05:59 AM EDT, 04/25/2024 (MT Newswires) -- S&P Global Ratings upgraded Air Canada ( ACDVF ) To 'BB' From 'BB-' on lower sustained debt, with an Outlook Stable. Debt and many EETC ratings were also raised.

S&P said its upgrade primarily reflects its expectation for adjusted debt to remain lower than it previously anticipated. Adjusted debt for Air Canada ( ACDVF ) at the end of 2023 was about 20% lower than previously anticipated owing primarily to strong discretionary cash flow generation in the fourth quarter, which led to more cash on the balance sheet that the ratings agency nets against debt. When compared to its previous estimates, working capital inflows, interest income, and EBITDA came in higher while lease liabilities were lower. The lower debt levels S&P now assumes is a key contributor for the improvement in the adjusted credit measures it expects over the next few years. These include adjusted FFO to debt of about 40% through 2025 and in the mid-30% area in 2026, roughly 10% higher than expected in November.

S&P still assumes adjusted EBITDA will be down about 15% in 2024 as higher operating costs and lower passenger revenue per available seat miles (PRASM) more than offset capacity growth. It assumes Air Canada's ( ACDVF ) costs per available seat mile (CASM), excluding fuel, will increase about 4% this year, which is at the higher end of management's 2.5%-4.5% guidance and higher than previously assumed. S&P said a potential new contract with its pilots later this year is a key contributor to these higher costs. Bargaining talks began early last year after the Air Canada's ( ACDVF ) 10-year agreement reached in 2014 came to an end. S&P assumes a new contract is likely to be announced later this year and could include pay increases that are higher than those that WestJet pilots were awarded last summer (a 24% increase in hourly wages by 2026). Other contributors to the higher CASM it assumes include new Air Passenger Protection Rules (APPR) that relate to compensating customers for delays and cancelations, additional airport fees, and general cost inflation. Beyond 2024, the ratings agency assumes CASM, excluding fuel, will be relatively flat to down modestly as cost inflation is offset by the benefit of additional capacity to leverage its fixed costs. Still, S&P expects costs to remain well above pre-pandemic levels and an adjusted EBITDA margin of about 15% (compared to 19% in 2019).

S&P assumes that the strong PRASM growth over the past couple of years will partially reverse as additional capacity is added and pent-up demand fades, reflecting pressure on yields and load factors. S&P's demand outlook incorporates its view that interest rate increases over the past couple of years have yet to have their full effect on discretionary spending in Canada. That said, it assumes only a modest decline in PRASM of about 2.5% this year and 3% in 2025 as demand for air travel on Air Canada's ( ACDVF ) Atlantic routes remain robust through most of this year and traffic continues to recover on Air Canada's ( ACDVF ) pacific routes.

S&P expects new aircraft investments to contribute to negative FOCF generation and increased debt levels over the next few years. It expects Air Canada's ( ACDVF ) capital expenditures (capex) will step up considerably in 2025 and 2026 to about C$3.2 billion and C$5.1 billion, respectively, as the company takes delivery of new aircraft. These investments contribute to S&P's assumption that Air Canada's ( ACDVF ) capacity will increase by about 30% by 2028 and lead to a younger and more fuel-efficient fleet.

Meanwhile, the Stable outlook reflects S&P's view that Air Canada ( ACDVF ) will sustain credit measures that it views as commensurate for its issuer credit rating, including adjusted FFO to debt above 30% despite its expectation of slowing air travel demand, higher costs, and increased capital expenditures.

S&P could downgrade Air Canada ( ACDVF ) within the next 12 months if it expects the airline to generate FFO to debt below 30% over the next couple of years. The ratings agency said: "This might occur from higher-than-expected costs and the effects of a weaker North American economy, prolonged geo-political escalations, or competitive pressures that reduce Air Canada's ( ACDVF ) traffic, revenues, and margins."

S&P could raise its rating within the next 12 months if it sees sustained improvement in traffic and it continues to expect Air Canada ( ACDVF ) will generate and maintain FFO to debt above 45%. In this scenario, the ratings agency would expect the company to generate stronger EBITDA and lower FOCF deficits than its current estimates. S&P added: "Greater clarity regarding the potential impact of increased capacity, cost inflation, and weaker macroeconomic conditions on Air Canada's ( ACDVF ) passenger traffic and margins is likely required for us to better assess the sustainability of our forecast credit measures."