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Canadian Airlines
BUS 419
Presented by:
Lin Chiu
Wilson Lam
Joti Muker
Xueming Yang
Cindy Yu
S Airline Industry Analysis
S Services
S Revenue
S Cost Structure
S Regulations
S Current Challenges
S Air Canada Business Strategy
S West Jet Strategy
S Risks
S Air Canada
S West Jet
Industry Segmentation
Industry Analysis
S Scheduled Flights / Chartered Flights:
S Transnational
S Regional
S International
S Cargo
S There are two sources of revenue for Airlines:
S Passengers
S Charters and cargos
Cost structure
Fuel Expenses
Wages & Salaries
Airport / Navigation Fees
Depreciation & Amortization
Food, Beverages, Supplies
Communications and Information Technology
Aircraft Rentals
S In the past few decades, government deregulation has
dramatically increased competition and allowed the
emergence of “low-cost carriers”
S Some regulations still in place:
S Federal Aviation Authority (FAA)
S Airline Safety and Security
S Environmental Concerns
S In recent years, the airline industry has been affected by:
S Terrorism attacks & increased security costs
S Epidemic diseases (SARs, Swine Flu)
S Economic Crisis
S Fuel Prices
Canadian Market
S The industry is slowly recovering from its decline in 2009
S The compound annual growth rate of the industry volume in
the period 2008-2013 is predicted to be 4.7%.
Market Value Forecast
S Implementing cost reduction initiatives
S Reducing company sizes
S Reducing operations
S Entering into agreements with supplier
S Airline alliances
S Apply hedging programs
Air Canada Strategies
S Cost Reduction:
S Corporate downsizing
S Capacity management
S Fleet renewal programs
S Customer Driven Revenue:
S Multi-tiered Fares
S Web Platforms
S Employee Incentives
WestJet Strategy
S Four-pillars:
S People and Culture
S Guest Experience and Performance
S Revenue and Growth
S Cost and Margins
S Operational
S Strategic
S Financial:
S Fuel Prices
S Foreign Exchange Rates
S Interest Rates
S Hazards
Airline Risk Factors
S Founded April 11, 1936 (as Trans-Canada Airlines)
S David Richardson (Chairman)
S Calin Rovinescu (President & CEO)
S Headquarters in Montreal, Quebec
S Subsidiaries
S Air Canada Cargo (operating division)
S Air Canada Jetz(operating division)
S Air Canada Vacations
S Destinations: 178
S Company slogan: GO FAR
Profitability in 4 year Interval
In thousands of Canadian dollars
Financial Statements
Reasons to Hedge
S Should the Company Hedge ?
S Fuel price changes have a significant impact on income
S Foreign exchange rate impact earnings and operating costs
S Interest rate changes effect borrowing costs
Risk Management
Hedging Strategy
Michael Rousseau
Executive Vice President & CFO, since 2007
Prior Position:
S Executive Vice-President & CFO in
Hudson’s Bay Company (HBC) Since 2001
S Executive Financial positions in Moore
Corporation, Silcorp Limited & The UCS
Education background:
S BBA degree from York University
S Member of the Ontario Institute of
Chartered Accountants since 1983
Risk Exposures & Strategy
Risk Factors:
Market Risk
Derivative Instruments.
Credit Risk
Review credit ratings on regular basis and sets credit limit.
Liquidity Risk
Cash from operation & financing.
Fuel Price Risk
Enter in derivative contracts: call, put options, swaps,
collars. Adjust the strategy with market
Interest Risk
Portfolio basis & swaps
Foreign Exchange rate
Forward foreign currency contracts and option
agreements, swaps. Try to get positive CF on Mark-toMarket
Fuel Price Risk
Air Canada’s Cost Structure
Fuel Price Risk Exposure
Sensitivity on Operating Income
S Estimated operating income impact from US$1/barrel
increase in WTI – ($25 Million) estimates are derived from
2008 levels of activity and make use of management
S A 1% increase in Jet fuel prices (CAD cents/litre) has an
estimated operating income impact of ($35 Million)
S Fuel Expenses – 31% of 2008 total operating expense, 25%
of 2007 total operating expense
Hedging Ratio
For 2009:
S 35% of anticipated purchases of fuel
S The contracts to hedge anticipated jet fuel purchases over 2009 is
comprised of jet fuel, heating oil and crude oil – based contracts
For 2010:
S 14% of of anticipated purchases of fuel
Hedging Strategy Dec 2008
Hedge Strategy Jan 2009
How much did they make/lose off
fuel hedges?
Comprehensive Income (Loss)
Gain (Loss) on Financial
Interest Rate Risk
Interest Risk
High level of Leveraging rate of 2008==$4691/$762 =615.616%
Section of Balance sheet:
Section of Cash Flow:
Interest Risk: Contractual
Sensitivity Analysis
Interest Risk Exposure
S Fixed rate debt
S Floating rate debt
S Lease on assets based on changes in short-term interest rates
S Aircraft financing agreements
Interest Rate Risk
S Objectives:
S Minimize the potential changes in cash flows from changes in
interest rates
S Long term objective: 60% fixed and 40% floating debt
S Dec 31,2009 – 59% fixed and 41% floating
S Dec 31,2008 – 58% fixed and 42% floating
S Designed to maintain flexibility in the Air Canada’s capital
Hedging Strategy Cont
S Use of Derivatives
S 3 cross-currency interest rate swap, financing Boeing 777 worth
300 million
2 Interest rate swap, financing Boeing 767
Terminated on Oct 1,2008, 4 million Gain
14 million gain
19 forward interest rate to manage risks associated US and
Canada interest rate market
No gain or loss recorded
Foreign Exchange Risk
Foreign Exchange Rate Risk
S Cash flow structure:
S Inflows primarily in Canadian dollars
S Large portion of outflows in US dollars
S Majority of outstanding debt is US dollars
S US dollar debt act as an economic hedge against the related
S Foreign exchange risk on foreign currency denominated trade
receivables and foreign currency denominated net cash flows
Foreign Exchange Rate Risk
Section of Cash Flow Statement:
Section of Income Statement:
Foreign Exchange Rate Risk
S Foreign Currency Forward Contract / Option Agreements
- USD to CAD(US$516 M)2009, Euro to CAD(EUR$3M)2010$64 M
- Gain , $327 M recorded in foreign exchange gain related to these
S Foreign Currency Forward Contract / Option Agreements
- USD to CAD(US$297 M)1009, Euro to CAD(EUR$3 M)2010
- $51M Gain
S Currency Swap Agreements on operating leases (2007,2011)
- $78 M notional amount.
Summary of Gain (loss) on Financial
Fuel Risk
Interest Risk
Forex Risk
Company Background
WestJet began service on Feb 29, 1996.
– founded in 1996 by the team of Calgary entrepreneurs
Canada’s leading high-value low fare airline.
WestJet flies an average of 383 flights everyday
Profitability in 4 Year Interval
In Thousands of Canadian Dollars
Operating Expenses
Risk Exposures & Strategy
Risk Factors:
Market Risk
Try to accurately predict market movements
Cash and cash equivalent
Credit Risk
Liquidity Risk
Maintain current ratio > 1
Fuel Price Risk
Enter in derivative contracts: costless collars and swaps.
Adjust to market expectations
Interest Risk
Canadian dollar fixed interest rate debt
Foreign Exchange rate
Forward foreign currency contracts and option
agreements, swaps
Outline of Risk Factors Related to
Derivative Securities
• Jet Fuel Price Risk
• Changes in crude oil and fuel prices
• Foreign Currency Risk
• Canadian-US dollar exchange rate
• Interest Rate Risk
• Interest rate fluctuations
Income Statement
Cash Flow Statement
Reasons to Hedge
S Should the Company Hedge ?
S Dependent on jet fuel and prices are volatile
S Currencies exchange rates fluctuations causing the value of
assets and liabilities and/or future cash flows change
S Interest rate fluctuations changes the value of financial assets
and liabilities and/or future cash flow
Fuel Risk
Jet Fuel
S Consumed 210,090,434 litres of fuel in 2008
S Every $1 USD Δ per barrel of crude oil ≈ $ 7 million annual
Δ in fuel costs
S Every 0.01¢ Δ per litre of fuel ≈ $ 9 million annual Δ in fuel
Jet Fuel Hedging Philosophy
As approved by the Board of Directors:
S Hedge a portion of anticipated jet fuel purchases
S Established maximum hedging limits
S Up to 36 months
S Using crude-oil based commodities
Average Market Price of Jet
Basis risk
Jet Fuel Price Hedging Strategy
S Mixture of fixed swap agreements
S Costless collar structures in Canadian-dollar WTI crude oil
derivative contracts
S Short position in call option
S Long position in put option
S 2008 hedge ratio: 30 percent
S 2009 hedge ratio: 14 percent
S 2010 hedge ratio: 32 percent
As of December, 2008 Fuel Hedge
Derivative Holdings
Fuel Cost
2008 Balance Sheet and Income
Statement~ Note 11
Interest Rate Risk
Interest Rate Hedging Strategy
S 85 % of borrowing is done at low interest through debt
guaranteed by Export-Import Bank in the US
S Borrow 1.3 billion CANADIAN
S Fixed interest rates
S Borrow in Canadian funds- use Canadian cash inflows to
pay Canadian outflows
Contractual Obligations and
Foreign Exchange Risk
Foreign Currency Exchange
S Arising risks
S Fluctuations in exchange rates on US-dollar denominated asset
and operating expenditures
S Aircraft fuel, leasing expense, maintenance costs and a portion
of airport operations costs.
S US $99.5 million in 2008
S Between 2008 and 2009
The average US exchange rate increase from 1.0651 to 1.1425
Foreign Currency Exchange
Hedging Strategy
S To reduce foreign exchange risk:
S Hold US-denominated cash and short term investment
S Foreign exchange forward contracts
S In 2010
S US 7.3 million per month for the period of Feb to Oct
S US $65.4 million at a weighted average contract rate of
1.0671 per US dollar
Foreign Currency Exchange
S Foreign Exchange Forward Contact
S average contracted rate on the forward contracts was 1.0671 (2008
– 1.0519) US dollars to Canadian dollars,
S average forward rate used in determining the fair value was
1.0512 (2008 – 1.2178) US dollars to Canadian dollars
Average contracted rate on the forward contracts
Average forward rate used in determining the fair value
Foreign Currency Exchange
S Impact of foreign exchanging hedging
S Every one-cent change in the value of the Canadian dollar versus
the US dollar will have an approximate $9 million impact on our
annual operating costs
S $9million =($6 million for fuel, $3 million related to other US
dollars denominated expense)
Five Year Foreign Exchange
Foreign Currency Exchange
S In 2007, lose 12.8 million
S In 2008, gain 31 million
S In 2009, lose 12.3 million
Summary of Derivative Instruments
Carry Amount
Future Outlook
S Expect a economic recovery
S Jet fuel prices stabilized and decreased in 2009
S Do not expect to see the same relief on costs going forward
S Hedged about 32 % of anticipated fuel requirements for
S 35 % of the total volume hedge using costless collars
S 65% of the total volume hedge using fixed swap agreements
Summary (2008)
West Jet
Air Canada
Market Share
Gain (Loss) on Jet Fuel Hedging
($18 millions)
($92 millions)
Gain (Loss) on Foreign Exchange Hedging
$31 millions
($822 millions)
Gain (Loss) on Interest Rate Hedging
$18 millions
Questions ?
Thank you