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Air Canada
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Good morning, ladies and gentlemen. Welcome to the Air Canada Third Quarter 2018 Conference Call. I would now like to turn the meeting over to Kathleen Murphy. Please go ahead, Ms. Murphy.
Thank you, Valarie, and good morning, everyone, and thank you for joining us on our third quarter call. With me this morning are Calin Rovinescu, our President and Chief Executive Officer; Mike Rousseau, our Chief Financial Officer; and Lucie Guillemette, Executive Vice President and Chief Commercial Officer.On today's call, Calin will begin by highlighting our financial performance for the third quarter. Lucie and Mike will then address our third quarter financial performance in more detail and turn it back to Calin, before taking questions from the analyst community.As usual, I would like to point out that certain statements made on this call, such as those relating to our forecasted costs, financial targets and strategic plans, are forward-looking within the meaning of applicable securities laws. This call also includes references to non-GAAP measures. Please refer to our third quarter press release and MD&A for important assumptions and cautionary statements relating to forward-looking information and for reconciliations of non-GAAP measures to GAAP results.I'm now going to turn it over to Calin Rovinescu, Air Canada's President and CEO.
Thank you, Kathy, and good morning, everyone, and thanks for joining us on our call today. I'm very pleased to report a solid third quarter, with EBITDAR of $1.265 billion, ahead of analysts' consensus estimates.Third quarter operating income amounted to $840 million. These strong results were achieved in the face of increased domestic and international competition from both legacy carriers and new entrant LCCs and ULCCs, underscoring both the global appeal of the Air Canada brand as well as our effective allocation of capacity.Strong revenue and cost management substantially offset the challenges we faced in the quarter, principally the significant increase in fuel prices. Our operating revenues exceeded $5 billion for the first time in a single quarter, reaching $5.4 billion.PRASM improved 4.2% year-over-year or 4.9% on a stage length adjusted basis. Our PRASM performance not only significantly exceeded that of our major domestic competitor, but was amongst the best in the North American airline industry and we are encouraged by the trends we are seeing.The economy has been strong. Our view is that this will continue, leading to modest GDP growth. Unemployment rates are at record lows and the recent settling of the U.S.-Mexico-Canada trade deal removes an overhang uncertainty. We expect our year-over-year PRASM performance both in the domestic market and on a system basis to continue to improve in the fourth quarter.With a healthy demand outlook for Q4, coupled with favorable pricing trends, we expect the higher revenue to fully offset the increase in fuel price in the fourth quarter.From a cost perspective, on an adjusted basis CASM increased 1.1% versus last year's third quarter, better than what we had projected on our Q2 call. All-in CASM increased 9.8% versus the prior year, largely reflecting the added cost of fuel.From a commercial perspective, we continued to invest in our customer experience. The introduction of high-speed Gogo 2Ku satellite Wi-Fi on our wide-body aircraft provides global internet coverage to our customers with the power stream content while flying internationally. We've already completed installation across Air Canada Rouge narrow-body fleet as well as our Boeing 777-300ER.The installation process is ramping up in the fall and we are currently installing Wi-Fi across our Boeing 767 Rouge aircraft as well as our Boeing 777-200LR. This quarter, we'll also begin Wi-Fi installation in our Airbus A330s as well as our Boeing 787s and our Boeing 737 MAX 8.Regarding our new 737s, after several technical problems with the antenna experienced by our selected supplier of the Wi-Fi equipment, which precluded factory installation, we intend to have all of these aircrafts fitted with the new service by next July. The entire Air Canada and Air Canada Rouge wide-body fleet is scheduled to be completed with Wi-Fi by Q3 2019.We're also in the early stages of transitioning the interior of our Airbus A330s to the Dream Cabin standard that customers value on our 777 and 787 fleet. We plan to begin the conversions in 2019, targeting a 2020 completion for the entire fleet, thereby creating a consistent and elevated cabin standard across our entire mainline wide-body fleet. This will be complemented by the new narrow-body cabin standard experience on our Airbus A220s, formerly the Bombardier CSeries, which start to arrive in Q4 of 2019, and on our Boeing 737 MAX 8s.Our investments in our cabin interior as well as our investments in Wi-Fi, in-flight entertainment and the continued rollout of our sharp, new livery underscores our focus on ensuring an updated and consistent world-class experience for our customers across our mainline product.When looking to our lounge product, we continue to refine and enhance our existing lounges, while looking for opportunities to grow our lounge network. In the third quarter, we opened up our new Maple Leaf Lounge in Saskatoon and have new lounge openings in LaGuardia as well as St. John's by the end of the year.We're delighted that the independent research firm Skytrax reaffirmed Air Canada's 4-star rating in the quarter and we're proud to be the only international network carrier in North America to hold this coveted distinction. These results validate our strategy to invest in our onboard and airport product, services and people.We're extremely pleased that Skytrax concluded that our new Air Canada Signature Suite at Toronto Pearson, a 5-star dining experience for our eligible international signature class customers, can now be considered amongst the best, if not the best, in the world for business class pre-flight dinning. Our suite continues to elevate our premium customer experience at our primary hub in Toronto.Before moving on, I'd like to thank our 30,000 member team for their hard work taking care of our customers during a very busy, but satisfying summer and for their contribution to a very strong quarter. This summer, we successfully ran an incredibly tight operation, carrying over 15 million customers from the beginning of June through the end of August. In the quarter, we had 5 days where we carried a record number of passengers, and on August 20th, we carried over 178,000 passengers in a single day.Our team served our customers with the care and class they expect of Air Canada, and on behalf of our entire executive team, thank you.Finally, I like to thank our customers for their continued loyalty and for choosing to fly with us. It is our unwavering commitment to continue to provide superior award winning service as we fly them safely to their destinations.And with that, I'll turn the call over to Lucie, who will discuss our third quarter revenue performance in more detail.
Thank you, Calin, and good morning. Echoing Calin's comments, I would also like to thank our employees for their continued hard work in taking care of our customers, particularly during the very busy summer months. Having Skytrax reaffirm our 4-star rating is a true testament to the ongoing hard work, passion, team work and dedication of our Air Canada team.Turning to our third quarter results. We achieved a very strong passenger revenue performance, totaling $5 billion in the quarter, up $504 million or an efficient 11.2% from last year on capacity growth of 6.7%. Traffic increased 7.5%, while yield improved 3.4%. When adjusting for a 1.3% longer stage length, yield increased 4.1% when compared to last year.The yield growth was largely driven by increases in fares and carrier surcharges, growth in high yielding local traffic and an improvement in the overall fare mix. We also saw greater proportional growth of high yielding business in premium economy passengers in the quarter. PRASM improved 4.2% year-over-year or 4.9% on a stage length adjusted basis.In the Business cabin, on a system basis, we successfully grew revenues by $98 million or 13% from the third quarter of 2017 on traffic and yield increases of 8.9% and 3.7% respectively. Both traffic and yield increases in all geographical regions versus the third quarter of '17.The continued strong performance of our Business class cabin reflects our strong position with this key segment as well as a clear return on investments from our premium products and services over the last few years, including the introduction of our Air Canada Signature Service, which provides an elevated premium experience throughout the entirety of our customer's journey as well as an increased emphasis on training for our premium airport agents and in-flight service directors.We also continued to see success in our strategy to attract traffic transiting our hubs, facilitated by our ongoing investments to improve the connection process at all 3 of our primary Canadian hubs.We've successfully grown ancillary revenue by 14% since the beginning of the year led by baggage fees, paid upgrades, seat selection and preferred seats. This represents growth of 8% on a per passenger basis achieved through a combination of enhanced branding as well as unbundling of services with our new fare categories and improved merchandizing of our ancillary option on aircanada.com.With that, let's turn to our key markets. In the domestic market, our capacity grew 4.3%, revenue increased $59 million or 4.3% on traffic growth of 3.4% and a yield improvement of 0.9%. Traffic growth was reflected on all major domestic services and included gains in the Business cabin. We also saw growth in connecting traffic to international destination and domestic yields improved on most major domestic services.We're pleased with the performance of the Eastern Canada triangle of Toronto, Montreal and Ottawa and continue to see improvements in these markets. However, our end-to-end regional market, where we have a relatively small presence, is seeing increased competitive pressures and capacity additions. Transcontinental routes were somewhat impacted by competitive pricing activities on point-to-point markets within Canada, particularly in the month of July. The overall domestic yield improvement versus the third quarter of 2017 reflected both gains in the Business cabin and the impact of new fare categories on our domestic services.Looking ahead to the fourth quarter of 2018, we anticipate continued improvement in traffic, revenue, PRASM and yield. While undertaking a competitive review, we are seeing some easing of competitor capacity growth in Eastern Canada, where we have our strongest presence. In the U.S. transborder market, on capacity growth of 5.9%, revenue increased 9.7% on traffic and yield growth of 5.6% and 3.8% respectively.The launch of our new fare categories, specifically our comfort fare, contributed to the positive yield performance. PRASM improved on most U.S. transborder services in the quarter and we were particularly pleased with our performance in California as well as our transborder leisure routes.Looking ahead to the fourth quarter, we anticipate our positive performance from a traffic, revenue and yield perspective to continue. Our U.S. short-haul business market showed significant resiliency in the third quarter and the outlook for the fourth quarter in these markets is positive.While the U.S. economy remained strong, we will continue to maximize the opportunity and will explore enhancing our presence in markets where we see potential, as illustrated by a recent announcement of our nonstop service from Montreal to Raleigh, North Carolina.Now turning to the Atlantic. This market saw the highest revenue growth in the quarter and this is the first time in a quarter that an international market has surpassed the domestic market from a passenger revenue perspective. I see this as a further evidence of the success of our international expansion strategy which we embarked on several years ago and illustrates the strong foundational market position across the Atlantic that we have built.Now moving on to the details. On capacity growth of 10.3%, Atlantic revenues grew $273 million or 20.3% to $1.617 billion in the quarter, driven by traffic growth of 13.1% and a yield improvement of 6.4%. We recently launched a new fare category on Atlantic Services, which contributed to the overall yield improvement versus the prior year.On a stage length adjusted basis, PRASM improved 9.9% when compared to last year, with improvements on all major Atlantic Services. During the busy month of June, we began operating several Transatlantic routes, including our nonstop Mainline Service to Shannon from Toronto, to Dublin from Montreal and to Zurich and Paris from Vancouver as well as our nonstop Air Canada Rouge services to Bucharest and Lisbon from Montreal and to Bucharest, Porto and Zagreb from Toronto.We're happy to say that all of these new routes met or exceeded our expectations. And I'd also like to highlight that Athens, Rome and Lisbon also performed very well.Looking to the fourth quarter, we're pleased with our outlook and we are anticipating another strong quarter over the Atlantic from a traffic, revenue and yield perspective. The network announcements from our primary domestic competitor represent a low level risk for the business in the short term.The composition and range capabilities of our modern, efficient fleet gives us the flexibility and the tools to take action with routes if they are not achieving our internal targets, which is illustrated with our seasonal suspension of our Toronto to Mumbai service, where we are reallocating the aircraft to a much better performing Vancouver-Delhi market.Recently, we announced our new nonstop service from Toronto to Vienna, as well as Montreal to Bordeaux, both to begin in 2019. Our confidence to invest in Vienna further illustrates how hub to hub flying remains the backbone of our Transatlantic strategy.Now looking to our Pacific markets. We were pleased to see significant improvements into several of our key markets. On capacity growth of 1.1%, revenue increased $70 million or 9.9%, driven by traffic growth of 2.9% and a strong yield improvement of 6.8%. The yield growth reflected increases in base fare and carrier surcharges as well as a general improvement in the fare mix. Year-over-year, PRASM improved a very healthy 8.6% in the quarter, with most major services showing increases.We are particularly pleased with the performance of our service to Korea and Japan. In Japan, we consolidated our service from Toronto to Tokyo-Haneda and started our Tokyo-Narita service from Montreal. Previously, we had operated into both Haneda and Narita from Toronto. This initiative to optimize our presence in Tokyo has exceeded our expectation.Services to Australia were slightly under pressure from a PRASM perspective, mainly due to increased industry capacity from North America. However, we expect this to improve as we enter the stronger winter period.Looking at the fourth quarter, bookings are in line with our expectation and we expect to see a favorable impact of increases to base fare and carrier surcharges to continue. We've also taken action to reduce specific capacity in Q4, which we feel will have a positive impact on our performance.Revenues from the remaining services increased $80 million or 7.9% on traffic growth of 11.1%. A yield decrease of 2.8% was mainly due to a significant increase in average stage length due to having removed the short-haul tag between Santiago and Buenos Aires as Air Canada now serves both markets on a nonstop basis. Q3 is traditionally a softer demand period for many of these routes, which tend to ramp-up in the winter.During the quarter, we saw continued competitive pressure on our Mexico services, which hurt our yield, although our traffic numbers remained strong. We also saw some softening of demand to certain Caribbean markets. And on a stage length adjusted basis, overall yield for the other markets was unchanged from the third quarter of 2017.For the fourth quarter, we expect to see traffic and revenue improve as we enter the stronger winter period. However, we anticipate competitive pressures, as well as the average stage length increase on the removal of the Santiago and Buenos Aires tag to continue to apply downward pressure on our yields relative to Q4 last year. We continue to believe that South America represents a growth option to deseasonalize the winter for us and we will continue to take advantage of opportunities to counter seasonality with markets where demand is strong in the winter.From a system capacity perspective, for the fourth quarter the growth rate versus the previous year will decrease and this tapering trend is projected to continue through next year as we sharpen our focus on further yield improvement.Moving on to cargo, which delivered another strong quarter. Cargo revenue increased $24 million or 12% year-over-year, driven by yield growth of 10.6% and higher traffic of 1.6%. Consistent with prior quarters, the Atlantic and Pacific cargo markets performed particularly well. In the quarter, Air Canada Cargo won the Platinum Air Cargo Excellence Award. This is our fourth Air Cargo Excellence Award and the third in a row in the category for airlines carrying up to 1 million tonnes. This award is based on the Air Cargo Excellence Survey, where carriers are ranked by freight forwarders on customer service, performance and value.Looking ahead of the fourth quarter, we anticipate the positive cargo performance to continue from a traffic, revenue and yield perspective. Cargo remains an important contributor to the Air Canada family.So I will now turn the call over to Mike for a discussion on our cost performance and balance sheet metrics.
Thank you, Lucie, and good morning to everyone. I would also like to thank our employees for the role and teamwork in achieving the strong Q3 results and for their professionalism and dedication in taking care of our customers.Our solid EBITDAR results in the quarter were also driven by a strong unit cost performance. On an adjusted basis, CASM increased 1.1% from the third quarter of last year, better than expected on lower than forecasted regional airline expense, the impact of cost reduction initiatives related to our cost transformation program and other operating expense reductions; lower regional airline expenses primarily due to certain engine maintenance events being recorded as capitalized maintenance rather than operating expense in the third quarter of 2018; and to timing of maintenance activities related to the Air Canada Express Fleet.Cost control remains an essential element of our strategy. As discussed in prior calls, we have a company-wide cost transformation program in place, which is aimed at securing incremental savings of $250 million by year-end 2019. At the end of the quarter, we've already identified or realized 2/3 of this targetMoving on to fuel. Fuel expense increased $403 million or 46% in the quarter, with higher jet fuel prices accounting for $324 million of this increase. A unfavorable currency impact accounted for $55 million, while a higher volume of liters consumed added another $40 million. The average price of fuel was CAD 0.83 per liter in the quarter, up 40% versus the same quarter in 2017.With respect to fuel hedging, we've currently hedged approximately 38% of our anticipated fuel consumption for the fourth quarter at an average WTI equivalent cap price of USD 68 per barrel. Looking ahead, our assumption is that the price of jet fuel will average CAD 0.86 per liter in the fourth quarter for 2018 and CAD 0.81 per liter for the full year of 2018.Now we provide some additional guidance on costs. For the fourth quarter, we expect adjusted CASM to increase 1.5% to 2.5% when compared to the fourth quarter of 2017. For the full year 2018, we project that adjusted CASM will range between no increase to an increase of 0.75% when compared to 2017. Our projections are also based on the assumption that the Canadian dollar will trade on average at CAD 1.30 per U.S. dollar in the fourth quarter and CAD 1.29 per U.S. dollar for the full year of 2018.Now turning to our balance sheet and liquidity. At the end of the quarter, unrestricted liquidity amounted to $5.3 billion, another record for Air Canada. A free cash flow of $470 million, increased $146 million from last year. The third quarter of 2018 included proceeds of $293 million from the sale of the 25 Embraer 190 aircraft. As discussed in our Q2 call, we will continue to fly these aircraft under operating leases until they gradually exit the fleet between 2018 and 2020.Looking ahead, we now project free cash flow of $500 million to $600 million for the full year 2018 instead of the $350 million to $500 million previously forecasted. The increase in projected free cash flow is largely due to higher cash from operations, including working capital than what was previously anticipated.Adjusted net debt of $5.6 billion at the end of September decreased $496 million from December 31, 2017 as higher cash and short term investment balances more than offset increases in long term debt and capitalized operating lease balances.Our leverage ratio was 2 at the end of September and we remain on track to achieve a target ratio not exceeding 1.2 by the end of 2020. At quarter-end, our return on invested capital was 12.7%, while our weighted average cost of capital was 7.4%. Our weighted average cost of debt was 4.3% at the end of September. Additional information can be found in our financial statements and MD&A, which were posted on our website and filed on SEDAR this morning.And with that, I'll turn it back to Calin.
Thanks, Mike. When Air Canada first began its transformation 9 years ago, our goal was to create an airline that could be sustainably profitable over the long term. We said that we would not rely on variables such as low fuel prices or other temporary advantages, but instead created a company that could perform under any circumstance.The results of the third quarter headlined by record revenue, amongst the North American industry's leading PRASM performance, record unrestricted liquidity, all demonstrate that our company is indeed delivering on this commitment. During the quarter, we saw fuel costs increase by nearly 46% versus the prior year, new low cost domestic and foreign carriers enter the market or expand services and general uncertainty about the economy in Canada's major trading relationship. We also face the wrath of Mother Nature with several high impact hurricanes, typhoons and storms.Yet against this backdrop, Air Canada turned in a very solid performance, well ahead of our major domestic competitor and at the forefront of major North American carriers. However, the transformation is not complete, nor will it ever be as we continually devise new strategies and adopt new technologies to remain ahead of our competition and to present an ever more appealing value proposition to our customers.One such initiative that will provide a foundation for others is our new passenger service system. PSS is a cross-functional company-wide initiative that will see legacy reservation and other behind the scenes technology replaced next year. The new system will give us greater functionality and adaptability to improve all aspects of our business, including customer service.PSS will also support our new loyalty program, which will set a new standard for the industry. When it launches in 2020, our program will further drive loyalty to Air Canada by providing customers additional earning and redemption opportunities, more personalized service and a better digital experience.The new program is also an example of how Air Canada intends to use data and artificial intelligence to better understand our customers and meet and even anticipate their needs. We are partnering in several AI ventures, including the SCALE.AI Supercluster in Montreal and the Vector Institute in Toronto to position ourselves on the ground floor to participate in advances of these remarkable technologies with machine learning and intuitive algorithms.We're also innovating commercially. Earlier this year, we became the first North American carrier to establish a joint venture with a Chinese carrier, Air China. Hinting at the promise of this new JV was IATA's 20-year passenger forecast released last week describing an eastward reorientation of the global aviation market.The Asia-Pacific region is now expected to drive the biggest growth, with more than half the total number of new passengers over the next 20 years. IATA expects China to displace the United States as the world's largest aviation market in the mid-2020 and Air Canada is now well positioned to serve in this rebalancing after having invested in the China market for nearly 20 years.At the same time, our Transatlantic A++ joint venture continues to deepen and the benefit of it is reflected in our strong performance in this market. Combined, these 2 JVs give us quite an important market presence over the vitally important Atlantic and Pacific markets.I'd like to conclude by once again thanking our 30,000 employees for their hard work and dedication during a busy, but rewarding summer season. I also thank our customers for their continued loyalty and assure them of our unwavering commitment to keep delivering superior customer service.And with that, I'll turn it over to you for some questions.
[Operator Instructions] Our first question is from Konark Gupta with Macquarie Capital.
I just had 2 -- good morning. I have 2 questions here, Calin. First on the liquidity. It remains quite strong here and free cash guidance was obviously raised here. Now the stock has come under pressure over the last few days or weeks. And in terms of your capital priorities, where do you see buybacks ranking right now and do see an opportunity to redeem any of your high yield debt in 2019?
Yes. I mean, Michael will cover that. I think we've stated in the past our objectives in terms of how we will deploy excess liquidity and we continue to opportunistically look at market buybacks. But Michael will provide a bit more visibility.
Good morning. Our capital priorities have not changed. Debt reduction and hitting that 1.2 target by end of 2020 remains the key priority. Opportunistic stock buybacks are still a focus for Air Canada. And in fact although we were in a blackout period, we had instructed our broker before the blackout period to buy back stock during the blackout period at a certain price -- or below a certain price. And we -- unfortunately, our price was hit in October and so we did buy back $50 million worth of stock in the month of October. And we think that's good value and a good allocation of capital and consistent with the objectives that we have established for capital allocation at this point in time. On the second issue, high yield, we would love to get rid of the high yield. However, it's not callable until 2021. And we've done the math and putting in any type of bid for that would not be accretive to us at this point in time. Certainly, if that opportunity becomes available, we will step into it fairly quickly. But again, it's not a large part of our overall capital structure at this point in time.
And then secondly -- Lucie, welcome to the conference call here. You mentioned about PRASM is expected to continue to improve in Q4 in the press release. Were you referring to the absolute PRASM number here or the growth rate versus last year? And can you also share some details on what's driving such a strong PRASM, because some of your competitors are kind of noting competitive pressures in the market right now?
Hi. And thank you. Well, first and foremost, the indication for RASM is in terms of growth rate. And to achieve the RASM improvements there's a few things that we're really focused on. The first obviously is in terms of recuperating the incremental cost to fuel. So we're very laser-focused on obviously pricing in surcharges. But above and beyond that, we have a pretty solid strategy for us to continue to improve in the premium cabins, which obviously provide some very good yield and RASM upside, and also on the ancillary side of the business.
And in terms of margin expectations, do you see margin rebounding at some point here in 2019?
Well -- it's Mike. We've already -- we kept our guidance consistent with Q2 that margins will move back into the 17% to 20% range beginning of '19. And certainly our comment today -- Calin's comment today that we will cover the fuel price increase in Q4 is a strong sign of that guidance.
Our next question is from Walter Spracklin with RBC.
My question I guess starts with on capacity. You'd given us indications before that the 7% is the level that we should expect for 2018. But I'm hearing a little bit more, perhaps indication that fourth quarter might be a little tighter than back when you give that 7% guidance. Am I reading that into -- am I'm reading right into that or were you always kind of considering a fourth quarter, "Well, we'll ratchet it back," when you gave that 7% guidance?
Yes, I think that we've always said we would be doing some -- Walter, it's Calin here. We've always said that we would be doing some trimming as we look at it, but I'll say it's around the edges. Well, I wouldn't characterize it as being a material reduction in any fashion.
Walter, it's Mike. We're still targeting in and around 7% for the year and that kind of backs into something a little higher than 5% in Q4. So you've seen a continuous decline of capacity growth, as we've always talked about, from Q1 through Q4 and that will continue somewhat in 2019.
And that was where I was going with the next one. I mean, based on your aircraft coming online and no real change in utilization on a hours per day basis, it would suggest you're in the 3% range. Is that something that you'd be comfortable? Is that reasonable or are you going to look at more utilization per day for 2019?
Walter, that's probably a little bit low. We're still bringing some wide-bodies in next year. And of course we're bringing in the 737s, which have more seats than the Airbus 320. So that's probably on a low side. But certainly we'll take a step down from where we end this year. And again, we haven't finalized all our business plans yet and we'll provide all that guidance in the next couple of months to you.
So less than 7%, but higher than 3%. Got it.
Yes. You got it.
Margin, 16% guide for this year. If we're going 7% capacity and just assuming some -- relatively close to that on traffic and then including your CASM and plugging in fuel, the only thing left to do is yield. And outside of kind of a -- something well north of 5% is what would be required on your yield or PRASM to get up to 16% margin. Is that reasonable to assume, something north of 5% to hit the 16% margin?
If we do all that, we will have done all your work for you, Walter. No, look, I think that that is from an indicative perspective. What we're saying here is that we expect the fourth quarter to be strong in terms of RASM and yield performance. And so you're kind of -- if you back into that kind of math and if you extrapolate from it, I think you could come to your conclusions.
Our next question is from Chris Murray with AltaCorp.
Mike, can you give us any more color on the Aeroplan transaction and how we should think about it?
Chris, good morning. I'd love to, but I can't is the short answer. We're also in the middle of negotiations and we've said that we expect to close by the end of the year. And at this point in time, that's all we can provide.
So once we -- okay, I'll leave it there then. And then just one other clarification if I can on your free cash flow guidance of $500 million to $600 million. Does that include the proceeds from the sale leaseback of the Embraer aircraft?
It does.
So that's one of the reasons for the step up. That's fine. And then maybe I'll ask the question a different way. So just to confirm. So your comment around RASM or yield into Q4 fully offsetting -- so with that in place, I'm just curious about what you think about sustainability of yields then as we go into Q4. And certainly there's been some concern maybe that the economy could be softening in certain places, maybe some turndown, been a lot of noise as of late. So I'm just kind of curious of what you're seeing sort of in the medium term as we get past Q4?
Yes. No -- it's here. I think, Chris, we have seen despite the noise -- we've heard a lot of the noise. We've seen obviously media reports of [ things ] around the trade dispute, about the softening of the economy, the weak equity markets or bumpy equity markets the last few weeks. Despite that, in our markets we continue to see strong demand fundamentally. And so we don't consider the top end of the business to be a commodity business. We've invested very heavily in the top end of our business and we think that that is something that helps sustain us. So as of right now, we see demand as continuing to be strong into the fourth quarter of this year. And obviously we're not going to have a crystal ball to predict what happens in 2019, but so far so good.
Calin, if I can ask one other question on Sixth Freedom traffic then? With capacity stepping down -- and it was interesting your comment about Atlantic revenue exceeding domestic revenue. Should we start expecting that the international traffic will start balancing out year-over-year or should we continue to see more of the growth focused on Sixth Freedom?
Sixth Freedom is one of our key objectives. So we certainly don't intend to take our foot off of the accelerator of Sixth Freedom traffic. I think in any market like this, we will take the temperature of how well we're doing on a given route. And I think you heard Lucie identify some of the routes where we're doing better than expected and some of the new routes that really were pleasant surprises. A lot of those are fed by Sixth Freedom traffic. So Sixth Freedom is a big part of this equation and it's the one that gives us the capability to have confidence to compete with international carriers. We're not -- as we've said over the last several years, we're not viewing this thing as being a domestic battle only. And so this has been the big driver of our success, Sixth Freedom, and we'll continue to focus on it going forward. And we're still scratching -- in terms of the U.S. side of the market, Chris, we're still just scratching the surface of what we think is available there as we've grown out our Canadian hubs.
And Calin, if I can add, there's one thing that we don't often talk about, but when we converted our revenue management systems 2 years ago to an [ OD ] control system, it was really intended to help us better make those decisions in terms of which traffic flows we should accept or reject. And given the fact, for example, that some of these connecting traffic itineraries provide better currency opportunities, we're well equipped to be able to make good decisions to capture that Sixth Freedom. So we don't turn it on or turn it off. On the contrary, we have the ability to optimize our network, which was the intention of this new tool.
Our next question is from Turan Quettawala with Scotiabank.
I guess, Mike, maybe I was wondering if you can talk a little bit on the cost side here going into 2019. I know you said that you had about 2/3 of the target on the CTP already sort of in the bag, I guess so to speak. Can you give us a sense of how much sort of on a year-over-year basis that will benefit your cost in 2019?
Good morning. I don't have those numbers off the top of my head right now. We can get those numbers to you possibly when we have a little more visibility. Again, we're in the middle of doing our business plans right now and we'll provide some CASM guidance probably in February when we release the year-end results. As we talked about our capacity, we'll take a step down next year. But our focus is still laser-focused on finding cost reductions, including filling the rest of the gap on the 250 CTP program.
And I guess is there possibility to maybe increase that? I know you're always looking at cost obviously, but...
We're always looking at cost. When we establish one of these CTP programs, Turan, it's really with the intent of giving the organization a bit of a target that we want to shoot for and be able to measure success. But of course we're in a constant CASM program. And when we look at having CASM performance like we had this quarter, CASM ex-fuel, it's a result of having that focus on costs. So once we get beyond the 250, we'll see what else needs to be done in terms of having specific programs. But when I finish -- these CTP programs are motivators for the team to be able to have a target that we can measure success and that we can then compensate in function of achievement.
And just to add. Calin's book -- in his closing comments about some of the technology investments we're making over the next couple years, I think -- our view is that we haven't yet determined how much, but our view is that will drive value both from the revenue side and from the cost side as well.
And I guess there's been a bunch of, I mean -- I guess maintenance has been a bit of a positive factor overall this year in terms of CASM performance. Mike, is there somewhat of a catch up that maybe comes up next year or has it just been obviously much better work that you've done on the maintenance side?
No, there's no -- I don't think there's any carry over into next year. Q4 will be a little bit heavier and that's built into our CASM guidance for Q4. As we talked about, some items got deferred from the first half into the second half. But we don't see anything hitting 2019. And as you know --and we'll have to give all the market and all the analyst community an update early in the year. IFRS 16, the new accounting standard, around bringing debt on the balance sheet will also have a major impact on maintenance expense going forward as well.
And just maybe one last one from me. I know you didn't want to talk about the Aimia program, but is it possible to at least give us a sense of what type of guidance we should expect once the deal closes?
Not yet, Turan. I think that -- you heard me say that we are building our loyalty program as a very compelling loyalty program that will -- the new program will come in place in 2020. So once we complete the acquisition of Aeroplan, assuming that that goes forward, then we'll provide guidance at the beginning of next year.
So we should expect something in terms of maybe margins or whatever as once that closes, is that fair?
Yes, our target is -- we're going to hold a fairly -- another, hopefully, very successful Investor Day in late February, at which point -- we'll bring the full picture at that point in time, if not earlier.
And our next question is from Cameron Doerksen with National Bank Financial.
Mike, just I guess a question on fuel efficiency. I mean, we know that with the 737 MAXs coming in and the existing 787s there, individually what kind of fuel efficiency improvement you get on those aircraft? And I wonder if you can maybe talk a bit about kind of what the aggregate impact is fleet-wide on bringing in these aircrafts. Is there anything you can sort of talk about in 2019 and what your expectation is for -- just kind of pure fuel efficiency improvement is on an aggregate basis?
Yes, that's a great question and I wish I had the answer off the top of my head. Right now we have 18 737s. We'll have another 18 coming in next year. So 36 by next summer. And those planes are delivering 10% to 15% fuel efficiency benefit for Air Canada. And so obviously that benefit will grow, will double next year as we double the number of planes.
And maybe just -- if you just maybe talk a bit about the sun destination markets, I guess both in the Caribbean and Mexico and also maybe Florida. I mean, does it appear -- so there's a fair amount of additional competitive capacity coming into those markets in the winter. Just sort of if you can talk a bit about what you're seeing in those markets and your confidence in still being able to have a good profitable business there?
Hi. It's Lucie. I'll start with the Caribbean market. So we did see a little bit of softness in the third quarter, but as we look forward into our advance bookings things are definitely stabilizing on the Caribbean. The Mexico story is a bit of a different one. There was a fair amount of incremental competition. So it was very competitive on the pricing side of the business. But as we said earlier, our demand did hold. So we hope that going into the winter season on some of these markets, we'll be able to push up the yield. With respect to Florida and other Rouge markets like Vegas as well, those leisure markets are doing very well. And in terms of the advance bookings, certainly meeting our expectations.
Our next question is from Andrew Didora with Bank of America.
I guess to ask the 4Q revenue question a different way. Can you give us some color on how the domestic entity overall unfolded over the course of 3Q to maybe help give us a sense of how big of an improvement we could see into 4Q? And then outside of domestic -- I would think domestic would be the vast majority of the sequential improvement. Should we expect international to improve as well or does that subside a little bit?
On the domestic network, the majority of the impact that we felt in the third quarter was definitely in July, and that's where the yield was most pressured. But we did see a very competitive environment all summer with the low cost carriers and the ultra low cost carriers as well. So that's really what impacted us most on the domestic network. Looking forward, we obviously are looking at what kind of capacity changes are occurring in the market. Based on what we're seeing, we feel also that there is some opportunity for some upside there as well. The good thing is on domestic we feel that we're well equipped to compete with the different fare categories that we have. So I think we have the right levers to be able to perform better in the fourth quarter on the domestic network.
And then Mike, just to clarify the updated free cash flow number. Your prior free cash flow guidance included the $295 million gain from the Embraer sale, correct? And so the update this morning was purely from an operations perspective? Do I have that right?
That's exactly correct. I should have mentioned that earlier -- in the earlier question. The $350 million to $500 million that we had previously included the $290 million plus or minus from the Embraer sale. And so we're comparing apples to apples here.
Our next question is from Helane Becker with Cowen.
So I just have I think 2 questions. One is, are you noticing at all a change in seasonality that is accounting for the strong market that you've been seeing over the last few months? And I just mean by that is, are you thinking that -- are you noticing a longer leisure travel season or a longer business travel season that would account for the strong premium yields that you saw in the last quarter?
Yes -- no, that's a good question, Helane. And the answer is yes. In fact you may have seen we've extended -- in some cases some of our European destinations we've extended the summer season to longer, to the end of September, end of October. So you're absolutely correct. We've made a big effort, as you know, over the last number of years of trying to balance the seasonality differences that we've seen here. And I think that you're starting to see the -- some impact of that this year. So your question is bang on. And we hope to see more of that as things evolve. We've seen it in markets like the Central European markets. We've seen it in Athens. So it's been a good -- directionally a good sign.
And South America could be an opportunity for us to further deseasonlize.
And then my other question actually with respect to that is, do you -- I don't know if you survey your passengers. I mean, I know you probably ask them how service was and stuff like that. But I'm wondering if you ask them also -- especially leisure passengers -- did you choose Canada versus the U.S. or another market, so that Canada as a country is actually winning business from maybe the United States or other countries?
Well, no -- look, I think that the thing that has helped us is the investment we've made in our domestic hubs. I mean, I think that people have not chosen Canada as a destination because of political reasons or for supporting the principles espoused by Canada, but the thing that has driven our traffic has really been the facilitation efforts that we've made both in terms of our network, the strength of that network and the connecting capabilities, as well as the improvements that we've made in our main hub airports, where we sought to make the experience equivalent, if not better, to connecting in any U.S. market. And so I think people are happy to do that. There may be in some instances where someone wants to avoid the United States or something like that, but we certainly have not built our business model around them.
Our next question is from Nishant Mani with JPMorgan.
I wanted to ask about kind of how to think about 2019 cost maybe in a different way. If I take a look at the 2018 growth forecast on a capacity basis, you guys are decelerating versus '17 at about 4.5% or so, kind of close to 7% growth rate in '18 versus 11.5% in 2017. Consequently, CASM-X fuel also swung about 3 points unfavorably in 2018. If I think about that relationship going into 2019 -- and you guys have just kind of targeted growth for 2019 capacity -- is that relationship broadly stay constant or should we expect some change to how -- you guys leverage fixed costs in 2019 and perhaps the implementation of the strategic cost program would offset some of that slower growth?
It's an interesting question. And I hate rules of thumb in this business, because there are so many other factors that we can influence, certainly the CTP program is one of those areas. This accounting standard that's coming in on Jan 1 will also impact CASM-X as well, given capitalization of maintenance versus historically expensing some maintenance expense. So there are a number of different factors that will go into the CASM guidance. So I -- certainly, the rule that you put in place can be used as a proxy, but then you've got to adjust it for all the other elements that exist. And there's no doubt that we can continue to leverage our overhead better as we go forward as well.
And then perhaps a roundabout way of asking about Aeroplan. I know you guys don't want to just comment on it specifically. But from my understanding, your 17% and 20% margin targets for '19 and '20 are X any kind of impact from Aeroplane. Is that correct? And then...
That is correct, that is correct, yes. So the 17% to 20% are drivers that we identified, as you know, at the last Investor Day and we -- that was of course prior to the Aeroplane transaction.
And then I guess a way of roundabout asking about Aeroplan is, should we expect your 2019 Investor Day in February, should the Aeroplan transaction close on time by year-end, a refresh to the long term margin target? Or you would be...
That is correct, that is correct. So you can breathlessly wait for February 2019. And hopefully if the transaction does close -- of course, as you know, whenever you're into a transaction, there's always closing risk. But to the extent that the transaction is closing, we intend to provide full visibility at the February Investor Day.
So we should expect 2019 X fuel CASM, a broader framework for capacity growth as well as updated margin targets?
Yes, correct.
Our next question is from David Tyerman from Cormark Securities.
I have 2 questions. The first one is on the international side. Your fleet -- according to your fleet plan for 2017 to 2019, wide-body is going to be pretty stable, up 2 planes. I was just wondering if you could talk about longer term, what kind of -- whether this can be a growth area, because if you don't add planes, obviously it's going to get hard to grow it and you seem to have done pretty well. So I would think it could be.
The way to think of it, David, is that we had not grown. Air Canada had basically not grown in well over a decade. Really, if you go way back to the acquisition of Canadian Airlines, there had not really been any wide-body growth. And that is a function -- that was a function of the events that occurred over that decade from 9/11 to the restructuring of the entire airline industry, SARS, et cetera, etcetera, to the combination of the 2 companies and then the downsizing. So our fairly significant growth that occurred with the 787s and then with the Rouge rollout were really a reset of the growth that we thought should have really occurred and we did it fairly quickly and we also did it -- I think now the proof is in the pudding -- fairly efficiently. So I think that as we look to the future, we certainly expect to continue growing. As airlines cannot deliver greater profitability by stagnating, so we certainly intend to continue growing. But the growth will be measured. We certainly have opportunities to add wide-body aircrafts. As you know, we still have some options, 787 options at excellent pricing. And so we will continue to look for opportunities like that. At some stage, we'll have to look at a re-fleeting around the 767 that still is in the Rouge fleet and so there will be some other decisions in and around that. So I think that you should view wide-body growth going forward as a tactical, more measured approach because we have -- we've had a great portion of that catch up so far. And then of course we'll monitor how we're doing on the Sixth Freedom progression that I discussed earlier. That could also help drive incremental wide-body growth.
And then the other question I have is on IFRS 16. So Mike, broadly should we be thinking in terms of depreciation and amortization expense and maintenance expense increasing, offset by lease expense decreasing, with relatively not a lot of impact overall? Or how should we think about that?
At a very high level -- and we're still working out the numbers because it is complicated. Like it's just not airlines. It's all companies are facing this new standard effective Jan 1st on both sides of the border. But typically maintenance expense will drop, will decline. Depreciation will go up. And rent will obviously go away and either go into -- a part will go to deprecation and part will go to interest.
So why would maintenance go down?
Because historically for leased planes we expensed maintenance. Now that they're on the balance sheet, their own planes, and therefore we capitalize maintenance.
And you've been using a times rent expense as a proxy for the capitalization process.
Right.
IFRS 16, does it result in a materially different number than that?
No, no.
Okay, that's perfect. Thank you.
Thanks, David.
Our next question is from Kevin Chiang with CIBC.
Maybe just 2 follow ups. I think you spoke earlier about deseasonalizing your business and talked about flying south as one of those initiatives. I'm just wondering are there other locations or other geographies that can help bring up earnings in the shoulder quarters? And I guess how important is a loyalty program to maybe having a step function improvement in that seasonality to reduce the volatility between, let's say, Q1, Q4 versus what you put up in Q2 and Q3?
Right. So this is something that we have identified as one of our objectives when we launched Rouge, for example, and Rouge is intended to address in part that challenge by using some of the wide-body airplanes in the summer to Europe and in the winter wide-body airplanes to larger sun destination markets, the Las Vegases of this world as well Floridas, et cetera. And that has worked reasonably well, but has not fully solved our problem to be very direct. And so we continue to look for opportunities. Lucie mentioned South America as one alternative. So we continue to look for opportunities to do that. A question that Helane Becker asked about the extension of the summer season helps a little bit as well. But there's no question that for us Q2, Q3 are such dramatically important quarters that we will always look weaker in Q4 and Q1. But I think that the picture is a lot better than it was in the past and we will continue to find these opportunities. We don't want to fly large airplanes into markets with really deteriorating yields and so we're not going to give the seats away to fill the airplanes. That's definitely not part of our strategy. But we will look to find strategic opportunities to deploy. They will be in and around sun markets, South America, and extension of some of the leisure markets for longer periods of time.
Yes, perhaps other than South America. There's markets, for example, like Australia that present those types of opportunities. India was another one that's highly seasonal. So we continue to look at those opportunities to capture opportunities in the off/shoulder periods.
And just the loyalty program. As you bring that [indiscernible] in-house, is that something that you see as materially changing the seasonality within Air Canada?
No, look, there's no question that if -- the loyalty coming in-house and us controlling the inventory will definitely give us some additional tools for those quarters which are weaker. For sure that will give us one additional tool that we don't have today to fully deploy.
And just -- maybe just following Cameron's question on fuel efficiency, if I were to ask it in a different way. If I look at the last, let's say, 7 to 8 quarters, you look like your fuel consumption per ASM is falling roughly -- let's call it 2% on a year-over-year basis. Is that kind of a good run rate to assume as you continue to add these newer planes over the next 3 to 4 years here?
Kevin, good morning. It's Mike. Certainly, that's -- I would say that's the floor. As we add the remaining 737s and then of course the A220s starting late next year, you'll see probably that improve.
[Operator Instructions] The next question is from Konark Gupta with Macquarie Capital.
Just a quick follow up. On the CASM side, so on the $250 million of cost initiative, I think you guys noted about 2/3 is identified or realized. I'm just wondering what's realized versus identified here. I mean, like how much do you expect to realize in 2018 versus 2019?
The majority -- certainly, more than half will be in '19 given the ramp-up that we've had. So I don't have the exact number for '18 realization, but it's going to be the smaller component of that 2/3.
So more than half is 2019 of that 2/3?
Yes.
Okay, that makes sense. Thank you, Mike.
Thank you.
Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to you, Ms. Murphy.
Thank you, Valarie, and thank you everyone for joining us on our call today. Thank you very much.
Thank you. The conference has now ended. Please disconnect your lines at this time and we thank you for your participation.