Case Analysis

AIR CANADA

- Risk Management

PRESENTED BY:Aarish Jolly Aashish Narang Ishan Sahni Jasdeep Singh Monisha Batra Vishesh Bhatia

INDUSTRY ANALYSIS

After the attacks on USA in 2001 the airlines industry faced 2 years downturn. The jet fuel increased from 27$ to more than 133$ . The industry faced another problem of H1N1 in 2003 . In 2008-09 the world faced the financial meltdown the fuel price came down but the passenger travel had also decline 5.4% . Low cost airlines had a better success.

AIR CANADA

In 2001 it acquired its largest rival Canadian airlines. Air Canada filled an creditor protection on April 2003. On sept.30,2004 declared itself bankrupt, with bail out from deutsche bank of $850 million. Air Canadas strategy focused on mainly cost cutting , reducing capacity and managing the risk. Risk management was the basic issue which all the board members were having its focus on from 2008 when the financial crunch started .

ISSUES IN AIR CANADA

Frequent fluctuations in Interest rates Fuel expenses
y y y

The jet fuel increased from $27 to more than $133 Interest > Operating income

Liquidity crisis Foreign Exchange reserves Risk

Revenue: Canadian Dollars y Expenses: US Dollars

Operational risk
y y

Low Severity-High Frequency Risk Low frequency-High Severity

Catastrophic risk

INTEREST RATE RISK & LIQUIDITY CRISES

Interest Expenses > Operating Income Decides profits and losses 60% LT debt @ fixed rate 40% debt @ floating rate

Risk Management
Used Swaps and return from cash reserves to mimic the return from a fixed interest rate. Converting debt to combination of equity and fixed rate debt (Recommended) E.g.- South-West Airlines

FUEL EXPENSES

Fuel comprised 20-30% of all expenses.

y

Increase in 1$ cost US airline industry $425 million in operating cost per year.

Risk Management
Policy to hedge 75% fuel purchase for 12 months, 50 % for 13-24 months and 25% for 25-36 months. Air Canada had hedged 34% of fuel purchases in 3rd quarter for 2010 and 8% for 2011.

FOREX RESERVES RISK

Revenue in Canadian Dollars and expenses in US Dollars. Impact was less on Air Canada as compared to other Canadian competitors.

Risk Management
Air Canada converted all Non-Canadian revenue to US Dollars.
But this strategy covered only 29% of Forex exposure.

Rest 71% is eligible to be hedged through a financial derivative.

OPERATIONAL RISK

Low severity High frequency (Quadrant-IV) Because of high volume of passengers and flights. Risks in carrying out day to day operations. Difference in expenses b/w low cost carriers and legacy passenger airlines.

Risk Management
All airline equipment required stringent preventative maintenance and safety. programs of

IT infrastructure had backup systems and contingency plans. HR policies ensured additional capacity in case of delay or illness. Ticketing and booking had programs for those who would not make their flight on time.

CATASTROPHIC RISK

Risk due to uncontrollable events.

E.g.- Plane Crash

Low frequency but High severity. Potential losses from a single event.

Risk Management
Best transferred to a third party through insurance. Aviation insurance is considered high risk as it takes $100-250 million to insure a single aircraft , and its liability coverage ranged $1.5million-$2 billion. Despite these large numbers, these premium represents only 0.1% of global insurance industry.

OTHER RISKS

Air Canada purchased forward contracts on its own stock to cover its exposure from PSUs. 2,700,000 common shares were issued and given to PSU Employees.

Impact:
Liquidity Crunch Increase in number of shares affected the trading of shares. Price per share decreases. Company will have diluted control.

Risk Management
Forward contracts portfolio should be well diversified over varied time frames so that the liquidity risk is mitigated Emphasis on giving cash and common stock as a combination Investment in futures would yield a better return as they can be exchange traded

THANK YOU