Econ Assignment 2, Abhishek Sinha

How can Air Canada minimize the negative impacts on its financial performance of an economic recession?

Introduction Air Canada is the Biggest Airline Service of Canada. For all the three segments: domestic markets, trans- border markets and international markets, Air Canada is the leader.

Air Canada is the largest provider of scheduled passenger services in the trans-border market. Air Canada is Canada's largest domestic airline as well. Air Canada, together with Jazz, carries more passengers, serves more nonstop destinations and provides more flights in the domestic market than any other airline. Competition in the domestic market is primarily from West Jet. Air Canada is also Canada's largest provider of scheduled passenger services in the international market to and from Canada and has a broad portfolio of international route rights.

Network carriers such as Air Canada generally benefit from brand name recognition and a long operating history. However, over the past three decades governments have gradually reduced economic regulation of commercial aviation. This has resulted in a more open and competitive environment for domestic, trans-border and international airline services, for both scheduled and leisure charter operations. This deregulation has transformed the airline industry and allowed the emergence of low-cost carriers, which has resulted in a rapid shift in the competitive environment.

Recession Effect Along with many airline carriers globally, Air Canada faced a number of significant challenges in 2008 because of the recession effect that triggered volatile fuel prices and foreign exchange, liquidity requirements and the weakening demand for air travel. The recession has put significant pressures on passenger and cargo revenues for many airlines, including Air Canada. In 2009, however, capacity adjustments made in 2008 because of the high fuel prices should provide some relief.

During 2008, the corporation’s operating results and cash flows were significantly affected by historically high and volatile fuel prices during the first half of the year and the weakening of the Canadian dollar during the second half of the year.

In summary, Air Canada’s results of operations for 2008 compared to 2007 are as follows: Air Canada recorded a net of loss of $1,025 million or $10.25 per diluted share in 2008 compared to net income of $429 million or $4.27 per diluted share in 2007. The net loss in 2008 included a provision for cargo investigations of $125 million and net losses on foreign exchange of $655 million.

Air Canada recorded an operating loss (before a provision for cargo investigations) of $39 million, a deterioration of $472 million from the operating income of $433 million recorded in 2007 and EBITDAR (before the provision for cargo investigations) of $934 million compared to EBITDAR of $1,263 million in the same period in 2007, a decrease of $329 million.

Operating expenses increased $908 million or 9% from 2007, which included an increase in fuel expense of $867 million, or 34% compared to the same period in 2007.

Assets, cash, cash equivalents and short-term investments have gone down by 18 %. These are required to maintain the leverage Air Canada currently enjoys. Current Liabilities have increased by a staggering 31 %. Long-term debt and capital leases have also increased by a significant 17 %.

Cyclical Industry The Airlines industry is an example of a cyclical industry. The demands for the products and services follow a cyclical pattern. For example, Air Canada has historically experienced considerably greater demand for its services in the second and third quarters of the calendar year and significantly lower demand in the first and fourth quarters of the calendar year. This demand pattern is principally a result of the preference of a high number of leisure travelers to travel during the spring and summer months.

However, the Corporation has substantial fixed costs that do not meaningfully fluctuate with passenger demand in the short term. The various initiatives undertaken by Air Canada in order to manage and mitigate these risks include: adjusting its capacity to match passenger demand; implementing cost containment initiatives; entering into hedging programs to manage its exposure to jet fuel prices and help mitigate volatility in operating cash flows ; and entering into new financial arrangements

Suggestions 1) Effectively managing Air Canada through an uncertain economic environment should be

the top priority. Following points should be taken into consideration:

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Leveraging its innovative customer driven revenue model;

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Further developing its innovative revenue strategy to generate additional revenues;

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Continuing to focus on costs;

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Continuing to focus on sound capacity management;

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Maintaining a high degree of web penetration and further increasing direct distribution;

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Further enhancing its product offering through a redesigned network and a renewed fleet;

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Further leveraging its technology for enhanced customer service and cost containment; and

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Maintaining positive employee and labour relations.

1) Air Canada should ensure optimization of operating cash flows. Air Canada’s principal

objective in managing liquidity risk is to maintain minimum cash, cash equivalents and short-term investments’ (“unrestricted cash”) balance in excess of a target liquidity level of 15% of operating revenues. However, Air Canada expects there may be challenges to achieving its target of unrestricted cash to operating revenue ratio of 15% in 2009.

2) Maintain the Highest Market share: According to Transport Canada, domestic revenue

passengers grew at an average annual rate of 3.6% from 2000 to 2008. Has Air Canada able to tap this market? (Air Canada 57 %, West Jet 36 %)

3) Continue to focus on measures that worked. For example, in the second half of 2008, Air Canada reduced its capacity by 5.4% compared to the second half of 2007. The traffic decrease of 3.6% was less than the capacity reduction of 5.4%, resulting in a 1.6 percentage point improvement in passenger load factor compared to the second half of 2007.

4) Keep working on the Innovative cost saving methods and products.

For example, customers continue to benefit from the ability to check into Air Canada flights departing from any Canadian city and from most U.S. and international cities to Canada up to 24 hours prior to departure by using the web check in facility provided on the Air Canada website. This has allowed Air Canada to generate cost savings while increasing its customer satisfaction. One innovative product is the Flight Pass™. This product provides Air Canada customers with the ability to lock-in their cost of travel through advance purchase of multiple segments within a defined geographic area. This product is gaining popularity with large corporations as well as with small businesses and families who value the set price and more importantly the flexibility and ease of use.

5) Air Canada can allocate some extra money on marketing as well, I will explain why. In

the Airlines Industry there is big significance of Brand Name. Given the current period of social insecurity and general fear, esp. in US, a Brand Name (that Air Canada has) can be utilized to inflict the thought that Air Canada is amongst the safest Airlines. This may

help in enhancing the market share, as security is the top most criterion in many passenger`s mind, nowadays.

6) When we look at the Financial Statements for Air Canada, we see that the Aircraft Rent has increased 29 % from 2007. Air Canada may want to look into that. When the number of travelling passengers has decreased, an increase in the aircraft rent may signify that there is an improper use of resources.

Also wages and salaries increased by 5.19 percent in 4rth quarter, even in this turbulent time. Air Canada may want to re look this policy and work with the unions.

Appendices The following material provided in the course materials has been used to derive this report: 1) Air Canada 2008 Annual Information Form

2) Air Canada Annual Report 2008

Prepared by: Abhishek Sinha Section B MBA Candidate, Schulich School of Business