COVID-19 and Aviation in Canada - Is a Loan Needed?
Last month while I was enjoying my ski trip out west, this whole #socialdistancing wasn’t a part of my vocabulary, I was more worried about a potential quarantine if travelling internationally and Air Canada’s stock (TSE: AC) started the trading day at $47.
Up, for the day, but down 75% for their peak
Oh have times changed for the negative - Instagram shows me a “StayHome” story, I’ve been pretty much at home for the last 10 days and Air Canada is trading at $12.41 (down almost 75%). Social distancing, or something even more than that (the Hammer), is here to stay. Even more than the past, It looks like a massive round of airline bankruptcies are coming.
Ouch
The real question is how the economy is going to get through this unprecedented time. In just the last week, 500K Canadians applied for Employment Insurance benefits, which represents about 2.5% of all employed Canadians. While many in the service industry have been affected, the airline industry has been decimated. As of Sunday, March 22nd, Air Canada laid off 5,100 flight attendants, Air Transat has laid off 2,000 FAs, Porter Airlines has suspended all flights and WestJet is suspending all international flights for 30 days. The magnitude of these government-ordered shutdowns are incomprehensible on the travel and tourism industry, and the government is going to have to step in to ensure Canadians have access to airlines in the future, as even the most risk-averse companies couldn’t withstand a shutdown of their capital intensive business for very long. So what should the government do?
All of Air Canada Rouge flight attendants were laid off
To lead this section, I’d like to quote economist Austan Goolsbee from the University of Chicago's Booth School of Business. With regards to stimulus in the economy, he said during an NPR Planet Money episode “If the rainstorm is coming, one approach is while the storm is coming we're going to wring our shirts out as fast as we can. While the storm is raging I don't think that’s going to work, instead, let’s give everyone an umbrella and try and get everyone inside. As soon as the rainstorm is over, that is the moment of stimulus.” In layman's terms, he’s saying we need to get everyone some cover and head inside until the storm passes. Once the storm has passed, that’s when we assess the damage and can see the extent of that damage.
“If the rainstorm is coming, one approach is while the storm is coming we’re going to wring our shirts out as fast as we can. While the storm is raging I don’t think that’s going to work, instead, let’s give everyone an umbrella and try and get everyone inside. As soon as the rainstorm is over, that is the moment of stimulus”
With that in mind, the Canadian Federal Government should take a two-staged approach to help Canadian airlines. Within the next few days, the government should provide a low-cost bridge loan to allow the airlines to make fixed cost payments for at least the next three months. Once the “rain” stops, and we’ve conquered COVID-19, the Federal Government needs to take a look at the industry and ensure a quick return to international travellers to and from Canada.
Part 1 - Bridge Loan
The first stage of the aviation support should be a low-cost bridge loan, to allow the airlines to continue to pay off their massive capital costs. For example, as per Air Canada’s most recent financial statements, Air Canada had a healthy $5.8B in Cash, Cash Equivalents and Short-term Investments. That being said, Air Canada over $7B in current liabilities including almost $3B in advance ticket sales, many of which were cancelled for the next few months causing a drop to free cash flow. In addition, in 2019 alone, the airline paid $493M in interest. Like most organisations with large capital debt, according to Note 10 on their statements, most of their aircraft financing is done in USD, further adding to their costs as the dollar continues to slide.
The quick financing that I’m suggesting, encouraging investors, has already happened in a few countries. Air New Zealand was given a credit line of NZ$900M by the government, with multiple strings attached including suspending its dividend and paying interest rates of up to 9%. Noteworthy is the fact that the government owns 52% of the airline. As reported by OMAAT, perpetually in trouble and unlucky Norwegian has received government aid, although with plenty of strings attached. Air Canada and Air Transat don’t currently issue dividends so the Government will have to attach other strings to this loan.
Lot’s of empty plane seats these days
Part 2 - Equity
The second part of this is trickier - we don’t know when this crisis is going to end. Each month that airlines are unable to fly will add to the costs that airlines will face, necessitating a larger potential funding pool.
Take Canada’s flag carrier Air Canada as an example. It was privatised in 1989 but has faced crises multiple times in the last few decades. In 2009, Air Canada received over $1B from the government to get through the financial crisis. Earlier then that, in 2003 the government considered purchasing Air Canada while it’s shares were near worthless, but instead, Air Canada received money from Deutsche Bank to stay afloat. Since then though, Air Canada’s stock has gained over 3,600% and was the top performing TSX 60 stock of the last decade which rewarded, Calin Rovinescu, the CEO, greatly in the last year (Last year he exercised options worth over $50M, in addition to his $10M salary).
So what should the Government of Canada do? If they provide a stimulus, they should ensure airlines don’t buy back their stock, like many US airlines have done (Air Canada last bought back $35M in Stock in 2015). Instead, the government should take an equity position, or have options, in the airlines accepting the cash, so the Government is compensated for the risk in return for their investment. For private companies like Sunwing (owned by the Hunter family), this would be a difficult decision, but I believe it should be necessary to receive government funding.
The Point
This is a desperate situation, that’s only going to get worse. There is no right answer now, but I believe the governments are going to have to provide liquidity for Canadian airlines to weather this significant downturn, to avoid several bankruptcies and potential further monopolisation of the Canadian airline industry.
What do you think the Canadian government should do?
