Friday, April 06, 2012

Labor woes, weak economy, fuel prices weigh on Air Canada's future

 Air Canada may get through its current rough patch but its longer term outlook remains of concern to analysts.

The airline's immediate future may look stable, following a reasonably strong month of March in which passenger loads were higher than a year ago.

Still, there are worries about ongoing labour problems, a weak economy, rising fuel prices and the bankruptcy of its Montreal-based heavy maintenance contractor Aveos. And other looming issues cloud the financial picture.

"We are concerned with the company's ability to absorb higher capital expenditures for new planes and additional funding requirements for its sizeable pension shortfalls beginning in 2014," said Moody's Investors Service analyst Darren Kirk in a statement.

Moody's this week downgraded the airline's credit rating, estimating that its pension solvency deficit may have risen to around $4 billion at the start of the year, from $2.2 billion in the previous year.

The ratings agency also noted that Air Canada has lagged on capital expenditure in recent years and will have to spend more to renew its fleet. In 2014, it will begin to take delivery on an order of Boeing 787 Dreamliners.

Moody's said the airline still has good liquidity, but lowered the credit rating by a notch — a move that may make it more expensive to fund its debt.

Given the high-profile labour problems with Air Canada unions and the controversial bankrupcty of Aveos, the last couple of months have been one of the darkest periods in the airline's history.

The share price has tumbled to below 90 cents, and market capitalization has fallen to around $250 million, compared to net debt of more than $4 billion.

"The worst of the negative headlines are probably behind Air Canada but we would still be hesitant to buy the stock even at current depressed levels," said National Bank Financial Analyst Cameron Doerksen in a note to clients.

He cited unresolved labour issues and their impact on customer confidence.

"We believe that customer anger and angst resulting from the labour disruptions and uncertainty this past quarter will lead to at least some loss of market share for Air Canada," the analyst said.

"While this may only be temporary, there is no doubt that Air Canada will need to work doubly hard (possibly with incentives such as fare sales) to regain the trust of its customers."

Doerksen also noted that employee motivation and morale are impaired. Two of Air Canada's major unions are likely to be forced into final offer arbitration — an outcome that rarely bodes well for labour relations.

Other employees on the front lines are suffering the stress of service disruptions and it may take years for morale to be rebuilt, he suggested.

At the same time, the threat of greater competition from low-cost carrier WestJet looms, as it adds capacity and targets some of Air Canada's high-yielding routes.

Porter Airlines has taken away business between Montreal and Toronto and Virgin Atlantic will begin Vancouver-to-London service in May.

The airline's financial position is okay for now, the analyst said, but will become more stretched as new aircraft are delivered and as cash payments are made to fund pension obligations.

It's been a steady decline for Air Canada since it emerged from bankruptcy protection and new stock was issued at $20 in 2006.

All the financial engineering by parent company ACE Aviation Holdings — including the spin-off of the Aeroplan loyalty program, the sale of regional carrier Jazz and the spin-off of Aveos, put money in the pockets of institutional investors who backed the restructuring.

But it left the airline stripped of some of its best assets and loaded with debt.

Of course, individual investors who have lost money on Air Canada stock might well recall the remarks of legendary U.S. money manager Warren Buffett in 2008.

"The worst sort of business is one that grows rapidly, requires significant capital to engender growth and then earns little or no money," Buffett said.

"Think airlines."

Overall, the airline industry has been one of the worst performing stock sectors in the last 50 years and Air Canada is doing little to change that perception.

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