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More ‘bruises and bloodshed’ expected for Air Canada and WestJet

It seems logical that the higher cost producer in Canada's airline sector – Air Canada – should be the first company to rationalize its capacity

Canadian airline investors aren’t reaping the benefits of the sharp decline in oil prices, and one analyst thinks he knows why.

Air Canada and WestJet Airlines Ltd. are both down about 25 per cent in the past six months, while WTI oil prices have declined more than 30 per cent during the same period.

However, Delta Air Lines Inc. — a bellwether for U.S. airline stocks — has gained 15 per cent.

Ben Cherniavsky at Raymond James believes the Canadian airlines are to blame, saying the domestic market is “plagued by carriers that are adding too much capacity into a weak economic environment.”

The analyst noted that Air Canada and WestJet together have added seven-per-cent more capacity to the market, despite economic growth of about one per cent.

He pointed out that more evidence of this trend emerged last week when both companies reported November traffic data. Air Canada, for instance, flew only 70 per cent of the available seat miles (ASM) it generated during the peak month of August.

“Effectively, Air Canada parked the equivalent of North America’s 8th largest airline between August and November!” Cherniavsky told clients. “They didn’t send the planes back to the lessors; they didn’t furlough the pilots or flight attendants; they didn’t downsize the head office. Instead, they just parked the capacity.”

WestJet during November flew 85 per cent of its August capacity.

The analyst believes lower fuel prices are the only reason why Air Canada and WestJet have been able to boost margins and profits.

But unless oil goes to zero, investors shouldn’t count on this as a source of sustainable earnings growth going forward.

“In this respect, we believe the market is being rational by treating the drop in fuel prices largely as a ‘one-time’ event, which is evident in the multiple compression that the airline sector has witnessed over the past 12 months,” Cherniavsky said.

He thinks it’s logical that the higher cost producer — Air Canada — should rationalize its capacity first.

However, the analyst cautioned that unless the Canadian economy quickly takes a turn for the better, the airline sector will likely see “some more bruises and bloodshed” before any rationalization happens.

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