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Air Canada (AIDIF.PK) was placed on Standard & Poor’s CreditWatch Tuesday with negative implications due to the increased pressure on the carrier’s short-term cash flow.

The decision was prompted by the need for the airline to post significant collateral on its fuel-hedging contracts because of the recent rapid decline in fuel prices and its capital expenditure in the past year on new planes and its fleet refurbishment program, the New York rating agency said.

But the possibility of increased pension payments and lower tickets sales compounded the urgency for the review, it added.

Greg Pau, a S&P credit analyst, said:

Although we believe the drop in fuel prices and a more modern and fuel-efficient fleet should help Air Canada’s cost position and improve its operating cash flow in 2009, these factors have a more near-term effect on the company’s liquidity.

Air Canada’s available free cash dipped to about C$1-billion at the end of October, or roughly 10% of its trailing 12-month revenue, compared to 15% to 20% of its competitors. In addition, it has been unable to access its C$400-million revolving line of credit due to the instability in the market.

While Air Canada is currently exploring means to improve its liquidity, its noninvestment grade “B” rating could slip a notch or two if it fails to improve its cash flow or its liquidity materially deteriorates in the next two quarters, S&P said. It would have to improve its cash levels and its revolving line of credit to 15% of its 12-month revenue in order to be taken of CreditWatch and have its rating untouched.

Source: Cash Flow Pressures at Air Canada Lead to S&P Credit Watch