Editor's Note: The annual return of WestJet has been corrected from an earlier version.
Do you want to be a millionaire? It's easy: Start with a billion and launch a new airline, as Sir Richard Branson once said.
But it's not true that you can't make money in the airline business. WestJet has given investors a 15-per-cent annual total return since it went public 11 years ago. And I think investors in Porter Airlines' initial offering will also fare well.
The airline likes to wax about its service. And it's fine, in my limited experience. But Porter's real advantage, apart from not being bound by ruinous union contracts, is those Toronto island airport slots, which it appears to have sewn up for a long time. It's easy to see why the airline doesn't stress that benefit too loudly but it's a great - indispensable even - advantage for shareholders.
Porter competes primarily with Air Canada and Jazz. (Jazz is a separate, publicly traded company, but it's still joined at the hip with Air Canada.)
Air Canada, according to Porter's prospectus, breaks even at a load factor of 83 per cent. Porter, by contrast, gets to the tipping point at 49 per cent. The load factor is a measure of capacity use, so that means, more or less, that Porter can fly a plane half empty and not lose money, whereas Air Canada/Jazz needs to sell four out of five seats.
So you might not exactly cower at the thought of competing with Air Canada. But that's a mistake: The airline competes as ferociously as a wounded animal, and since it has an arguable monopoly on certain highly profitable routes, it can easily subsidize a price war with Porter. In fact, it does so as a matter of routine. So does WestJet.
And I would guess that the battle will only get more heated. In 2006, Air Canada had 76 per cent of the Toronto-Ottawa market (measured by available seats); Porter had 3 per cent. Last year, Porter's share of that market had grown to almost 25 per cent and Air Canada had 58 per cent.
The numbers for the Toronto-Montreal route are similar: Porter went from zero to 17 per cent, almost all of it won from Air Canada. WestJet has also lost market share to Porter.
Of course, since the duopoly that is Air Canada and WestJet has a common enemy in Porter, they'll price their fares accordingly. As the Porter prospectus puts it: "Other airlines regularly price their fares equal to or below our fares."
So what does Porter have? A niche regional market to be sure. And there's lots of room for growth in that market too, from both existing routes (see the market share numbers above) and new ones (there are many other destinations Porter can reach from its hubs, especially if and, likely, when it gets U.S. Customs preclearance.)
It also has no union, which is a big advantage too.
But ultimately, Porter's greatest edge comes from that Toronto Island airport. It's three kilometres from the downtown core. Pearson International, where Air Canada and Jazz and WestJet fly out of, is 10 times farther away. It's also faster to get on board at Porter. Time is money to the coveted business and high-end traveller. So, that island airport is crucial.
The Billy Bishop Toronto City Airport, as it's officially called, is a slot-constrained airport. (A slot is a takeoff or a landing. If you have two daily slots, you can take off and land every day.)
At BBTCA, demand for slots exceeds the supply. By the end of this year, when the terminal at the airport is completed, there will be 202 slots available. Porter will likely have access to 157 of them. The rest will go to new entrants, including Jazz.
Under the rules, any new slots are split 50-50 between incumbents and new entrants. If there's more than one incumbent, the half that goes to them is allocated pro-rata.
So while Porter faces intense fare competition from flights leaving Pearson today, it will soon face intense competition in its own backyard. But, and this is the rub, it will have a dominant position because of its share of slots.
And furthermore, as the owner of the terminal and the fuel company on the island, it will earn revenues from its competitors.
Air Canada is already litigating to wrest slots from Porter. However, the airline walked away from the airport a few years ago voluntarily. I'm no lawyer, but I have to think a court would take that into consideration.
There are many moving parts to watch when you invest in an airline. I submit that Porter has a huge advantage because of its control of Toronto's island airport. Investors should pay special attention to how tight a grip Porter can keep on that asset.