(Clarification: This story has been updated to include reaction from the pilot’s union and more accurately reflect what Air Canada officials intended to say about e-commerce developments during a briefing with analysts.)
Buoyed by its ability to pivot to lucrative cargo-only flights during the coronavirus crisis, Air Canada (TSX: AC) on Monday said it would develop an all-cargo fleet with converted freighters to take advantage of fundamental shifts in the airfreight market.
Officials said an extended shortage of aircraft to carry cargo as passenger airlines downsize until demand recovers has created a path to significantly grow cargo revenues.
Air Canada plans to convert Boeing 767 passenger aircraft, recently retired from passenger service to help reduce its cost structure, into heavy freighters that can carry large containers and pallets on the main deck. The airline will test the market next year with two converted freighters, offering advanced technology, dynamic pricing and transparency on shipment status to attract retailers and logistics providers, officials said.
“Cargo will become an increasingly important part of our business as we plan to expand to dedicated freighters and focus on e-commerce,” CEO Colin Rovinescu said during a call with analysts to discuss the company’s third-quarter earnings.
E-commerce refers to a couple small, localized pilot projects related to parcel handling that Air Canada is involved with and is not connected to the plan fly all-cargo aircraft, Johanne Cadorette, global communications manager for Air Canada Cargo, explained after the briefing.
Pilots must approve a new pay agreement for freighter flying because clauses in their labor contract outline what type of work they perform and under what conditions. Rovinescu, who recently announced he will retire in February, said Air Canada will need to pay cargo pilots less to make the new business economically viable, noting that the airline stumbled two previous times it was in the freighter business.
“This time around to get it right, especially with the opportunity that arises with the fewer number of widebodies in circulation and the e-commerce opportunity, we think that the right kind of deal with the right kind of cost structure would make sense,” Rovinescu said. “So we’re in discussions with our pilots to try to come to the right outcome here.”
“This matter is being put to our membership for ratification and we should know the results of the vote later this month,” said Julie Rolph, a spokeswoman for the Air Canada Pilots Association.
Air Canada possesses 30 B767-300 Extended Range aircraft, 25 of them from its budget subsidiary Air Canada Rouge. The 767s are well-suited to cover trans-Atlantic routes, as well as North America and parts of South America.
Converting passenger planes to a cargo configuration requires extensive engineering modifications, such as reinforcing the floor beams to support heavy cargo, installing a main deck cargo door and installing a rigid metal barrier behind the cockpit to protect against sliding loads.
Riding the cargo wave
Air Canada is the first international passenger airline to publicly express interest in becoming a freighter operator since the coronavirus raised awareness of cargo’s importance, joining companies such as Lufthansa Airlines, Korean Airlines and Cathay Pacific with dual fleets.
The move resembles ones this year by leisure airline Sun Country and regional carrier Mesa Airlines to diversify their businesses by adding freighter operations, although the Sun Country deal with Amazon Air was in progress before the pandemic began. Mesa began flying small converted jets for DHL in October.
Air Canada’s third-quarter cargo revenue grew 22% year-over-year to CA$216 million ($166.2 million), helping mitigate an 86% drop in total revenue that was primarily responsible for a CA$685 million loss. During the second quarter, cargo revenue skyrocketed 52% and surpassed passenger revenue for the first time ever.
Air Canada enjoyed robust revenue despite handling fewer shipments because so many passenger flights, and their belly capacity, are grounded while demand for critical goods such as medical supplies and e-commerce continues to climb. Cargo yield shot up 133.3% in the third quarter while traffic declined 47.8%. For the first nine months of 2020, yield was 96.3% higher than the same period last year, while traffic declined 39%.
“We operate a profitable cargo business that is expected to deliver more than CA$850 million of revenue in 2020,” Chief Commercial Officer Lucie Guillemette said. Last year the cargo division generated CA$717 million in revenue amid overall industry sluggishness, down from $803 million in 2018.
Since late March, Air Canada has flown more than 3,000 passenger freighters and said it plans to operate up to 100 cargo-only international flights per week in the fourth quarter with widebody aircraft. Cargo is also playing a large role in determining which international passenger routes to fly because it can make flights profitable enough to operate even with low passenger loads.
Air Canada is also bidding to participate in the distribution of a future COVID-19 vaccinefor the Canadian government, likely as a partner with a prime logistics contractor.
Catering to customers with goods to move became a priority for airlines after COVID-19 caused passenger traffic to abruptly drop, leading to drastic declines in earnings and cash from operations. Thousands of aircraft were dedicated to scheduled cargo routes or charter hires, including more than 2,500 in which cargo is often loaded in the empty passenger cabin — usually strapped into seats or put in overhead bins.
At many carriers, cargo went from sideline to primary business in a matter of weeks, with cargo revenue surging despite volume reductions due to the global recession and grounding of passenger flights.
Air Canada was the first airline to temporarily remove cabin seats to enable floor-loading of boxes. It now operates three Boeing 777s and four Airbus A330 without seats, doubling the available volume for each flight.
But most passenger airlines are reluctant to invest in pure freighter aircraft because the air cargo market is historically uneven and owning assets that are underutilized during a lull in demand is risky.
The retirement of the 767s is part of fleet rationalization designed to help lower capital costs by about CA$3 billion over the next three years as the company looks for every conceivable way to stabilize finances.
A total of 79 aircraft, including Airbus A319 single-aisle aircraft and Embraer 190 regional jets, are being decommissioned sooner than planned. The smaller fleet will rely on more modern aircraft that burn less fuel.
The Montreal-based carrier this month also reached agreement with Airbus to defer delivery of 18 A220 long-range regional aircraft and cancel 12 orders. It also canceled 10 Boeing 737 MAX 8s from its order of 50 aircraft and deferred its remaining 16 aircraft for one to three years.
Deferred deliveries, emergency government subsidies to cover a portion of worker wages and deferred payments to suppliers helped reduce third-quarter cash burn to CA$9 million per day compared to management’s projection of CA$15 million to CA$17 million per day.
Canada’s largest airline has eliminated 20,000 positions, cutting its workforce in half.
Air Canada’s fourth-quarter outlook calls for daily cash burn to increase to between CA$12 million to CA$14 million per day because of extra payments to cover residual values for terminated aircraft leases, fewer cash receipts from the government and a higher level of capital expenditures partly due to A220 deliveries.
The company said passenger capacity will be about 75% less than last year’s level during the fourth quarter compared to an 81% reduction last quarter.
Air Canada said it will postpone plans to cut 95 domestic, cross-border and international flights and nine stations needed to preserve liquidity and function as a smaller airline until it sees what progress is made on the Canadian government’s proposal Sunday to develop an aviation industry rescue package that could include loans for airlines.
Rovinescu reiterated the domestic airline industry’s frustration with government travel restrictions it insists are too onerous and making it difficult for companies to survive. Airlines continue to call for increased rapid testing ahead of travel as an alternative to the blanket ban on foreign nationals, and the mandatory 14-day quarantine that they say stifles demand and frustrates travelers.
Management noted that the more severe travel restrictions in Canada resulted in an incremental revenue loss of approximately CA$520 million to CA$600 million relative to the Big 3 U.S. airlines, with traffic down 91% versus 80% for the U.S. competitors.
Air Canada’s stock bounced up 28% to $20.35 at Monday’s close on news of an effective COVID-19 vaccine, the Canadian government’s bailout and the lower cash burn.