Open skies to the US, new Asian routes and preparation for a hefty fleet renewal made 1995 a busy year for Air Canada. But has the cost taken too heavy a toll on the carrier's financial health? Sara Guild reports from Montreal. 'Nonstop America' says the inflight serviette on Air Canada's domestic service. And that phrase certainly summarises the carrier's actions in 1995.

From eight scheduled routes to the US in March 1995, prior to open skies, the Canadian carrier will be serving 30 one year on - surpassing its original target of 20. That includes the conversion of seven charter routes into scheduled routes.

In January Air Canada will launch Toronto-Philadelphia and at the end of the month will announce at least four new US routes to be launched in the second quarter. The carrier aims to double its transborder revenues from C$640 million (US$463 million) as of March 1995 to C$1.2 billion by March 1998. Capacity to the US in the first 10 months of 1995 was up 14 per cent over 1994.

This growth, however, has not come without considerable pain and the balance sheet and bottom line have suffered. Even the carrier's controller and vice president of financial planning, Paul Brotto, concedes that the debt to equity ratio is 'awful' while the shareholders complain that the level of profitability is anaemic.

Debt reduction is a primary focus for chairman and chief executive Hollis Harris. The carrier's long-term debt of C$2.5 billion (US$1.8 billion) will be reduced to C$1.5 billion by the turn of the century. At present the debt to equity ratio is far from ideal. 'Eighty per cent of the company is debt leveraged. Ideally the ratio would be 50:50 or 60:40 but that will not happen until the backend of this decade,' says Brotto.

The approved 1996 budget plan calls for a 20 per cent increase in operating income, to about C$360 million, and carries a net profit target of C$100 million without any one time items, such as this year's proceeds from the sale of Continental warrants.

In 1995 the carrier expected to meet its operating income target of C$275 to C$300 million, but was falling short of its forecast net result of C$100 million and lagging behind the 1994 result. The nine months to 30 September showed a net profit of C$68 million compared to C$125 million in 1994 and the fourth quarter was heading for break even, according to Brotto. A slow first half and start up costs were being blamed for the shortfall in net earnings.

Despite Air Canada's rapid US expansion, Harris says the carrier is basing future traffic growth on an extremely conservative estimate that Canadian GDP will grow just 2.5 per cent in 1996. The carrier is also predicting a downturn or flattening out of the economic cycle, if not an outright recession, by late 1997.

The job of returning Air Canada to profitability was included in Hollis Harris' mandate when he joined in March 1992. Since then he has concentrated on reducing costs and increasing productivity and, in 1994, the carrier finally made a profit of C$129 million on revenues of C$4 billion - the first black results since 1989.

A constant check on how Air Canada is performing against its North American rivals, or benchmarking, has been central to the carrier's recognition of where its costs were too high. In this way it discovered that its food and bar costs were excessive and that employee and airport operation productivity were well below average. 'In terms of available seat mile per employee, we are 20 per cent below the North American average,' says Brotto.

Gains have been made with the carrier's employees in the past year. In 1993 pilots flew an average of 43 hours a month, a figure which has since reached the mid-50s. But Brotto now points to the US, where some pilots are in the 65-70 hour range. Similar goals are being set for flight attendants and maintenance personnel. However Air Canada's cost per available seat mile is currently at 8 US cents, while US full service carriers battle to bring their costs down to US7.5 cents, and the likes of ValuJet are below 7 US cents.

Air Canada's new fleet of Airbus A319s will also give the airline a maintenance honeymoon period, which Brotto says should be 10-20 per cent of the total cost of current routine overhaul maintenance. The decision in May 1993, when manufacturers were hungry for buyers, to order 35 A319s to replace the ageing DC-9 fleet allowed Air Canada to negotiate 100 per cent financing - 85 per cent export credit guaranteed with Airbus taking the remaining 15 per cent - while Boeing financed 80 per cent of the five new 767-300ERs against an Exim guarantee. The first of the 35 A319s will arrive in December 1996, with deliveries continuing at a rate of two per month until June 1998, while the two outstanding 767-300ERs were due to be delivered by March.

By mid 1998, in addition to the A319s and A320s, Air Canada's fleet will consist of three Boeing 747-400s, six A340s, 21 767-200s, six 767-300ERs and 24 Canadair Regional Jets, and will have an average age of less than five years.

The carrier may have negotiated well for its fleet but this will not ease the one-off start up costs for a new route, an eight digit figure in Canadian dollars, according to Brotto. In Air Canada's case these included training 850 pilots to get the right 150 pilots correctly trained for the right aircraft on the right routes.

Indeed there have been questions raised over the soundness of Air Canada's rapid expansion. But Robert Milton, senior vice president marketing and inflight service, says he has seen the growth in Air Canada's traffic, watched the load factors rise and witnessed the US carriers pulling out of Canadian markets. Milton refers to ValuJet abandoning its Atlanta-Montreal service; USAir Shuttle dropping LaGuardia-Montreal and Boston-Montreal; American cancelling Montreal-Dallas; and Continental terminating Vancouver-Newark and Vancouver-Houston.

'If we look at the volume of traffic we have picked up we know a significant volume of this has come out of the hides of the US carriers which were formerly able to force people to fly over their hubs. Now it comes to us at a higher yield,' says Milton.

Origin and destination versus hub traffic is an important element of Air Canada's success. While Toronto and, to some extent, Vancouver are hubs for the carrier, they are not true multi-directional North American hubs, says Milton. 'We tend to be more comfortable playing an O&D game and we are good at it and the US guys aren't. They have no confidence in their ability to do things outside their hub,' he says.

Prior to open skies Air Canada had the largest transborder market share with 26 per cent, even though it only had access to 40 per cent of the US population. In contrast US carriers had access to 90 per cent of the Canadian population. Worse still, Air Canada was not picking up the Canadian traffic in its home territory: while 64 per cent of the transborder market is generated in Canada, before open skies the large US carriers were taking more than 50 per cent of that, says Harris.

Air Canada's ability to fly Canadians directly to US destinations is the main focus of the carrier's push into the US. 'Let's not try to beat our heads against the wall and beat American in Dallas or Delta in Atlanta, let's go after the Canadian traveller,' says Harris.

Milton is reluctant to reveal route specific information and merely states that Air Canada is maintaining its market share on the US routes.

The conversion of the charter flights to scheduled services on routes out of Toronto and Montreal to Fort Lauderdale, Fort Myers and Orlando, and from Toronto to Las Vegas, has allowed Air Canada to list the services on the CRSs and market a premium product to US travellers, instead of being restricted to lower yield, Canadian only tourist traffic. Air Canada estimates this change alone, which will be introduced into the winter 1995-6 schedule, will boost yields on those flights by at least 10 per cent.

Air Canada's partners, Continental and United, are another asset in the US. In September the carrier sold its 6.2 million warrants, issued as part of its original investment, back to Continental Airlines for a net asset gain of C$58.3 million in the third quarter of 1995. Harris says the investment in the warrants has been sound financially and strategically. The sale does not affect Air Canada's 23 per cent stake in Continental as Air Canada is retaining its C$55 million in common stock and $30 million in preferred convertible shares.

That investment has been repaid in full through the sale of the warrants, more than C$7 million paid in interest on the 12 per cent preferred convertible shares, and the incremental revenue from the carriers' alliance. Harris says the latter amounted to more than C$100 million for both carriers in the first part of 1995.

'We still have our investment, it is secure, as is our strategic reason for doing it which was to lock us into the big US market,' says Harris.

Air Canada's flights to Houston, Newark and Cleveland feed into Continental's hub network but the rest of the US is covered by Air Canada's marketing partner, United. The latter also provides coverage to the South Pacific and South America. Air Canada's flights from Vancouver to California are codeshared with United, tapping into United's frequent flyer membership which totals 5 million in California alone, against Air Canada's total of 2 million. The strategic alliance with United brought in incremental revenue of $60 million in 1994, of which a third went to Air Canada.

Harris ranks the importance of Air Canada's alliance strategy second with regard to his mandate to achieve profitability. 'We want to be part of a global network, rather than selling ourselves and becoming a secondary carrier like CP [Canadian Airlines] did to American. We want to be independent and have our own say,' says Harris.

Air Canada is currently negotiating with All Nippon Airways and is extending its western Canadian codeshare arrangements with Swissair to the east by adding Montreal and Toronto to Zurich. And as Harris reflects on potential future global alliances, there is a clear implication that he believes Air Canada could sit comfortably with Lufthansa and United. Air Canada has ended its exclusive major European deal with Air France, and Harris says Canadian and Lufthansa will dissolve their partnership in June. Air Canada already has indirect links with the German carrier through its partners United and SAS, the latter via Air Canada's codeshare through London/Heathrow with British Midland.

In Asia, Air Canada's codeshare with Korean Airlines currently adds three flights a week to the three the Canadian carrier provides from Toronto and Vancouver to Seoul. Air Canada is however seeking fifth freedoms from Seoul to Jakarta and Singapore.

Indeed the carrier expects its Asia-Pacific operations to boom next year with traffic increasing 50 per cent and revenue predictions of C$200 million, double that for the first 10 months of 1995. Air Canada is well aware its expansion in that region was '10 years too late', as Milton puts it, but the carrier is now going for broke on its routes to Seoul, Osaka, Hong Kong, Jakarta and Singapore.

Former Canadian transport policy was to split the world and give Air Canada the European destinations and Canadian the Asian destinations. As a result the Pacific accounts for only 5 per cent of Air Canada's total RPMs compared to 40 per cent for the Atlantic which holds the largest share. The remaining RPMs break down as follows: domestic 36 per cent; Florida and the Caribbean 6 per cent; the rest of the US 12.3 per cent; and charters 0.5 per cent.

Milton says Air Canada has seen an 11 per cent jump in transatlantic capacity, helped by the start of two weekly flights to Tel Aviv and a move to daily Zurich services. The Canadian government will also be negotiating a bilateral with South Africa, having given Air Canada authorisation to serve Johannesburg. And the carrier is evaluating the possibility of serving Brussels and Madrid in 1996.

At home Air Canada holds 58 per cent of the domestic market and capacity in 1995 was up 10 per cent on 1994. Milton says Air Canada is dominant east of Saskatchewan and hopes a drive in western Canada - home to Canadian International - will increase its market share to 50 per cent by the end of 1997 from its present 30 per cent.

Harris's five-year mandate is nearly finished, and although he says he will most probably stay until the spring of 1997, there is his potential involvement in a US start-up carrier to be considered. Harris says it is possible Air Canada will be involved in some way, most probably through the sale of the DC-9s which Harris reckons are worth US$2 million each before they have been renovated and hushkitted. Harris says he will not be involved in the new carrier as long as he remains CEO at Air Canada.

However the last item of his mandate checklist is to remove the crown corporation - or non-profit oriented state owned - mentality from privatised Air Canada and groom a successor. After two major managerial overhauls, Harris feels the board has a few options for its next CEO. But Harris is in charge for now and his main goal will be to keep tight control over costs and productivity as he strives to pursue Air Canada's extremely ambitious strategy for rapid growth.

Source: Airline Business