The shares of Canada's two largest airlines have been downgraded and their price targets and profit estimates cut by Bank of America Merrill Lynch analyst Glenn Engel.
Air Canada and WestJet Airlines Ltd. will face significant headwinds this year from the drop in the value of the Canadian dollar, Mr. Engel wrote in a research note Tuesday.
The Canadian currency has depreciated 6 per cent against the U.S. dollar and euro since Jan. 1 and the two airlines have more expenses in U.S. dollars than revenue, he said.
The key costs include fuel and price of new airplanes, although some of the airplane deliveries are far enough out that the currency could recover or the airlines could increase their hedging to offset future declines in the dollar.
In Air Canada's case, "since two times as many Canadians travel abroad than foreigners fly to Canada, [the] weak Canadian dollar could also have traffic impact," he said.
Mr. Engel cut his price target for Air Canada shares to $8 from $9.75 and downgraded them to underperform. He trimmed WestJet shares to neutral and the price target to $28 from $32.
Every 1-cent drop in the Canadian dollar knocks $33-million and $14-million from operating income for Air Canada and WestJet respectively.
"We have a massive exposure to the U.S. dollar," Calin Rovinescu, Air Canada's chief executive officer said in Montreal Monday.
Air Canada Vacations has slapped a $35 surcharge on travellers, but WestJet Vacations has so far refrained from doing so.
The dollar has a big impact on fuel purchases, which represent about one-third of the airlines' costs.
AltaCorp Capital analyst Chris Murray said fuel prices in U.S. dollar terms rose 9 per cent in the last three months, but more than 13 per cent as measured in Canadian dollars.
"We expect currency may remain a headwind for 2014, which will require some adjustment, mainly in fares to relieve some of the cost pressure," Mr. Murray wrote.
Air Canada shares fell about 11 per cent by mid-afternoon. WestJet shares slid 5 per cent.