Fate of low-cost carrier rests on cost cutting

Air Canada will introduce a low-cost carrier to help weather rising fuel costs and cyclical downturns, but only if it can sustainably reduce labour and other costs, the airline’s chief executive said Thursday.

MONTREAL — Air Canada will introduce a low-cost carrier to help weather rising fuel costs and cyclical downturns, but only if it can sustainably reduce labour and other costs, the airline’s chief executive said Thursday.

“We will only proceed with it if we are satisfied it has the scale and scope to truly remain low cost,” Calin Rovinescu told shareholders.

Canada’s largest airline failed in its attempts to introduce low-cost carriers about a decade ago. This time, the model will ramp up to 50 aircraft over five years and use two aircraft models: one narrowbody plane type for sun destinations and one widebody for flights to Europe.

Air Canada said the carrier expects to create jobs for 462 pilots, three times as many flight attendants and some airport and maintenance positions.

“I am increasingly convinced that a low-cost carrier should be a key driver in our tool kit. We need to seize this opportunity as an important means to achieving our ultimate goal of long-term, sustained profitability.”

Rovinescu made his remarks after the airline reported trimming its losses to $19 million, or seven cents per share, in the seasonally weak first quarter.

The loss for the three months ended March 31 included $104 million in foreign exchange gains.

That compares to a deeper $112 million loss, or 41 cents per share, a year ago when it logged $123 million in foreign exchange gains.

Excluding foreign exchange gains, its adjusted loss was 45 cents per share, in line with analyst forecasts, compared with a loss of 85 cents a year earlier.

Operating losses improved by $70 million to $136 million.

Passenger revenues increased by $216 million, or 10.3 per cent, due to a 5.7 per cent growth in traffic. Premium cabin revenues grew $57 million, or almost 13 per cent, mainly due to an increase in passengers.

Air Canada (TSX:AC.B) also warned that rising fuel costs will add about $800 million to its operating costs this year. The fuel bill rose by $120 million in the quarter.

That’s all the more reason that a new low-cost carrier with a fundamentally different cost structure is needed to profitably operate in leisure markets and European destinations where the mainline carrier doesn’t attract many business and corporate customers, Rovinescu added.

Among the potential high-volume, low-yield destinations that could be served are Amsterdam, Dublin, Nice, France, Manchester, England, Lisbon and Casablanca, Morocco, as well as southern sun cities.

Approval from Air Canada’s unions is an important step in proceeding with the plan, but not all five labour groups need to support the move.

The key groups such as pilots and flight attendants would need to accept lower wage rates and different work rules. Other changes, such a seat density and commissions to travel agencies, would help to reduce or eliminate the 30 to 40 per cent advantage that low-cost rivals like WestJet (TSX:WJA) have over legacy carriers.

Not everyone is convinced that Air Canada will or should pursue the low-cost option.

Robert Kokonis, president of AirTrav, said it’s a diversion from the complicated challenges the airline faces such as its pension deficit, soaring fuel costs and difficult labour negotiations.

“I believe, to a certain extent, that the low-cost carrier is a bargaining chip to leverage concessions from employees,” he said in an interview after the annual meeting.

While the new carrier may create some jobs, Kokonis said Air Canada is “overplaying that card.”

A more immediate challenge is to achieve labour peace with employees.

Rovinescu declined to comment on the ratification vote by pilots of a tentative agreement that gets underway on Monday, saying the process is an internal union matter.

But the chief executive said he’s hopeful that “adult conversations” can be conducted with union leaders to build a sustainable business.

However, the union representing call centre and airport workers picketing outside the annual meeting said it is through with concessions and slammed a large bonus that Rovinescu is in line to receive.

Sandra Cormier, regional vice-president for the Canadian Auto Workers’ union, said workers are angry enough to go on strike.

“We don’t want to go there but if we have to we’re ready for it,” she said.

Kokonis said he’s “cautiously optimistic” that new collective agreements can be reached but said strikes by one or more employee groups would have an impact on the Air Canada brand.

Rovinescu declined to discuss contingency plans in case of a strike, saying that would be premature.

Cameron Doerksen of National Bank Financial downgraded Air Canada shares in part because of his belief that labour negotiations will be more contentious than originally hoped.

He also pointed to higher fuel costs, revenue weakness on key international routes and doubts about the airlines strategy for creating a separate lower-cost airline.

“Air Canada’s results, while significantly improved over last year, look rather uninspiring compared to WestJet’s numbers,” he wrote in a report.

Doerksen said the Calgary-based rival doesn’t face Air Canada’s labour issues and has a vastly superior balance sheet. The analyst added he’d prefer that Air Canada didn’t chase after low-profit leisure traffic and instead focus on its strengths.

Air Canada once again reduced its outlook for the 2011. It trimmed its capacity growth to between 3.5 and 4.5 per cent and expects domestic capacity will decrease by up to 0.5 per cent.

However, it expects EBITDAR earnings before interest, taxes and other items in the first half of the year to be up to five per cent better than last year.

On the Toronto Stock Exchange, Air Canada shares closed up nine cents or nearly four per cent at $2.35 in Thursday trading.