30-Apr-2010 8:00 PM

Porter Airlines' IPO document reveals red ink, but management sees lots of blue sky

Analysis

Hoping to capitalise on the recent upswing in airline stocks, Porter Aviation Holdings on 16-Apr-2010 filed its preliminary prospectus for an initial public offering. Porter did not specify the number of shares that will ultimately be made available, nor the price it expects to achieve. However, it is targeting CAD120 million as proceeds from the IPO. Current stockholders would not be selling any shares.

Summary

Porter Aviation Holdings files preliminary prospectus for an initial public offering, targeting CAD120 million in proceeds.
Porter Airlines has yet to make an annual net profit despite its near-monopoly market position.
The airline reported a net profit of CAD455,000 in the fourth quarter of 2009.
Porter Airlines experienced a decline in revenue per available seat mile (RASM) in 2009 due to the economic downturn and rapid expansion.
The airline plans to expand its network and increase load factors to achieve profitability.
Porter Airlines has a dominant position at Toronto's downtown airport, which provides high-yielding routes and potential for growth.

Along with the overall market, airline stock prices have recovered solidly over the past 12 months, back to almost the levels of a year earlier, albeit well below 2007's pre-oil crisis levels.

AMEX Airline Index: Jan-2005 to Apr-2010

IPO a bold move - but promise of upside after 4Q 2009 profit

Even so, conditions will offer a challenge for a Porter IPO, since the nearly five-year-old airline has yet to make an annual net profit, despite having carved out a near-monopoly market. It is, after all the only carrier serving Toronto's lake front (Billy Bishop) city airport. To date the carrier has focused on its expansion rather than profitability, preferring to maximise its size while its perhaps threatened monopoly at the downtown airport remains intact.

Porter Aviation Holdings, parent company to Porter Airlines, is privately held jointly by EdgeStone Capital Partners, Borealis Infrastructure, GE Asset Management Inc and Dancap Private Equity Inc and began with a reported CAD120 million investment.

The carrier posted a loss of CAD4.69 million, or CAD0.57 per share, on revenues of CAD151.2 million and expenses of CAD155.6 million for fiscal 2009 ended 31-Dec-2009, according to the prospectus, which paints a picture of an airline, as with other airlines, that is struggling to reduce costs. To be fair, few carriers were profitable last year - a year when Canada's flag carrier required a government bailout, just short of a repeat bankruptcy.

While it is Porter Aviation Holdings that is promoting the IPO, almost all the information in the prospectus relates to Porter Airlines which posted EBITDA profitability in every year but its first fiscal year ended 31-Aug-2007, when EBITDA losses were CAD10 million, while net losses were CAD11.4 million. But since then it has posted a net loss in the fiscal year ended 31-Aug-2008 of CAD3.3 million. Last year it changed its fiscal year to 31-Dec-2009, posting a CAD4 million loss.

More positively though, in its fourth quarter Porter reported a net profit of CAD455,000, a significant achievement compared with the 31-Dec-2008 period's losses of CAD11.2 million.

RASM declined substantially in 2009

Canada's third largest carrier posted a fiscal 2009 Revenue per Available Seat Mile (RASM) of CAD0.231, a decline from CAD0.317 in Fiscal 2008 and CAD0.241 in fiscal 2007. The airline cited the decline in the economy and its rapid expansion from eight to 18 Bombardier Q400s, which nearly doubled the ASMs flown during last year.

...but so did CASM

Cost per available seat mile (ex depreciation) in fiscal 2009 fell to CAD0.219, compared to CAD0.290 in Fiscal 2008 and CAD307 in fiscal 2007, as the airline expanded. During 4Q2009, Porter's CASM (ex depreciation) was CAD0.200. The airline noted that CASM has declined significantly on the fleet growth decreasing by about 35% from CAD0.334 in fiscal 2007 to CAD0.217 in the fourth quarter of 2009.

Porter Airlines cost per available seat mile*

Porter Airlines Fiscal 2009 Operating Costs

Porter Airlines contribution to CASM (trailing 3-months)

First quarter 2010 operating metrics improved significantly; downtown airport monopoly supports high yields

Porter posted significant improvements in the latest quarter. Load factor was 47.0% in 1Q2010, a 5.7 point increase over the same period in 2009. Revenue passenger miles (RPMs) for the first quarter of 2010 increased 148% year-on-year, and capacity grew 118% over the same quarter in 2009. Porter also flew an additional 148,077 passengers in the first quarter of 2010 compared to the same period in 2009. It flew 912,613 passengers in the fuil year 2009.

Porter Airlines operational metrics: 1Q2010

	1Q2009	1Q2010	Change
RPMs (mill)	41.9	103.8	148%
ASMs (mill)	101.3	220.8	118%
Load factor	41.3%	47.0%	5.7 ppts

Porter Airlines operational information: 2007 to 2009

	Three months to 31-Dec-2009	Fiscal year ended 31-Dec-2009	Four-month period ended 31-Dec-2008*	Fiscal year ended 31-Aug-2008	Fiscal year ended 31-Aug-2007
RPMs	118,277,892	314,058,593	66,129,324	133,877,037	61,456,419
ASMs	235,421,620	655,060,700	116,009,460	257,502,840	151,954,040
Load factor	50.20%	47.90%	57.00%	52.00%	40.40%
Yield	$0.45	$0.48	$0.58	$0.61	$0.60
RASM	$0.23	$0.23	$0.33	$0.32	$0.24
CASM	$0.22	$0.24	$0.33	$0.31	$0.33
CASM (excluding fuel)	$0.17	$0.19	$0.26	$0.24	$0.28
CASM (excluding depreciation)	$0.20	$0.22	$0.31	$0.29	$0.31
Passengers	315,781	912,613	215,115	448,783	208,735
Flights	9,000	26,895	5,388	12,692	7,892
Average flight length (miles)	374	348	308	290	275
Average daily aircraft utilisation (hrs)	8.8	8.7	8.5	8.5	7.8
Number of operating aircraft	18	18	8	6	4
Full-time equivalent employees	847	847	465	388	252

As a point of reference, the power of the downtown Toronto airport operation is reflected in an average revenue of CAD166 per passenger on a 348-mile average stage length - compared to WestJet's CAD168 on a 923-mile average stage length.

Revenue per Passenger and Flight Length Comparison

A picture of very rapid expansion

Porter's fleet expansion last year increased the number of flights by a remarkable 84% from the calendar year 2008 by launching new routes and increasing capacity on its current 12-point route network in Canada and the United States. It expects to add two more aircraft this month and could add up to nine addition Q400s this year if the market supports it. Current US markets include New York, Chicago, Boston and Myrtle Beach, SC. Currently each aircraft contributes approximately CAD13.2 million of total revenue per aircraft in Fiscal 2009.

Porter's ASMs have expanded rapidly since the airline's inception in Oct-2006, more than doubling between the fiscal year ended 31-Aug-2008 and the fiscal year ended 31-Dec-2009. Based on the current schedule of flights and expected completion rate for the fiscal year ending 31-Dec-2010, Porter's ASMs are expected to reach approximately 1.1 billion.

Porter Airlines available seat miles: FY2007 to FY2010

Porter Airlines overall ASM, RASM and CASM (excluding depreciation)

During the fourth quarter, Porter's aircraft operated an average of 8.8 hours per day. It operates a single-class configuration at a time when many airlines are putting two classes in their 70-seat regional aircraft fleets, the same number of seats on the Porter Q400. However, Porter says the single-class configuration simplifies operations, enhances productivity and has an operating cost advantage.

Accumulated deficit of CAD38.5 million

According to the prospectus, Porter has an accumulated deficit of CAD38.5 million and a working capital deficiency of CAD11.8 million at 31-Dec-2009 when it reported CAD20.1 million of debt that requires, beginning in Dec-2010, the maintenance of a minimum working capital ratio of 1:1 and a long-term debt/tangible equity ratio not exceeding 3.2:1.

As of 31-Dec-2009, Porter has committed financing of CAD9.9 million related to additional airport terminal construction in 2010 and of approximately CAD35.8 million (85% of the purchase price) related to aircraft deliveries in 2010. The corporation also has a credit facility with undrawn availability of CAD6.7 million. Long-term debt was CAD322.7 million, compared with long-term debt of CAD131.8 million at the year-ago period. Debt maturity ranges from 2011 to 2025. The corporation has secured low-interest-rate fixed debt commitments on many of its aircraft acquisitions, representing approximately 78% of total long-term debt.

Growth in domestic and trans-border markets

The airline is banking on significant growth, especially in the trans-border markets and is hoping to codeshare with a US carrier given its strategic position only three kilometres from Toronto's financial district.

However, Porter shares a common problem with many other recent startups if it wants to make that transition. It must upgrade its existing Navitaire platform and wants a new platform in place by 2011 in order to accommodate any codesharing opportunities. It will need the power of both a major code since it is facing stiff competition should Air Canada and Jazz win the suit they filed to gain access to island airport (see below).

The technology upgrades are also designed to increase direct sales via its website, www.flyPorter.com, telephone reservations through its call centre, travel agencies, corporate accounts. Direct bookings via the website and its call centre account for more than 70% of Porter's bookings. Approximately 30% of total passenger revenue comes from Porter's travel partners, which now include over 2000 individual agencies and the management of over 300 corporate and government accounts.

Porter identified significant incremental market potential still available, noting its flights represent only 9.4% of total ASMs within 800 miles of Toronto and only 7% of the total within 800 miles of Toronto, Ottawa, Montreal and Halifax, combined.

Q400 range chart

Porter's market share has grown steadily, especially in its longest serving routes, to 23% in the lucrative short haul Toronto-Ottawa market and 17% in Toronto-Montreal in 2009, its first two routes.

Capacity shares (%) of Toronto-Ottawa and Toronto-Montreal city pairs

Low break-even load factor offers opportunities

Porter plans to grow its existing network with higher load factors. Currently, it has industry leading break-even load factors at about 49%, compared to 71% at WestJet and 83% for Air Canada. Its break-even load factor is well below the 74% for Southwest and 73% for JetBlue. Its non-unionised work force is about 47 FTEs per aircraft compared to 73 at LCC, WestJet.

The company is well positioned, it says, to grow passengers and revenue on its existing network, pointing out that, last year, it expanded its seat capacity in its core markets of Toronto-Ottawa, Toronto-Montreal, Toronto-New York, Toronto-Chicago and Ottawa-Halifax. Its new markets, Toronto-Thunder Bay, Toronto-Boston, Halifax-St John's and Toronto-Quebec, were launched in 2009 and deliver a 113% increase in ASMs over calendar year 2008.

In addition, it expects to expand its short-haul network including new destinations and additional point-to-point service in Eastern Canada and US markets from its main hub at Toronto. "Significant incremental market potential exists within the range of the Q400 (800 miles) from Porter's focus cities of Toronto, Ottawa, Montreal and Halifax," it said, "In 2009, Porter's flights represented only 9.4% of total Available Seat Miles within 800 miles of Toronto and only 7.0% of total Available Seat Miles within 800 miles of Toronto, Ottawa, Montreal and Halifax, combined."

Given the small number of carriers in Canada - Air Canada, Jazz, WestJet - Porter sees plenty of room for growth. Transport Canada is forecasting more robust domestic passenger growth of 4.9% and 4.8% in 2011 and 2012, respectively. An annual average growth rate of 2.3% is expected in the domestic market between 2008 and 2022.

Top 20 domestic Canadian routes (800 Miles or Less) by capacity share: 2009

More growth seen in US markets

And for the trans-border market, it expects more growth opportunities. In 2009, there were approximately 445,000 scheduled trans-border flights between Canada and the US, or an average of 1,219 per day. Air Canada and Air Canada Jazz has the largest market share of 17 trans-border flights at 33% with the remainder of the market primarily served by WestJet and US-based airlines and their regional affiliates. The chart below illustrates capacity market share (by number of seats) in 2009 of the 20 highest capacity trans-border routes that are 800 miles or less.

Last September, Transport Canada projected a trans-border traffic decline of -7.9% in 2010, resulting from the recession and slower recovery. The trans-border market is not expected to resume positive growth until 2011 and 2012 at 6.5% and 5.6%, respectively, although that is less of a hindrance to a carrier which is seeking to capture market share.

Top 20 Transborder routes (800 Miles or Less) by capacity share: 2009

Pre-clearance would be a boost

The Toronto Port Authority, which oversees BBTCA, is working on gaining US customer pre-clearance at BBTCA which promises to boost competitiveness there dramatically. "In addition to opening up routes to destinations in the U.S. that do not have inbound customs facilities, US customs preclearance will allow for more convenient travel and easier connections for Porter's passengers," said the company. "Space required for US customs preclearance at BBTCA has already been built within the new terminal facilities and will be available if customs preclearance is approved by the U.S. government."

Slot restrictions a key to Porter's success in future

In addition to its airline operations, Porter owns the terminal facility at which it is currently the only commercial airline. Additional airlines - and competition - are expected, but this would be a double-edged sword. It would increase the company's ancillary revenues through terminal and gate space leases but it would also dilute the monopoly position the airline now enjoys.

Porter subsidiary CCTC just opened its new CAD49 million terminal at BBTCA, the first phase (75% of the total project) opened in March 2010. The terminal has been built to accommodate Porter's long-term growth plans and is part of a vertically integrated infrastructure that, in addition to the terminal, includes operation of four hangers, a corporate flight centre, office space, ramp handling and fuel facilities. The new, approximately-150,000-square-foot-terminal, has been designed to accommodate more than two million passengers annually. The remainder of the facility is scheduled to be completed by the end of 2010.

Air Canada sues to open Toronto City to other airlines

This is significant because access to BBTCA is currently the subject of a law suit by Air Canada and Jazz, both now seeking access to the airport, in order to try to head off the growing threat to their Toronto operations. However, the prospectus gave an interesting history of the service there clearly showing Air Canada's declining interest in the airport before Porter launched operations and built the market to unprecedented levels after Air Canada left. Porter has had a monopoly market for nearly four years and expects to keep it that way despite the availability of 90 new slots at the airport.

Air Canada/Air Ontario (Jazz predecessor) launched operations in 1990 when City Express ceased operations, which, at one time, served as many as 400,000 passengers annually through the airport. By 2005, in the midst of substantial growth in nearly all airline markets, service at the BBTCA had fallen to approximately 27,000 passengers, with Jazz operating as the only commercial air service.

The Toronto Port Authority (TPA) wanted Air Canada/Jazz to stay, approaching them to expand operations, but the two declined. Porter opportunistically entered into a sweet commercial carrier operating agreement with the TPA, giving it virtual control of the airport. Despite that, after Porter launched service in 2006, TPA offered 10 daily slots to Air Canada/Jazz, more than the average six it had used in the previous two years. Slots were also offered to a US carrier, but (fortunately for Porter) both declined.

Porter now serves the island airport using up to 120 daily slots, but expects to have 157 slots of a total of 202 slots available once a new slot allocation process is complete (slot restrictions were previously imposed as part of an agreement to limit noise). Since Porter launched service in October 2006, passenger traffic at BBTCA has rapidly increased and was approximately 800,000 passengers in 2009, with over 315,000 passengers in the fourth quarter alone.

Amid growing controversy about keeping Air Canada out, the TPA last year called for airlines to show interest in serving the airport, with Air Canada and Jazz responding. In Dec-2009, the Authority said it would institute a slot-allocation process.

Under Porter's agreement with the TPA, the carrier was initially entitled to not less than 95 of the then available 120 slots at BBTCA. Porter was subsequently granted the remaining 25 available slots when they were not used by any other carrier. It also recently gained an additional 20 slots until at least the opening of the second phase of the terminal later this year.

Under international slot standards for slot-constrained airports, enshrined in Porter's agreement with the TPA, new entrants are typically allocated up to 50% of new slots, with the balance to incumbents. An independent study showed slot capacity to be 202, once the new terminal is completed. Porter's agreement with TPA calls for it, as the sole incumbent carrier at the airport coupled with its historical use of slots, to operate 112 of the 202 slots. Under the TPA agreement, Porter is also entitled to be allocated at least 50% of the 90 unallocated slots for a total of 157 with the remaining 45 slots allocated to new entrants.

The likelihood that Air Canada will end its suit and settle for only 45 additional slots is small, in light of Porter's dominance at the airport. And, it may not be the only one interested in serving the airport. Given the fact hat Porter serves New York via Newark, a carrier such as Continental could assign one of Colgan Airways' Q400s to the route.

To add insult to injury for the new entrants - they will have to lease terminal space and gates from Porter's wholly-owned subsidiary, City Centre Terminal Corp (CCTC), thus at least providing some incremental revenue to their competitor.

Other revenue from its terminal operations includes selling advertising space and rental income from concessions, retail shopping and other services. In addition, revenue could come from leasing hangar and administrative space and selling fuel to other air carriers, since Porter has its own fixed base operation. It will also be pursuing retail and entertainment opportunities such as packaging flights with non-air travel products or services including hotels, rental cars and insurance.

The Bishop is Porter's ace

In a complex and troubled airline industry, Porter so far appears to have swum against the tide of recent opinion, rapidly expanding and being prepared to lose money in the process of stamping its identity on the market. This may well have been a sound strategic approach, capitalising on its monopoly operation at the major financial city's downtown airport, after the Air Canada team was shortsighted enough to leave the fledgling carrier a free rein.

The value of Porter's judgment may be tested in the near future - as its owners probably expected from the outset. The carrier is arguably however now well entrenched in its niche, with only limited opportunity for competitors to expand. Here there are overtones of JetBlue's strategy in adopting New York JFK as its starting hub at a time when the airport was out of favour with others. And, for the high yielding market, Porter places itself in a useful position for investors, whether they be other airlines or regular shareholders.

That said, airline managements are today typically seeking to build a strong balance sheet and gain sustainable profitability. Managers have decided that any growth, especially in this economic climate, will have to earn its way on the network.

Investors and analysts take an even harder line. They now see airlines as a short-term, opportunistic investment. It is mainly for that reason that airline stocks have risen so strongly over the past year - that is, the broad gains are not based on the "fundamentals" of the airline industry, whatever they may be. They have followed in the wake of economic recovery and analysts have talked up merger activity since the fourth quarter of 2009, stoking gains.

So, while the rise in stocks may present an immediate opportunity for an IPO for Porter, the airline will have to start delivering profits if it is to meet the new standards of good fiscal management. It will have to slow growth dramatically and will likely have to cut costs further to demonstrate that it can make a profit. Following on its recent performance, this looks to be entirely possible, but one swallow does not make a spring.

But Porter's ace card is its dominance at Billy Bishop Airport and will fight hard to retain its advantage. Although it has had to compete with flights out of Pearson, it has not had to compete head to head. A change in that equation will drive strategic changes, notably, for investors, in the shape of realising profits.

As for codesharing opportunities south of the border, its reliance on the small airport limits it to a small, unique service carrying 800,000 passengers annually in a premium market. Its value, regardless of the premium it might have in being three kilometres from Toronto's business district certainly does not have the breadth that WestJet offers Delta and KLM. But it does offer a sweet taste to the right operator. With the recent rush in the US to rationalise and merge, the number of potential legacy partners is drying up, but as LCCs blend in more with the legacy scenery and seek yields, there are undoubtedly still suitable suitors to be haad.

Porter's catchment area includes all East Coast hubs down to Atlanta and as far west as Milwaukee (the territory of Frontier, AirTran and Southwest) and Minneapolis. That makes for some interesting scenarios. There could also be opportunity for a link with JetBlue, everyone's favourite partner, at Boston. It could even, in fact, link to WestJet.

But that again leads into expansion territory at a time when caution is high on investors' agendas. So, it is unclear how successful Porter's IPO will be. It is still a very tough financial market out there. Regardless, the future for this plucky little airline with the raccoon mascot, is going to be interesting.

The fact that all of its current investors are staying in suggests that they are keen to back their Bishop some more, which could be a good sign.