New flight path: Has Air Canada moved past its boom-and-bust history?

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The Air Canada museum in Montreal, scheduled to open officially this spring, will show off some of the relics of ancient times in the airline industry.

Cigarette lighters, a set of playing cards and a cribbage board sit alongside a metal box called a Travel Pak, containing "anti-enzyme" toothpaste, ammonia inhalants, Vaseline and a small bottle of isopropyl alcohol – all necessary items, presumably, for long-distance travel in the days before jets ruled the skies.

There are no copies of past Air Canada financial statements written in red ink, but if the airline's chief executive officer Calin Rovinescu has his way, such documents will become similar museum pieces.

As Mr. Rovinescu sits in a leather chair in front of a museum wall featuring models of Air Canada planes past and present, he outlines the elements of the turnaround at the airline, where the cycles of boom and bust have been the order of the day since 1937.

When he took over as CEO in 2009, Air Canada was, as he describes it, "a burning platform."

He ticks off some of the accomplishments since then: eliminating a pension deficit of about $4-billion; reducing costs to help hit financial targets; winning long-term labour peace with several unions; winning awards for customer service; and establishing low-cost subsidiary Rouge to compete with Air Canada's largest domestic rival, WestJet Airlines Ltd.

"The transformation is largely complete," Mr. Rovinescu declares in an interview. So Air Canada is moving on to the next stage, which he calls "sustainable profitability," a mantra he has been repeating in recent quarterly conference calls.

There is skepticism, however, that Air Canada has been permanently transformed and thus will be able to break the bonds of its boom-and-bust history, weather the inevitable shift in the economic cycle and generate profit through a downturn.

There is also concern that low fuel prices and robust growth in passenger traffic have already begun to shift, threatening the strong financial results posted by Air Canada – final profit that rose almost threefold last year from 2014 levels – and U.S. airlines that have been riding even higher.

And given the airline industry's long record of value destruction, a popular school of thought believes investing in airlines makes no sense.

Mr. Rovinescu insists Air Canada has laid down the foundation for long-term success. The pension deficit is now a surplus of about $1.3-billion; pilots, customer service representatives and airplane service personnel have signed labour deals of five to 10 years; and costs per available seat mile are on pace to drop 21 per cent from 2012 levels by 2018.

He points to financial milestones reached last year, compared with 2009 numbers:

• A record 18.3-per-cent return on capital invested versus a 1.5-per-cent drop;
• Earnings before interest, taxes, depreciation and aircraft rent hitting a record $2.5-billion, compared with $679-million;
• Share price appreciation of more than 800 per cent since April, 2009.

"That's progress. That is transformation," he says.

But there is a disconnect between the airline's improved financial results and the performance of Air Canada's stock since the middle of 2015 and including Feb. 17, the day those results were released, when the shares fell 12 per cent or $1.02 to $7.39.

The stock has risen in recent days to above $8, but is still well below the 52-week high of $14.50 that it hit last summer, which flies in the face of applause about the results from many analysts, praise for Mr. Rovinescu personally from the leader of one of Canada's largest and most influential pension funds, and an acknowledgment by WestJet CEO Gregg Saretsky that Air Canada has improved.

"Their costs have come down, their people are friendlier," Mr. Saretsky told a meeting of The Globe and Mail editorial board last month. "Probably WestJet can be thanked for much of what Air Canada has accomplished."

Mr. Rovinescu says markets will reach their own conclusions on the value of the shares, but part of the issue is that short-term investors focus too closely on month-to-month swings in traffic.

Repeating the numbers Air Canada put up last year – or improving on them – requires a long-term plan, he says, which is why he took the unusual step on Air Canada's financial results conference call last month of calling out short-term investors and encouraging them to sell if they disagree with the airline's decision to stop issuing monthly reports on passenger traffic.

"I thought it was time for leading companies in Canada and in the United States to start speaking out about the fact that we need to have a longer-term horizon to run our businesses," he says. "You can't do that if you're only thinking from one month to the next, looking forward one month to the next."

The views of Michael Sabia, chief executive officer of the Caisse de dépôt et placement du Québec, provide some insight into why the financial results are not translating into increased share value – both in the case of Air Canada and the airline industry in general.

"I think Air Canada's done a great job and Calin Rovinescu's done a terrific job at Air Canada," Mr. Sabia said when asked last week why the giant investment fund does not hold shares of Canada's flag carrier.

But as an explanation, Mr. Sabia recounted a comment legendary investor Warren Buffett made about the airline industry when he was asked what he would do if he could change history.

"His answer was: 'Well if I could go back in time, I'd probably get a gun and I'd probably deal with Orville and Wilbur Wright.' That was a reference to the airline industry. [It] has not been a long-term creator of value, shall we say. So you know, we're cautious about the airline sector in general."

That Air Canada and the industry have come back from the dead is not in question. Air Canada emerged from restructuring under the Companies' Creditors Arrangement Act in 2004 and several of the U.S. carriers including American Airlines, Delta Airlines and United Airlines went through protection under Chapter 11 of the U.S. Bankruptcy Code before a round of industry consolidation rationalized the industry and gave the legacy carriers a new lease on life. But billions of dollars worth of shareholder equity were vaporized.

Air Canada was back in dire straits again at the end of the 2008-09 recession, but another CCAA filing would not have solved many of the problems, says Mr. Rovinescu, who was the airline's chief restructuring officer during the CCAA process.

Instead, after stabilizing the company, he raised $260-million with an equity and rights offering.

That's when Letko Brosseau and Associates, a Montreal-based investment management firm that is now the largest single holder of Air Canada shares, sensed an opportunity.

The firm thought the industry was poised to grow coming out of the recession and that Air Canada in particular could generate an extra $330-million profit if it could gain an extra $10 yield on each of the 33 million tickets it was selling annually, recalls Peter Letko, one of the founders of the firm.

Letko Brosseau watched the stock ride up from the $1.56 equity issue price to last year's high and has noted its drop since then.

"We think that the share value today is quite depressed and represents a very attractive opportunity," Mr. Letko says. "I've been a student of finance and stock markets and bond markets for a long time and I think this is as good a value as you see."

Several analysts made similar comments after the year-end financial results were released.

"We believe Air Canada is in a better financial position to weather a downturn than it was in 2008-2009, has a lower cost structure, better pension picture and improved relations with its unions," wrote Hilda Maraachlian, who follows the airline for Cormark Securities Inc. in Toronto.

The industry as a whole has been helped immensely by the drop in fuel prices, but Air Canada and WestJet have taken a hit from the corresponding drop in the value of the Canadian dollar.

There is at least one voice of dissent among the analyst community about how strong the financial recovery at Air Canada has been.

It ranks last among a group of airlines that includes WestJet and legacy U.S. carriers Delta Airlines, United Airlines and American Airlines in profit margin, break-even load factor and net-debt-to-capitalization ratio, Raymond James Ltd. analyst Ben Cherniavsky wrote in a research note last month.

Carriers that boast the highest profit margins, lowest break-even load factors and strongest balance sheets are doing best in the current environment, he wrote.

"Until Air Canada improves its ranking on these fronts, we remain skeptical of its strategy."

Mr. Rovinescu responds that where Air Canada stands on those measures versus WestJet does not interest him.

But he is interested in landing investors who will support and pay attention to a long-term strategy.

To win such investors, it is likely Air Canada will have generate profits through the economic cycle to overcome the stigma that has dogged the industry.

Airlines are a risky long-term investment because revenues are volatile and largely discretionary on the part of travellers, they have high fixed costs and their product is priced like a commodity, notes George Athanassakos, who is the Ben Graham Chair in Value Investing at the Ivey Business School at the University of Western Ontario in London, Ont.

"It cannot get any worse than that," Prof. Athanassakos says.

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THE AIR CANADA FLEET

Air Canada

• 19 Boeing 777-300ER *
• 6 Boeing 777-200LR
• 29 Boeing 787-9 **
• 8 Boeing 787-8 **
• 17 Boeing 767-300ER
• 8 Airbus A330-300
• 13 Airbus A321-200
• 42 Airbus A320-200
• 18 Airbus A319-100
• 45 Embraer E190

Air Canada Express

• 15 Embraer E175
• 16 Bombardier CRJ705
• 25 Bombardier CRJ200
• 5 Bombardier CRJ100
• 26 Bombardier Q400
• 26 Bombardier Dash 8-300
• 34 Bombardier Dash 8-100
• 17 Beechcraft 1900D

Air Canada Rouge

• 14 Boeing 767-300ER
• 5 Airbus A321-200
• 20 Airbus A319-100

* expected as of end 2019

** expected as of June, 2016

Source: Air Canada