Delivering the Goods
For almost a century, aircraft have hauled machinery and supplies to remote locations across Canada.
July 27, 2009 By Frederick K. Larkin
For almost a century, aircraft have hauled machinery and supplies to remote locations across Canada. Much of that activity has been related to the development of natural resources and performed by charter outfits or corporations. The arrival of scheduled domestic cargo flights came after the Second World War. It proved to be a niche business, as dedicated freighter aircraft adhering to timetables demanded a steady flow of time-sensitive traffic between major centres.
During the ’50s and early ’60s, the railroads dominated the inter-city transport of freight. With the opening of the Trans-Canada Highway in July 1962, trucks began to compete against the two transcontinental railways for long-haul movements of goods. Scheduled airlines have tended to look at the cargo business as a byproduct of their raison d’etre – carrying people. The excess capacity in the bellies of their aircraft has provided a revenue-generating opportunity on flights across their networks. Throughout much of its history, Air Canada has operated scheduled cargo services.
Back in the ’50s, as Trans-Canada Air Lines, it had three Bristol 170 freighters. Those high-winged bulbous-nosed beasts could carry 12,000 pounds at a blistering 140 knots; roughly twice the speed of a train. Later that decade, they were replaced by five cargo configured Canadair North Stars that could haul 16,500 pounds at 220 knots. With the advent of the turbine age block, speeds increased further, thereby enhancing the air cargo operators’ competitive position vis-à-vis the surface modes. Between 1966 and 1972 Air Canada (AC) operated a Vickers Vanguard Cargoliner that boasted a 42,000 pound payload. That aircraft was replaced by a pair of twin-jets (a DC-9-15F and a DC-9-32CF) from 1972 until 1978. From 1963 until 1994 it operated a succession of Douglas DC-8 freighters (-54Fs, then -63Fs and re-engined -73Fs). That was it for AC’s scheduled cargo operations. Air Canada ordered a pair of Boeing 777Fs (with massive 229,000-pound payloads) in 2005 but they were subsequently cancelled. The only other domestic passenger airline to offer sked cargo service was Canadian Airlines. It briefly flew a pair of 737-200Cs on transcon routes during the mid-’90s. While regional carriers such as Pacific Western Airlines, Transair and Nordair operated cargo configured 707s and DC-8s during the ’70s and ’80s, those aircraft were tramps and could be found working charter contracts at airfields around the globe. Not to be left out of the action were six smaller scheduled cargo carriers that used jets to seek market share during the past two decades. They were AllCanada Express (727s), CanAir Cargo (737s), ICC International Cargo Charter Canada (A300s), Jetall Airways (737s), Swiftair Cargo (DC-8s) and World Wide Air Charter Transport Systems (DC-8s). Longevity was not their strong suit.
Today there are three major Canadian scheduled cargo airlines. The youngest of those, and the one that has achieved the fastest growth in recent years, is Cargojet. In light of the turbulent economic environment that is buffeting the business, it is fair to ask, “Will Cargojet be able to avoid the fate of the aforementioned six carriers?” Before we attempt to answer that, it is worth reviewing the company’s history.
That Was Then…
The driving force behind Cargojet is Ajay K. Virmani. Ten years ago he owned a pair of freight forwarding companies that he later sold to EGL Eagle Global Logistics of Houston, Texas, in January 2000. Virmani became the president of EGL’s Canadian operations. He was now a manager in a large, well-run foreign company and his inner entrepreneur began to stir. Virmani believed that the cargo business at most major airlines was not treated as a top priority. He felt that an opportunity existed to develop a service-oriented air cargo organization in Canada. After all, as a freight forwarder he had been an airline customer and knew the customers’ needs. To that end he and two partners (Dan Mills and Jamie Porteous) purchased 50 per cent of Canada 3000 Airlines’ Royal Cargo unit for $10 million in July 2001. The new joint venture became Canada 3000 Cargo on Aug. 1, 2001, and Virmani was appointed president and CEO.
|Ajay Virmani, president and CEO of Cargojet.|
On Nov. 8, 2001, Canada 3000 Airlines declared bankruptcy and its liquidation began. Canada 3000 (C3) Cargo, however, continued to operate during that process with the support of its customers. On Feb. 21, 2002, Virmani and company acquired the other half of C3 Cargo, which was renamed Cargojet Airways. Operations included a fleet of eight wet-leased aircraft that served a dozen domestic destinations. On July 21, 2002, Cargojet purchased Winnport Logistics of Winnipeg and thereby attained its own air operator certificate. That same month saw the delivery of the carrier’s first aircraft – a pair of 727-200 freighters. Three months later Cargojet received its approved maintenance organization certificate enabling it to do all but heavy work. A significant development in the company’s history occurred on April 14, 2003, when it took over the UPS Canada contract. The following month it entered into marketing alliances with Air France and British Airways, and became a domestic feeder for those carriers.
On June 1, 2003, Cargojet joined the International Air Transport Association. That same month it established Winnipeg as its domestic hub. It now operated six flights each weeknight from Winnipeg to Hamilton, Montreal, Vancouver, Edmonton and Calgary. Effective Sept. 22, 2003, Cargojet expanded its marketing alliances with international carriers by adding Korean Air. It now provided feed to and received traffic from trans-Atlantic and trans-Pacific flights.
In February 2004, Cargojet applied to the Canadian Transportation Agency for permission to create a passenger charter subsidiary. A month later Starjet Airways took delivery of two 727-200s, each configured with 60 first-class seats. Service began on April 1 from a base at Toronto. Starjet never achieved its financial performance goals and voluntarily ceased operations in October 2006. The company’s focus would be on the freight business.
The company became a publicly traded entity when Cargojet Income Fund completed its initial public offering of units on June 9, 2005. The fund controls Cargojet Holdings, which in turn owns Cargojet Airways. In November of that year the company began operating five flights per week from Newark, N.J., to Bermuda. A month later, one of Cargojet’s domestic competitors, AllCanada Express, declared bankruptcy. This provided further opportunity to capture market share.
As major passenger airlines rely on regional carriers to feed traffic from smaller markets into their transcontinental networks, Cargojet recognized the potential to do the same with regional cargo operators. On July 17, 2007, it agreed to purchase Georgian Express of Toronto. Its fleet (two Beech 1900Cs and four Cessna 208B Caravans) began operating under the Cargojet Regional brand on Oct. 2, serving 19 destinations within Ontario, Quebec and the Maritimes. Cargojet announced its intention to acquire 51 per cent of Prince Edward Air (PEA) of Charlottetown on Jan. 18, 2008. The deal closed on May 1 of that year and resulted in a Cargojet Regional fleet of 19 aircraft operated
Cargojet Income Fund completed a $36 million offering of 7.5 per cent convertible debentures on April 16, 2008. The proceeds were used to finance a fleet upgrade program at Cargojet Airways, to fund the acquisition of PEA and to repay short-term debt. On Aug. 5, 2008, Cargojet took delivery of a Boeing 757-200F capable of carrying 80,000 pounds – a 33 per cent increase over the 727-200F’s 60,000-pound payload. Two days later, Cargojet’s first Boeing 767-200ERF arrived, followed by a second 767 in late September. These wide-bodies each have a 100,000-pound payload. This new trio of leased aircraft entered revenue service at the end of September 2008 and represented a meaningful expansion of capacity and operating capabilities. On March 5, 2009, the company announced its plan to purchase the other 49 per cent of PEA.
This Is Now…
Today Cargojet is a leading provider of time-sensitive overnight air cargo services. Its business is segmented into four categories:
Domestic cargo – operates a weekday overnight air cargo co-load network between 13 destinations. Non-scheduled charters are also operated during weekdays and on weekends.
International cargo – operates between Newark, N.J. and Bermuda five times per week.
ACMI – provides aircraft, crew, maintenance and insurance for customers on operations within North America.
Regional cargo – operates a fleet of smaller aircraft between 19 destinations within eastern Canada.
Cargojet’s fleet of 13 jets consists of 10 727-200Fs, one 757-200F and two 767-200ERFs. Its regional fleet of 19 aircraft includes one Saab 340A, one King Air 200, three Beech 1900Cs, three Beech 99s, seven Navajo Chieftains and four Caravans. In addition, two Beech 1900Cs are operated by Skylink Express on behalf of Cargojet’s regional services. These 34 aircraft transport more than 760,000 pounds of freight each business night. The domestic cargo operations, which last year represented approximately 70 per cent of the company’s revenues, carry traffic from contract customers, non-contract clients and other airlines.
International cargo operations are represented by the Newark-Bermuda route as well as some charter work. The aircraft operated on that route is done so on an ACMI basis and is the only ACMI contract currently operated by the company. The regional cargo business is operated by Prince Edward Air and connects 19 points within the eastern half of Canada with Cargojet’s mainline network. It currently represents approximately 15 per cent of Cargojet’s total freight related revenues. Cargojet’s more than 400 customers include leading courier companies, freight forwarders, manufacturers and scheduled passenger airlines. In addition, it performs ad hoc charters that carry atypical loads. UPS Canada, DHL Express Canada, Sameday Worldwide, ICS Courier Services, DB Schenker, CEVA Global Logistics, ATS Andlauer Transportation Services and Midland Transport are some of Cargojet’s largest clients. It also has commercial alliances with close to 40 passenger carriers that serve North America, South America, Europe, Asia and Oceania. Cargojet’s customer base includes companies from the agriculture, clothing,
electronics, chemical, pharmaceutical, seafood and precious metals industries. Its charters can carry livestock, emergency relief supplies and military equipment. Last November, one of its 767s flew equipment for the band Coldplay from Phoenix, AZ, to Sheffield, UK. All of this work is performed by a team of approximately 520 members. Of these about 300 are in airline operations, 170 handle the cargo and 50 are in administration. To gain a better understanding of any business model and appreciate how a company may perform in the future, it is useful to perform a S.W.O.T. analysis (Strengths, Weaknesses, Opportunities and Threats). Doing so with Cargojet yields the following insights:
S.W.O.T. ANALYSIS OF CARGOJET
Cohesive culture – From Day 1 Cargojet’s senior management has made it a priority to focus on the requirements of its clients.
This may sound trite, but when one reads customer testimonials on the Cargojet website there is a recurring theme. Terms such as “teamwork,” “a can do attitude,” “partnership with customers,” “attention to detail,” “commitment to service,” “exceed expectations,” “highly motivated,” “customer centric” and “integral partner” are peppered throughout comments made by senior officers of client companies. Nothing wins business and keeps customers like excellent service provided by user-friendly professionals. Such a culture is helpful in attracting and retaining capable staff. Interesting to note that approximately 80 per cent of its people hold units of Cargojet Income Fund. That makes them owners of the enterprise, not merely employees.
Revenue visibility – Approximately three-quarters of Cargojet’s revenues come from contracts that are three to five years long. These contracts provide for guaranteed minimum volumes, which enables the company to more accurately forecast its capacity requirements and thereby better control related costs. The balance of its revenues comes from ad hoc charters.
Reduced Capex requirements – With the investments related to the introduction of the 757 and 767s now behind it and with the completion of its new hangar at Hamilton, Cargojet’s discretionary spending should be lower going forward.
Aging fleet – The backbone of Cargojet’s fleet is the Boeing 727-200F. The average age of its ten 727s is approximately 29 years. Cargojet owns seven of those and leases three. Since these aircraft each have an annual utilization rate of about 1,200 hours, they still have years of useful life in them. The key to the timing of their retirement is likely going to be the price of fuel. The aircraft type that will eventually replace the 727s will probably be the 757-200F. Cargojet’s 757 is 19 years old.
Commercial concentration – During 2008 Cargojet generated 44 per cent of its sales from its top three customers each of whom represented more than 10 per cent of its total revenues. Furthermore, approximately 73 per cent of its revenues came from its ten largest customers. While this appears to be a high degree of concentration, its traffic is sourced from a diverse base of companies representing a wide range of industries.
International missions – Whether it be scheduled services or charters, Cargojet now has the equipment to pursue overseas business. The development of scheduled trans-Atlantic/Pacific services will probably not occur until pricing improves. Current inter-continental yields are depressed due to the passenger carriers’ massive amount of lower hold capacity. Providing supplemental lift for the Canadian Forces might be another possibility. In addition to its four Boeing CC-177 Globemaster IIIs, the Canadian military has relied upon chartered Antonov An-124-100s and Ilyushin IL-76TDs for logistical support.
Regional expansion – Cargojet currently lacks regional feed west of Thunder Bay. With its mainline service touching down in Vancouver, Calgary, Edmonton, Regina, Saskatoon and Winnipeg, it would make sense to access secondary markets in the four western provinces.
ACMI contracts – Operating cargo aircraft for North American scheduled passenger airlines and/or for charter carriers, where Cargojet provides the aircraft, crew, maintenance and insurance, is a possibility. These so-called wet leases provide additional capacity on a flexible basis to carriers that want to capture revenues without major capital outlays.
Competitive environment – The domestic air cargo scene is reasonably balanced today with three dominant players. Kelowna Flightcraft Air Charter of Kelowna has served Canada Post and its 91 per cent owned subsidiary, Purolator Courier, since 1976. It operates a fleet that includes 15 727-200Fs and two DC-10-30Fs. Morningstar Air Express of Edmonton has provided lift for FedEx since 1990. Its fleet includes five 727-200Fs, seven Cessna 208Bs and an ATR42-300F. Could a new entrant be established and prove to be a destabilizing force? In theory yes, given the liberal regulatory environment. The biggest challenge, beyond assembling personnel and equipment, would be winning customers.
The success of that effort would likely depend on a major slide in the quality of the service provided by the three incumbents.
Fuel prices – During periods of high fuel prices, Cargojet has implemented fuel surcharges to mitigate the impact on earnings. While jet fuel prices have retreated about 66 per cent from their peak, reduced levels of crude oil production might result in a rebound in fuel prices as global demand increases. The greater threat is what might happen to economic activity should crude oil ever return to its record high level.
Foreign exchange exposure – Cargojet purchases goods such as aircraft parts and components that are priced in US dollars. In January the company ended its foreign exchange hedging program and realized a small gain on the sale of its US dollar forward purchase contracts. Since then, the Canadian dollar has strengthened against its US counterpart and reduced the threat.
What Does This All Mean?
If it weren’t for repeat customers no company could survive, let alone expand. This fact is central to Cargojet’s business model and has been ingrained in its culture. Talking about providing good service is one thing, but doing it on a consistent basis is quite another. By supporting its service offering with reliable operations the company has been able to deliver on its promise. What makes this feat all the more impressive is that it has been accomplished during a period of substantial growth.
To meet the challenges brought on by the economic meltdown, Cargojet staff meet regularly with its customers to discuss ways of enhancing service through co-ordinated strategies. The company has also rationalized its capacity and trimmed its headcount.”
What Does The Future Hold?
The major determinant of Cargojet’s future financial performance will be the level of economic activity within North America. The current pullback has been something of a test for this relatively young company. Proof of its ability to deal with the difficult conditions was provided with the release of Cargojet’s results for the three months ended March 31, 2009. While revenues were down 10 per cent, due primarily to reduced volumes, the gross profit was up almost 40 per cent – thanks to 50 per cent lower fuel costs. The overall result was a profit of $1.2 million versus a $0.4 million loss in the year-earlier period. It is worth noting that this was achieved during what is seasonally the company’s weakest quarter. Given its disciplined approach to account management, provision of reliable service and attention to operating costs, it wouldn’t be a surprise to see Cargojet’s earnings plateau until the economy recovers. In light of the havoc being wreaked upon the global airline industry.
Having established a regional feeder network within eastern Canada, it only makes sense to do the same in the west. The mega energy projects currently on hiatus are expected to resume their expansion once commodity prices enable an acceptable return on capital. The long legs of its wide-body aircraft offer international potential. Be it scheduled services or charter work, the sight of Cargojet 767s in Europe and Asia may occur more frequently.
Cargojet’s story is one of classic entrepreneurial success. Having identified a market niche, the management team has effectively executed a client-focused business plan. Very simply, Cargojet’s mission is to provide a reliable air transport service at a price that is both competitive and compensatory. To accomplish this, the company has built a team of skilled personnel and assembled a fleet of well-maintained aircraft. Has it succeeded? With its 98 per cent+ rate of on-time performance, its recognized esprit de corps and its expanding customer base, the answer is “affirmative.”
In so doing, it has achieved an enviable financial performance in a tough industry. During the past year, the economic environment has provided challenges to all businesses. Those companies that are flexible in their planning and adapt to changing market conditions will not only survive but be better positioned to achieve future growth. Cargojet’s moves to reduce fixed costs and to accumulate cash through the reduction of its distribution to unit holders are examples of enlightened thinking in perilous times. As the economy recovers, we expect to see Cargojet continuing to deliver the goods – in more ways than one.