Tuesday, January 28, 2014

Air Canada's Pension Flying High?

The Canadian Press reports, Air Canada eliminates $3.7B pension deficit, posts small surplus:
Air Canada took a major step forward Wednesday as it reported its pension plans posted a small surplus, compared with a $3.7-billion deficit last year.

The improvement, to be confirmed later this year, helped boost shares in the airline to a nearly six-year high Wednesday.

Air Canada shares closed up 72 cents at $9.67 on the Toronto Stock Exchange.

The pension deficit have been a major drag on Canada's largest airline for many years, resulting in friction with Air Canada's unions as well as a significant expense. Air Canada's pension deficit peaked at $4.2 billion in 2012.

"We have, over the past four years, made significant progress," Air Canada president and chief executive Calin Rovinescu said.

The unions welcomed the turnaround, which they say will assuage fears of employees and retirees.

"Obviously we're pleased that the projected deficit has been eliminated because that has been a monkey on our back since 2003," said Leslie Dias, national representative of Unifor, which represents airport and call centre workers.

The head of the pilots' union said the surplus means that employee pensions are more secure and that about $1 billion worth of pension benefit cuts it agreed to, produced results.

"Many of our members and employees at Air Canada were cynical and skeptical about their pension benefits and I think today we've been shown that with sound management and sensible regulations that these pension plans can survive," Craig Blandford, president of the Air Canada Pilots Association, said in an interview.

The small surplus came as Air Canada (TSX:AC.B) saw a big drop in its pension plan liabilities as the interest rate used to calculate them increased sharply, reflecting an increase in long-term bond rates.

The rate for determining the plan's liabilities increased to 3.9 per cent compared with three per cent last year, reducing the deficit by an estimated $1.35 billion. Every tenth of a percentage point increase in the discount rate lowers the solvency deficit by $150 million.

The pension plan also reported a 13.8 per cent return on investments in 2013, benefit amendments that decreased the deficit by $970 million, and a $225-million contribution by the company.

Under a deal with Ottawa last year, Air Canada agreed to put $1.4 billion over seven years -- at least $150 million annually or $200 million on average -- into its pension plan to deal with its deficit. Without the agreement , the airline would have been forced to devote hundreds of millions more annually to its pension plans.

The airline said Wednesday that it may now consider opting out of its agreement with Ottawa, although not likely this year.

Such a move would free up as much as $200 million per year.

The unions, whose support was crucial in obtaining the deal with Ottawa, said employees would be irked if the airline rewarded shareholders instead of workers during the next round of bargaining in 2015.

"We think the company should err on the side of prudence and continue to make payments of at least $150 million annually to make sure that our members receive the decent retirement they are entitled to," stated Katherine Kontosthenos, vice-president of CUPE which represents flight attendants.

Air Canada is not alone in seeing an improvement in the status of its pension plans.

Consulting firm Mercer said earlier this year that rising interest rates and strong stock markets have helped defined pension plans across the country post some of their best results in years.

The Mercer pension health index, which tracks the funded status of a hypothetical defined benefit pension plan, stood at 106 per cent at Dec. 31 -- its highest level since June 2001.

Analyst Walter Spracklin of RBC Capital Markets, who raised his target price for Air Canada's shares to $13 from $10, said the elimination of the pension deficit was "a significant positive" for the airline.

In addition to the benefit of the pension improvement, David Tyerman of Canaccord Genuity said the airline's shares have substantial upside due to the introduction of more high-density seating on Boeing 777s, the launch of its Rouge low-cost carrier and pending arrival this spring of Boeing 787 Dreamliners.

"Given Air Canada's strong long-term potential, we continue to recommend investors buy Air Canada shares," he wrote in a report.
Air Canada wasn't the only corporate pension plan to benefit from rising rates and asset values but the speed of the reversal caught everyone, including their CEO, off guard. Francois Shalom of the Montreal Gazette reports, How Air Canada eliminated a $3.6-billion pension deficit in under a year:
Calin Rovinescu conceded Monday that he was as surprised as others by the startling reversal of fortunes of Air Canada’s employee pension plan.

“Our expectation was that it was going to take a few years to get back to zero,” the airline president told reporters Monday after a luncheon speech to the Canadian Club of Montreal.

A plan had been put in place and into effect some years ago, and executives “always expected to settle the problem. But frankly, I would have thought it would take another year or two to get there.”

The carrier surprised observers last week by announcing that its previously ever-widening employee pension plan shortfall, a problem thought to be structural — the airline has roughly the same number of retirees as employees — had been fixed. The fund deficit that had ballooned to as much as $4.4 billion and stood at $3.6 billion less than a year ago, had been erased. In fact, Rovinescu told assembled business people, it has morphed into a modest surplus.

A “four-pronged process” combined to wipe out that deficit in under one year, he said later; reductions in early retirement provisions for some employees, which accounted for $1 billion; the “excellent (investment) fund performance” of 14 per cent; the differential in interest rates over the year; and the revised repayment schedule that Ottawa allowed Air Canada to make to the plan.

The third factor was “a big driver for us,” Rovinescu said. “We used a discount rate of 3.9 per cent, and it was three per cent at the beginning of the year. So that 0.9 per cent just shows you the level of sensitivity to the long-term bond rate.”

“Actuaries have confirmed that discount rate, so it’s basically done now,” said Rovinescu.

Air Canada’s perennially cyclical stock has also been an eye-popper. Shares in the Montreal airline jumped three-fold in 2013, making it the best performing stock on the Toronto Stock Exchange.

On the other hand, the slumping Canadian dollar has prompted the carrier and its competitors to apply a surcharge to international travel.

“And we buy all of our fuel in U.S. dollars, ... so it is for sure a significant driver,” Rovinescu said. Fuel is an airline’s single largest expense, usually between 30 and 40 per cent of total operating costs.

He noted that Air Canada typically hedges — buys in advance at a set price — about 35 per cent of its expected annual fuel consumption. But he added the airline would provide details only at the next quarterly results.

Rovinescu said he was not worried about the latest entry-into-service delay Bombardier Inc. announced recently for its CSeries airliner in development.

Air Canada is replacing the lion’s share of its fleet with Boeing Co. aircraft, including 37 B787s and five B777s. It also said recently it will buy 61 Boeing 737 MAX narrowbody airliners, an aircraft Boeing is rushing to market to counter Bombardier’s CSeries and Airbus A320 neo.

Air Canada’s 737 purchase, however, did not close the door to a possible deal for the CSeries.

Rovinescu said that his team expects to announce its decision by mid-year on whether it will buy some CSeries or other aircraft to replace older and smaller Embraer jets.

“There’s room for (the CSeries). But it’s a very complicated (150-point) analysis. It’ll be a very good airplane no matter what. The delays in and of themselves are not ... a factor for us at this stage.”

Considerations include cost, efficiencies and multiple aircraft types within one fleet.

“It’s not just about getting a good deal if you (buy) early. We’re aware of that. It may or may not work. I don’t know at this stage.”
My take on all this? I've already covered how Canadian and U.S. corporate pension plans experienced a dramatic rebound in 2013, mostly owing to the rise in long term interest rates, but the reversal of fortune at Air Canada's pension plan is nothing short of miraculous. Nobody expected them to close their pension gap this fast.

We can debate whether Air Canada deserved a pension lifeline but we can't debate the results. And it's not just about rising rates. Their investment team did an outstanding job in 2013, delivering 14%. They have adopted the same asset-liability approach that has worked so well at HOOPP and Ontario Teachers, and basically do a lot of the same arbitrage trades, variance swaps and volatility selling that the latter funds engage in.

As far as Air Canada's shares, they've been on a tear, rising from $2 a little over six months ago, to close to $10 before the latest correction (closed at $8.70 on Monday). All airline shares have been on a tear over the past year, benefiting from lower jet fuel prices and a global economic recovery.

I'm still bullish on airlines but think the extraordinary gains are over and they're due for a correction. Also, as I wrote back in December on why it's time to short Canada, the loonie will keep falling and so will Canadian energy stocks. This means Canadian airlines better hedge their fuel cost carefully or risk losing money.

And since I'm not one to hold back, I think Air Canada has a lot of work to improve its service and competitiveness in terms of pricing. To be blunt, despite massive subsidies, it's still a shitty airline with terrible service and their airfares are outrageous, especially within Canada. (It's a frigging joke! I switched to Air Transat for my direct flights to Athens in the summer because I was fed up with delays with Air Canada and their high airfares. The seats in Transat's planes are a bit tighter, the food is just as horrible but I get there on time, which is all that matters to me and my friends).

One more area Air Canada needs to improve? Diversity in the workplace. It's a federally regulated private company which enjoys millions from taxpayers and yet just like our major public pension funds and Crown corporations, it hasn't done enough to promote true diversification in the workplace (I know, I applied to their pension plan and was shut out after stating I have a mobility issue. I've experienced the same nonsense at other public and private pension funds. It's truly appalling!).

But I will give credit to my old buddy from PSP Investments, Marc-André Soublière and the rest of the team at Air Canada Pensions. They're doing an outstanding job managing a pension that was a real mess before they got there and they adopted the right strategy. I would like to see them work at a new public pension fund so they manage the pension assets of all Canadians, not just Air Canada's employees. The same goes for HOOPP, our country's best DB plan.

And let me remind my good friends at Air Canada Pensions, HOOPP, Ontario Teachers, Caisse, PSP, bcIMC, AIMCo, and a lot of other places that this blog is simply the best blog on pensions and investments out there so pay up and support it. I don't want to hear any excuses, especially from Gordon Fyfe, Michael Sabia, Leo de Bever and Ron Mock. If you only followed my advice from my short Canada piece, you would have made off like bandits, so pay up and subscribe (use the $1000 option, you can all afford it!)

Speaking or airlines and air turbulence, every market pundit has their panties tied up in knots because of the latest correction. They all need to chill out and go back to read my hot stocks of 2013 and 2014 as well as my outlook 2014. I discussed the emerging market crisis and think if it gets worse, the Fed will have no choice but to hold off on tapering or maybe even increase its bond purchases (low probability). The key threat to the global recovery right now remains deflation, not inflation, and if you think otherwise, you're in for a shocker.

Below, one of my favorite fund managers, Leon Cooperman, appeared on CNBC this morning to discuss his hunt for value. Watch the interview below and listen to him carefully, he is one of the top fund managers I regularly track every quarter. And he's right: "Corrections like this create adjective but they create opportunity." Buy the dips on the biotechs I recommended in my comment on hot stocks of 2013 and 2014 and don't forget to pay up for my advice when you score huge! (but hang on to your biotech balls and boobs, it will be a wild ride up!)