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SHAKEN but not yet Stirred

It promises to be a summer to remember next year in Canada’s air transport sector, one that will have significant reverberations for the next few years.

WestJet is scheduled to take delivery of its first Bombardier Q400 turboprops in June, followed by one aircraft per month until the end of the year. Photo: Bombardier

Next June will be a watershed month as Air Canada and WestJet prepare to launch new subsidiary airlines, sparking the biggest shakeup in Canadian air transport since the arrival of Jetsgo 10 years earlier. Completing the picture will be the start of Air Canada’s retooling of its mainline narrowbody fleet.

After two lost years, largely dragged down by losses at Air Canada, the Canadian air transport sector is expected to see a narrow return to profitability in 2012. Walter Spracklin, an analyst with RBC Capital Markets, expected solid operating results for both Air Canada and WestJet this third quarter as higher traffic and fares compensate for volatile fuel prices. “We see top-line revenue as being lifted in the Canadian airline segment and we are adjusting our forecasts accordingly,” he wrote in a note to clients.

Spracklin’s optimism is echoed by the Canadian Conference Board. The Board expects a profit of $231 million next year – a razor thin margin of just 1.2 per cent – which aligns with the International Air Transport Association’s (IATA) first glimpse for 2013 of a global profit margin of 1.1 per cent. But the Board also cautions that fiercer competition in the industry will continue to put pressure on airline profit margins, which are already struggling to keep pace with the cost of capital. Competition will grow fiercer in 2013, especially in the low-cost leisure and regional markets, where Air Canada and WestJet are respectively upping their offerings.

Air Canada has started to colour in details of its anticipated low-cost airline, although a formal announcement of the complete package is not expected before early November when the carrier will release third-quarter results. The subsidiary, which will launch in June, is to be merged with Air Canada Vacations to form an integrated leisure group offering full-service flights to destinations in Europe and the Caribbean where the mainline carrier has traditionally struggled to remain competitive because of higher operating costs, and to new destinations not currently served by Air Canada.

The fleet, which will be released from Air Canada, will start with two Boeing 767-300ER and two Airbus A319 aircraft. It will expand as the mainline carrier takes delivery of new wide-body equipment including two Boeing 777s this year and the Boeing 787 starting in 2014. The startup could have 20 767 and 30 A319 aircraft by the end of 2015, depending on market demand. The new leisure group will add 20 per cent more seats into each airplane – and more seats plus lower flight crew costs add up to profit.

“On the leisure side, it makes sense for Air Canada to pull capacity out of the mainline,” said Cameron Doersken, an analyst with Montreal-based National Bank Financial. “Where I have a bit of concern is with the wide-bodies. A lot of what they are doing sounds like incremental capacity. So you operate 777s and 787s and have 20 additional 767s with the low-cost carrier. That is an awful lot of extra capacity on European routes that are already well served.”

Air Canada’s leaner leisure operation will face tough competition from SunWing and Transat A.T., the parent of Air Transat, and WestJet Vacations on popular medium haul destinations down south. Its strongest competitor over the long haul will be Air Transat, which has had a near lock on the European market among Canadian leisure operators, and would be most vulnerable should Air Canada dump lower cost capacity on routes to snatch market share.

Air Canada is expanding as a mainline carrier by taking delivery of new wide-body equipment including two Boeing 777s this year. Photo: Air Canada

Air Transat turned 25 this year and is undergoing a two-year, $4-million cabin makeover on its entire Airbus A330 fleet, including mood lighting ambience, ergonomic seats and individual entertainment systems in both economy and Club Class cabins. The carrier has struggled in the European market recently as many Canadian consumers stayed home to pay down debts and the Euro crisis widened, affecting bookings both ways.

This past summer season, Air Transat cut capacity by four per cent and in 2013 is expected to make further seat reductions. The airline is reported to be testing the waters in Asian markets, shifting some of its base to Vancouver. Speculation over Air Canada’s low-cost, long-haul flights has also ping ponged between Europe and Asia, which means the two airlines will inevitably go head to head over the Pacific at some point.

“There will be point-of-sale demand in Canada for leisure packages focused on Asia,” Doersken confirmed. “But for those routes to become viable for Canadian carriers, you will also have to see a lot of point-of-sale demand in Asia for trips to Canada.”

Closer to home, WestJet is scheduled to take delivery of its first Bombardier Q400 turboprops in June, followed by one aircraft a month until the end of the year. Bombardier’s WestJet order is for 20 Q400s with options for another 25. The launch of Encore, WestJet’s regional airline, will take place in the third quarter of 2013, and will closely mirror that of its parent by going small with a handful of services from one base, either Calgary or Toronto. Both cities will be active hubs in 2014 as more Q400s are added to the fleet.

WestJet Encore comes with high expectations to crack the Air Canada Express monopoly on some routes, fill service gaps on others and lower point-to-point airfares in many markets. Last June, 30 communities arrived in Calgary to pitch for regional service. Most will be left empty handed, at least for the first two years. With a limited number of airplanes split between two regional hubs, new destinations will have to compete with existing city pairs such as Saskatoon and Winnipeg that do not have direct service, and the opportunity to swap Boeing 737s with smaller Q400s on high-frequency routes such as the eastern triangle and Vancouver and Calgary during off peak times. A decision on first routes will be made in early 2013.

WestJet is entering the regional game in Canada as the rules are changing in the United States and elsewhere, with airlines such as Delta and American either grounding or trying to sell off regional subsidiaries, and other regional airlines engaged in bidding wars to feed passengers into the majors. Even in this country the ground is shifting, and WestJet Encore’s lower cost structure is certain to put pressure on Air Canada Express partners by the main carrier to lower unit costs.

Indeed, Air Canada is already using its collective agreement with pilots to look beyond its Capacity Purchase Agreement with Halifax-based Jazz and outsource more regional flying. Between February and June 2013, Air Canada will transfer 15 Embraer 175 aircraft to Sky Regional Airlines to operate short-haul regional routes, primarily from Toronto and Montreal to destinations in the northeast U.S., under the Air Canada Express banner. Sky Regional also operates Q400 turboprops between Montreal and Toronto’s Billy Bishop City Centre Airport on Air Canada’s behalf.

The transfer of the Embraer 175 is part of a broader plan by Air Canada to retool its narrow-body fleet. With the bulk of the company’s A319s already earmarked for the low-cost carrier, what is most likely to happen is a phasing out of the Embraer 190, which the airline has described as an excellent aircraft but an awkward fit (and too large to transfer to a regional partner under the scoping clause in the collective agreement) and early retirement of the thirsty Bombardier CRJ100 and CRJ200s. This could be potentially good news for Bombardier, with CRJ700s and CRJ900s seen as a possible replacement aircraft.

The re-engined Boeing 737 MAX and Airbus A320 NEO are candidates to eventually replace Air Canada’s existing A320s on the larger end, but National Bank’s Doersken also sees a gap in the under 150-seat segment that could be plugged by the 110-seat to 145-seat Bombardier CSeries. “It depends on what Air Canada wants to do here. If they continue to split the size of the narrow-body fleet they are going to have a need for an aircraft under 150 seats, so I see an opportunity for an order for the CSeries.” Air Canada is expected to make a decision on new narrow-body aircraft next year, but will not start taking deliveries until the end of the decade at the earliest.

Despite new lines being drawn and capacity added in the regional and leisure sectors, the full impact of the shakeup in 2013 is not likely to be felt before mid-2014 at the earliest. This is especially true in the regional sector where Air Canada partners already have 158 aircraft spread across the continent.

“Both airlines are not starting up until the middle of next year,” Doersken points out. “By the end of the year, WestJet will have ramped up to only seven aircraft. It starts to become more material in 2014. On the leisure side, it will depend on how quickly Air Canada’s low-cost airline ramps up. But it is likely that the full impact of both subsidiaries will not be felt until 2015.”

However it pans out, it promises to be one of the most significant three-year periods in the history of Canada’s air transport industry.

What’s in a name?
Both Air Canada and WestJet have introduced contests to name their new subsidiaries. In October, Air Canada asked its customers and travel agents to visit Air Canada’s Facebook page to submit suggestions. Entrants were eligible to win a $1,500 gift certificate to apply to a package holiday by Air Canada Vacations, suggesting that the airline could still make money on the deal. A separate contest was held for employees.

“This is an exciting new venture for us and our customers, so we wanted to hear from them, our partners in the travel industry and our employees,” said Michael Friisdahl, chief executive officer of Air Canada’s Leisure Group. Friisdahl said the leisure group wanted to have some fun coming up with a distinctive brand name for the airline.

WestJet’s internal naming competition resulted in more than 800 submissions. According to the National Post, WestJet took out trademarks in more than a dozen names, including Venture Q4 Connect, Connex, Breeze and Encore with employees selecting Encore in a runoff ballot. “Encore reinforces that our WestJetters are ready to repeat the success of WestJet, liberating Canadians in many communities from the high cost of travel,” said Bob Cummings, WestJet’s executive vice-president of sales, marketing and guest experience.

Air Canada will brand the low-cost leisure airline separately from the mainline carrier. WestJet’s regional “guests” are going to have to search to find traces of the new name. WestJet will not create a separate regional brand similar to Air Canada Express. WestJet and WestJet Vacations recently received the highest brand equity scores among airline and vacations brands in the annual Harris/Decima EquiTrend study. This low-key approach means the new name will be limited to boarding passes, the website, flight announcements and areas to satisfy regulatory requirements.  “Familiarity, quality and consideration are the foundations of a strong and profitable brand,” said Richard Cooper, Harris/Decima’s senior vice-president.

Growth in ancillary revenue among reporting airlines slowed to 5.3 per cent, or $22.6 billion in 2011, compared with 60 per cent growth for 2010. The data is provided by Amadeus, a supplier of transaction technology for the global travel and tourism industry and IdeaWorksCompany, a consultancy specializing in airline ancillary revenue.

IdeaWorksCompany analyzed financial data for 108 airlines, including 50 companies that continue to disclose ancillary revenue activity. United, Delta, American, Qantas and Southwest were top performers in 2011 among reporting airlines. Ancillary revenue at Air Canada grew a healthy 18 per cent in 2011, but the airline stopped disclosing details in 2010.

The Amadeus Review of Ancillary Revenue Results for 2011 includes unbundled services, commissioned-based services such as hotel or car rental bookings, and other service revenue from co-branded credit cards, loyalty programs and other activities. It is difficult to accurately pinpoint ancillary revenue because there is no industry standard. Revenue at Delta dipped in 2011, in part because the airline recently removed some aviation-related revenue from its listing. Delta reported ancillary revenue of $2.5 billion for 2011, making the airline strong enough to place the air carrier a distant second behind industry leader United/Continental ($5.2 billion) on the overall chart, but not strong enough to be among the leading 10 airlines reporting ancillary revenue per passenger. Top prize in that category goes to Australia’s Qantas, which collected $1.4 billion in ancillary revenue for 2011, or $50.82 per passenger. WestJet’s ancillary revenue is equivalent to $14.89 per passenger.

Wings estimates Air Canada’s ancillary revenue to be approximately $1.1 billion or $33 per passenger. If inserted into the Amadeus chart, Air Canada would continue to be a global powerhouse both in total ancillary revenue (tied with Ireland’s Ryanair for seventh spot) and revenue per passenger (also seventh, just behind Allegiant). Top 10 spots in a third measure, percentage of total revenue, are almost exclusively held by low-cost carriers. Ancillary revenue accounts for one-third of Florida-based Spirit Airlines’ total revenue compared with approximately 15 per cent for United/Continental and an estimated 10 per cent for Air Canada.