Strong demand helping Air Canada and WestJet

MONTREAL — Lower costs and strong passenger demand in spite of higher fares and fees could propel Canada’s two largest airlines to new heights, according to industry observers.

MONTREAL — Lower costs and strong passenger demand in spite of higher fares and fees could propel Canada’s two largest airlines to new heights, according to industry observers.

Walter Spracklin of RBC Capital Markets boosted his target price for Air Canada on Friday by nearly 42 per cent to $17, adding that the airline’s shares could nearly triple from the current levels to hit $30 under a best-case scenario of industry growth accelerating on a strong economy.

“Air Canada is undergoing a fundamental and structural cost reduction initiative that is playing out in a climate of steadily increasing demand for air travel,” Spracklin wrote in a note.

He said growing profits and undervalued shares are forming a “seldom seen” investment opportunity with the airline.

Shares of the country’s largest carrier hit a more than six-year high Friday, peaking at $10.58 on heavy volume. They closed up 54 cents or 5.44 per cent at $10.47 on the Toronto Stock Exchange.

Air Canada’s (TSX:AC.B) shares had the best performance of all public companies in Canada last year and are up from a 52-week low of $2.07, but still well below the $21.05 price it hit in November 2006.

Cameron Doerksen of National Bank Financial also increased his target price for Air Canada to $12, from $8.50, citing several catalysts such as higher fares, stabilized costs and better than expected trans-Atlantic revenues are emerging for the airline. Higher airfares also prompted him to upgrade WestJet Airlines (TSX:WJA), raising WestJet’s target price to $29, up from $27. That prompted the Calgary-based carrier’s shares to close up 68 cents or 2.65 per cent at $26.34.

In addition to a “strengthening domestic fare environment” Doerksen pointed to stabilization in fuel prices and an increase in the valuations of airline peers. Meanwhile, Spracklin said Air Canada’s operating results are beating forecasts across all measures.

Traffic increased by nine and 10.1 per cent in the past two months, well in excess of estimates for 6.5 per cent growth. Each one per cent gain adds an estimated $100 million in pre-tax operating income (EBITDAR) and 20 per cent to the share price at current levels, he wrote in a report.

Analysts believe that several initiatives, including the launch of low-cost Rouge subsidiary, addition of more seating on Boeing 777s and the delivery of long-haul Boeing 787 Dreamliners, give the airline a promising future.

A survey of fares suggests that a dramatic increase in capacity on trans-Atlantic routes is not causing a dramatic reduction on fares as was feared.

Fares on routes where Rouge is competing directly against Air Transat have remained relatively unchanged as neither carrier is offering major fare discounts, Doerksen said. That suggests the number of unsold seats are at acceptable levels for the carriers.Doerksen said a five per cent increase in summer fares that Transat AT (TSX:TRZ.B) indicated in March may not have held in more recent bookings, putting pressure on the Montreal-based tour company.

The number of trans-Atlantic seats are forecast to increase nine per cent to 4.13 million this summer, driven by a 16 per cent increase from Air Canada.

Transat is expected to report next Thursday much deeper adjusted losses in the February through April quarter. The second-quarter adjusted loss is forecast to be 35 cents per share on $1.14 billion of revenues, compared to a four-cent loss a year earlier, according to analysts polled by Thomson Reuters. But Kevin Chiang of CIBC World Markets says Transat’s summer results will be good as the rollout of Air Canada Rouge is still in the early stages.

“Longer term, we have concerns on whether Transat can effectively compete against a mature Rouge banner and expectations that WestJet will look to commit to a network expansion into Europe before the end of this decade,” he wrote.

Although Transat gained flexibility by moving to a more seasonal fleet structure, it is less able than scheduled carriers like Air Canada and WestJet to adjust to challenges likes sudden changes in currency.

Doerksen said Air Canada and WestJet are able to offset fare weakness on the trans-Atlantic by higher domestic fares, especially on Western Canadian routes and transcontinental journeys such as between Toronto and Calgary or Vancouver.

Transat’s shared lost 18 cents to close at $9.47 on Friday.

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