards?
There's a couple, I don't want to get into the detail of the benchmarks.
Okay.
But there are specific benchmark, it's not an objective ones there.
Okay.
But again, they can make that decision on whether it's met or not. If they deem that the benchmark is met, then the contract continues for another year.
Through '24?
Through…
End of September '24?
September 2024, correct.
Okay, got it.
So again, coming back, we have very good labor relations and some part of, again, the culture change that we've had. So we'll have dialogue. We'll have -- discussions with them. And so, when we sort of think about what we see here what's going on in North America and how does that inform us and what we see in Canada, 1 of the things to keep in mind is that we do have a 10-year agreement, which actually continued with salary increases year-over-year-over-year. So unlike in the U.S., where many of them became amendable or open in 2018, 2019, just before going then into the pandemic and then nothing happened. So there are no increases in there. So when you look sometimes at the headline stories of its 35%, 40% increase in costs if you sort of factor out over the number of years, it works maybe 4, 5, 6 again.
Right, your pilots were getting those contractual increases throughout the pandemic?
Exactly. So that sort of, as you will, has helped -- will help sort of temper the view. Now then we have in front of us in the WestJet, WestJet.
They started canceling flights this morning, I saw.
Yes, they're bringing the fleet back, because they have put in a lockout notice and then the union has provided a strike notice. So fundamentally, when that agreement is done, at some point, they will reach agreement, hopefully before. But at some point, there will be an agreement. Then that will help sort of again establish a bit of a benchmark up than where our ALPA pilots would be looking match whatever the case may be.
I should probably know this, but what's the pay differential today?
It's hard because it's sort of driven looking at our wide-bodies, narrow-bodies, and then work -- compensation pieces, duty rigs and so forth. So it's hard to have a dollar-to-dollar scale comparison. Suffice it to say that we are higher than WestJet as currently stands and -- see after this next round, which I'm sure their perspective going in as they certainly wanted -- Air Canada rates.
Yes.
And from there, what do they take?
Yes, sure, you won't comment on this, but I'm sure your network planning department is very busy looking at WestJet is canceling flights today?
Well, they certainly are -- the network guys are always looking at everything. But unfortunately, there isn't -- and unfortunately, there isn't really much we can do from a perspective of this is a long weekend in Canada, 3-day weekend, its Victoria Day weekend. And so flights are already full. And as we've sort of spoken about in terms of our demand, May is quite full. So not a lot of space to say, let's add another extra section here or we can create lines there.
Fair enough, fair enough. Lastly, on the pilot topic, if the reopener happens, they can reopen at the end of September this year, fair to say you're probably not getting a contract on October 1, so there's probably not much in terms of labor in your 2023 cost assumptions?
Right now, I would tell you the way that we've guided on costs is we've made assumptions that incorporates all of the line items that we have and what we sort for now. So we'll leave it at that.
Got it. Okay. On the pilots, but not pay or contractual are you having any -- just any problems hiring any of the problems that you -- that we've seen in the United States creeping into Canada at all, whether it's pilot hiring, or pilot training or anything like that? Where do you stand?
At the top of it, we don't -- we are not having the same -- not experiencing the same issues that we have here in the United States that we see on the pilot side at Air Canada. I think it's made up of 2 pieces; one is fleet and the other is flow. And from a fleet perspective is now our competitors are, for most part, narrow-body operators. And they look at -- in Air Canada and gee, I've got a bunch of wide-bodies, 787s, 777s, and I can progress all the way up there and retire top of scale flying big airplanes. So Air Canada is an attractive place to be as a pilot, because you can work your way on. And then, so that's the fleet side of what makes a difference. And the other element is flow. And the flow comes from Jazz. We have a pilot mobility list, a flow list where pilots from Jazz flow on up into the mainline. So there, you can start out, if you will, flying Q400s or E175s and then ourselves find yourself getting on into the mainline operation into Air Canada and work your way on it. So that's provided a source of pilots, then, of course, the attraction of Air Canada and of itself. So we have not had that issue -- has been experienced here.
Always have to ask the question. Maybe changing gears here turning towards demand and revenue, Canada has always been trailing the U.S. recovery a bit. It's caught up a lot to-date. At least in our U.S. data, we're beginning to see maybe the customer push back on some of the rate gains that we've seen over the past year. I mean -- the panel before, this were just talking about, I mean, the only time I've seen covering the sector where we've got a full year of kind of no consumer pushback? I think in the U.S., maybe we're beginning to see that a little bit. What's your kind of demand looking like in Canada? Obviously, with the guidance increase that you put out a couple of weeks ago, yields seem to be incredibly healthy. Just kind of update us -- on where you stand from a pricing standpoint?
That been, well, I guess there's no wood here, knock on wood. Essentially, it's been a very good, strong story for us. Demand continues to be strong. We've got bookings ahead of 2019 levels going into Q3, Q2, balance of Q2 here and into Q3 and begin to see now into Q4, a little bit of perspective there. And pricing has held up through all of that. And so pricing, we're seeing above 2019 levels and in some markets, above -- 2022 levels, last year levels. So demand environment is robust, which has allowed sort of the pricing to remain -- as it is. And effectively, I can't say we've seen any pushback as a pushback you would see from the demand curve, bookings falling off and weakness in some markets, and we really aren't seeing -- that right now. So it's been strong really across all of the geographies for the man profile. And again, you would expect that pushback, if you would see it, would see bookings falling off or markets, particular -- markets weakening, but that's not what we're seeing.
Did you see more extended booking curves for international leisure this summer or were they normal?
They're now think returning back to normal on the booking curve. So, we're past this point that -- we were in the pandemic was 1 day, 30 days out. It was about the best you could get. Now we're seeing more of that historical view booking curve building.
And that's been all year, right?
And that's been all year. So that's been a change all year. And that's when we talked at the end of the first quarter, our advanced ticket liability was $5.3 billion.
Yes.
So it's way above 2019 levels by a large margin.
Well, I think -- 40% or 50% above '19 okay?
Yes, so that continues to reinforce the whole view that the demand profile is robust.
Yes, yes. When I think about your demand mix between corporate and leisure, what was it pre-pandemic and where is it right now?
That's always been a tough question for us to answer because, again, it comes back to the question of whether you're self-declaring we survey you claims. I mean you can perhaps either look at it from a number of J Class or premium seats that you have in the aircraft, but that again, is not even a good proxy. So hard to give you that straight answer. I know that some of the other airlines in the U.S. particularly have better metrics on that, and we don't have is -- has good of that insight on.
I guess in terms of your, I'll call it, I don't know, your managed corporate business if you, what percentage of that, what percentage of your business was that previously. I'm sure that's what's still trailing a lot?
Yes, so managed corporate business is the one that is fairly well, say it's not peak, but it's stabilized and it's nowhere aired was pre-pandemic. And it's been interesting to see that sort of that managed corporate piece, because some of it has, again, back to do, we think, with back to work, back to the.
Office.
See articles continually about that has slowed and is sort of there that sort of has stopped. Do you see sort of the -- retail establishment in the downtown cores, sort of suffering through all of that so our -- so that managed corporate bookings are off. But on the other hand, the element that we sort of see there is this, call it the leisure travel is as people are working remotely they're actually vacationing traveling for leisure. But then also they're working remotely for a couple of days in that week and then extending that. So that behavioral change is where we're, then I think is -- what we begin to see, and I think that's also contributing to the strong demand forecast there. So the behavior change on how that managed corporate where I can work remotely still is being taking advantage of. Now in the other elements and if we get into the other parts of the business travel, there we have some other indicators that we see in particular sectors and routes where we see the sale of flight passes. So they can book by flight passes, books of flight passes for particular markets, and we see those sales up. You see in our small or SME portals, we see actually additional activity in the SME side. So we see that -- portion of business travel in some areas, at least some strength of it and other areas somewhat stabilize. But then what continue sort of building on top of all of that is the leisure travel and leisure continues to grow and then in combination of what we see here of this business leisure, the leisure travel.
Structurally, do you think that managed corporate business or corporate overall is going to be a smaller part of the pie going forward or does it eventually get back to where it was? Because I know -- both leisure and corporate will grow as the market grows, but does corporate get back to the same mix?
I think that's the question that we've all sort of been asking ourselves and we just really don't see that. Would have expected by now where we're sort of in recovery is that, that would have come back and would have been people back in the office whatever. And you see some various experiments and everybody will be in the office and you get that push back and still. So I don't know. It doesn't -- for me it doesn't feel. I don't know your perspective?
I think it's structurally different. I don't think corporate will be traveling the same way they were pre-pandemic. So I think it's changed. But it's actually pretty dramatic that the revenue recovery has been what it has been without corporate really being right.
Yes, and I think that's a part of the leisure traveler that is buying up into those cabins. And that's what the activity that we see and the mix there of the travel that's sort of coming into that, that is really -- I don't call replacing it, but certainly is.
Yes -- that's doing that right? Yes, it will be interesting to see how that premium traveler, if that softens at all, particularly given maybe some of the macro concerns out there, so that could be kind of what are the indicators to watch?
Yes, definitely so.
Competitive position within Canada obviously, current WestJet issues aside, we've been tracking, obviously, the ULCC community has been popping up a little bit more. I know pre-pandemic, everyone is trying to get funding and grow and come into the market. Porter is getting some new aircraft. How much do these smaller airlines kind of worry you and kind of infringe on maybe some of your higher margin routes?
So good question is to get into the competition landscape, certainly Canada. It's been fascinating to watch actually never I've seen in a period of the year -- where you have now Canada, 4 new carriers, all ULCCs, LCC type in a geography where fundamentally, Canada is huge geographically, right.
Yes.
But population-wise, $35 million is very -- is a small population and don't have the density other than maybe 3 or 4, maybe 5 cities there. So, we do watch what the competition is doing. I'd say that space is crowded if you sort of believe all of the ambitions that they have out there from their fleet announcements and where they see. That's an awful lot of capacity for the Canadian marketplace to absorb. So from our perspective, we still -- we keep an eye on it. It really hasn't -- given the products and services that we have, we're able to compete with that. and so, we don't see that impact.
You don't price though?
So far, given the pricing environment and given where fuel price has been, they fairly much have come along on various price increases as well. They have -- input cost just as the rest of us, and they have others to answer to as well. So, we haven't seen them bring down the fare structure within the domestic marketplace per se. But even if they have, then we can manage through our branded fare types, and we have very sophisticated yield management systems to again be able to compete there. And then fundamentally, when you look at it, what's their network offering and what's Air Canada's network offering. So dynamically, considerably miles different and so, where do you want to get to? And how do you get there. And then when you sort of throw in the last key pieces of loyalty program, which is some of the attractiveness and stickiness that you get to that, then we look at our tools and that certainly is a big one. It certainly helps mitigate any sort of impact that you have from a ULCC, LCC.
Got it. Got about 5 minutes left, just want to give the audience a chance if anybody had a question. We have one question up here.
Just wanted to ask you about general strategy within Canada. What's going on with that? Are you putting back servicing smaller cities, increasing it? I guess there's less competition from WestJet you see these ULCCs. I mean what your thinking is on that?
So regional markets, that's been a little bit tougher area for us, and we've had to pullback from some of that regional flying as we've had -- capacity demands and movement of making sure that all our markets were covered. So, we've had to pull back in some regional markets through some of our Jazz flying, if you will. And it is a difficult market to serve financially economically. And so it's a challenge from that perspective. And so when we look at returns and capability to sort of serve it financially, make it viable, they're less viable in today's sort of cost environment and probably in the future cost environment. So, we've had to reallocate regional flying and as such, it's a service no longer perhaps is 3 or 4 or 5 times a day, it may be 1 trip a day and so forth. But -- we're still trying to keep regional service where we can.
And lastly for me, balance sheet. I asked the question on the call. Based on my numbers, I'm getting by 2024 target leverage getting back towards your target, which could potentially lead to capital returns. I know -- you they'll be retired in 2024, so I'm not going to ask you kind of capital return potential here? But just theoretically speaking about the balance sheet, because I'm not sure this is more of a firm kind of -- a company mandate as opposed to an Amos mandate. But when I think about as your -- with your order book and bring on new assets and the ability to finance them or pay cash, when I think about your asset structure, what percentage is kind of the right amount to encumber -- and how much do you want to leave as sort of dry powder for potential future liquidity events?
No, it's good question. It's something that we run a very conservative balance sheet, as you know. And so for us, liquidity and having unencumbered assets is very important. We've built up our unencumbered assets now as during the course here of taking deliveries of the MAXs and the 787s and the 767 freighters, we purchased them with cash. So, again, building up that book of unencumbered assets there, I think it's about CAD 4 billion, CAD 4.5 billion, CAD 4.7 billion roughly. And that excludes before you look at Aeroplan…
Yes just planes right?
That's just planes and engines and some real estate that's in there, parts. So going forward, right now, our plans are continuing to pay cash for the next 787s couple of 787 deliveries that we have. And right now, it's too far ahead to sort of thinking about the XLRs down the road here. But ideally, we want to always maintain strong liquidity, strong unencumbered asset pool. So I don't know if I have really a percentage there other than making sure that we have enough. It served us obviously very well going into the pandemic, where we were in terms of probably one of the best balance sheets in the industry, strong liquidity. And so that got us through the pandemic, as we didn't get much help from government. And so I want to be able to -- in another catastrophic event, would be able to get through that. But I'm sure John will be giving some thought to that. And I did leave him -- a sheet on my desk leaving of his targets to meet, right.
Well, Amos thank you very much and congratulations once again on retirement.
Thank you very much, Andrew. Thank you all for attending.
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