Capacity growth hits shares of Air Canada
Analysts voice doubts over plans to aggressively add new planes
Several competitive, economic and geopolitical factors conspired in the second quarter to weigh on Air Canada’s results, but the airline insists that its rapid growth is being carried out prudently with an eye to improving margins.
The quarter was characterized by fierce domestic and transatlantic competition, economic weakness in Alberta, terrorist attacks in Europe and ongoing fallout from the Brexit vote, executives said Friday.
This comes as Air Canada embarks on the most aggressive expansion in its history, rolling out its discount leisure carrier Rouge and adding several new international destinations to its mainline network.
Air Canada’s capacity grew 11 per cent in the second quarter alone and it spent $2.6 billion in the first half of the year on new aircraft, an amount that chief financial officer Michael Rousseau described as “the heaviest capital expenditure program for a six-month period probably in the history of the company.”
“We are walking a tightrope here to ensure that as we add this capacity we are delivering year-overyear margin expansion while positioning ourselves to be in a much stronger position medium and long term,” Ben Smith, president of passenger airlines, told a conference call Friday.
Air Canada’s adjusted net income fell 18 per cent in the second quarter to $203 million or 72 cents, well ahead of the 60 cents expected by analysts. Operating revenue rose 1.3 per cent to $3.46 billion.
However, shares tumbled 4.77 per cent to close at $8.99 amid concerns that Air Canada is adding too much capacity into a highly competitive environment.
“I have concerns about the capacity growth,” said David Tyerman, an analyst at Cormark Securities. “To me it seems rather high in the context of the Canadian economy and the global economy.”
Combined with added capacity on transatlantic routes from competitors like WestJet Airlines Ltd. and Transat AT Inc., “it just seems to be to be an awful lot for those markets to swallow,” he added.
More competition usually leads to lower fares, and Air Canada’s yield — the average fare per passenger, per mile — fell 6.8 per cent in the quarter. Load factor, or the percentage of seats filled across the network, fell 1.2 points to 82.4 per cent, leading to an 8.2-per-cent drop in revenue per available seat mile (RASM). This was somewhat offset by lower adjusted unit costs, which fell 1.1 per cent.
But CEO Calin Rovinescu said none of that matters as long as margins are expanding. (Operating margin fell 1.5 points in the quarter to eight per cent, but another measure, EBITDAR margin, rose 0.2 points to 17.5 per cent.)
“Our eye is on the ball of margin expansion, so we’re not chasing RASM, we’re not chasing yield, we’re not chasing load factor, we’re chasing bottom-line margin expansion,” he said. “We’re confident that we’ll be able to profitably fill this increased capacity.”
Air Canada no longer releases capacity forecasts, but AltaCorp Capital analyst Chris Murray said he expects the airline to add 15.3 per cent to its capacity in the third quarter.
“The issue is how effective can they be at filling that capacity?” he said. “The rate of capacity growth over the next couple quarters, it’s a pretty sizeable magnitude.”
However, Murray said summer travel demand appears to be strong and while yields will continue to fall, Air Canada’s fundamentals are resilient.
“Do we expect yields to be down year over year? Definitely,” he said. “But they made the case fairly succinctly that they’re going to be able to add that capacity in a way that’s margin accretive. Even though the revenue number’s going to come down, the cost number’s coming down faster.”
Air Canada reiterated that it still expects full-year EBITDAR (earnings before interest, taxes, depreciation, amortization and aircraft rent) to increase four to eight per cent. Adjusted unit costs for the full year are now expected to fall 2.75 to 3.75 per cent, one percentage point more than the previous forecast.