Air Canada 2014 Annual Report Download - page 69

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2014 Management’s Discussion and Analysis 69 2014 Management’s Discussion and Analysis
Foreign Exchange
Air Canada’s financial results are sensitive to the
fluctuating value of the Canadian dollar. In particular,
Air Canada has a significant annual net outflow of
U.S. dollars and is affected by fluctuations in the
U.S./Canada dollar exchange rate. Management
estimates that during 2014, a $0.01 strengthening
of the Canadian dollar versus the U.S. dollar (i.e.
$1.16 to $1.15 per U.S. dollar) would have had an
estimated $33 million favourable impact on operating
income and a $45 million favourable impact on pre-
tax income. Conversely, a corresponding opposite
change in the exchange rate would have had the
corresponding opposite effect. Air Canada incurs
significant expenses in U.S. dollars for items such as
fuel, aircraft rental and purchases and maintenance
charges, interest payments, debt servicing and
computerized reservations system fees, while a
substantial portion of its revenues are generated in
Canadian dollars. A significant deterioration of the
Canadian dollar relative to the U.S. dollar would
increase the costs of Air Canada relative to its U.S.
competitors and could have a material adverse effect
on Air Canada, its business, results from operations
and financial condition. Due to the competitive nature
of the airline industry and consumer sensitivity to
travel costs, Air Canada may not be able to pass on
increases in Canadian dollar costs to its customers
by increasing its fares. In addition, Air Canada may
be unable to appropriately hedge the risks associated
with fluctuations in exchange rates.
Economic and Geopolitical Conditions
Airline operating results are sensitive to economic and
geopolitical conditions which can have a significant
impact on Air Canada. For example, economic and
geopolitical conditions may impact demand for
air transportation in general or to or from certain
destinations, and may also impact Air Canada’s
operating costs, costs and availability of fuel, foreign
exchange costs, pension plan contributions, and
costs and availability of capital and supplies required
by Air Canada. Especially in light of Air Canada’s
substantial fixed cost structure, any prolonged
or significant impact arising from economic and
geopolitical conditions, including weakness of the
Canadian, U.S. or world economies, or threatened or
actual outbreaks of hostilities in or adjacent to regions
Air Canada serves or operates flights over, could have
a material adverse effect on Air Canada, its business,
results from operations and financial condition.
Airline fares and passenger demand have
fluctuated significantly in the past and may
fluctuate significantly in the future. Air Canada is
not able to predict with certainty market conditions
and the fares that Air Canada may be able to
charge. Customer expectations can change rapidly
and the demand for lower fares may limit revenue
opportunities. Travel, especially leisure travel, is a
discretionary consumer expense. Demand for business
and premium travel are also impacted by economic
conditions. Depressed economic conditions in North
America and other areas served by Air Canada, as well
as geopolitical instability in various areas of the world,
concerns about the environmental impacts of air
travel and tendencies towards “green” travel initiatives
where consumers reduce their travel activities,
could have the effect of reducing demand for air
travel in Canada and abroad and could materially
adversely impact Air Canada, its business, results from
operations and financial condition.
Fuel Costs
Fuel costs constituted the largest percentage of the
total operating costs of Air Canada in 2014. Fuel
prices have and may continue to fluctuate widely
depending on many factors including international
market conditions, geopolitical events, jet fuel
refining costs and the Canada/U.S. dollar exchange
rate. Air Canada cannot accurately predict fuel
prices. Significant fluctuations (including increases)
in fuel prices could have a material adverse effect on
Air Canada, its business, results from operations and
financial condition. Due to the competitive nature of
the airline industry, Air Canada may not be able to
pass on increases in fuel prices to its customers by
increasing its fares. Furthermore, the impact of lower
aircraft fuel prices could be offset by increased price
competition, and a resulting decrease in revenues, for
all air carriers. Based on 2014 volumes, management
estimates that a US$1 per barrel movement in the
average price of jet fuel would have resulted in an
approximate $29 million change in 2014 fuel expense
for Air Canada (excluding any impact of surcharges,
foreign exchange rates and fuel hedging), assuming
flying capacity remained unchanged and that refining
spreads between WTI crude oil and jet fuel as well as
foreign exchange rates remained constant.
COMPETITION
North America
Air Canada operates within a highly competitive
industry. Over the past few years, several carriers
have entered or announced their intention to enter
or expand into the domestic (including regional), the
U.S. transborder and international markets in which
Air Canada operates.