Turbulence ahead for airline

Deteriorating market conditions will force Air Canada (TSX:AC.B) to dramatically reduce costs by laying off thousands of employees despite winning agreements to extend labour contracts, an industry analyst said Tuesday.

MONTREAL — Deteriorating market conditions will force Air Canada (TSX:AC.B) to dramatically reduce costs by laying off thousands of employees despite winning agreements to extend labour contracts, an industry analyst said Tuesday.

Jacques Kavafian of Research Capital said Canada’s largest airline needs to undergo a more severe restructuring than previously anticipated, likely through bankruptcy protection, to respond to a worsening outlook for the airline industry this fall.

That means cutting costs by at least 25 per cent just to break even.

“They have to do this quick. The market out there is ugly, prices are depressed and volume isn’t there,” he said.

Air Canada has previously rejected Kavafian’s suggestion it cut the number of domestic and transborder route by more than half and capacity by 25 per cent to survive.

But Kavafian believes the airline deliberately underplayed its restructuring intentions to win union support to 21-month contract extensions and a pension moratorium on past service contributions.

“They had to make the unions believe that there won’t be massive layoffs so they accept the agreements,” he said.

Analysts expect Air Canada will post large losses over the coming quarters. Kavafian said the second-quarter loss will exceed $260 million, rising to $1.1 billion for the year and $672 million in 2010.

Market conditions have forced U.S. carriers to shed thousands of jobs. Continental announced plans Tuesday to shed 1,700 workers.

Securing union support for Air Canada’s changes was the easy part, Kavafian said.

More challenging is undoing the damage caused by parent company ACE Aviation Holdings (TSX:ACE.B) unbundling strategy that removed Air Canada’s flexibility to weather the economic storm, he wrote in a report.

He advocates terminating the relationship with Air Canada Jazz (TSX:JAZ.UN), renegotiating terms with Aeroplan (TSX:AER) and re-acquiring Aveos (formerly Air Canada Technical Services).

Rovinescu, who helped devise this strategy, has said spinning off the feeder airline, loyalty rewards program and maintenance division Aveos provided the airline with $2 billion to pay pensions and purchase modern aircraft.

But Kavafian said the airline got long-term pain for short-term gain.

The assessment is belated vindication for pilots who went to court in 2006 in a failed bid to stop the previous restructuring, said Andy Wilson, president of the Air Canada Pilots Association.

He agrees that Jazz, Aeroplan and Aveos have profited at the expense of Air Canada by being paid well above market rates for their services.

But Wilson said his members were under no illusion during the recent contract vote about the need for a significant airline restructuring after Air Canada was “stripped to the bone” by ACE, bad financial management and a market meltdown.

“Those are three pretty big tidal waves. I think everybody understands that there would have to be a restructuring,” he said.

The head of the union representing service agents doesn’t believe the airline’s problems will be solved by dramatically reducing capacity.

Leslie Dias, local president of Canadian Auto Workers’ Union, said fall layoffs are a routine part of the cyclical travel business.

“If there’s huge layoffs they would be surprised,” she said of her members.

“If there’s some layoffs I don’t think they would be all that surprised. We encounter this almost every fall that there’s a cutback of some sort and the economy obviously still have a long way to go to recover.”

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