For months, executives at Air Canada and WestJet have defended to investors their recent rapid expansion, insisting new international routes will pay off despite the relatively slow growth of Canada's economy.
Now at least one major investment bank is onboard.
In reports issued on 29 September, Credit Suisse paints a positive picture of Canada's airlines – particularly Air Canada – and argues that investors have "misunderstood" capacity growth.
The report also argues that Air Canada and WestJet, the country's only major players, have largely maintained "pricing power" in recent years by limiting domestic expansion.
"Canadian airlines investors have feared that the last three years of capacity growth… is a sign that the capacity discipline the duopoly structure was supposed to enforce is breaking down," says Credit Suisse. "However… the duopoly has shown its benefits domestically as growth has been in new markets and much of the seat growth has been international."
"Canada has historically underserved the long-haul international traveller and is beginning to leverage its geographical position… catching up to latent demand," Credit Suisse adds.
The bank rates Air Canada "outperform", projecting the Montreal-based carrier's net profits will increase to C$1.25 billion ($950 million) by 2018, up from $308 million in 2015.
Credit Suisse rates Calgary-based WestJet "neutral", citing uncertainty posed by changes to the carrier's business model – such as its acquisition of Bombardier Q400s and Boeing 767s. It projects WestJet will earn a pre-tax profit of C$408 million in 2018, down from C$520 million in 2015.
Credit Suisse's reports come about one week after executives at both carriers urged investors not to be overly concerned by domestic capacity increasing faster than Canada's gross domestic product (GDP).
Canada's GDP inched up just 1.1% in 2015 and is forecast to increase about the same rate in 2016, according to the World Bank and the Bank of Canada.
Meanwhile, in the second quarter of 2016 Air Canada's capacity increased 11% year-over-year. And WestJet anticipates that it will end 2016 with capacity up 6.9% year-over-year.
Speaking during the Canadian Imperial Bank of Commerce's Eastern Institutional Investor Conference on 22 September, Air Canada chief financial officer Michael Rousseau reminded investors that 90% of his carrier's growth in recent years has come from new international flights.
Rousseau insisted Air Canada's can profitably serve new international routes thanks to a number of factors, including the acquisition of lower-cost 787s and the addition of seats on long-haul aircraft.
In addition, much of the new routes are operated by low-cost subsidiary Rouge, which operates aircraft at a 25% cost savings compared to the mainline operation, he said.
"The results, to date, have been incredibly," Rousseau said of the financial performance of Air Canada's international operations.
Likewise, during the same conference, WestJet chief executive Gregg Saretsky said two-thirds of WestJet's 2016 growth will result from the launch earlier this year of 767-300ER service to London from five Canadian cities.
"I think people are overly obsessed with growth that exceeds GDP," he said, "I guess the comfort I would give to investors is, in our 20-year history, we have never grown less than GDP, and yet we have generated record returns."
Credit Suisse's reports make similar points.
"International seat growth is the major driver of seat growth by Canadian carriers in 2016, as Air Canada expands its international reach and WestJet begins to experiment with widebody service into London," the bank says. "The Canadian airlines industry has historically underserved demand, and… GDP growth is an incorrect way to assess capacity discipline."
OTHER POSITIVE FACTORS
Credit Suisse projects a number of factors will enable Air Canada to continue to expand margins in the coming years.
It says the carrier's growth should ease after 2017 as deliveries of new 787s slow. Air Canada has outstanding orders for 16 787-9s, with nine to be delivered in 2017, three in 2018 and four in 2019, according to FlightGlobal's Fleets Analyzer.
Also, in the coming years Air Canada intends to take delivery of new, more efficient narrowbodies, Credit Suisse notes.
The airline has orders for 61 Boeing 737 Max and 45 Bombardier CS300 aircraft, Fleets Analyzer shows.
Credit Suisse also says Air Canada has "one of the best cost trajectories in the industry", projecting it's unit costs, excluding fuel expenses, will be 7% less in 2018 than in 2015.
Air Canada should achieve the savings thanks to a restructured capacity purchase agreement with its regional partner Jazz Aviation, the addition of seats to mainline aircraft and new 10-year labour agreements, the bank says.
The new agreement with Jazz should save Air Canada C$100 million annually through 2020, and a new revenue management system should generate $100 million in additional revenue annually, says Credit Suisse.
The bank has taken a more cautious view of WestJet. It notes the carrier has transformed in recent years away from its roots as an all-737 operator.
WestJet's regional subsidiary Encore, launched in 2013, now operates 32 Bombardier Q400s, and in the last year WestJet acquired four used 767s, Fleets Analyzer shows.
Those new types add complexity to WestJet's operation and may erode WestJet's cost advantage over Air Canada, Credit Suisse says.
At the same time, however, WestJet has orders for 65 737 Max, aircraft that will help reduce its cost per available seat mile by 10%, Credit Suisse writes.
The bank also suggests WestJet could add more seats to its aircraft, renegotiate airport fees and reduce its maintenance expenses.
Source: Cirium Dashboard
