EUR 850.00 For Business Accounts Only

Morningstar | High Yield Passenger Traffic Offsets Rising Fuel Costs; Raising FVE

We raised our fair value estimate to CAD 35 from CAD 32 after Air Canada delivered third-quarter results that surpassed our expectations. Passenger yields remained strong through the third quarter, reaching 17.60 cents, a 3.4% improvement over the year-ago period and about 3% higher than our initial assumption for 2018. We now expect passenger yields will finish the year closer to 17.30 cents, near the nine-month average for 2018 and reflective of improved fair mix and firm growth for high yielding passengers. We also raised our assumptions for full-year capacity growth from about 6% to 7%, placing 2018 capacity at 111 billion available seat miles. Against a resilient demand back-drop in the third quarter, our model now includes tighter load factors, closer to 83%, but we still factor in operating margins below 7% for 2018. Shares trade in 4-star territory at our new fair value estimate.

Air Canada’s yield growth took center stage this quarter, as the network carrier successfully passed through a swath of its rising fuel costs to high yielding travelers. According to management, business cabin revenue grew 13% over the third quarter last year with the assistance of traffic and yield increases of 8.9% and 3.7%, respectively. The carrier also picked up relief from ancillary revenue, which picked up CAD 7 million over the third quarter last year on baggage fees, paid upgrades, seat selection and preferred seats.

Costs per available seat mile rose a little under 10% in the third quarter, due mostly to accelerating fuel prices, but the carrier’s remaining costs were held in check. Adjusted CASM (costs per available seat mile excluding fuel, package costs, and special items) only rose 1% over the same period last year and management guides full-year adjusted CASM flat to up .75%. What’s more, management left EBITDAR margin guidance through 2020 unchanged and raised full-year free cash flow guidance from its initial midpoint of CAD 400 million to CAD 550 million.

We’re encouraged by Air Canada’s third-quarter results, and even though we forecast narrowing profit margins against 2017, falling below 7%, we think declining oil prices, cost transformation initiatives, and investments in premium products will drive operating margins above 9% in our 2022 midcycle year.