How the Stabilization of the Canadian Dollar Is a Huge Win for Air Canada

In late January, shares of Air Canada (TSX:AC.B) were hit hard as the Canadian dollar took another drop after sliding through most of 2013. Combined with guidance that reflected the lower dollar value, Air Canada shares were down about 40% from their peak by mid-February. But some stabilization and rebound in Canada's currency is good news for Air Canada, and investors are beginning to reflect this in the stock.

Why it matters
For a company in Air Canada's position, the value of the Canadian dollar is critical. Of the company's $3 billion-plus in debt, much of it is denominated in U.S. dollars, so the value of the Canadian dollar affects the size of the debt and interest payments in Canadian dollars. And like other major airlines, Air Canada is a major user of aviation fuel, which has a price highly correlated with U.S. dollar-denominated oil prices.

WestJet Airlines (TSX:WJA) has also been hit by the drop, but its shares were not hit as hard. This is partially due to the smaller impact on WestJet because of its smaller debt but can also be a result of generally lower volatility in WestJet shares seen over the past few years. Nonetheless, WestJet raised fares alongside Air Canada to make up for the increased costs relating to the weakened currency.

Both Canadian carriers are also feeling the impact when it comes to acquiring new aircraft. Air Canada has already ordered 37 Boeing (NYSE:BA) 787 Dreamliners valued around $6 billion and will eventually look to replace its regional jet fleet (although the airline has delayed this portion of fleet renewal). WestJet is also preparing for international expansion, which would probably also require the purchase of additional aircraft. A weaker Canadian dollar can make fleet renewal more difficult, since most aircraft are priced in foreign currencies, making them more expensive in Canadian dollars.

Currency rebound
Since briefly falling below the $0.90 USD level a few times between January and March, the Canadian dollar has moved higher again, back to almost $0.92 USD. While it may not seem like much of a move, for an airline with billions in debt and large fuel costs, it means big cost savings.

The current stabilization of the Canadian dollar also breaks the downward movement of the currency since 2013, and it has even shown some signs of recovery.

Benefits of stability
Shares of Air Canada were pounded in January largely because of the quickness of the currency slide, making the current stabilization in the Canadian dollar a major positive for the airline. Air Canada has ways to manage its operations with a lower Canadian dollar by implementing fare and fee increases. However, doing this too quickly can cause consumer backlash and hurt ticket sales when they're needed most.

Air Canada is also working on a cost-cutting strategy that it hopes will give the airline greater margins to absorb possible future currency issues. In its March traffic report, the airline said it expects to reduce adjusted cost per available seat mile by 2.5% to 3.5% for the year 2014 compared with 2013.

The bottom line
By reducing costs while maintaining its growth plans, Air Canada is better positioning itself to weather future currency issues if they do indeed occur. In the meantime, the airline can benefit from an exchange rate closer to $0.92 USD, which is very much favorable over early 2014's lows.

The market has begun to reflect this, along with the airline's improved guidance, in pushing Air Canada shares up from their lows in the $5 range to the low $8 range today. Still, shares trade below their $9.90 peak in January, and if the airline can continue to execute alongside a stabilized Canadian dollar, I believe shares have a reasonable shot at reaching that level again in the near future.