Air Canada
TSX:AC
If you don’t study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards.
Utilize notes to systematically review your investment decisions. By reflecting on past outcomes, you can discern effective strategies and identify those that underperformed. This continuous feedback loop enables you to adapt and refine your approach, optimizing for future success.
Each note serves as a learning point, offering insights into your decision-making processes. Over time, you'll accumulate a personalized database of knowledge, enhancing your ability to make informed decisions quickly and effectively.
With a comprehensive record of your investment history at your fingertips, you can compare current opportunities against past experiences. This not only bolsters your confidence but also ensures that each decision is grounded in a well-documented rationale.
Do you really want to delete this note?
This action cannot be undone.
| 52 Week Range |
14.9
24.57
|
| Price Target |
|
We'll email you a reminder when the closing price reaches CAD.
Choose the stock you wish to monitor with a price alert.
This alert will be permanently deleted.
Air Canada
You don't have any saved screeners yet
Good morning, ladies and gentlemen. Welcome to Air Canada's Fourth Quarter and Full Year 2019 Conference Call. I would now like to turn the meeting over to Kathleen Murphy. Please go ahead, Ms. Murphy.
Thank you, Elena, and good morning, everyone, and thank you for joining us on our fourth quarter and full year call. With me this morning are Calin Rovinescu, our President and Chief Executive Officer; Mike Rousseau, our Deputy Chief Executive Officer and Chief Financial Officer; Lucie Guillemette, our Executive Vice President and Chief Commercial Officer; and Craig Landry, our Executive Vice President of Operations. On today's call, Calin will begin by highlighting the financial performance for the year. Lucie and Mike will then address our fourth quarter financial performance and turn it back to Calin before taking questions from the analyst community. We'll start by taking questions from equity analysts, followed by questions from fixed income analysts. Before we get started, please note that certain statements made on this call, such as those related to our forecasted costs, financial -- the timing of the return to service of Boeing 737 MAX aircraft, the recovery of Air Canada's China and Hong Kong businesses and strategic plans are forward-looking within the meaning of applicable securities laws. This call also includes references to non-GAAP measure. Please refer to our 2019 year-end press release and MD&A for important assumptions and cautionary statements relating to forward-looking information and from reconciliations of non-GAAP measures to GAAP results. I will now turn the call over to Calin Rovinescu.
Thank you, Kathy, and good morning, everyone, and thanks for joining us on our call today. I'm pleased to report a strong financial performance in 2019. We generated EBITDA of more than $3.6 billion, 13% above the prior year, and reported an EBITDA margin of 19%, which met our guidance and surpassed the prior year's margin. These results were achieved despite the loss of approximately 25% of our narrow-body fleet for most of the year, following the worldwide grounding of the Boeing 737 MAX, and I'll have a few words to say about this later. Operating income of $1.6 billion reflected an improvement of $154 million from 2018. We generated record operating revenues of $19.1 billion and ended the year with recordables of unrestricted liquidity of $7.4 billion and a leverage ratio of 0.8. These strong results during a difficult year are further evidence of our ability to effectively and nimbly manage through major challenges and demonstrate the commitment of our 37,000 employees who take care of our customers under extremely complicated operating circumstances. For our transformation, we built a rock-solid foundation, which allowed us to fully deliver on our outlook on key financial metrics for the year, and this is something I'm very proud of. Our discipline was rewarded by an 87% return on our shares in 2019. This...[Audio Gap]...been added to our strong stock market performance over the previous 9 years, helped make Air Canada the top-performing stock on the TSX over the past decade with a 3,575% return. On past calls, I've often spoken about resiliency and consistency as key objectives for Air Canada, and a 10-year consistent track record is exactly what we have aspired to achieve. The agility displayed in 2019 gives me confidence that we'll successfully execute on several valuable opportunities in front of us. This includes the launch of our new loyalty program later this year, which we expect will be the best airline loyalty program in the world. It will also enable us to successfully integrate Transat, assuming we obtain the requisite regulatory approvals for our proposed merger. We have no doubt that our wholly Canadian solution is the best possible one as it will secure jobs, result in more travel options for traveling public and benefit all stakeholders. We started 2020 with the constraints imposed by the ongoing grounding of the Boeing 737 MAX as well as emerging economic and geopolitical risks and route suspensions resulting from the 2019 Novel Coronavirus, now known as COVID-19. However, our strong balance sheet, extensive and diversified network, brand strength as the best airline in North America, young fleet as well as our remarkable employees, equip us to respond effectively to any challenges that come our way. Before turning it over Lucie, I'd like to acknowledge all employees for their dedication and thank them for delivering exceptional customer service and their contribution to achieving these strong 2019 financial results in the face of greater than normal challenges. I also, of course, thank our customers for their continued loyalty. And with that, I'll turn the call over to Lucie.
Thank you, Calin, and good morning, everyone. I would also like to thank our employees for their adaptability and commitment to taking care of our customers. Their passion and drive allowed them to deliver excellent customer care despite the challenges created by the grounding of the MAX as well as complex cutovers to our new reservation system. On this last point, we will undoubtedly achieve the financial benefits outlined in our business case, but more importantly, we remain confident that this much needed, yet extremely complex transformation, will facilitate improvements across our customers' journey. I would also like to thank our customers and our trade partners for their continued loyalty and understanding during these exceptional circumstances and for choosing Air Canada. Throughout 2019, we continued to focus on enhancing the overall customer experience. In the fourth quarter, we began refurbishing our Airbus A330 fleet to bring it up to the same standards as our Boeing 787 and Boeing 777, offering a consistent product across our mainline wide-body fleet. This refurbishment will be completed within the next 12 months. We also completed installation of high-speed satellite WiFi on our Rouge fleet in December and expect to have completed WiFi installation across the entire Air Canada mainline fleet by the end of 2020 as well. We're honored to be recognized with awards such as the best airline in North America by Skytrax and Global Travelers' Airlines of the Year in 2019, and we will continue to innovate and invest in our product. In fact, in 2019, we introduced our Air Canada Café in Toronto, a unique lounge experience, as well as we launched our onboard café and Skyriders kids programs. We're very pleased with the feedback received from our customers to date. Turning to our revenue performance for the fourth quarter. On capacity growth of 3.3%, passenger revenues increased $199 million or 5.3% on a traffic increase of 2.9% and yield improvement of 2.3%. The yield improvement versus last year included additional revenue from Aeroplan flight redemptions. Yield and PRASM improvements were recorded on all markets with the exception of the Atlantic. In the business cabin, on a system basis, passenger revenue increased $31 million or 3.7% on yield growth of 4.1%, further highlighting the strength of the premium experience we've created throughout the customer's journey. Turning to the domestic market, on capacity growth of 3.4%, passenger revenues increased $46 million or 3.8% for the fourth quarter. Yield growth of 3.8% reflected improvements on all major domestic services. PRASM increased 0.3% on the higher yield. Traffic for the quarter was slightly down compared to last year due to a weaker Western Canadian market, transitional impact created from the cutover to our new RES system and less connecting traffic as a result of scheduled adjustments related to the MAX grounding. Ancillary revenues were impacted negatively by the grounding as well as the reservation system cutover. Despite the weakness experienced in Western Canada, our important transcontinental services continued to perform very well. Looking to the first quarter, we anticipate year-over-year domestic revenue and capacity growth. However, we will continue to be impacted by the MAX grounding from a schedule and product consistency perspective. It has been necessary to strategically deploy Air Canada Rouge on select frequency markets that normally would be operated by our mainline service. This deviates from several of our scheduling guidelines and creates inconsistency for our customers. However, mitigation tactics such as this are necessary when faced with the alternative of spending routes or further reducing capacity. On the U.S. transborder markets, on capacity growth of nearly 1% in the fourth quarter, revenues increased $61 million or 7.2% versus the prior year. Yields increased 8.3% and reflected improvements in all major U.S. transborder services and a strong business class performance in the quarter. Traffic for the quarter declined 1%, which reflected reduced capacity on services to Hawaii and on certain long-haul services due to the MAX grounding. Looking ahead at the first quarter, we expect to see year-over-year revenue growth in the U.S. transborder market. However, we will continue to be impacted by the MAX grounding and we anticipate a slight capacity reduction. The impact of the MAX grounding is perhaps best exemplified by the significant decrease in our profitable Hawaii operation. In the first quarter of 2019, we had 6 daily flights from Western Canada to Hawaii with the 737 MAX. We have -- had to half this operation, backfilling the capacity with less efficient wide-body aircraft and through extensive wet lease operation. This has impacted our overall profitability in just one example of the considerable impact of the MAX grounding. Consistent with the last few quarters, our international transit strategy of connecting U.S. customers to international destinations through our hubs has been adversely impacted by the MAX as we consolidate frequencies to several U.S. markets. In the last several years, the strategy has delivered very strong results and has been a key component of our profitable international growth. The negative impact on our transit traffic was felt throughout our international network and will continue into the first quarter of 2020 given the ongoing grounding of the MAX and the impact of the Coronavirus. We do, however, see very good results for traffic connecting over Montreal. We took delivery of our first Airbus 220 in December, and this aircraft is currently operating between Montreal and Calgary. Starting in May, once we've taken delivery of 3 more A220s, we will begin flying between Montreal and Seattle, connecting 2 important aerospace markets, as well as Toronto and San Jose, California. Benefiting from a modern and efficient aircraft, these routes will bolster our extensive U.S. network and will support our strategy to attract U.S. customers to transit our hubs when traveling internationally. We firmly believe that the A220 will enable us to create new profitable city pairs in our network, where other aircraft don't have the economics or operational performance required to do so. Additionally, our customers' experience with the A220 is being enhanced as the aircraft offers large overhead bin space, wider seats and state-of-the-art entertainment. Suffice it to say, we're extremely excited about this aircraft and the opportunities it represents for our North America network, not to mention the reduced environmental impact it'll have. Turning to our Atlantic performance on capacity growth of 7% in the quarter. Revenue increased $52 million or 5.9%. Our capacity growth over the Atlantic was an intentional strategy to reduce our exposure in Asia and to invest in the very stable North Atlantic. Traffic increased on all major Atlantic services with the exception of Halifax and St. John's to the U.K., where service was temporarily suspended as a result of the MAX grounding. We saw a 1.8% decrease in yield in the quarter due to competitive pricing activities as a result of increased industry capacity. In addition to the above, we experienced a strong quarter in the Middle East and India, 2 markets that hit their peaks in the Canadian winter. The growth prospects in India are very encouraging. Our longer average stage length and currency also played a part in the yield decline compared to the fourth quarter of 2018. Looking at the first quarter, we anticipate continued capacity growth as we redeployed capacity from the Pacific, especially China and Hong Kong, over the Atlantic due to the impact of the Coronavirus as well as the ongoing geopolitical tensions between Canada and China. PRASM and yields will continue to be under some minor pressure due to increased industry capacity, resulting in a competitive pricing environment. However, our strategy is still focused on reducing our exposure to Asia. We're confident in the performance over the Atlantic, and later this year, we will be introducing our year-round Montreal to Toulouse service, connecting Montréal to another important aerospace market as well as Toronto to Brussels, which was achieved through cooperations with one of our transatlantic joint venture partners, Brussels Airlines. The North Atlantic continues to be a very robust part of our network, and we see considerable opportunities for further profitable growth. Moving on to the Pacific. On a capacity reduction of 1.5%, revenues increased $6 million or 1.2%. Yield improved on China, Japan and Taiwan. Traffic was essentially flat to the prior year's quarter. The geopolitical situation between Canada and China as well as the tensions in Hong Kong continued to negatively impact travel demand, particularly business-related traffic. As mentioned, we were able to redeploy capacity from China and Hong Kong over the Atlantic. In the quarter, we successfully launched our seasonal service from Vancouver to Auckland, supporting our efforts to reduce seasonality throughout our network. Looking forward to the first quarter, our specific capacity will be significantly reduced as we suspended service to Mainland China as well as from Toronto to Hong Kong until the end of March, which will also significantly impact revenues over the Pacific. We're closely monitoring the situation and we'll be adjusting this schedule as necessary. We've redeployed this capacity throughout our network, including updating certain services as well as increasing frequencies between several markets. Moving on to our other services. On capacity growth of 7.3%, our revenues increased $34 million or 12.1%. Traffic increased 9.8% with traffic growth recorded on services to South America and en route to traditional leisure destinations. Yield improved 2.2% with improvements of services to South America and Mexico. In the quarter, we introduced service from Toronto to Quito as well as Montreal to São Paulo. These services bolster our network to South America and, similar to our Auckland service, support our efforts to reduce seasonality in our schedule. We're encouraged by the early results of these efforts. New routes to São Paulo, Auckland and Quito have all delivered positive results with a favorable outlook. We will continue to explore opportunities to better diversify our network on a year-round basis. For the first quarter, we anticipate continued revenue and capacity growth supported by our new South American services to Quito and São Paulo. We look forward to introducing our service for Montreal to Bogotá later this year. Turning to cargo. The fourth quarter of 2019 saw a year-over-year reduction in cargo revenues of $31 million or 14.2%. The Atlantic and Pacific continue to be impacted by an industry-wide decrease in air cargo demand due to continued global trade uncertainty. Overall, cargo yield was down 8.7%, while traffic declined 6% versus the prior year's fourth quarter. Looking ahead, we anticipate cargo to be significantly impacted by the suspension of service to China and Hong Kong. While facing exceptional circumstance, our cargo group remains focused on continuing to invest in new technology and artificial intelligence to optimize our revenue generation capabilities and also enhance the collection and use of data. Turning to other revenues. We saw an increase of $34 million or 15% in the quarter with the net margin recorded on the redemption and delivery of non-air goods and services related to the Aeroplan program being the largest contributor. We also saw an increase in ground package revenue from the fourth quarter at Air Canada Vacations, contributing to a record year for Air Canada Vacations. 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 their part and teamwork in achieving these solid results by their continued focus on taking care of our customers. We reported EBITDA of $665 million in the fourth quarter, $46 million or 7% above prior year's fourth quarter. Operating income amounted to $145 million. Fourth quarter EBITDA was negatively impacted by 2 items, which we want to call out. First was a onetime negative revenue impact from our transition in mid-November to our new passenger services. The second was higher-than-expected stock-based compensation expense, reflecting the increase in our share price and an increase in employee incentive program accruals. The combination of these 2 items had the effect of reducing EBITDA by $60 million in the quarter. Each item contributed similarly to the impact. CASM increased 2.5% in the quarter, while adjusted CASM, which excludes fuel expense, ground package, costs at Air Canada Vacations and the operating expenses of Aeroplan, increased 5.5%. Consistent with prior quarters, these increases were largely due to the impact of the MAX grounding, which resulted in an ASM increase of 3.3% in the quarter versus a planned ASM growth of 4.6% with the relatively higher costs associated with replacement aircraft and the ongoing MAX-related operating expenses, including depreciation and pilot wages, which continue to be incurred despite the grounding. As disclosed in our news release this morning, we've estimated that had we operated the 36 Boeing MAX aircraft as originally planned in 2019, adjusted CASM would have reflected an increase of approximately 2.5% when compared to 2018. This speaks to our continued focus on cost reduction and containment, which remains a key priority at Air Canada. Turning to fuel. Fuel expense decreased $78 million or 7% in the quarter on lower jet fuel prices year-over-year. The average price of fuel was CAD 0.75 per liter in the quarter, down 11% versus the same quarter in 2018. Looking ahead, we expect the price of jet fuel to average CAD 0.71 per liter in the first quarter and CAD 0.74 per liter for the full year. Air Canada has not entered into any fuel hedging contracts for 2020. Wages and salary expenses came in above the prior year by $93 million or 17%, largely driven by an increase in full-time equivalent employees of 9.2%. This growth in the workforce included the impact of the acquisition of Aeroplan in January 2019, incremental personnel support technology projects and the in-sourcing of certain IT functions previously outsourced to third parties. As mentioned earlier, we also recorded increases in stock-based compensation expense and expenses related to employee incentive programs. Communication and information technology expenses increased $40 million over the prior year's fourth quarter. This increase reflected additional information technology projects year-over-year, notably those related to security, data platforms, systems resiliency and monetization. It also includes the impact of the acquisition of Aeroplan, transitional costs associated with the in-sourcing of certain functions previously outsourced to third parties as well as transaction fees related to the new reservation systems.I would now like to provide you some guidance for 2020. For the full year 2020, we project an EBITDA margin of approximately 19%, which would result in a small increase in 2020 EBITDA versus the 2019 EBITDA of $3.636 billion. We expect system ASM capacity growth of 1% to 2% when compared to the full year 2019. In addition to the other assumptions, we provide our 2020 outlook for the first quarter and full year with respect to both EBITDA and ASM capacity notably assumes: one, that Air Canada's mainline China and Hong Kong services fully recover by the third quarter of 2020; and two, that the Boeing 737 MAX aircraft gradually return to service commencing late in the third quarter of 2020. If either or both of these assumptions should change and impact our projections, we will revise guidance as appropriate. We had operated up to 24 Boeing 737 MAX aircraft in the first quarter of 2019 and the impact of their grounding, along with the suspensions to Mainland China and from Toronto to Hong Kong, and a higher proportion of projected annual operating expense increases in both aircraft maintenance and employee benefits in the first quarter of 2020, is expected to result in a first quarter 2020 EBITDA that is approximately $200 million lower than the first quarter of 2019. Given the overall projected EBITDA increase in 2020, we expect to more than make up for the first quarter 2020 shortfall over the remainder of the year. Our annual fuel assumption of CAD 0.24 Canadian per liter is well above the current fuel curve. We believe that as the China-based business returns, fuel prices will move closer to 2019 levels. As a result, we believe that our EBITDA guidance has more upside than risk, assuming our MAX return to service and China recovery assumptions prove to be accurate. Moving on to the balance sheet and liquidity. As Calin mentioned earlier, we ended the quarter with unrestricted liquidity of almost $7.4 billion, another record. Looking at the full year 2019 and excluding onetime proceeds related to our acquisition of Aeroplan, free cash flow amounted to $2.075 billion. This reflected an increase of $748 million from 2018 and was higher than the free cash flow of between $1.3 billion and $1.5 billion projected in our third quarter news release. This improvement was due to a combination of factors, including higher cash from operations, a lower-than-projected level of capital expenditures due to certain projects being deferred to 2020 and to an initial settlement payment from Boeing. Air Canada continues to project cumulative free cash flow of $4 billion to $4.5 billion over the 2019 to 2021 period, which now includes the $2.075 billion of free cash flow recorded in 2019. We have been in discussions with Boeing to seek to settle the terms of an arrangement in relation to the grounding of the Boeing 737 MAX aircraft. Until this arrangement is finalized, information of the outstanding purchase commitments for the aircraft is subject to change. An initial settlement payment was made to Air Canada in the fourth quarter of 2019, with any further amounts subject to the finalization of the agreement. From an accounting perspective, the compensation will be reflected as an adjustment to the purchase price of the current and future deliveries and will flow through Air Canada's consolidated statement of operations as reduced depreciation expense over the life of the aircraft and as a reduction to the additions to property and equipment on Air Canada's consolidated statement of cash flow. Net debt of $2.8 billion in 2019 decreased $2.4 billion from December 31, 2018, reflecting an increase in cash, cash equivalents and short- and long-term investment balances of almost $1.7 billion and a decrease in long-term debt and lease liabilities of $679 million. Our leverage ratio was 0.8 at the end of the year, in line with leverage ratio not exceeding 1 projected on our third quarter news release. Our return on invested capital was 15.5% at year-end, in line with our guidance provided in the third quarter news release and significantly higher than our weighted average cost of capital of 7%. Excess cash amounted to almost $2.7 billion at the end of 2019. As discussed in prior earnings calls, we expect to deploy this excess cash over the next several years to purchase aircraft, make strategic investments and reduce existing gross debt levels. Shareholder buyback programs will be funded by annual free cash flows. In respect to our normal course issuer bid, we repurchased approximately 9.1 million shares in 2019 at an aggregate consideration of $378 million for an average cost per share of $41.64. Of course, 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. Before closing, I want to take a few minutes to say a bit more on the MAX, our mitigation program and its impact. At the time of the worldwide grounding of the MAX in March 2019, Air Canada was operating 24 MAX aircraft and was in a significant ramp-up phase for scheduled deliveries from Boeing. By the summer peak of last year of July 2019, Air Canada was scheduled to operate 36 MAX aircraft. By year-end 2019, there were 8 billion MAX ASMs that were effectively not flown as a result of the grounding. To mitigate, in part, the loss to Air Canada of the ASMs that would have been flown by the MAX, we kept, in our fleet, certain aircraft that otherwise were scheduled to exit either through lease extensions or through sale deferrals. We sourced new aircraft from other airlines and lessors. We wet leased aircraft with crew from other operators, and we covered mainline flying with Rouge and with regional partners. In total, we operated approximately 97% of our schedule in 2019, and our efforts from the outset have been focused on minimizing disruption for our customers so they maintain confidence to book with Air Canada while also preserving value for our shareholders. For 2020, our plans were to have 50 MAX aircraft operating by the summer for a total of 13 billion ASMs flown by the MAX during the year. As it stands today, all MAX aircraft scheduled for delivery beyond the original 24 have not been delivered, and Boeing has now suspended production of new aircraft. Now I assume everyone heard that Boeing announced on January 21, 2020, that it expects that the MAX aircraft will start to return to service during mid-2020. We will continue with our mitigation plans, but as the ungrounding date continues to shift to the right, this becomes increasingly challenging and operational complexity is compounded. We're quite confident that the Boeing 737 MAX will fly again and we believe customers will regain confidence in this aircraft. To be clear, safety is paramount and we're working closely with the governing bodies involved to achieve absolute certainty that this aircraft is safe for our customers and for our crews before it takes to the skies again. Once the aircraft is ruled safe by the regulators, by Boeing and by our own internal safety and pilot groups, we will be fully dedicated to returning it safely to service. More generally, I feel 2019 tapped an incredible decade of transformation at Air Canada. In the year, we recorded record revenue of $19.1 billion and achieved record levels of liquidity. Our stock was a top performer, increasing 87% during the year. We have a pension solvency surplus of about $2.5 billion versus a major deficit, not so long ago. And in the year, we received significant upgrades from 2 major debt rating agencies moving us to within 1 level of our goal of investment grade. Perhaps more importantly, for the future, we also continue to put in place the building blocks to achieve even further growth and increase profitability. Throughout the year, we consummated transformative transactions, such as the acquisition of Aeroplan, which will be foundational for our new loyalty program, and the signing of our new capacity purchase with our major regional partner, Jazz, rationalizing our important regional flying operations and securing estimated annual savings of approximately $50 million. We also signed a definitive agreement, of course, to acquire Transat. This was subsequently approved by 95% of Transat's shareholders. We're now awaiting regulatory approval of the transaction, which we are confident of obtaining as it provides a wholly Canadian solution that will benefit travelers, employees of both companies and other stakeholders while also strengthening the economy of Québec and Canada as a whole. In the fourth quarter, we launched our new reservation system and took delivery of our first Airbus A220, 2 foundational elements for the next stage of our transformation. The introduction of a new reservation system, something we last did 25 years ago, is tantamount to a heart and lung transplant for an airline. It's never undertaken without residual effects, and we fully appreciate and regret any issues our customers have encountered. However, we have continued to operate our regular schedule without disruption. And as the system continues to stabilize, all stakeholders, particularly our customers and our travel agency partners, will increasingly see the benefits of the new system. Since implementation of the new system, we have already carried nearly 12 million customers. As Lucie mentioned, the A220 is another game changer, helping transform the traveling experience for our customers. In its short time in service with Air Canada, the aircraft has already garnered rave reviews from our customers. We know it'll serve us well and open new market opportunities for us, all the while achieving operating efficiencies that will flow directly to the bottom line. We also continue to receive affirmation throughout the year that Air Canada has truly become a leading global carrier. This includes the Skytrax award for Best Airline in North America for the third consecutive year and eighth in the last 10 and other awards for all aspects of our service. One reason for this and our numerous other accolades is the engagement of our employees, and our success was recognized through awards as that for the -- one of the top 100 employers in Canada, and one of the top diversity employers in Canada. What makes these and other achievements notable is that 2019 was a year of tremendous adversity with ongoing geopolitical events, a more complex regulatory environment, significant weather events and, of course, the sudden and ongoing grounding of the 737 MAX. This black swan event unseen previously in our industry, now, coupled with the impact of the COVID-19 virus in our industry, the magnitude of which only became apparent in early February of this year, would have been an existential threat a decade ago. There's no question that we are now not only stronger than we were 10 years ago but that we are truly transformed. The crux of our strategy has been to build an airline that is sustainably profitable for the long term. These crises have put this sustainability to the test, a test that I'm proud to say we're passing with flying colors. I applaud the nimbleness of our people and the agility of our leadership team, which was fully displayed in 2019. It also gives me great confidence for the future. I'd like to close by thanking again our employees for a tremendous year and for continuing to keep our customers at the core of everything that they do as well as our customers for their continued loyalty. And now we'd be pleased to take some questions from the analyst community.
[Operator Instructions] The first question is from Walter Spracklin with RBC Capital Markets.
So focusing on your comment with regards to redeployment of capacity over to Atlantic as a result of the China service disruption, the impact there is, as all other airlines are doing the same, would be suggestive that of competitive pressures that you alluded to. Is it possible that we could see yields effectively turn negative in the early part of 2020 here as that capacity is redeployed?
First of all, the redeployment of this kind of capacity when the duration of the China situation is still unclear, means that people will be largely doing it on a short-term basis. And of course, airplanes, especially wide-body aircraft like this being redeployed, is not an easy feat. So it's not as if people are going to change their entire plans for the rest of the year. And so I think that you'll probably see some tactical capacity redeployment, Walter, but it's not going to be a wholesale dynamic where everyone changes their plans for the summer.
So you don't see yields as being -- because of that tactical, you don't see it being overly impactful on overall yields as a result. Is that right?
No. At this stage, we don't see that. And then you could also assume that given the pressures in Asia that the Atlantic will become an even more attractive destination with greater demand.
Okay. Turning to CASM, I don't know if you -- Mike, you can give us what you're implicitly putting into your 2020 there for CASM. But the real question here is when you -- let's just say that the MAX does return in the third quarter, looking at your ability to bounce back to, let's call it, your 2018 level for CASM, how quickly do you think it would take for you to get back to that level? Or is it a multi-quarter duration where we may not see that level in 2021?
I think -- good morning, Walter. I think you'll see it in 2021. As you probably have seen from our discussion today, the MAX will -- we believe the MAX will start gradually coming back into our operation in Q3. So there will be a little bit of overlap during that transition period. But certainly, as we get critical mass for the MAX in early part of 2021, there's no reason why the CASM ex can't get back to pre-grounding levels.
Perfect. And just last question here is on the cadence of your free cash flow, Mike. I know before you gave the -- before the MAX grounding occurred, your free cash flow was essentially starting low and then ramping up significantly over the 3-year period you would forecast. But now that the MAX was grounded, you've got kind of an early lift in free cash flow and now it's probably going to come back down as you accept deliveries. Over the course of that time, you're still guiding to the same level cumulatively. Any risk that because of this pushback, we do -- and the CapEx increase that would come in 2021 as we accept delivery, that you don't hit the 4.5 level or 4 to 4.5 level over that period?
We don't think so, and that's why we reaffirmed the long-term guidance. We've spent a lot of time looking at different scenarios and where the MAX may fall in. Right now, we're obviously assuming 30 will come in -- well, 30 will be operating by year-end '20 being pushed into next year, and that's built into our CapEx plans. So we do not see -- at this point in time, assuming given all the assumptions we put around the guidance that the $4 billion to $4.5 billion of cumulative free cash flow is at any risk.
And the next question is from Kevin Chiang with CIBC.
Maybe if I could just start on the Boeing front. Just from an accounting perspective, when you come to a finalized agreement here, should I think of that as a onetime benefit to, let's say, 2020 CapEx? Or does that bleed through multiple years as you take delivery of the MAX? And then secondly to that, I think you planned for about $475 million of CapEx in Q4, and it looks like you're roughly $220 million shy of that. Would that be primarily related to the Boeing preliminary settlement? Or are there other moving parts in that number?
Let me start with the Q4 number. CapEx was lower in Q4 than we had anticipated for a couple of reasons. One, we did defer some capital into 2020. And also, we did net the initial payment from Boeing to that CapEx, and I can't give you the breakdown of what that variance is. To your first question, Kevin, any cash we receive in 2020, and we expect upon finalization of the arrangement to receive cash in 2020, will go against CapEx in whatever quarter we receive the cash. Aside from that, that means the cost of the aircraft that we currently have on property and the ones to be delivered will be reduced in book cost. And so there, our depreciation will be slightly lower over the next 20, 25 years of life of the plane than it otherwise would be.
That's helpful. And then can you just update us on where you are in terms of how many MAX simulators you have and maybe how many you'll be receiving over the next, I don't know, let's call it, 6 to 12 months as you prepare your pilots for the recertification year?
We have 2 sims, and we've always had 2 sims for the most part, and we think that's more than sufficient for our -- for the fleet size. We do have access to another 1/2 a sim on a rental basis that we'll probably be using to bring our pilots up to requalify once the MAX is ungrounded. So it's only about 2 to 2.5 sims are more than sufficient for our fleet size.
And just lastly for me, and I appreciate, on the cargo front, there's uncertainty with, I guess, how the Coronavirus plays out here. But when I look at Q4 results down year-over-year but sequentially up 5%, and I think the last time we saw sequential growth was over a year ago, are you at least -- were you at least maybe at least seeing some signs of stabilization before the coronavirus broke out? And is that something that if you think of that being a transient headwind, at least the cargo revenue might have found a floor here exiting 2019?
Yes. Kevin, I think that's a fair statement. I think -- and Lucie can confirm this, but our China business was stabilizing, if not showing some signs of growth, small growth, very small growth, but some signs of growth. So I think your observation is absolutely correct. Also, our cargo group has looked at other ways of generating revenue and primarily looking at domestic opportunities as well. So a combination of the stabilization, if not a small growth in China or Asia in Q4, plus some very good initiatives on the domestic front helped the issue in Q4.
The next question is from Konark Gupta with Scotiabank.
And glad to see some good free cash flow numbers despite the perfect storm here. So first question is on the Q1 EBITDA guidance. So Mike, you called out some items that caused EBITDA to decline by $200 million in Q1. Now maintenance and employee benefits are about $85 million of that. Can you quantify the remaining items and also clarify if the reservation system will continue to have impact in Q1?
I can't publicly quantify or reconcile the items, but certainly, the largest item is the absence of the MAX, 24 MAX that are not operating in Q1 that were operating last year in Q1 are one of our most efficient aircraft and being somewhat backfilled by less efficient aircraft is certainly not helping. Again, that will come full circle in Q2, where we're up against the ungrounding -- the grounding last year as well. So certainly, the biggest, largest item is the absence of the MAX. And certainly, there is some impact from not flying to China for 2 months of Q1, including cargo as well. So -- but certainly, the MAX -- the absence of the MAX is the single biggest item.
And remember, Konark, we've talked about this in past calls, it's Calin here, that in addition to flying less efficient aircraft to replace the MAX flying, we're also, because of our unique situation, covering the cost of the pilots who are subscribed to the MAX. When the aircraft was grounded, the 24 aircraft in our fleet, we had 400 or so 737 pilots. And because we did not fly the NG before, our situation is different than the other North American carriers that were all operators of the 737NG, so in addition to operating less efficient aircraft, we're also continuing to carry the cost of the pilots that had been trained on the MAX and that are now kind of awaiting for the MAX to come back into service because there is no NG for them to fly. So that is an incremental cost, which we certainly had not expected to cover in our operating budget.
That's good color. And I understand, obviously, maybe there's some kind of some noise around that, as well as I think you are kind of assuming a slightly higher fuel price than what's kind of implied by quarter-to-date or year-to-date numbers, right? Sounds like you're probably keeping some conservatism there as well.
Yes. Yes, we're looking at that conservatively. Also, I think we do see a correlation between the return of China and the potential increase in fuel price over that period of time. So we think that there is some correlation, but you're right, we have taken a conservative approach to that.
Okay. And then on CapEx, there seems to be like $900 million reduction in 2020 and then there's a similar increase in 2021. I'm guessing that's mostly related to the pushout of the 20 MAX deliveries from 2020 to 2021. But were there any other nuances beyond that? I'm like, I understand there is some Boeing compensation noise as well, but anything else that we should be looking out for?
Yes. Certainly, the largest item was the push of the 20 MAX, but there were other items. We've had to defer some work we're doing on some of our planes, notably the Dream Cabin to our 330 fleet. And so some of that was initially thought we could get that done this year. It'll be pushed into next year. So there's a -- again, that's all because of the MAX situation where we need the aircraft flying and not in MRO for the most part. So MAX, certainly, but then also capital projects, which would improve our product, are being pushed out a bit as well.
Okay. And if I can clarify, Mike, is the Boeing compensation, you mentioned, on future settlements, is that already reflected in the CapEx schedule? Or will that be incremental?
No. That is already reflected actually our expectation.
Perfect. And lastly, on the free cash flow. So you said the $4 billion to $4.5 billion free cash flow cumulatively, that seems still reachable. But if I look at it in a different way, like you already have 1/2 of that in 2019 and then CapEx has been pushing out. What gives you comfort that this number is not conservative significantly?
Well, our internal analysis gives us the comfort to continue to tell the market that we believe in that number. It's all -- $4 billion and $4.5 billion is -- we think is realistic at this point in time. And you're right. We achieved 1/2 of that in almost -- more than 1/2 of that in the first year of the 3-year plan. And to Walter's earlier question, when we went into this from Investor Day, we thought it was a bit of a hockey stick and it's turned out to be quite different, given the situation. But we still believe the $4 billion to $4.5 billion is a realistic target over that period of time.
The next question is from Chris Murray with AltaCorp Capital.
Just thinking about the reservation system. I know we had some of the conversations last year about being prepared for it and the whole bit. Just trying to understand, I guess, there have been a number of issues and then, of course, compounded, I think, maybe by some of the shutdown of the Pacific operations. Can you give us kind of a time line or an idea on when you think you're going to have those systems normalized? And any expectations for additional costs as we go through Q1 and into Q2?
Hi, It's Lucie. First, I just want to put a few things in perspective for the new RES system. So when we say in the quarter that we did see some revenue impact as a result of the cutover, I want to make sure it's understood that our new reservation system is not preventing us from generating revenue from bookings. That's a very, very stable environment. The area where we faced more difficulties on the revenue side was with ancillary revenue collection. So in certain cases, once we cut over, we chose to waive some of the fees in order to reduce some of the friction for our customers and in areas, frankly, where we were a little bit surprised and some of the functionality wasn't performing as planned, we quickly worked in conjunction with our IT team to make sure that we could restore that functionality. So I could tell you that even folks cut over on the 19th of November, we saw enhancements come in, roll in, in December, January, and we continue to move to improve in those areas. So we're very, very confident that we're going to get there. And as we said earlier, we regret some of the inconvenience that it may have caused. But by and large, given the size of our airline and the complexity of the system like a new RES system, we're confident that we're going to be able to get through this relatively quickly.
Okay. So, do you have any particular time line when you think you're actually going to be stable? And would it be a fair way to put it?
Well, we're certainly -- the system is very, very stable now. Now there are some areas where we're looking to bring in some significant improvements quickly, and notably, one of them is in the call center environment where our call center wait time is still long. And some of that is due to us improving on the new system, being more used to using the new RES system and, at the same time, dealing with call volumes that, regrettably, we should not be facing because of some of the system issues that we faced on some of our direct channels. So given the size of the airline and the volume of bookings that we actually generate, we believe that we are -- that our system is stable. Now the other item that I didn't talk about, but in truth, as we were cutting over at the end of November, we were starting to face the situation with the Coronavirus, which had massive implications on the schedule change side. So you can only imagine that at that time, not only were we canceling bookings, but we were also busy reaccommodating customers on to other flights. So that, at the same time as the cutover of our RES system, made it that much more difficult.
Okay. I'm going to leave it there. Just as we go into Q1, just if you can give us a rough idea, how much of your Pacific capacity does China and the Hong Kong group represent? Assuming that, well I think you talked about 1% to 2% capacity increase overall, but I guess that'll be just reallocated either domestically or to the other things you talked about. But how much should we be really thinking about pulling out of the Pacific in Q1?
Well, numbers, I think China represents, I think, as Calin said or someone said earlier, about 6% of annual ASMs for us and Hong Kong is another, I think, 3% roughly. Now we've pulled out 1 frequency from Hong Kong or from Toronto, Hong Kong --
For March.
For March. So those are kind of the background numbers. And as Calin talked about and others have talked about, we're looking to redeploy those on a more opportunistic basis or fill-in basis.
Okay. And overall, you don't think that there'll be a tremendous yield impact with the trade-offs at this particular point? Is that fair to keep thinking about that?
That's our going-in view at this point in time, that there will not be an impact on yield.
The next question is from Andrew Didora with Bank of America.
Mike, CASM ex question for you, obviously, been pressured kind of in the up-mid to high-single digits as the MAX has been grounded. And so as we lap the grounding and the costs are in the base, how should we think about kind of the core inflation in your business as the MAX continues to sit here? Should still it kind of be tracking in this up- to mid-high single digit level? Or as you lap it, does that come down a little bit?
No. I think, Andrew, and we didn't provide specific guidance on CASM ex consciously. But you're right, the CASM ex for 2020 will come down a bit versus the run rate in 2019.
Okay. And then, I guess, CASM ex over the longer term, do you think you can drive CASM ex down? And what kind of growth rate would you need in order to accomplish that?
Yes. To the earlier question, I think we can get back to where we were once the environment stabilized, and we've got the MAX back up and running in the 220s, and again, those are all key drivers to better CASM ex as we go forward.
And Andrew, it's Calin here. You'll see, as we mentioned in the press release, and I think we mentioned in our remarks as well that we extrapolated the CASM ex number and concluded that basically had we operated 36 MAX as originally planned, that CASM ex would have reflected an increase of about 2.5% compared to 2018.
Right. And that was based on our original capacity plan of roughly 4.8%.
So that's another proxy that you can use in your analysis.
Right. Got it. Okay. And then just last question for me. It's more of a mechanics issue of the model. I guess, with China and all the cancellations, how do we think about the kind of PRASM/CASM trade-off of all of these cancellations? It seems like maybe you're a little bit more bullish on yields. So when we kind of forecast our earnings hit from the loss of China, do you think it's probably more CASM than PRASM at this point in time?
It's a good question, Andrew, and we need to think about that one. Let us think about that one, and come back to you on that question.
And the next question is from Hunter Keay with Wolfe Research.
This is Andrew Quach on for Hunter. In your MD&A, you noted a significant acceleration in direct channel share in 2019. Can you talk about how this looked over the past few years and how you expect that to trend following the implementation of new Aeroplan?
Sure. It's Lucie. A couple of things. In the very short term, we did take a little bit of a slowdown in that area, and the reason for that was because we were preparing for the new reservation system and, as you rightfully say, Aeroplan. Once we have completed all the work with the new Amadeus system, we will be in a very, very good position to be able to significantly shift demand from our current channels to our direct channels at a much, much better cost, but it was necessary for us to get the system implemented, get the new Amadeus product in, and then we can start to focus on how we can move forward with our distribution strategy. But definitely, this is something that we look forward to in 2020, 2021, very big opportunities ahead for us.
Great. And for my second question, can you tell us when exactly in 2020, you expect to complete the final stage of the reservation system cutover and realize the greater than $100 million benefit?
It's Craig Landry here on the operations side. From our perspective, the system is already very stable. It's important to note that the system doesn't impact our ability to either sell to customers or to operate our global schedule of flights. So the impacts that we're experiencing now are more in the servicing level, perhaps from a customer service side, and we're seeing rapid improvements in that area. But in terms of our ability to generate revenues or to operate our schedule, we don't have any impacts from what we've seen so far.
The second phase.
The second phase will continue to roll out in the first half of the year. We expect to be completed by the mid-year point.
And just to finish off, Andrew, the majority of the benefits will start accruing after the entire program's in place, so back half of this year.
The next question is from Helane Becker with Cowen.
I just had a question about timing of Transat. Have -- can you just kind of update us on where that stands and when you're thinking about completing it? That's part 1 of my question.
Okay. Good morning, Helane. Calin here. So the filings with all of the requisite regulatory authorities have, of course, all been made. There are approval requirements in both Canada and in the EU, and primarily, there's 1 or 2 others as well, but those are the 2 primary filing jurisdictions. Our people are now engaged in discussions. And the Minister of Transport has an approval as well and the Minister has indicated in his initial communication that the date by which you would receive recommendations from the bureau is in the May time frame. And so we continue to look at that data as being a useful target. But of course, as you know, in these environments, we can't take that to target fully to the bank. So we're optimistic. We think that good progress is being made and look at that as being the earliest possible date where we can get the approval.
Got you. That's very helpful. And then my second question is, I know you guys said that you were leasing in some aircraft. Are you able to wet lease aircraft in from Transat? Or does it have to be specific ACMI providers?
No. We are able to and, in fact, have done so already. We've done it on 2 occasions throughout this MAX grounding scenario. Of course, Transat operates now as an entirely third-party carrier. Until our -- the completion of our transaction, that's the basis of our relationship. And so we have arm's length third-party rates consistent with what we have with other wet lease providers, and the use of their 330s have come in very, very handy for us so far.
Okay. And then I just have 1 maintenance-related question probably for Mike. I know you said in the MD&A discussion that you were going to spend an extra $150 million this year with 1/3 of that in the current quarter. So as we think about 2021 potentially being a normal year, would we -- would you see a big decline? Would we see that decline in maintenance flow through the income statement?
I think you'll probably see some decline because a lot of that -- some of that $150 million is incremental maintenance cost to keep some of the planes that we're keeping longer than we expected because of the MAX situation.
Right. So are you going to keep those planes in service even as the MAX comes back?
No. No. Those planes, primarily the Embraer 190s and the 320s, will go back once the MAX is ungrounded.
And the next question is from Cameron Doerksen with National Bank Financial.
Maybe just to follow-up on that last question. Just as far as flexibility you have with the fleet with the narrow-bodies that are, I guess, scheduled to go back to lessors. I mean, what kind of flexibility do you have should the 737 MAX grounding maybe extend longer than what is even anticipated today?
I think -- I mean, Cameron, we've looked at different scenarios internally. I think we've got fairly good flexibility to probably the end of the year and then after that, it becomes a little more challenging because maintenance costs will go up and some of these planes need to go back to lessors because of that reason. But certainly, I think we've got reasonable flexibility up till the end of the year.
Okay. That's good. And just secondly, I just wanted to make -- if you can just update us on some of your most recent discussions with some of the credit rating agencies and I guess, anticipation for a potential upgrade to investment grade. I'm guessing that maybe there's some -- maybe some anxiety around the Coronavirus situation and what that means for airlines, but I'm just wondering if you could just update what the sort of the latest feedback has been from them.
Yes. We haven't had a conversation yet about our year-end results. We will have those conversations in the next little while, using our strong year-end results as a proxy to try and convince them to upgrade us. I want to manage everyone's expectations. It does take some time for the agencies to put you up to investment-grade that last level. But certainly, our metrics, for the most part, hit the majority, if not all of the criteria. And so we'll be having a conversation with Moody's and S&P in the next 1 month to 1.5 months.
The next question is from Jamie Baker with JPMorgan.
Most of my questions have been answered, but first one, on the assumption regarding a full snapback in China by the third quarter, obviously, hoping you're correct. But is there much analysis that lies at the root of that forecast? Was it shaped by data that might have emerged, I don't know, during SARS or after 9/11? I'm just curious as to the genesis of that forecast?
Right. Yes. Yes. Jamie, good question, and the answer is yes, although obviously, the analysis is imperfect because each one of these viruses is different than the last. But our folks here did analyze how long it took post SARS, in particular, for things to recover. And it kind of depends when you start counting as well. As I think Lucie mentioned there were already signs starting in November, in the November time frame. And so the question is how quickly does the global health community get their arms around this. And yes, I mean, we looked at SARS and we looked at a couple of other epidemics that have affected the airline industry. There were several after SARS where SARS was the most visible. So yes, that's the nature of that. And I think while we certainly appreciate the amount of anxiety that there is out there now, and especially in China, we've seen other of the Asian markets still being relatively strong at this stage, not seeing them fall off a cliff like Japan and so on, but we're hopeful that, that continues. But the answer is yes. It was done on the basis of having looked at recoveries from past epidemics.
Perfect. And second question, MAX-related -- and I'm sorry if I missed this before, but how confident are you in the time line for recertification? Do you anticipate starting to put pilots through the sims prior to recertification? Will you start doing the maintenance prior to recertification? Or do you really need that event recertification before you start the work associated with the ungrounding?
Right. So again, our situation, while it was more difficult because we were not operating the NG from the pilot cost perspective. It was better from the perspective that we were the only carrier in North America that have had the simulators from the beginning because we didn't operate the NG. So we've had these simulators from the beginning. So our pilots have been going through the simulators for the last year basically since the grounding. This has been going on. So the training has continued. Now as the final fix, so to speak, is approved by the FAA and Transport Canada, of course, there will be incremental time for our pilots to go through that. But that will, by definition, be a shortened environment because they've gone -- they've been in the simulator for the past year. And as Mike said in addition to our 2 simulators, we also have -- bought access to another simulator. So this is -- we're relatively in good shape when it comes to that. And as far as maintenance, taking care of these aircraft throughout the grounding, we've had authority to move aircraft for maintenance purposes, and they've been properly taken care of because of all kinds of procedures that have to be undertaken while they're grounded. So that has all been going on. And so we're hopeful that assuming that the Boeing estimates of so-called mid-year come to pass. And remember, this mid-year announcement by Boeing only came out on January 21. And so this is, in a way, relatively new information for us as to what their time line was because sort of last -- following the third quarter, our expectation was that this would have occurred sooner. So this most recent event of mid-year announcement came on January 21, and so we're still kind of -- adjusting for that. And I think what you're seeing today is our best view on how the MAX comes back into service. We think that we'll start introducing it in the third quarter, as Mike has outlined, but not be fully up to our numbers until after the third quarter.
And there are no further questions registered at this time. I'd like to turn the meeting over to Ms. Murphy.
Thank you, Elena, and thank you, everyone, for joining us on our fourth quarter call. Thanks very much.
The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.