1.  Canadian Airlines BUS 419 Presented by: Lin Chiu Wilson Lam Joti Muker Xueming Yang Cindy Yu

2. Agenda  Airline Industry Analysis  Services  Revenue  Cost Structure  Regulations  Current Challenges  Air Canada Business Strategy  West Jet Strategy  Risks  Air Canada  West Jet

3. Industry Segmentation

4. Industry Analysis

5. Services  Scheduled Flights / Chartered Flights:  Transnational  Regional  International  Cargo

6. Revenue  There are two sources of revenue for Airlines:  Passengers  Charters and cargos

7. Cost structure  Fuel Expenses  Wages & Salaries  Airport / Navigation Fees  Depreciation & Amortization  Maintenance  Food, Beverages, Supplies  Communications and Information Technology  Aircraft Rentals

8. Regulations  In the past few decades, government deregulation has dramatically increased competition and allowed the emergence of “low-cost carriers”  Some regulations still in place:  Federal Aviation Authority (FAA)  Airline Safety and Security  Environmental Concerns

9. Challenges  In recent years, the airline industry has been affected by:  Terrorism attacks & increased security costs  Epidemic diseases (SARs, Swine Flu)  Economic Crisis  Fuel Prices

10. Canadian Market  The industry is slowly recovering from its decline in 2009  The compound annual growth rate of the industry volume in the period 2008-2013 is predicted to be 4.7%.

11. Market Value Forecast

12. Strategies  Implementing cost reduction initiatives  Reducing company sizes  Reducing operations  Entering into agreements with supplier  Airline alliances  Apply hedging programs

13. Air Canada Strategies  Cost Reduction:  Corporate downsizing  Capacity management  Fleet renewal programs  Customer Driven Revenue:  Multi-tiered Fares  Web Platforms  Employee Incentives

14. WestJet Strategy  Four-pillars:  People and Culture  Guest Experience and Performance  Revenue and Growth  Cost and Margins

15. Risks  Operational  Strategic  Financial:  Fuel Prices  Foreign Exchange Rates  Interest Rates  Hazards

18. Airline Risk Factors

20.  Founded April 11, 1936 (as Trans-Canada Airlines)  David Richardson (Chairman)  Calin Rovinescu (President & CEO)  Headquarters in Montreal, Quebec  Subsidiaries  Air Canada Cargo (operating division)  Air Canada Jetz(operating division)  Air Canada Vacations  Destinations: 178  Company slogan: GO FAR

22. Profitability in 4 year Interval In thousands of Canadian dollars

23.  Financial Statements

28. Reasons to Hedge  Should the Company Hedge ? YES!  WHY?  Fuel price changes have a significant impact on income  Foreign exchange rate impact earnings and operating costs  Interest rate changes effect borrowing costs

29.  Risk Management

30. Hedging Strategy  Michael Rousseau Executive Vice President & CFO, since 2007  Prior Position:  Executive Vice-President & CFO in Hudson’s Bay Company (HBC) Since 2001  Executive Financial positions in Moore Corporation, Silcorp Limited & The UCS Group  Education background:  BBA degree from York University  Member of the Ontario Institute of Chartered Accountants since 1983

31. Risk Exposures & Strategy Risk Factors:Strategy Market RiskDerivative Instruments. Credit RiskReview credit ratings on regular basis and sets credit limit. Liquidity RiskCash from operation & financing. Fuel Price Risk Enter in derivative contracts: call, put options, swaps, collars. Adjust the strategy with market Interest Risk Portfolio basis & swaps Foreign Exchange rate Forward foreign currency contracts and option agreements, swaps. Try to get positive CF on Mark-to- Market

33.  Fuel Price Risk

34. Air Canada’s Cost Structure

35. Fuel Price Risk Exposure

36. Sensitivity on Operating Income  Estimated operating income impact from US$1/barrel increase in WTI – ($25 Million) estimates are derived from 2008 levels of activity and make use of management estimates.  A 1% increase in Jet fuel prices (CAD cents/litre) has an estimated operating income impact of ($35 Million)  Fuel Expenses – 31% of 2008 total operating expense, 25% of 2007 total operating expense

37. Hedging Ratio For 2009:  35% of anticipated purchases of fuel  The contracts to hedge anticipated jet fuel purchases over 2009 is comprised of jet fuel, heating oil and crude oil – based contracts For 2010:  14% of of anticipated purchases of fuel

38. Hedging Strategy Dec 2008

39. Hedge Strategy Jan 2009

40. How much did they make/lose off fuel hedges?

41. Comprehensive Income (Loss)

42. Operating Income/Expenses

43. Gain (Loss) on Financial Instruments

45.  Interest Rate Risk

46. Interest Risk High level of Leveraging rate of 2008==$4691/$762 =615.616% Section of Balance sheet: Section of Cash Flow:

47. Interest Risk: Contractual Obligations:

48. Sensitivity Analysis

49. Interest Risk Exposure  Fixed rate debt  Floating rate debt  Lease on assets based on changes in short-term interest rates  Aircraft financing agreements

50. Interest Rate Risk  Objectives:  Minimize the potential changes in cash flows from changes in interest rates  Long term objective: 60% fixed and 40% floating debt  Dec 31,2009 – 59% fixed and 41% floating  Dec 31,2008 – 58% fixed and 42% floating  Designed to maintain flexibility in the Air Canada’s capital structure

51. Hedging Strategy Cont  Use of Derivatives  3 cross-currency interest rate swap, financing Boeing 777 worth 300 million  Terminated on Oct 1,2008, 4 million Gain  2 Interest rate swap, financing Boeing 767  14 million gain  19 forward interest rate to manage risks associated US and Canada interest rate market  No gain or loss recorded

54.  Foreign Exchange Risk

55. Foreign Exchange Rate Risk  Cash flow structure:  Inflows primarily in Canadian dollars  Large portion of outflows in US dollars  Majority of outstanding debt is US dollars  US dollar debt act as an economic hedge against the related aircraft  Foreign exchange risk on foreign currency denominated trade receivables and foreign currency denominated net cash flows

56. Foreign Exchange Rate Risk Section of Cash Flow Statement: Section of Income Statement:

57.  Foreign Currency Forward Contract / Option Agreements - USD to CAD(US$516 M)2009, Euro to CAD(EUR$3M)2010$64 M - Gain, $327 M recorded in foreign exchange gain related to these derivatives  Foreign Currency Forward Contract / Option Agreements - USD to CAD(US$297 M)1009, Euro to CAD(EUR$3 M)2010 - $51M Gain  Currency Swap Agreements on operating leases (2007,2011) - $78 M notional amount. Foreign Exchange Rate Risk

58. Summary of Gain (loss) on Financial Instruments Fuel RiskInterest RiskForex Risk Gains/lossesLossGainLoss Reported Amounts (208)18(655)

59. Effective?

60. 

61. Company Background WestJet began service on Feb 29, 1996. – founded in 1996 by the team of Calgary entrepreneurs Canada’s leading high-value low fare airline. WestJet flies an average of 383 flights everyday

63. Profitability in 4 Year Interval In Thousands of Canadian Dollars

64. Operating Expenses

65. Risk Exposures & Strategy Risk Factors:Strategy Market RiskTry to accurately predict market movements Credit Risk Cash and cash equivalent Liquidity RiskMaintain current ratio > 1 Fuel Price Risk Enter in derivative contracts: costless collars and swaps. Adjust to market expectations Interest Risk Canadian dollar fixed interest rate debt Foreign Exchange rate Forward foreign currency contracts and option agreements, swaps

66. Outline of Risk Factors Related to Derivative Securities Jet Fuel Price Risk Changes in crude oil and fuel prices Foreign Currency Risk Canadian-US dollar exchange rate Interest Rate Risk Interest rate fluctuations

67. Income Statement

68. Cash Flow Statement

69. Reasons to Hedge  Should the Company Hedge ? YES!  WHY?  Dependent on jet fuel and prices are volatile  Currencies exchange rates fluctuations causing the value of assets and liabilities and/or future cash flows change  Interest rate fluctuations changes the value of financial assets and liabilities and/or future cash flow

70.  Fuel Risk

71. Jet Fuel  Consumed 210,090,434 litres of fuel in 2008  Every $1 USD Δ per barrel of crude oil ≈ $ 7 million annual Δ in fuel costs  Every 0.01¢ Δ per litre of fuel ≈ $ 9 million annual Δ in fuel costs

72. Jet Fuel Hedging Philosophy As approved by the Board of Directors:  Hedge a portion of anticipated jet fuel purchases  Established maximum hedging limits  Up to 36 months  Using crude-oil based commodities

73. Average Market Price of Jet Fuel Basis risk

74. Jet Fuel Price Hedging Strategy  Mixture of fixed swap agreements  Costless collar structures in Canadian-dollar WTI crude oil derivative contracts  Short position in call option  Long position in put option  2008 hedge ratio: 30 percent  2009 hedge ratio: 14 percent  2010 hedge ratio: 32 percent

75. As of December, 2008 Fuel Hedge Derivative Holdings

76. Fuel Cost

77. 2008 Balance Sheet and Income Statement~ Note 11

78.  Interest Rate Risk

79. Interest Rate Hedging Strategy  85 % of borrowing is done at low interest through debt guaranteed by Export-Import Bank in the US  Borrow 1.3 billion CANADIAN  Fixed interest rates  Borrow in Canadian funds- use Canadian cash inflows to pay Canadian outflows

80. Contractual Obligations and Commitments

81.  Foreign Exchange Risk

82. Foreign Currency Exchange Risk  Arising risks  Fluctuations in exchange rates on US-dollar denominated asset and operating expenditures  Aircraft fuel, leasing expense, maintenance costs and a portion of airport operations costs.  US $99.5 million in 2008  Between 2008 and 2009  The average US exchange rate increase from 1.0651 to 1.1425

83. Foreign Currency Exchange Hedging Strategy  To reduce foreign exchange risk:  Hold US-denominated cash and short term investment  Foreign exchange forward contracts  In 2010  US 7.3 million per month for the period of Feb to Oct  US $65.4 million at a weighted average contract rate of 1.0671 per US dollar

84. Foreign Currency Exchange Risk  Foreign Exchange Forward Contact  average contracted rate on the forward contracts was 1.0671 (2008 – 1.0519) US dollars to Canadian dollars,  average forward rate used in determining the fair value was 1.0512 (2008 – 1.2178) US dollars to Canadian dollars 20082009 Average contracted rate on the forward contracts1.05191.0671 Average forward rate used in determining the fair value1.21781.0512

85. Foreign Currency Exchange Risk  Impact of foreign exchanging hedging  Every one-cent change in the value of the Canadian dollar versus the US dollar will have an approximate $9 million impact on our annual operating costs  $9million =($6 million for fuel, $3 million related to other US dollars denominated expense)

86. Five Year Foreign Exchange Graph

87. Foreign Currency Exchange Risk  In 2007, lose 12.8 million  In 2008, gain 31 million  In 2009, lose 12.3 million 20082007

88. Summary of Derivative Instruments

89. Carry Amount

90. Future Outlook  Expect a economic recovery  Jet fuel prices stabilized and decreased in 2009  Do not expect to see the same relief on costs going forward  Hedged about 32 % of anticipated fuel requirements for 2010  35 % of the total volume hedge using costless collars  65% of the total volume hedge using fixed swap agreements

91. Summary (2008) West JetAir Canada Market Share36%57% Gain (Loss) on Jet Fuel Hedging($18 millions)($92 millions) Gain (Loss) on Foreign Exchange Hedging$31 millions($822 millions) Gain (Loss) on Interest Rate Hedging$18 millions

92. Questions ?

93. Thank you