Until now, Canada's recovery from the recession has provided remarkably smooth flying for the country's airlines. But with the skies for 2014 already severely clouded by the Canadian dollar, this year could test the resiliency of demand for air travel – and finally show the limits of how much the airlines can get away with before they feel a backlash from customers.
The post-recession era for WestJet Airlines Ltd. and Air Canada has been a period of unprecedented success: Booming passenger numbers; planes filled to near-capacity, even with expansion; record revenues, surging profits and soaring stock prices. WestJet's 2013 profit, reported Tuesday, was the highest in the carrier's 18-year history. (Air Canada reports its year-end numbers next week.)
In a conference call with analysts and reporters following the earnings release, WestJet's executives expressed confidence that the Canadian air-travel market still has plenty of strength. But there was an unspoken message: It's going to need it. The plunge of the Canadian currency – down nearly 8 cents against its U.S. counterpart since last fall, including 4 cents since the start of 2014 alone – has changed the cost proposition for Canadian carriers almost overnight, and poses a major obstacle in their financial course over the next 12 months.
For airlines, the vast majority of currency risk lies in fuel costs, as both jet fuel and its underlying raw commodity, crude oil, are priced globally in U.S. dollars. WestJet said that each penny the Canadian dollar drops costs the company $13.3-million on an annualized basis, 80 per cent of which is fuel costs, all other things being equal.
Of course, all other things are rarely equal. Jet fuel, and the crude oil from which it comes, often respond to U.S.-dollar appreciation by declining in price, to essentially take currency gyrations out of the equation and reflect the underlying value of the commodity rather then the value of the currency. In 2013, when buyers flocked to the U.S. dollar in anticipation of the unwinding of the U.S. Federal Reserve's monetary stimulus, WestJet noted that lower jet fuel prices essentially cancelled out the decline of the Canadian dollar against its U.S. counterpart.
But now that the Bank of Canada's inflation concerns and increasingly dovish stance on interest rates has turned the Canadian dollar's decline into a made-in-Canada phenomenon, the loonie's fall is outpacing the adjustment in the fuel market; the airlines can't expect the same offset in 2014. And already, the airlines are leaning on what has proven a reliable source of strength to help them overcome the currency hit: Their customers.
WestJet revealed that it raised airfares 2 per cent across the board last week – and said all of its competitors operating in Canada matched the increase. As a nominally "discount" airline, WestJet isn't eager to be taking the lead on fare hikes, but its executives indicated in the conference call that if their competitors raise fares further this year, they may well join them.
Meanwhile, WestJet revealed in its conference call that it is considering introducing fees for all checked baggage. While the idea is still in its infancy, company executives clearly see it as a viable possibility to capture new revenues.
The caveat – and it's a big one – is whether customers will have the appetite. The Canadian dollar's fall is not entirely a function of divergent monetary policy triggering a re-pricing of currency markets; it also reflects Canada's tepid economic outlook, not to mention Canada's over-extended household debt levels. WestJet and its domestic competitors may be looking at a 2014 double-whammy of both a weaker dollar and weaker demand.
In this climate, fare increases and revenue grabs may be easier said than done. The airlines will want to gauge customer response very carefully if they want to avoid killing their golden goose.