Air Canada today reported record second quarter 2017 EBITDAR(1) (earnings before interest, taxes, depreciation, amortization, impairment and aircraft rent) of $670 million compared to the previous record second quarter 2016 EBITDAR of $605 million, an increase of $65 million and consistent with the forecast in Air Canada's July 6th, 2017 news release. The airline recorded a second quarter EBITDAR margin of 17.1 per cent. On a GAAP basis, Air Canada reported second quarter operating income of $281 million versus operating income of $277 million in the second quarter of 2016.
Air Canada recorded adjusted net income(1) of $215 million or $0.78 per diluted share in the second quarter of 2017 compared to adjusted net income of $203 million or $0.72 per diluted share in the second quarter of 2016. The airline reported record second quarter net income of $300 million or $1.08 per diluted share compared to net income of $186 million or $0.66 per diluted share in the second quarter of 2016.
"I am pleased to report that, in our second quarter, we delivered record operating revenues, record EBITDAR and ended with record liquidity levels, exceeding last year's financial results and analysts' consensus estimates for EBITDAR. We also improved our guidance for key financial measures, including a significant improvement in projected free cash flow for 2017," said Calin Rovinescu, President and Chief Executive Officer.
"Moreover, we delivered an excellent unit cost performance and our unit revenue, on a stage-length adjusted basis, increased 1.6 per cent versus last year's quarter. These are important drivers of margin expansion and are the result of the successful execution of our business plan.
"With the launch of 16 international and U.S. transborder routes this quarter alone, we continue to increase international-to-international connecting passengers via Canada. On June 29th, we served close to 167,000 customers, setting an all-time record which we expect to surpass during the upcoming August long weekend. Demand continues to be robust in a stable fuel and pricing environment as we move into what has historically been our most important quarter given the travel demands and patterns of our North American customers. In 2018, capacity growth, driven by our wide-body fleet expansion, will begin to slow as we shift our focus to our mainline narrow-body fleet replacement program which is expected to further reduce our unit costs and improve operating margins.
"I would like to thank our growing customer base who are increasingly choosing Air Canada for convenience, value and comfort. Our achievements are a tribute to our team of 30,000 employees whose dedication and professionalism have been instrumental in Air Canada being named Best Airline in North America in a survey of almost 20 million air travellers by Skytrax, the global benchmark of industry excellence. Also in the quarter, Air Canada was recipient of this year's Airline Strategy Award by Flight Airline Business for its successful financial turnaround allowing for significant investments in, among other things, improvements in the customer experience and environmental initiatives. These recognitions, joining others citing Air Canada as one of Canada's top diversity employers and one of North America's most engaged workplaces, are testament to the team's hard work as we evolve into a global champion," concluded Mr. Rovinescu.
Second Quarter Income Statement Highlights
In the second quarter of 2017, on capacity growth of 13.5 per cent, record system passenger revenues of $3.517 billion increased $374 million or 11.9 per cent from the second quarter of 2016. The increase in system passenger revenues was driven by traffic growth of 13.6 per cent. Yield improvements were recorded in all markets with the exception of the Pacific market. An increase in average stage length of 5.0 per cent had the effect of reducing system yield by 2.8 percentage points. On a stage-length adjusted basis, system yield increased 1.4 per cent year-over-year versus, on an unadjusted basis, a reported system yield decline of 1.4 per cent.
In the business cabin, system passenger revenues increased $90 million or 14.6 per cent from the second quarter of 2016 on traffic and yield growth of 11.2 per cent and 3.0 per cent, respectively.
In the second quarter of 2017, operating expenses of $3.629 billion increased $448 million or 14 per cent from the second quarter of 2016, mainly driven by the 13.5 per cent increase in capacity and higher fuel prices year-over-year.
Air Canada's cost per available seat mile (CASM) increased 0.5 per cent from the second quarter of 2016. The airline's adjusted CASM decreased 3.5 per cent from the second quarter of 2016, better than the 1.5 per cent to 2.5 per cent decrease forecast in Air Canada's news release dated May 5th, 2017. This improvement was largely driven by lower than anticipated aircraft maintenance expense, which was mainly attributable to the deferral of certain maintenance activities into the remainder of 2017 and to lower end of lease maintenance provisions due to more favourable terms on wide-body aircraft lease extensions.
Financial and Capital Management Highlights
At June 30, 2017, unrestricted liquidity (cash, short-term investments and undrawn lines of credit) amounted to a record $4.493 billion (December 31, 2016 – $3.388 billion).
At June 30, 2017, total long-term debt and finance leases (including current portion) of $6.765 billion increased $147 million from December 31, 2016. In the first six months of 2017, new borrowings of $733 million were largely offset by debt repayments of $371 million and the favourable impact of a stronger Canadian dollar of $212 million, as at June 30, 2017 compared to December 31, 2016, on Air Canada's foreign currency denominated debt (mainly U.S. dollars).
At June 30, 2017, adjusted net debt of $6.393 billion decreased $697 million from December 31, 2016, reflecting the impact of higher cash and short-term investment balances partly offset by the impact of a higher capitalized operating lease balance and higher long-term debt and finance lease balances. At June 30, 2017, the adjusted net debt to EBITDAR ratio(1) improved to 2.4 versus 2.6 as at December 31, 2016.
Net cash flows from operating activities of $829 million improved $171 million when compared to the same quarter in 2016. Free cash flow of $305 million in the second quarter of 2017 increased $748 million from the second quarter of 2016 due to a lower level of net capital expenditures year-over-year and the impact of higher cash flows from operating activities versus the second quarter of 2016.
For the 12 months ended June 30, 2017, return on invested capital (ROIC(1)) was 12.3 per cent, significantly higher than Air Canada's weighted average cost of capital of 7.6 per cent.
2015 Investor Day Targets and 2017 Outlook
At its June 2015 Investor Day, Air Canada provided guidance on key financial metrics:
Annual EBITDAR margin (EBITDAR as a percentage of operating revenue) of 15-18 per cent in 2017 and 2018:
Air Canada now expects to achieve an annual EBITDAR margin of 17-19 per cent for the full year 2017 and 2018, as opposed to the annual EBITDAR margin of 15-18 per cent projected in its May 5th, 2017 news release. This increase in projected EBITDAR margin takes into account Air Canada's strong second quarter 2017 EBITDAR results and reflects Air Canada's expectation of a more robust revenue environment in the second half of 2017, as well as a stronger Canadian dollar when compared to the U.S. dollar and a lower fuel price per litre than what was assumed in Air Canada's May 5th, 2017 news release.
Annual ROIC of 13-16 per cent in 2017 and 2018:
Air Canada now expects its annual ROIC to be between 11-14 per cent in 2017 and 2018, as opposed to the annual ROIC of 9-12 per cent projected in its May 5th, 2017 news release. This improvement in projected annual ROIC reflects Air Canada's expectation of a higher level of adjusted net income than what was previously expected.
A leverage ratio not exceeding 2.2 by the end of 2018 (measured by adjusted net debt over trailing 12-month EBITDAR):
Air Canada continues to expect to achieve this target by the end of 2018.
Update on CASM Reduction Target
Air Canada completed a thorough review of projects which supported its CASM reduction target of 21 per cent over the 2012 to 2018 period (excluding the impact of foreign exchange and fuel prices). These projects included the addition of Boeing 787 and high-density Boeing 777 aircraft, the launch of Air Canada Rouge and other fleet and strategic initiatives. These projects are achieving their expected contribution towards this CASM reduction target. However, largely as a result of lower than anticipated capacity growth and higher non-cash depreciation expense, and also due to cost increases not anticipated at the time related to the airline's investment in initiatives focused on improving customer service levels, the overall CASM reduction over the period is approximately 17 per cent compared to 2012 (excluding the impact of foreign exchange and fuel prices). Given that the contribution of these projects to CASM reduction is now fully known and that Air Canada's focus is on improving EBITDAR margins (of which CASM is but one component), this measure of CASM reduction guidance is being withdrawn and will be subsumed within Air Canada's EBITDAR margin targets, including those provided in this news release.
Free Cash Flow
Air Canada now expects positive free cash flow in the range of $600 million to $900 million in 2017, as opposed to the positive free cash of $200 million to $500 million projected in its May 5th, 2017 news release. This increase in projected free cash flow takes into account Air Canada's strong second quarter 2017 operating results and reflects Air Canada's expectation of a more robust revenue environment in the second half of 2017, as well as a stronger Canadian dollar when compared to the U.S. dollar and a lower fuel price per litre than what was assumed in Air Canada's May 5th, 2017 news release.
For the third quarter of 2017, Air Canada expects adjusted CASM (which excludes fuel expense, the cost of ground packages at Air Canada Vacations and special items) to decrease 1.5 to 2.5 per cent when compared to the third quarter of 2016.
For the full year 2017, Air Canada continues to expect adjusted CASM to decrease 3.0 to 5.0 per cent compared to the full year 2016. Air Canada expects a favourable impact from a stronger Canadian dollar when compared to the U.S. dollar. However, this favourable impact is expected to be offset by lower than previously projected capacity growth, as well as certain cost increases, including the impact of a higher share price on stock-based compensation expense (included in wages and salaries expense), higher sales and distribution costs due to competitive pricing initiatives, and higher customer inconvenience expenses.
Depreciation, Amortization and Impairment
Air Canada continues to expect depreciation, amortization and impairment expense to increase by approximately $145 million from the full year 2016.
Air Canada continues to expect employee benefits expense to increase by approximately $50 million from the full year 2016.
Air Canada now expects aircraft maintenance expense to increase by approximately $75 million from the full year 2016, as opposed to the $110 million increase projected in its news release dated May 5th, 2017. This improvement in projected aircraft maintenance expense is largely due to a stronger Canadian dollar when compared to the U.S. dollar than what was assumed in Air Canada's May 5th, 2017 news release.
The outlook provided constitutes forward-looking statements within the meaning of applicable securities laws and is based on a number of additional assumptions and subject to a number of risks. Please see section below entitled "Caution Regarding Forward-Looking Information".
Assumptions were made by Air Canada in preparing and making forward-looking statements. As part of its assumptions, Air Canada assumes relatively modest Canadian GDP growth for 2017 and 2018. Air Canada also expects that the Canadian dollar will trade, on average, at C$1.29 per U.S. dollar in the third quarter of 2017 and C$1.31 per U.S. dollar for the full year 2017 and that the price of jet fuel (taking the impact of fuel hedging into account) will average 59 CAD cents per litre in the third quarter 2017 and 61 CAD cents per litre for the full year 2017.