Updating the Canada to Europe market in summer 2017: implications for AC, WJA and TRZ

Transcription

1 March 2, 2017 The NBF Daily Bulletin Industry Comment Airlines Updating the Canada to Europe market in summer 2017: implications for AC, WJA and TRZ Industry Rating (Airlines): Market Weight (NBF Economics & Strategy Group) Cameron Doerksen, CFA - (514) cameron.doerksen@nbc.ca Umayr Allem, CFA, MBA - (416) umayr.allem@nbc.ca Canada to Europe in summer 2017 second look We closely analyze the trans-atlantic market as it is the key driver of Transat s summer profitability (~80% of Q3 and Q4 revenue), an important market for Air Canada (~25% of summer revenue), and a relatively small, but future growth market for WestJet. Our first look at the market was published in late November. The key takeaways from this update are: Trans-Atlantic capacity up 5.7% y/y, close to unchanged from prior survey Our analysis of the Canada-Europe markets shows total planned industry seat capacity up 5.7% for summer 2017, which is essentially unchanged from the 5.5% increase we observed in our first survey at the end of November. Air Canada continues to be the most aggressive airline with capacity up 8.6%. Industry trans-atlantic capacity in summer 2016 was up 14% so summer 2017 looks to be more rational. Pricing looks positive y/y, but fuel price also up We are tracking several specific trans-atlantic routes during a peak travel period (mid-july) to assess how airfares compare with a year ago, as well as how they are evolving over the booking period. Our first look at pricing was a mixed bag, with prices to London generally higher y/y, but with most other routes showing price reductions. Our latest pricing survey conducted in late February shows a firming of pricing compared with the same point a year ago. Air Canada s fares to London were notably higher y/y while fares to Paris were higher for all carriers we track (versus mostly down y/y in our late November survey). The airlines will need to generate higher fares y/y to offset higher fuel prices; whereas the average spot price of jet fuel in summer 2016 was Cdn$0.57/liter, the current spot price is Cdn$0.64 (+12%). Implications for our coverage universe Air Canada (Outperform, $16.00 target) Air Canada continues its aggressive international expansion next summer, but it is important to highlight that much of the new capacity is coming on at a low incremental cost with demand supported by growth in 6 th freedom connecting traffic. We also expect summer 2017 to be the last year of significant expansion for Air Canada as its wide-body fleet renewal and the growth of rouge will be largely complete. WestJet (Sector Perform, $24.00 target) Although WestJet s trans-atlantic capacity this summer will be flat, with a new agreement with its pilots to grow its wide-body fleet, we expect new routes to be added in summer Additional capacity from WestJet has the potential to be disruptive for both Transat and Air Canada. Transat (Sector Perform, $7.00 target) Transat suffered lower profits on the trans-atlantic in summer 2016, largely due to the increase in competitive capacity, so we are encouraged by the lower industry capacity growth in 2017 as well as what appears to be some better pricing. However, the market will remain competitive noting that several of the new routes Air Canada will fly or add capacity to are existing Transat routes. Shares EBITDAR EPS 12-Mth Stock Stock Risk O/S Stock Market est. est. EV/EBITDAR est. est. P/E Price Total Sym. Rating Rating (Mln) Price cap FY1 FY2 FY1 FY2 FY1 FY2 FY1 FY2 Target Return Air Canada AC OP AA 275 $13.46 $3,702 $2,514 $2, x 3.9x $2.79 $ x 4.4x $ % Transat A.T. Inc. TRZ SP AA 37 $5.50 $202 $162 $ x 2.9x -$0.23 $0.18 na 30.4x $ % WestJet Airlines WJA SP A 118 $21.83 $2,576 $957 $1, x 4.0x $1.94 $ x 8.9x $ % Rating System: OP = Outperform; SP = Sector Perform; UP = Underperform; T=Tender; UR= Under Review; R=Restricted Risk Rating: BA = Below Average, A = Average, AA = Above Average, S = Speculative Pricing as of March 2, 2017 Source: Companies, Thomson Reuters, NBF

2 A few notes on our methodology The source for our capacity data is OAG, a well-recognized provider of airline scheduling data. We focus our analysis on total seats being offered into the market and departures (seats and departures in both directions). We believe OAG data properly reflects both flight increases as well as changing seat configurations. Our analysis includes all European destinations from points in Canada including Iceland (where much of the capacity is connecting to other European cities). The timeframe analyzed was May 1 st to Oct. 31 st, which corresponds to Transat s summer season. We note schedules can change as airlines adjust capacity. However, we believe most of the planned routes and capacity by airlines for summer 2017 have been loaded into the schedule at this point. Our updated analysis reflects the airlines plans as of late February We looked at seats deployed and departures as key measures of capacity. The airlines generally report capacity as available seat miles (ASMs), but this measure factors in distance flown so can be skewed higher by longer-haul flights. We believe our analysis is a better reflection of the actual capacity being added to the market trans-atlantic capacity- minimal changes from November survey Our analysis of the Canada-Europe market shows total planned industry seat capacity up 5.7% for summer 2017, which is essentially unchanged from the 5.5% increase we observed in our first survey at the end of November. Trans-Atlantic capacity in summer 2016 was up 14% so summer 2017 looks to be more rational. Total industry departures this summer are up 3.5% versus the 3.9% increase in the November survey. (Transat management s industry capacity estimate for summer 2017 was +4%, but there are some differences between our methodology and Transat s). TRANS-ATLANTIC 2017 CAPACITY GROWTH Air Canada 4,014,681 4,359, % 13,729 14, % WestJet 398, , % 2,043 2, % Transat 1,748,375 1,870, % 5,697 6, % Air France 551, , % 1,582 1, % British Airways 521, , % 1,840 1, % KLM 555, , % 1,912 1, % Lufthansa 619, , % 2,098 2, % Total 9,942,005 10,504, % 35,245 36, % Air Canada/rouge has scaled back growth a bit Whereas our prior capacity survey showed Air Canada/rouge adding 9.8% more seats in summer 2017, the most recent survey shows an 8.6% increase. Since our initial report, Air Canada has made several tweaks to its planned summer trans-atlantic schedule, but nothing overly significant. One new route announced in February that we do not include in our trans-atlantic analysis is Montreal-Tel Aviv, which is in response to Transat s announcement of the same route in early January. Transat capacity plans roughly the same Air Transat is growing its capacity by 7.0% this summer, only a slight change from the 7.3% planned back in November. WestJet trims its plans growth coming in 2018 WestJet is now planning flat trans-atlantic capacity for summer 2017 versus its prior plan for a modest 2.2% increase. We believe the change is largely a reflection of WestJet s decision to shorten the number of weeks it will offer flights from Winnipeg and Edmonton to London (late June-August this year versus early May-October last year). The most notable development for WestJet since our first look at the trans-atlantic market is the company has received approval from its pilots group to grow its wide-body fleet beyond the four aircraft it operates now. We therefore see WestJet expanding its trans-atlantic flights in 2018, which will potentially be disruptive to Transat and Air Canada.

3 European legacy carriers tweak capacity plans The major Europe-based trans-atlantic competitors have made only minor capacity adjustments from our prior survey with Air France, British Airways and Lufthansa all adding back some seats driven mainly by up-gauging aircraft. London and Paris still looking more rational; Dublin very competitive Three key destinations we are tracking closely are London (the most popular destination for Canadian travelers to Europe), Paris and Dublin. In summer 2016, the most competitive market was London as WestJet added new routes. We still expect a very competitive market to London, but industry capacity is down 1.3% for summer Paris capacity is down 3.5% y/y driven by Air Canada s reductions. Although a much smaller market, Dublin looks even more over-supplied than in our November survey with capacity now up 20.9% (versus 18.3% previously). CANADA-LONDON 2017 CAPACITY GROWTH Air Canada 1,220,806 1,231, % 4,108 3, % WestJet 308, , % 1,347 1, % Transat 305, , % % British Airways 521, , % 1,840 1, % Total 2,356,018 2,325, % 8,210 7, % CANADA-PARIS 2017 CAPACITY GROWTH Air Canada 426, , % 1, % Transat 316, , % 1, % Air France 551, , % 1,582 1, % Corsair 64,496 57, % % Total 1,359,312 1,311, % 3,855 3, % CANADA-DUBLIN 2016 CAPACITY GROWTH Air Canada 147, , % % WestJet 45,360 46, % % Transat 44,625 53, % % Aer Lingus 63,720 92, % % ASL Airlines France 3,660 2, % % Total 305, , % 1,415 1, % Air Canada adds to Iceland over-supply Iceland-based carriers Icelandair and WOW Air have carved out a share of the trans-atlantic market with their strategy to connect European bound travelers through Iceland. WOW Air is set to grow its capacity from Canada to Iceland by 54.2% and now Air Canada will add flights from Toronto and Montreal to Iceland, adding to what we think is already an over-supplied market (total industry capacity up 20.9%). Since Air Canada has no connecting flights beyond Iceland, we see this move as purely a defensive play. CANADA-ICELAND 2017 CAPACITY GROWTH Air Canada 0 29, Icelandair 251, , % 1,366 1, % WOW Air 95, , % % Total 347, , % 1,876 2, %

4 Pricing update fares look mostly higher y/y; fuel also up We are tracking several specific trans-atlantic routes during a peak travel period (mid-july) to assess how airfares compare with a year ago, as well as how they are evolving over the booking period. Our first look at pricing was a mixed bag, with prices to London generally higher y/y, but with most other routes showing price reductions compared with the same time a year ago. Our latest pricing survey conducted in late February shows a firming of pricing compared with the same point a year ago. Air Canada s fares to London were notably higher y/y while fares to Paris were higher for all carriers we track (versus mostly down y/y in our late November survey). SUMMER 2017 TRANSATLANTIC FARES - Y/Y COMPARISON Return Fare Airline Service 28-Feb Mar-16 Y/Y Change Toronto-London Air Canada Direct $1,317 $976 $341 Air Transat Direct $1,066 $1,011 $55 British Airways Direct $1,442 $1,375 $67 Montreal-Paris Air Canada Direct $1,073 $931 $142 Air France Direct $971 $932 $39 Air Transat Direct $1,054 $909 $145 Corsair Direct $974 $889 $85 Vancouver-London Air Canada Direct $1,239 $1,057 $182 Air Transat Direct $1,064 $1,064 $0 British Airways Direct $1,620 $1,620 $0 WestJet Direct $1,144 $1,088 $56 Montreal-Nice AC rouge Direct $986 $1,016 ($30) Air Transat Direct $969 $952 $16 Toronto-Dublin Aer Lingus Direct $946 $1,117 ($171) AC rouge Direct $977 $828 $149 Air Transat Direct $1,053 $943 $110 WestJet Connect $1,105 $1,057 $48 Toronto-Lisbon AC rouge Direct $1,038 $870 $168 Air Transat Direct $878 $1,000 ($122) Montreal-Barcelona AC rouge Direct $978 $1,067 ($89) Air Transat Direct $975 $998 ($23) Note: Fares as of Feb. 28, 2017 and Mar. 1, 2016; mid-july 2017 itineraries Source: Aer Lingus, Air Canada, Air France, Air Transat, British Airways, Corsair, WestJet, NBF We also track the progression of airfares as date to departure nears as highlighted in the table below. If fares move higher as date of departure nears, it would imply that the flight is booking well and vice versa if we start to see discounting. Looking at how airfares have progressed from our first survey in late November to late February and the picture is mixed. Fares on Montreal-Paris are all higher versus a few months ago while flights from both Toronto and Vancouver to London show mixed results with Toronto-London skewing higher.

5 TRANSATLANTIC FARE TRACKER - SUMMER 2016 Return Fare Airline Service 29-Nov Feb-17 Note Montreal-Paris Air Canada Direct $1,022 $1,073 CDG Air France Direct $872 $971 CDG Air Transat Direct $827 $1,054 CDG Corsair Direct $897 $974 Orly Icelandair Connect $1,075 $1,116 Connect Iceland WOW air Connect $1,004 $1,060 Connect Iceland Toronto-London Air Canada Direct $1,309 $1,317 Heathrow Air Transat Direct $938 $1,066 Gatwick British Airways Direct $1,617 $1,442 Heathrow Icelandair Connect $1,223 $1,292 Connect Iceland - Heathrow WestJet Direct $1,007 $1,371 Gatwick WOW air Connect $870 $1,150 Connect Iceland - Gatwick Vancouver-London Air Canada Direct $1,234 $1,239 Heathrow AC rouge Direct $1,086 $1,044 Gatwick Air Transat Direct $1,091 $957 Gatwick British Airways Direct $1,503 $1,352 Heathrow Icelandair Connect $1,506 $1,615 Connect Iceland - Heathrow WestJet Direct $1,144 $1,490 Gatwick Montreal-Nice AC rouge Direct $979 $986 Air Transat Direct $1,060 $969 Toronto-Dublin Aer Lingus Direct $996 $946 AC rouge Direct $1,012 $977 Air Transat Direct $1,034 $1,053 WestJet Connect $871 $1,105 Stops St. John's Toronto-Lisbon AC rouge Direct $1,004 $1,038 Air Transat Direct $949 $878 Montreal-Barcelona AC rouge Direct $1,031 $978 Air Transat Direct $897 $975 Note: Fares for mid-july itineraries Source: Aer Lingus, Air Canada, Air Transat, Corsair, Air France, Icelandair, WestJet, WOW Air, NBF The airlines will need to generate higher fares y/y to offset higher fuel prices. Whereas the average spot price of jet fuel in summer 2016 was Cdn$0.57/liter, the current spot price is Cdn$0.64 (+12%). The CAD is also currently modestly weaker ($1.34 versus the average of $1.30 last summer), which will be a headwind to some costs. Conclusions unchanged still competitive, but better than 2016 Our conclusion about the market this summer is essentially unchanged from our earlier update: we expect competitive market conditions to persist due to higher industry capacity. However, based on the slowing of capacity growth we see relative to summer 2016 and airfares that are so far holding up, we expect a more rational market overall. Air Canada (Outperform, $16.00 target) Air Canada continues its aggressive international expansion next summer, but much of the new capacity is coming on at a low incremental cost (through rouge ) and demand is also supported by growth in 6 th freedom connecting traffic to and from the United States. Air Canada should also benefit from the maturing of all of the international routes it has added in recent years with positive implications for pricing. Based on Air Canada s fleet plans, summer 2017 should be the last year of significant expansion for Air Canada and rouge. We value the stock by applying a 4.5x EV/EBITDAR multiple to our forecast for next four quarter EBITDAR, which results in a target of $ WestJet (Sector Perform, $24.00 target) WestJet has made only minor adjustments to its trans-atlantic capacity for summer 2017, but we expect the airline s performance on the market to be improved. Firstly, we believe WestJet has been less aggressive with introductory fares this year with positive implications for pricing. Secondly, WestJet should not experience the significant operational issues it faced with its 767 fleet this summer, which will lower costs. Growth on the trans-atlantic is likely to resume for WestJet in summer 2018 as it now has an agreement in place with its pilots to add more wide-bodies to its fleet. We expect the company to outline its wide-body expansion plans at an investor day planned for early May. We value the stock by applying a 5.0x EV/EBITDAR multiple to our forecast for next four quarter EBITDAR, which results in a target of $24.00.

6 Transat (Sector Perform, $7.00 target) Transat suffered lower profits on the trans-atlantic market in summer 2016 largely due to the 14% increase in competitive capacity. We are encouraged by the lower industry capacity growth this summer as well as what looks to be firmer pricing. However, several of the routes Air Canada/rouge will fly or add capacity to are existing Transat routes so we still expect a competitive market. We are also concerned about the likely expansion of trans-atlantic capacity from WestJet in 2018 that has the potential to be disruptive for Transat. We derive our $7.00 target on Transat by applying a 4.0x EV/EBITDAR multiple to our forward four quarter EBITDAR forecast to which we add the book value of the company s hotel investment. Please see our separate note on Transat, also published today, for more details on our investment thesis.

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8 Additional company related disclosures for Air Canada (6,7) 6 National Bank Financial Inc. or an affiliate has a non-investment banking services related relationship during the past 12 months. 7 The issuer is a client, or was a client, of National Bank Financial Inc. or an affiliate within the past 12 months. Additional company related disclosures for Transat A.T. Inc. (6,7) 6 National Bank Financial Inc. or an affiliate has a non-investment banking services related relationship during the past 12 months. 7 The issuer is a client, or was a client, of National Bank Financial Inc. or an affiliate within the past 12 months. Additional company related disclosures for WestJet Airlines Ltd (6,7) 6 National Bank Financial Inc. or an affiliate has a non-investment banking services related relationship during the past 12 months. 7 The issuer is a client, or was a client, of National Bank Financial Inc. or an affiliate within the past 12 months.