Bloomberg News

Air Canada Trades Passenger Legroom for Profit: Corporate Canada

March 18, 2014

777

An Air Canada Boeing 777 taxis down the tarmac at Toronto Pearson International Airport in Toronto, Ontario, Canada. Photographer: Brent Lewin/Bloomberg

Air Canada is betting less legroom for passengers translates into higher profit.

Canada’s largest carrier has done the math and figures that adding at least 22 seats on jets of its Rouge unit turns money-losing routes to destinations such as the Caribbean profitable. Air Canada’s main carrier has also begun flying five “high-density” Boeing Co. (BA:US) 777 jets with more than 100 additional seats than standard models.

“Densed-up” aircraft are a key part of a plan by Chief Executive Officer Calin Rovinescu to cut expenses for each seat flown a mile by 15 percent over five years -- even as some customers lament the lack of legroom. Other cost-saving measures include the addition of 37 fuel-efficient Boeing 787 Dreamliners starting this year and the full roll out of Rouge, Rovinescu said.

High-density planes have “turned out to be a great strategy for us,” Rovinescu, 58, said March 6 in an interview at Bloomberg’s office in Toronto.

While customers have registered complaints about the moves on such sites as Skytrax and TripAdvisor, investors welcome Air Canada (AC/B)’s efforts.

Air Canada’s widely traded Class B stock has risen sixfold in the past two years, outstripping a 15 percent gain by Canada’s benchmark Standard & Poor’s/TSX Composite Index. The Bloomberg Americas Airlines Index has almost doubled during that time. Air Canada rose 5.3 percent to C$5.94 by the 4 p.m. close of trading in Toronto today.

Cutting Costs

Rovinescu, who marks his fifth anniversary at the helm of the carrier on April 1, is betting the strategies he’s employing to cut costs -- along with the elimination of the company’s pension overhang -- will break the stock free of the lower multiples at which Canada’s two biggest airlines trade compared with U.S. peers. Air Canada’s stock relative to earnings trades at less than half the rate of Atlanta-based Delta Air Lines Inc. (DAL:US) and United Continental Holdings Inc. of Chicago.

Putting passengers in 30-inch pitch seats “is standard practice now,” said Walter Spracklin, a transportation analyst at RBC Capital Markets in Toronto who recommends investors buy Air Canada stock. “It’s the norm. It’s not like a competitor is offering a better product solution for the same price.”

Pitch is the distance from the back of a seat to the back of the one behind it. The pitch differs according to fare category and plane, ranging from 29 inches in the cheapest Rouge seats on the A319, to 44 inches in Air Canada’s high-density 777s in executive first class.

Slimline Seats

Several airlines are installing “slimline” seats made of thinner material and a shorter seat bottom, which allows them to add an extra row or two in coach without making the seating feel more crowded. Southwest did this to get six additional seats on its 737s.

Air Canada began Rouge July 1 with a view to improving the profitability of routes that typically draw fewer high-paying business passengers. Rouge’s fleet, which had 10 planes at the end of 2013, will grow to 33 planes by the end of this year and eventually reach 50, Rovinescu said. Rouge now flies to 28 destinations, with plans to add 17 over time.

Rouge’s Airbus Group NV A319 jets cost 21 percent less to operate than the same planes on Air Canada, while the Boeing 767s, with 51 extra seats, cost 29 percent less. Seat configuration accounts for about two-thirds of the difference, with labor representing the rest, the CEO said.

Not Ryanair

“The strategy with Rouge is not to create a low-cost carrier that is going to out-Ryanair (RYA) Ryanair,” Rovinescu said, referring to the Dublin-based discount airline. “It’s to have a leisure carrier that will assist Air Canada in lowering its costs for that segment of its business, meaning leisure, largely sun destinations.”

While Air Canada doesn’t break out Rouge’s results, Rovinescu said the unit has met its cost-reduction goals “bang-on” since it started.

“The six-month indications were stellar,” he said. “Obviously the success is measured if we can manage the operation and keep the infrastructure costs down. We are keeping those low.”

David Tyerman, an analyst at Canaccord Genuity who recommends investors buy Air Canada stock, said 2014 will go far in determining the long-term success of Rouge, which means red in French.

Jury’s Out

“The jury is very much out on Rouge,” Tyerman said by telephone from Toronto. “We don’t really know how well it’s going to work out.”

Air Canada still has a ways to go to improve its cost picture. Seat mile costs at the Montreal-based company amounted to 16.9 cents in the fourth quarter of 2013, exceeding the 13 cent average of 12 North American carriers tracked by Bloomberg. That’s partly due to higher landing fees and other costs related to operating in Canada. The airline also pockets more revenue per domestic mile than the other North American carriers, according to data compiled by Bloomberg.

“They’ve got lots of levers to pull on the cost side,” said Bob Decker, a fund manager with Aurion Capital Management Inc. who helps manage about C$6 billion and owns Air Canada stock. “Those denser planes are the nature of air travel nowadays. Airlines are going to have to do more with less.”

Packing More

Air Canada’s strategy of packing in more passengers also extends to its mainline, where it now flies new Boeing 777s on routes such as Vancouver-Hong Kong and Montreal-Paris. Air Canada’s 777s are built to carry 458 passengers, 109 more than standard models.

“That is huge, because you are basically getting 100 seats for free,” Rovinescu said.

After Air Canada deployed a 777 to the Montreal-Paris route last year, “it went from being from one of our poor international routes to being one of our best,” Rovinescu said March 10 at a JPMorgan Chase & Co. conference in New York.

Aurion’s Decker recently flew on one of the Air Canada high-density 777s between Vancouver and Toronto, and said the journey proved to be “a lot more pleasant experience than you’d think. I was surprised at how comfortable it was. I’ve been in far worse planes than that.”

To contact the reporter on this story: Frederic Tomesco in Montreal at tomesco@bloomberg.net

To contact the editors responsible for this story: David Scanlan at dscanlan@bloomberg.net Molly Schuetz, Edward Greenspon


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