SUMMARY: The 1st Half 2016 numbers are out for Air Canada and Westjet Airlines, the “duopoly” that controls +85% of the Canadian market, where Canadians still have NO domestic or transborder access to a low cost airline. A brief analysis of the financial performance of the 2 Canadian airlines this year with a introduction to airline economics on how a few key numbers drive operating profit. Seems Air Canada does not make an operating profit from passenger services alone, and why its LCC (low cost carrier) rouge has not really cut costs, with the vast majority of savings being higher density seating, and like other Major airline attempts at an in-house LCC in North America like TED (United), Song (Delta #2), Lite (Continental), Express (Delta #1) the cost cutting has NOT gone deep enough, and hence why ALL the North American in-house LCC “experiments” ultimately failed. Lastly, Air Canada’s decision to buy 45 x CS300’s was a politically coerced deal with legal and legislative changes promised by Quebec and Ottawa, and the recent Air Canada threat to “walk away” from the deal if promised legislation was not forthcoming soon, said it all, Air Canada’s EVP Kevin Howlett said it best, “there are alternatives to the CSeries, there are other manufacturers that make comparable airplanes”, meaning we can take it or leave don’t matter as they do have 61 x B737Max firm orders (33 x Max8’s and 28 x Max9’s) to replace its older A319/320’s and E190’s in due course.

The 1^st half 2016 numbers are in for Air Canada and WestJet Airlines, and it’s worth looking at how the 2 airlines that control 85% of the Canadian domestic market, which also has NO low cost airline as of yet (the only OECS) whose citizens have no access to a domestic or transborder LCC (low cost airline).

Let’s first just take a look at the key numbers that drive an airline’s profitability, and I will comment on each, in short OPERATING PROFIT = (YIELD x LOAD FACTOR) – CASM, easy enough right ?

Now remember that airline profitability is determined by Demand Potential which is driven by 2 factors (Pricing and Volume), with Pricing being evident and Volume determined by factors such as market, destinations, competition, service, brand and sources of competition.

The Supply Demand is driven by factors cost of operation and capacity of aircraft, larger aircraft have lower unit costs but require more passengers, smaller aircraft have higher unit costs but require less passengers, and here lies the fleet planning dilemma, matching appropriate capacity to demand.

So far, 2016 is shaping up to be a tough year for Air Canada and Westjet, and surely very frustrating one President/CEO Calin Rovinescu of Air Canada who has been in the job now for 7 years and seen his share of ups and downs and the same applies to President/CEO Gregg Saretsky of Westjet Airlines who is also into his 7th year at the helm.

Revenue for the 1st half of 2016 at Air Canada is at $6.801 billion (up 2.0% to 2015), while net income is down to $288 million (-22.5% to 2015), while WestJet Airlines revenue is down to $1.980 billion (-2.2% to 2015) and its net income is down to $124 million (-38.6% to 2015), as both airlines have added a great deal of capacity (ASM’s) so far this year (Air Canada 9.6% and Westjet 7.0%).

All of this is bringing down yields and and load factors, which combine for a decrease to Passenger Revenue per ASM (PRASM) of 6.8% at Air Canada and 8.5% at Westjet, a worrying trend especially given that fuel cost per liter at both airlines is down to $0.50 per liter, and the fact LCC (low cost carriers) are starting to show up at Canadian airports (the least of any OECS country) with Canadian virtual airline NewMaple (B737-400’s operated by Flair Airlines) and Iceland’s WOW with very low fares to Iceland and beyond flying to Toronto and Montreal as of May this year.

Meanwhile return on invested capital  is stable at Air Canada at an impressive 16.2% and down at Westjet to 11.4% (-25.5% to 2015).

I was disappointed to see Air Canada buy 45 x Bombardier CS300’s not because it is a great airplane, but because of politics in Canada. Where the Quebec Government dropped a long running lawsuit against Air Canada for shutting down its maintenance. The Quebec government launched the lawsuit against Air Canada after Aveos Fleet Performance, which underook Air Canada’s aircraft maintenance, but closed in 2012 in a move that laid off 2,600 employees.

The province argued that Air Canada (TSX:AC) breached its legal obligations under the 1988 Air Canada Public Participation Act, which required the airline to keep heavy maintenance operations in Quebec, Ontario and Manitoba. Quebec won the original court decision in 2013 and the Quebec Court of Appeal decision in November. In January, 2016, Air Canada asked the Supreme Court of Canada to overturn the appeal court ruling, but lost. Now Quebec is asking for a commitment for 20 years to maintain the CSeries in Montreal and for the purchase of the CS300.

Then the Canadian Federal Government stepped in and offered legislative changes to the Air Canada Public Participation Act, political coercion is sadly alive in Canada even on a public corporation. To prove that only look at June 22, 2016 announcement from Air Canada that it may walk away from the Bombardier CSeries deal if the promised legislation changes are not done soon, with Air Canada EVP Kevin Howlett saying “there are alternatives to the CSeries, as I’m sure you know. There are other manufacturers that make comparable airplanes“, which says it all, Air Canada bought the CSeries because of legal and legislative promises, the airline is good with the current E190’s and for the CSeries it can take it or leave it, as it has 61 B737Max orders (33 x Max8’s and 28 x Max9’s) in place to replace its older A319/320’s and E190’s in the coming years, and a Max7+ could and would fit in nicely.

Bombardier, after 8 years of sales and marketing of the CSeries, still has only 330 firm orders, with up to 25% still very “questionable” orders some going back to 2010, and with deals like Delta Air Lines at a $7 million loss per aircraft according to Airbus’s CCO, Mr. Leahy, that is a $525 million loss on 75 aircraft, how long can that last ? not long.

Anyway, back to the financials of Air Canada and WestJet Airlines for the 1st half of 2016.

The number #1 key figure is YIELD which is passenger revenue per passenger mile ($/RPM), in short net fare to the airline divided by distance in miles.

1. YIELD: Air Canada had a Yield of $0.1700/RPM (-5.9% on 2015) and $0.1688/RPM at WestJet (-10.3% on 2015), mainly higher for Air Canada because it has a global network with widebody aircraft, and more Business and First class service.

With Air Canada having added 9.6% more ASM’s in the 1^st Half of 2016 to 22,344 million ASM’s and WestJet having added 7.0% capacity to 7,115 million ASM’s, both airlines are growing capacity very quickly, and to keep the planes at reasonable load factors, yields are coming down, for both airlines.

2. LOAD FACTOR: Air Canada had a LF of 81.8% (-0.8 pts on 2015) and WestJet had a LF of 81.5% (+1.6 pts on 2015), both airlines did a great job filling their perishable seats.

3. PASSENGER REVENUE PER ASM (PRASM): The combination of (yield x LF), gives Air Canada $0.1390 ($0.1700 x 81.8%), while WestJet managed $0.1375 ($0.1688 x 81.5%), both good airlines have good unit revenue numbers, what decides profitability level now is how well they manage their unit costs, cost per ASM (CASM).

4. COST PER ASM (CASM): Air Canada has 380 aircraft in its very diverse fleet, with an average daily utilization of 9.9 hours per day, and has managed to get a CASM of $0.1510 (-5.4 on 2015), while WestJet’s CASM is $0.1246 (-2.9% on 2015) and 17.4% lower unit cost than Air Canada while flying 11.2 flight hours per day, a BIG differential between the 2 airlines, exists here, but Air Canada has done a good job lowering the costs, mostly on the back of its LCC (low cost carrier) rouge. The airline is a questionable LCC, like other LCC in North America that failed (Song-Delta, TED-United, LITE-Continental, Express-Delta) SEE PHOTOS BELOW its savings are mostly due to higher seating density, The rouge B767-300 has 280 seats vs 211 at Air Canada (+32.7% more seating) for 29% lower operating costs, while the A319-100 at rouge has 136 seats versus only 120 seats at Air Canada (13% more seats) for 18% lower operating costs, clearly seating density is main cost advantage and little has been achieved with lower crew and maintenance costs, and that is why the BIG airline sin the US failed with their LCC experiments, the cost cutting was not deep enough beyond just more seats in an aircraft. READ PREVIOUS ARTICLES ON LOW COST AIRLINES

5. OPERATING PROFIT: Air Canada (PRASM – CASM is $0.1390 – $0.1510 = – $0.0120 per ASM), a operating loss on passenger revenue alone (-6.3% operating margin), but Air Canada has other sources of revenue (e.g. cargo, charters, etc.) which add 15.8% to passenger revenue, so operating revenue per ASM is $0.1610, which then gives Air Canada a 6.3% operating profit margin, yet that has to be worrying, no ?

Meanwhile WestJet, has PRASM – CASM ($0.1375 – $0.1246 = $0.1290) a 9.3% operating margin, 47% higher operating profit than Air Canada.

While both airlines are doing OK, their stock prices are down, as investors are discounting airline stocks in 2016 a great deal, not only in Canada but the US as well. Below graph is Air Canada’s (TSE:AC) stock price for the past 12 months, and blow it is Westjet Airlines (TSE:WJA) stock price for the past 12 months, lots of volatility and declines (in red) and increases (green).

AIR CANADA  TSE:AC

WESTJET AIRLINES  TSE:WJA

US AIRLINE STOCKS SINCE THE BEGINNING OF 2016 (A RELATIVE COMPARISON STARTING AT 100)

This was a brief blog, got lazy ! till next time, thank you for reading my blog and hope you learned something, cheers.