As part of a broad expansion of international charter operations, Canadian carrier Cargojet (TSX: CJT) is aggressively looking to invest in a startup cargo airline in the U.S. so it can participate in strong trade routes where it is currently blocked from offering service because of its foreign status, CEO Ajay Virmani said Monday.
Backing a small entity that essentially acts as a U.S. license holder would require a modest investment of $5 million to $20 million instead of hundreds of millions necessary to take a large stake in an existing all-cargo carrier, he said.
U.S. law restricts commercial air operations within two points in the country to domestic carriers. And U.S. airlines must be at least 75% owned, as a percentage of shares, and effectively controlled in terms of voting stock by U.S. citizens. Additionally, two-thirds of an airline’s governing board and its top executive officer must be U.S. citizens.
Cargojet flies from Canada to Cincinnati, for example, but can’t go from Cincinnati to Miami and then to Panama.
“The growth in the U.S. market is tremendous. There are many routes and many areas that we cannot cover with our current license arrangements, and we continue to seek a U.S. partner for our growth strategy across the border as many of our customers in Canada are also customers in the U.S.,” Virmani said during a conference call with analysts.
“We are looking at that opportunity very seriously because we feel there is a lot more opportunity to place aircraft and to have an ownership position. … The company will seriously pursue that over the next quarter to have an investment that gives us another outlet to sell our products and services.”
Cargojet revealed its merger intentions after reporting first-quarter revenues increased by 30.3% and net income by more than 5,000%, to CA$89.4 million ($68.4 million), compared to the same period in 2020 due to a dramatic growth in e-commerce demand and the steep drop in international passenger air service.
New e-commerce trend
Business has been extremely brisk for express carriers of all stripes since the pandemic started and motivated people to shop virtually rather than in person. The carriers depend on air networks to help them quickly deliver business-to-consumer orders. Cargojet supports package delivery giants such as Amazon (NASDAQ: AMZN), DHL Express (DXE: DPW) and Purolator.
Company officials said the acceleration of online purchases is increasingly being spurred by small retailers finally adopting e-commerce years after large merchants enabled consumer interest in shopping from home or a mobile device.
“Now, tens of thousands of small businesses have discovered the opportunity that the digital economy presents. So far, the e-commerce revolution was driven by the consumers who were pushing retailers to move online, but the pandemic has fundamentally changed this equation,” Virmani said. “We feel that the next phase of e-commerce revolution will be merchant-led. Thousands of new businesses have started during the past year that never even considered a brick-and-mortar store. This changes the shopping equation fundamentally.”
Canada still lags other markets in terms of total e-commerce sales, but online sales as a percentage of total retail sales has doubled from 7% to more than 14% during the past year. That’s on par with the U.S. and other parts of the world. The e-commerce share of total global retail sales is forecast to hit 21.8% by 2024, according to Statista.
Since last year, Cargojet has paid down most of its debt, invested in aircraft and broadened its services offerings to take advantage of the e-commerce explosion.
Cargojet generated CA$160.3 million in revenue during the quarter, with daily average operating revenue up 35% to CA$2.5 million and gross margin jumping 28.3% to CA$45.3 million. It also increased adjusted free cash flow by 18% to CA$35.2 million.
Company officials were bullish about continued revenue growth as existing customers seek further airlift and new air charter opportunities arise. They said future growth likely won’t be as substantial as in 2020, when the carrier flew dozens of emergency flights to carry personal protective equipment from China to Canada, but will be much better than before the crisis.
Cargojet generates most of its revenue flying packages at night across Canada for primary customers in the parcel sector. It also leases aircraft and crews to companies that need one-time moves between Canada, the U.S., Mexico and Europe. Other customers commit to longer regular service for routes between the U.S. and Bermuda and between Canada and Germany.
The domestic network is more lucrative because the pricing is by the pound and customers contractually commit to certain amounts of space. The price is based on the roundtrip because shipments tend to move from the eastern part of Canada to the West, with planes flying empty on the backhaul because there is no industrial base in the western part of the country. In the domestic market the only competition comes from Air Canada. Cargojet has to price differently on international routes where it goes up against many carriers. But the medium- and-long-term international charters provide supplemental revenue with little risk. Cargojet operates them on days and weekends when the aircraft and crews aren’t busy operating the domestic express network, which allows it to leverage its existing infrastructure with few added costs.
Cargojet operates 25 freighters and plans to have two more aircraft this year — a converted Boeing 767 freighter in the fourth quarter and one 757 in May. Four more 767s are scheduled to be received through early 2023, with each conversion costing about $30 million. It also has three aircraft in passenger charter service. Virmani said Cargojet was able to acquire the 757 at a reasonable price and will put it, or one of its existing 757s, into the DHL network.
The company recently inked a four-year contract extension with Amazon that can be stretched up to six more years at Amazon’s discretion.
Chief Commercial Officer Jamie Porteous said Cargojet could see a dip in second-quarter volumes because of COVID lockdowns in Ontario and Quebec and the shutdown of Amazon warehouses.
In February, the airline raised CA$365 million through a public offer and last month began operating two Amazon-owned aircraft for the retail giant.
Diversification and savings
The Canadian carrier expects to further diversify its international charter business with passenger airlines unable to ferry normal amounts of cargo because fleets remain substantially grounded. The incoming aircraft will enable more dedicated contract carriage for specific customers.
But the lack of a domestic U.S. affiliate has handicapped those expansion plans, Virmani acknowledged.
“If we were to look at a U.S. carrier, it’s not going to be a huge capital investment, to be honest with you. It would be more of a startup. A week doesn’t go by when a U.S. carrier doesn’t want to sell. But our idea is we have the strength and backroom operations of Cargojet, which with some modification and FAA approval, we can use on American carriers. So we don’t anticipate spending hundreds of millions buying a company unless something very good came up.
“But our initial thoughts are that we’re going to invest in a small license more than a carrier and provide our backroom capability and utilize the overhead over there so that we get the synergies. And we are not paying for something that is already built because we are fully capable of, within three to six months or a year, to get it up to the standards of Cargojet and enjoy our growth in the U.S.,” the chief executive said.
The strategy essentially involves finding investors willing to start a U.S. airline and obtain an operating certificate from the Federal Aviation Administration and then outsource dispatching and operations to Cargojet through a long-term lease of aircraft, crew, maintenance and insurance. Cargojet could also take a stake in an existing carrier interested in operating with foreign equipment.
After rapidly scaling up to meet demand, the company will focus the remainder of the year on cost controls and efficiency, Virmani said.
Cargojet added more than 60 pilots in the past three to four months to keep up with demand and to comply with new pilot-fatigue regulations that went into effect at the end of 2020.
Total crew costs including salaries, training and positioning increased 58% to CA$15.2 million primarily due to the pilot hires, annual salary increases, and increased crew positioning and training costs.
Since the pandemic began, Cargojet has expended large sums for overtime to process higher volumes, personal protective equipment and COVID testing for employees, incentives that encourage workers to stay healthy, and hotel costs for pilots restricted from flying to certain destinations in Asia because of new outbreaks. It also operates small Challenger aircraft to ferry a dozen pilots each day between its headquarters in Toronto and DHL’s hub at Cincinnati Northern Kentucky Airport. Cargojet provides crews to DHL there and needs the shuttle flights because it doesn’t have direct commercial service each day to Cincinnati and pilots would use up their on-duty hours making three intermediate stops.
The company expects to save money in those areas as the pandemic subsides, vaccinations increase and emergency unemployment benefits, which made it difficult to attract workers, expire Virmani said.