Air Canada Shops for Jets as Return to Profit Is Forecast

Air Canada is considering purchases of mid-sized jets amid growing confidence the country’s biggest carrier will be profitable next year after an anticipated fifth straight loss.

Talks are under way with Boeing Co., Airbus SAS and Bombardier (BBD/B) Inc. for more than 100 aircraft, Chief Commercial Officer Ben Smith said in a telephone interview. A decision to buy planes may come “in the short term,” Smith said last week, sooner than the one-year timeline the airline gave on Nov. 8.

Adding single-aisle models with the latest fuel-saving technology that can carry about 150 passengers could help Air Canada shed its status as North America’s least-efficient carrier. Its fleet is twice as old as that of discounter WestJet Airlines Ltd. (WJA), which Montreal-based Air Canada is challenging by creating a low-cost unit.

“It’s always a good sign when they’re thinking about new plane orders,” said John Braive, vice chairman at CIBC Global Asset Management, which holds Air Canada bonds among C$40.6 billion ($40.9 billion) of Canadian fixed-income assets. “Your aircraft are starting to get older. You do have to upgrade to the newer type of planes, which have better wings, more room for passengers, better fuel efficiency.”

The widely traded Class B shares have soared 65 percent to C$1.79 since July 30, the day a federal arbitrator let Air Canada implement a pilot contract to help pave the way for the as-yet-unnamed low-cost business.

‘Profitable Growth’

Chief Executive Officer Calin Rovinescu now has “a higher degree of comfort around what his cost lines are going to be, what his constraints are,” Walter Spracklin, an RBC Capital Markets analyst, said in a telephone interview from Toronto. “Air Canada is entering a new phase of profitable growth.”

Analysts expect a return to profit in 2013, based on estimates compiled by Bloomberg. Air Canada is in talks with the government about a possible delay to the January 2014 deadline for restoring pension contributions to their usual level. The airline has said its Canada-based unions support an extension.

“We’re continuing our discussions,” Canadian Finance Minister Jim Flaherty told reporters yesterday in Ottawa.

The current narrow-body fleet consists of 88 planes from Airbus’s A320 family, along with 60 Embraer SA (EMBR3) regional jets. The smallest of those planes, 15 E175s, will be shifted next year to feeder carrier Sky Regional Airlines Inc. for use on short-haul routes in Canada and the U.S.

2005 Order

Air Canada’s last major order came in 2005, when it bought wide-body Boeing (BA) 777s and 787s. Any new single-aisle deliveries probably wouldn’t come until the end of this decade, Smith said.

Boeing says its 737 Max with new engines will have a 19 percent fuel-use advantage over the current A320. Airbus is reworking that plane into the A320neo for a 2015 debut that would beat the Max’s 2017 arrival. Bombardier’s first CSeries will probably enter service in mid-2014.

“Neo, Max and the CSeries are all very exciting airplanes,” Smith said. “We are studying them very closely. There are fuel-efficiency levels that we’ve never seen, costs that are much lower. But, of course, there are high capital costs to bring these airplanes in.”

The latest Boeing and Airbus narrow-bodies list for about $100 million each, though airlines typically buy at a discount. Bombardier’s smaller CSeries planes retail for $61.8 million to $70.6 million, depending on the model.

Fleet ‘Backbone’

The A320s are “the backbone of our North American fleet,” said Smith. “It’s a tall order to replace them.”

Counting all aircraft, Air Canada’s 204 planes average 12.1 years of age, topping WestJet’s 5.8-year average, according to the carrier’s website and data compiled by Bloomberg. The first A320s joined the fleet in 1989, followed by the A319 version in 1996 and the A321 in 2001, according to Air Canada’s website.

“The concept of fleet renewal makes sense,” Chris Murray, a PI Financial Corp. analyst, said by telephone from Toronto. “It’s a classic case of long-term planning. But it’s an appropriate time to start it. The narrow-body age right now isn’t bad but by the end of the decade they will be toward the end of their lives.”

Survival, not new planes, has been a focus for Air Canada in recent years.

Annual Losses

Annual losses starting in 2008 and estimated by analysts to extend into this year rekindled speculation about a return to bankruptcy after the airline’s 2004 exit. Costs for each seat flown a mile, an industry benchmark, have been North America’s highest, according to data compiled by Bloomberg. Analysts project a 2012 adjusted loss of 20 Canadian cents a share, the average of 11 estimates in a Bloomberg survey.

Liabilities totaled C$13.3 billion as of Sept. 30. The amount includes current liabilities of C$3.4 billion, long-term debt and finance leases of C$3.6 billion, and C$5.3 billion in pension liabilities.

“They are still highly levered, but the pension relief means they are going to be in a better position,” David Tyerman, an analyst at Canaccord Genuity, said by telephone from Toronto. He and Murray rate the shares a buy, and RBC’s Spracklin recommends the stock as outperform.

Air Canada (AC/A)’s bonds also have rallied since the July 30 arbitrator’s decision, which imposed the airline’s last contract offer on pilots. That ruling let Air Canada proceed with its proposed low-cost unit.

Spread Narrows

The spread on the 9.25 percent notes due August 2015 has narrowed 245 basis points, or 2.45 percentage points, to 609 basis points more than government debt since July 30, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Peers in a Bank of America Merrill Lynch index of U.S. and Canadian high-yield bonds narrowed 59 basis points to 557 basis points in the same period.

While Air Canada hasn’t disclosed wage details for the low- cost unit, Rovinescu has said the carrier may be patterned after Qantas Airways (QAN) Ltd.’s Jetstar. Average pay for Jetstar captains and second officers amounted to about 42 percent of Qantas’s level, Spracklin said in a Nov. 30 note to clients.

The low-cost service will start in June with four planes, and Air Canada (AC/B) projects the unit eventually may reach 50. Air Canada also will take deliveries of two 777s next year, followed in 2014 by the first of the Dreamliners, for which the original order was almost doubled to 37 planes as the airline starts the biggest international expansion in its 75-year history.

“It’s going to elevate the capital expenditures and further increase the debt” even with some financing in hand, Darren Kirk, senior credit officer at Moody’s Investors Service in Toronto, said of the new twin-aisle jets. “There will be some time before they see the benefits of these aircraft.”

Air Canada’s Smith said a potential single-aisle order “has to financially make sense for us.”

“We have to make sure that the math works,” he said. “Planes aren’t cheap. We have well over 100 narrow-body aircraft, and we’d like to ensure that whatever we buy can carry us through for many years.”

To contact the reporter on this story: Frederic Tomesco in Montreal at tomesco@bloomberg.net

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

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