WestJet Just Gave Air Canada Investors Another Reason to Smile

Investing

Published: June 20, 2023 6:55 am

Last Updated: June 20, 2023 11:15 am

Air Canada (CA:AC) stock holders have much to be happy about. AC stock is up almost 22% in 2023, keeping pace with the global air carriers share rebound. And last week brought news of a competitor’s exit.

Sunwing Airlines president Len Corrado announced in a June 14 internal memo to company employees that the airline was shutting down with the low-cost carrier’s business integrated into WestJet.

The move is the second such closure. Earlier this month, WestJet announced that it would fold its budget airline Swoop into the Calgary-based airline’s main operations. The decisions are part of WestJet’s move to consolidate operations around one brand, leading to lower operating costs and higher margins.

“WestJet will eventually move to a one jet aircraft operating certificate (AOC) model and Sunwing Airlines will be integrated into WestJet. This is a long-term move that will unlock greater scale and growth opportunities for our people, and specifically for our airline employees within the group,” Corrado said in the memo, The Globe and Mail reported.

The integration is expected to take up to two years to complete. In the meantime, Canadian travelers could face higher airfares due to reduced competition.

In the near term, this is good news for AC stockholders. In the long term, these moves could force the federal government to loosen the rules for foreign-controlled airlines operating in Canada to appease voters.

Money managers remain keen on the shares, which garner a Fintel Fund Sentiment Score of 81.86, ranking AC stock at 2,393 out of 36,054 global stocks being most bought by funds. That compares to the 73.21 score currently evident on Fintel’s quant dashboard for air carrier exchange-traded fund U.S. Global Jets ETF (US:JETS), whose share price is also up almost 22% this year. Air Canada stock represents a 2.99% weight, putting it in the top 10 of the fund’s 52 holdings.

WestJet’s Private Equity Playbook

The moves by WestJet should be familiar to most investors. Acquired for $5 billion by Onex (CA:ONEX), a Toronto-based private equity firm, in 2019, the private equity playbook typically involves buying a struggling business using plenty of leverage, dramatically cutting costs and expanding margins through enhanced productivity, and then exiting the company in 5-7 years through a strategic sale or initial public offering.

More than three years into its acquisition of WestJet, Onex has concluded that it can’t deliver above-average returns on its investment without integrating Swoop and Sunwing into a single operation with one plane across its entire fleet of aircraft, simplifying maintenance and lowering costs to operate its planes.

WestJet created Swoop to compete with low-cost carriers such as Flair. The discount airline’s first flight was on June 20, 2022, from Toronto to Deer Lake, Newfoundland and Labrador.

On May 1, 2023, WestJet completed its acquisition of Sunwing Airlines and Sunwing Vacations. In true private equity fashion, it had a very rosy prediction for Sunwing.

“The transaction, originally announced in March 2022, combines the two Canadian aviation and leisure travel success stories, and will bring greater choice, competitive airfares and increased direct access to sun destinations to Canadian travelers,” WestJet’s May 1 press release stated.

“In addition, it positions Sunwing to continue its growth across Canada and permits the newly merged company to protect jobs.”

In less than two months, both the Sunwing name and possibly hundreds of jobs will disappear due to the integration.

The writing was on the wall when WestJet agreed to a new collective labor agreement with its WestJet and Swoop pilots on May 19, bringing a level pay scale between the two airlines and a 24% pay hike.

The discount airline might not be dead in Canada, but it’s likely on life support. This is not good news for travelers.

Higher Prices Here We Come

The Competition Bureau warned that the sale of Sunwing to WestJet would result in higher prices for travelers, especially those headed to the Caribbean and other sun destinations through vacation packages. The federal government approved the sale in March despite the warning.

Now, Canadian travelers will pay the price for the federal government’s disinterest in keeping Canada’s air travel industry competitive.

McGill University aviation expert John Gradek spoke to CTV about the Sunwing closure.

“Carriers that were operating the same route on the same day in the same city, you know, that’s not going to happen,” Gradek told the network.

“Rather than having two flights going from Toronto to Montego Bay or two flights going from Calgary to Phoenix, operated by two separate carriers, the odds are, those services will be reduced.”

Fewer flights to high-demand locations almost always result in higher prices. Gradek did say that the federal government could step in to reduce the cost to travelers, but given it had a chance to say no to the acquisition in the first place, Canadians shouldn’t hold their breath.

Air Canada is the big winner in the near term due to the reduced competition created by eliminating two airlines serving Canadians.

In the long term, however, the federal government might be forced to revisit foreign ownership rules — it raised the cap on foreign ownership from 25% to 49% in 2018 — to appease Canadian voters should prices rise dramatically through the lack of competition.

WestJet’s latest announcements should act as a headwind for Air Canada stock over the second half of 2023.

This article originally appeared on Fintel