A Stronger Canadian Dollar Means a Stronger Air Canada

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Ten years ago, a Canadian Dollar bought less than $0.75 of an American dollar. As of the writing of this article, the exchange rate has drastically changed. Today's Canadian dollar buys around $1.01 USD. While this has not been as good for Canadian exporters, a boost in the Canadian dollar can bring many helpful consequences to one company; Canada's largest passenger airline, Air Canada (TSX: AC.A) (TSX: AC.B).

Input costs 

As any airline investor knows, fuel costs are of critical importance to the airline industry. Many airlines employ elaborate fuel hedging strategies to mitigate volatility risk on this one cost alone. Considering that fuel is the largest or second largest cost at most airlines, an emphasis on handling fuel costs is important.

Air Canada has another part to the fuel price story though. Since jet fuel prices follow in tandem with oil prices, Air Canada is following oil prices for volatility. While the airline's cash and earnings are in Canadian dollars, oil prices are denominated in U.S. Dollars, meaning that a rise in the Canadian dollar reduces fuel costs for Air Canada. Based on the airline's fuel consumption, a change of a single dollar in the price per barrel results in a change of $30 million in annual fuel expenses. Using these figures, we see a little currency fluctuation goes a long way to reducing, or increasing, fuel prices at Air Canada.

Fleet modernization is also a key component to Air Canada's cost reduction strategy and this will require the purchasing of many new aircraft. The airline has already bought 37 Boeing (NYSE: BA) 787 aircraft, with an option to increase that number to 50. Delays in the production of the fuel saving 787 have pushed back the delivery dates for Air Canada's planes. Some analysts believe this has been a benefit to the carrier overall, since it still needs to raise the funds to pay for the planes.

Besides the popular 787, Air Canada is looking to pick up some narrow body aircraft as well. It is currently looking at Boeing's latest 737, Airbus' A320 NEO, and the Bombardier (TSX: BBD.B) C Series as its choices. Despite being another Canadian company, Bombardier lists its aircraft prices in U.S. dollars, but the manufacturer's location does offer Air Canada an option to buy domestically. If the Canadian dollar gains strength against the U.S. dollar and the Euro, aircraft purchases will require less financing, and thus keep the airline's debt levels under better control. Air Canada may also chose to use currency savings to increase their order size, which would help them modernize their fleet faster.

Debt management

As with most large scale airlines, Air Canada carries with it a heavy debt load, in this case currently around CAD 4 billion. However, much of Air Canada's debt is denominated in American dollars, meaning a change in the CAD/USD exchange rate could impact Air Canada's effective debt levels. The airline noted this in a recent earnings report where it booked a foreign exchange gain that pushed net earnings well beyond the expected levels. For an airline that is actively paying down debt, a reduction in the value of that debt should be a boost to the company's bottom line.

As mentioned earlier, Air Canada is planning to revitalize its fleet through new aircraft purchases. To do this, the airline will need to go raise more funds. Since most aircraft prices are in foreign currencies, a strong Canadian dollar would mean less funds would need to be raised. Additionally, Air Canada's Canadian assets would be worth more, thereby reducing credit risk and possibly obtaining a lower interest rate. Like at other carriers, controlling one's debt is critical, and it appears the value of the Canadian dollar could play a key role in Air Canada's future finances.

Two part gain

For Air Canada, a stronger Canadian dollar helps the airline on both the input cost front and on their management of debt. Both are critically important to an airline trying to shed a reputation of being one of the least efficient airlines in North America, while at the same time managing a massive nearly $4 billion debt load. Clearly, if Air Canada can realize gains in these two key areas, shareholders should benefit as the airline rebuilds itself.

Conversely, should the Canadian dollar fall, most of these effects would be reversed and Air Canada could see declining fortunes. But I remain bullish on Air Canada's recovery, which is built on much more than currency rates alone. Debt reduction and fleet modernization should benefit the airline long term and the current stock price values the airline at less than six times forward earnings. If this carrier can continue to execute it could be one of the best buys in the industry, and for this reason I have taken a long position in Air Canada.

TulipSpeculator1 owns shares of Air Canada. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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