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Mathew Ingram

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Phoenix or flop?

Mathew Ingram

 

TORONTO (GlobeinvestorGOLD) — Like a phoenix rising from the ashes, Air Canada is finally emerging from bankruptcy protection after more than a year of wrangling and more than one abortive attempt at refinancing. As a final step, the airline's virtually worthless old shares are being converted into new shares (at about 12,000 to one). So should your portfolio tune-up include buying some stock in this resurrected airline? Not without thinking long and hard.

There are certainly some big differences between the new Air Canada and the old Air Canada, and one of the biggest is a dramatically lower debt level. Instead of the $13-billion in short- and long-term debt it had before — including airplane lease agreements that never appeared on the carrier's balance sheet — the new airline will have about $5-billion in debt. That will reduce one of Air Canada's biggest costs, which were the interest payments on that debt.

There are other costs to running an airline, however, and one of the major ones — apart from planes — is labour. One of the main strengths of low-cost carriers such as WestJet Airlines Ltd. and Southwest Airlines Co. is a non-union work force, which keeps their costs a lot lower. After much struggle and turmoil, Air Canada managed to convince its pilot, flight attendant and other unions to accept more than $1-billion in labour cuts. But will that be enough?

US Airways Group Inc. thought it would be, but it was wrong. The airline recently filed for bankruptcy for the second time, saying the concessions it won from its labour unions the first time it restructured weren't enough to get its costs in line with its revenue, and that it needed at least another $1-billion (U.S.) in cuts in order to survive. Delta Air Lines Inc. has said that it may have to file for bankruptcy as well due to high costs. And while Continental Airline Inc. has been hailed as a great turnaround story, it had to file for bankruptcy three times before it finally recovered.

There's no question that Air Canada has made a lot of progress on cutting costs. According to industry analysts, the airline's cost per available seat mile — a key measure of efficiency — has dropped to about 14.5 cents from as much as 27 cents in 2002. WestJet's cost per ASM, however, is still substantially lower at about 11 cents, and Jetsgo says its costs are even lower still. Air Canada CEO Robert Milton has said that the difference can be explained by costs associated with the Aeroplan loyalty program and other non-airplane related assets, and that as those units are sold or spun off as separate entities those costs will fall.

WestJet has also been hitting some turbulence of late, while Air Canada has been steadily improving. In the latest quarter, the larger carrier's "load factor" — the percentage of seats filled per flight — rose to 83.2 per cent, which bodes well for profitability. In the not-too-distant past, Air Canada's load factor was in the low 70s. This time it is WestJet that is facing a decline in load factor: in the latest quarter its load fell to below 80 per cent from 83 per cent in the year-earlier quarter, as the airline added more planes and routes.

WestJet's costs have also been increasing, as the company spends more money on marketing, adding new features such as TV screens in seat-backs, and higher rent at airports such as Pearson International. So have the two competitors closed the gap with each other when it comes to costs? To some extent, yes — Air Canada's have come down and WestJet's have gone up. The smaller airline still maintains an advantage, however, and that could be a crucial competitive strength as Air Canada tries to find its feet (or wings) in a newly restructured world.

Many aspects of the national airline's strategy also remain to be proven. Mr. Milton says he will focus on Air Canada's traditional strength in international routes, and not pay as much attention to the local market. But how will it affect Air Canada if WestJet and Jetsgo carve out more and more market share in Canada and in cross-border routes? It would be nice to think that the larger carrier could just ignore that kind of threat and be content with high-margin flights to Paris and London, but the airline business doesn't work that way.

With fuel costs higher than they have been in years, Air Canada's new balance sheet will be under pressure, and competition from Jetsgo and WestJet means that the pressure on ticket prices will also continue. Air Canada has more breathing room now, but it will also have to run hard in order to make its strategy work. Investors might want to wait for more evidence the phoenix is really risen before they go placing bets on its flight path.

Mathew Ingram joined The Globe and Mail's online news team in June of 2000, after spending four years as the Western business columnist, based in Calgary.

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