MIAMI — Air Canada reported a full year 2013 net profit of C$340 million, or $1.20 per share, on Wednesday. The profit is the highest in the company’s history, despite a troubling fourth quarter—thanks to a weakened Canadian dollar and winter weather—that contributed to a meager C$3 million net profit (C$0.01).
Operating revenues increased 2.21% YOY to $12.38 billion in 2013. The modest gains were the result of a 2.1% YOY increase in revenue passenger miles (RPM), bolstered by a high 82.8% load factor for the year. Passenger revenue per available seat mile increased 0.6% YOY to 15.9 cents on 1.9% growth in capacity as measured by available seat miles, while yields correspondingly rose 0.5% YOY to 19.1 cents.
Segment wise, the trans-Atlantic market was a top performer for Air Canada, with a 5.0% YOY increase in PRASM against a 2.0% increase in ASMs driving a 7.1% increase in trans-Atlantic revenues to $2.26 billion. Additionally, a major slice of that trans-Atlantic capacity was operated by Air Canada rouge, which has much lower costs, making the segment a true star performer for Air Canada.
US trans-border revenues sagged a bit under the combined pressure of rivals WestJet and Porter Airlines, with PRASM growing 1.9% on a 0.1% decline in ASMs yielding a 2.1% increase of $2.18 billion. These competitive pressures also impacted domestic pricing in particular, as the entrance of WestJet Encore onto several former Air Canada monopoly routes drove a 0.5% PRASM decline on a 2.0% increase in capacity.
In the trans-Pacific marketplace, Air Canada brushed up against the same capacity expansion from Asian carriers that drove down yields for American legacies, seeing PRASM decline 3.3% on aggressive 6.7% ASM growth.
Operating expenses rose 0.8% YOY thanks to a reduction in fuel prices YOY of 0.8% to $3.53 billion and strong cost discipline across the board. Fuel price paid per liter decreased 0.6% to 0.80 cents per litre. Almost every cost line increase showed a YOY decrease or negligible increase with the exception of wages and capacity purchase agreement, which rose 6.5% YOY and 4.8% YOY respectively.
Cost per available seat mile (CASM), excluding benefit plans amendments, fell to 17.3 cents in 2013, down 1.5% from 17.5 cents in 2012. Adjusted CASM fell by the same percentage to 11.6 cents, down from 11.8 in 2012. Air Canada has made major headway in reducing CASM through a several avenues.
In 2013, the carrier launched Air Canada rouge, a low cost provider initially flying to long haul leisure destinations, to reasonable success. While the airline-within-an-airline concept had largely failed across North America (see Song at Delta or Ted at United for just two examples, rouge has been a surprising success in the vein of Jetstar for Qantas (with less under-performance for the mainline brand) thanks to CASM that is 21% and 29% lower than mainline A319s and mainline 767-300ERs respectively.
The strategic importance of Rouge for Air Canada cannot be understated. The value of the lower cost operation against WestJet and Air Transat in the Caribbean and North American beach markets is important in maintaining revenue streams and competitiveness. And across the Atlantic, using the aggressive pricing enabled by Rouge’s low CASM will allow Air Canada to profitably steal passengers away from Air Transat and European charter operator and grow its Atlantic revenue streams at a time when it is increasingly under attack on shorter haul routes from Porter and WestJet.
Moreover, having a low cost operation in place to secondary destinations in the British Isles like Dublin and Manchester serves as a natural hedge against upstart players like Norwegian Air Shuttle or WestJet, who is set to launch services between Toronto and Dublin via St. John later this year.
High Density Aircraft
Air Canada has also embraced the value of high density configuration (with 10-abreast seating in economy class in the Boeing 777-300ER) on long haul aircraft in competing with lower cost rivals like the Middle East Big 3 such as Emirates. To that effect, Air Canada has taken delivery of four (out of five ordered) Boeing 777-300ER aircraft in high density 458-seat configurations ( 36J / 24Y+ / 398 Y ).
Air Canada is taking a page out of the Emirates playbook here, though they’d never admit it. Basically, Emirates was the first to realize that in a deregulated world (where a lot of aviation bilaterals are Open Skies), the way you make money is by offering a really fantastic premium product (First and Business Class for Emirates but it can just be true flatbeds in business class for most carriers), and pack economy class passengers in like sardines to give them the low fares that they so desire. Western carriers, such as Air Canada and American Airlines are finally catching up to this tactic, which ironically enough, should allow them to offer economy class fares competitive with those offered by the Middle East Big Three (Emirates, Etihad, and Qatar Airways).
Other Cost Initiatives
Less headline-grabbing but no less financially important, Air Canada has restructured its pension obligations and its contracts with the airport authority for its largest hub at Toronto Pearson International Airport. With regards to the pension plan, Air Canada has entered into a deal with the Canadian Office of the Superintendent of Financial Institutions (OSFI) to amend its defined benefit pension plans.
Essentially, between 2014 and 2020, Air Canada will be required to make payments averaging $200 million a year to reduce its pension solvency deficit (which stood at $3.7 billion on January 1st, 2013). However, the combination of these payments, a 13.8% return on investments in 2013, the amendments to the plan which reduced the solvency deficit structurally by $970 million, and a $225 million contribution to the solvency deficit have combined to position Air Canada with a small pension surplus as of January 1st, 2014. In practical terms, these changes saved Air Canada $82 million in operating expenses in the fourth quarter of 2013, and is expected to save hundreds of millions of dollars over the next seven years.
On the Greater Toronto Airport Authority front, Air Canada has entered into an enhanced commercial relationship which will improve customer service, provide more seamless connectivity for Air Canada and Star Alliance partners, and reduce costs per passenger for international connections.
Returning to finances, Air Canada ended the year with net debt of $4.35 billion, a 5.2% increase YOY due to the aforementioned purchase of four Boeing 777-300ER aircraft. Largely tied to this increased capital expenditure, Air Canada’s free cash flow swung to –$231 million from $199 million a year prior.
Given that Air Canada is rapidly turning over its fleet with new Boeing 787 aircraft and building up a new infrastructure for the rouge operation, its cash flow generation is likely to lag the North American industry over the next two to three years. Operating margin for the fourth quarter came in at a strong 4.7% for the fourth quarter, though much of this was due to the benefit plan restructuring. Full year operating margin came in at 5.0% with an operating profit of $619 million, good by Air Canada’s historical standards, but poor in comparison to WestJet and most US airlines. Return on invested capital (ROIC) did jump 3.1 percentage point to a healthy 11.0%.
Historically, Air Canada has been known as a poor investment. However, the carrier is making a serious attempt to tackle its cost problem and restructure the leisure-driven portions of its network with lower costs via rouge. Looking forward into 2014, net profitability should continue to improve as these restructuring initiatives take effect, though the growth of WestJet Encore onto highly profitable regional routes is a point of major concern for domestic yields and pricing. Still, the carrier has begun to deliver on its promise to revitalize itself financially.
Editor’s Note: All figures from here on out are in Canadian dollars unless otherwise noted