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
The jet fuel increased from $27 to more than $133
Liquidity crisis
Interest > Operating income
Foreign Exchange reserves Risk
Revenue: Canadian Dollars
Expenses: US Dollars
Operational risk
Low Severity-High Frequency Risk
Catastrophic risk
Low frequency-High Severity
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.
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 programs of
preventative maintenance and safety.

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