Air Canada Targets Renewed Growth With Low-Cost Unit

Air Canada (AC/B) plans to boost revenue with a low-cost carrier that may start as soon as 2013 and invest in more fuel-efficient jets to shake its status as North America’s least efficient airline.

A labor accord with pilots selected by an arbitrator last week lets Air Canada start its proposed low-cost business with as many as 50 aircraft, including single-aisle Airbus SAS A319s and twin-aisle Boeing Co. (BA) 767s, Chief Executive Officer Calin Rovinescu said on an earnings call today. Routes will include leisure destinations such as Las Vegas, Mexico and Florida.

“This agreement is a key element in the blueprint that will allow Air Canada to not only compete more effectively, but also renew growth after years of stagnation,” he said.

Air Canada had the highest annual cost to fly a single seat a mile of any North American airline for the past three years, according to data compiled by Bloomberg Industries. Its fleet is twice the average age of rival WestJet Airlines Ltd. (WJA), the most recent data show, and Air Canada said today it will conduct a review to determine which aircraft need replacing.

“There’s still periods of lots of restructuring they have to work through and there’s going to be lots of noise around the name but I think they have enough momentum and enough dominoes in play they can probably extract some good cost savings in various initiatives across the board,” said David Newman, a Cormark Securities Inc. analyst in Toronto who raised his rating to speculative buy from market perform on Aug. 1.

Earnings Miss

Air Canada reported a second-quarter adjusted loss of 5 Canadian cents a share today, wider than the 1-cent average of analysts’ estimates, after labor disruptions and the closing of a maintenance provider curbed bookings.

Including a currency-exchange loss and other expenses, net loss widened to C$96 million, or 35 cents a share, from C$46 million, or 17 cents, a year earlier. The report marked Air Canada (AC/A)’s sixth consecutive unprofitable quarter. Operating expenses for each seat flown a mile increased 2.3 percent from the same period a year ago, Air Canada said.

“The rest of the industry has been moving ahead to capture a large portion of the ever-growing leisure or low-cost market,”Rovinescu said on the call. “The low-cost model contemplated in the agreement would allow us to maintain or grow Air Canada’s presence in the low-cost market where we are no longer able to compete against new entrants.”

Full-service carriers in North America have a troubled history running low-cost units. In 2008 surging fuel prices and an industrywide contraction forced United Airlines to shut down its low-cost Ted airline.

Song Ends

Delta Air Lines Inc. folded its Song unit in 2006, and reduced demand after the Sept. 11 attacks put an end to Delta Express, United Shuttle and US Airways’ Metrojet.

One success story is Australia’s Qantas Airways Ltd. (QAN) which introduced its low-cost Jetstar Airways Ltd. in 2004.

In the early part of the decade Qantas was also struggling with high costs and competition from a low-cost carrier, Russell Shaw, an analyst with Macquarie Group Ltd. in Sydney, said in an e-mail. Qantas’ solution was a low-cost carrier with separate labor contracts.

“It then successfully segmented its own network into premium and leisure routes, such that Jetstar did not compete directly against Qantas on any route,” he said. “Where there was overlap, the flight times were different to cater to different markets.”

Qantas’ control of Jetstar was key to making sure the airlines didn’t compete, Shaw said, and this allowed Qantas to apply best practices from its low-cost unit in its main business, including paying Qantas employees at Jetstar rates.

Fleet Review

Low-cost WestJet Airlines Ltd. plans to increase its competition with Air Canada by starting a regional carrier next year that will use Bombardier Inc. (BBD/B)’s new Q400 turboprop jets.

Air Canada said today its narrow-body Embraer SA (EMBR3) 175s, which joined the fleet in 2005, may be succeeded by newer, more fuel-efficient planes.

Cormark’s Newman said Air Canada could move as many as 60 new jets into its regional operations. Replacing the Embraer jets with more efficient jets could save between C$30 million to C$50 million, he said in an interview.

“It would make sense, at least from my perspective, that they would eliminate those from their fleet, because they’re probably not cost-efficient,” Cameron Doerksen, an analyst with National Bank Financial, said by phone yesterday.

Air Canada fell 7.8 percent to C$1.06 in Toronto today, its largest drop since February. The shares have gained 7.1 percent this year.

Pension Solvency

The carrier said the recent labor deals will save it C$1.1 billion in pension costs. Even with those savings, the company still faces a C$3.1 billion pension solvency deficit and is in discussions with its unions and Canada’s finance department about the possibility of extending a moratorium on funding payments.

Without the extension, the airline said it will face more than C$900 million of pension payments in 2012 and 2013.

“Transformational change is not easy, especially in the case of a legacy carrier with high fixed costs, unionized labor, and a huge and onerous pension commitment,” Rovinescu said on the call. Still, with principal labor agreements complete and potential growth from the low-cost airline, “we are well positioned to transform Air Canada into a more competitive, sustainable and solidly profitable airline.”

To contact the reporters on this story: Frederic Tomesco in Montreal at tomesco@bloomberg.net; Ari Altstedter in Toronto at aaltstedter@bloomberg.net

To contact the editor responsible for this story: Ed Dufner at edufner@bloomberg.net

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