Date: Wednesday, May 3, 2023
Cargojet, which operates an extensive middle-mile air cargo network in Canada for express delivery and e-commerce companies, has increased steps to cut costs and preserve cash amid weak shipping demand that contributed to a 32% reduction in gross profit margins during the first quarter.
The most dramatic step to maintain financial flexibility and match fleet size with demand is the unloading of a third secondhand Boeing 777-300 intended for conversion into a main-deck freighter, according to financial reports released Monday. Cargojet (TSX: CJT) confirmed it plans to finalize the sale of three 777-300s this year for a total of $110 million because of the slowdown in the global economy and air cargo shipping. Two deals have already been signed and a third is being negotiated with undisclosed buyers.
The airline reported revenue of CA$232 million ($171.2 million), nearly flat with results during the March period a year ago and slightly below expectations for low-single-digit growth. Adjusted earnings, excluding nonoperating expenses, declined 9.6% to $55.3 million.
How times have quickly changed.
Last fall, executives assumed high-single-digit revenue growth this year for the domestic overnight business. Six months ago, management was optimistic Cargojet would escape harm from the downturn in general air cargo demand because its business was heavily tied to express parcel carriers that require daily flights to serve customers regardless of load factors. But fourth-quarter adjusted earnings before interest, taxes, depreciation and amortization sagged 8.4% as customers like DHL Express scaled back flight tempo because of lower package volumes. The company said in March it would sell two used Boeing 777-300s designated for freighter reconfiguration and postpone conversion of two more jets. And it tempered its revenue outlook even more.
Now, it is disposing of one more aircraft it had planned to send to Israel Aerospace Industries (IAI) for conversion to a heavy-duty freighter. Cargojet purchased the 777-300s a year ago from Etihad Airways. It never bought a fourth plane as originally intended.
The company is sticking to its order with U.S. startup Mammoth Freighters for four Boeing 777-200 passenger-to-freighter conversions but said it expects delivery of the first unit to be delayed by supply chain challenges facing aerospace companies and a lengthier process for Federal Aviation Administration approval. Cargojet previously said it expects deliveries to begin in the first quarter of 2024 but indicated the timetable could be pushed out to next summer, or longer.
Executives say their strategy is to better time feedstock acquisitions closer to actual conversion dates and a rebound in global economic activity so they can focus on reducing debt and meeting investment returns. The company, in fact, is holding on to reservations for IAI production slots for potential future expansion.
“We’ll continue to strike the right balance between cost management and staying prepared for opportunities when the tide turns. It is a delicate balancing act. Training pilots and maintenance personnel takes time. Likewise, securing aircraft and bringing them on our certificate and making them operational takes time,” President and CEO Ajay Virmani said during a briefing with analysts.
The 777 sales will lower Cargojet’s capital expenditures for 2023 to about $200 million.
The airline operates 36 Boeing 757 and 767 converted all-cargo aircraft, six more than last year. It has signed agreements for the purchase and conversion of two 767-300s, which are expected to be delivered during the second quarter.
“Indications are that demand is softer than we would have anticipated even back in March when we were reviewing our Q4 results. The domestic network really fell off” in December, said Chief Strategy Officer Jamie Porteous. He predicted a slight decrease in demand could extend into the start of the third quarter before improving.
Comprehensive cost management
Management is combing through the entire enterprise for efficiencies to minimize the impact of fewer express air shipments as consumers shifting spending from online storefronts to physical stores and services.
BMO Capital Markets estimated that Cargojet’s flight hours declined about 5% in the first quarter. Comparisons look worse than normal because all-cargo airlines enjoyed unprecedented revenue and profits during the previous two years when the pandemic threw ocean supply chains into chaos and companies needed fast transport alternatives.
The airline streamlined its domestic network by recently substituting one 767 medium widebody aircraft for two smaller 757s on a direct route between Edmonton, Alberta, and Hamilton, Ontario.
“We are focusing hard on our cost management across the entire business, and more specifically, working closely with our largest customers to rightsize our network to reduce block hours while maintaining delivery standards. Block hours is a key driver of our direct costs, and if we can find opportunities without sacrificing services, we can drive efficiencies,” said Virmani.
DHL continues to treat Cargojet as a preferred carrier, he said. The parcel giant, which owns warrants that could allow it to eventually acquire a 9.5% stake in Cargojet, has not reduced the number of planes it leases even if some flight activity has been trimmed. Cargojet will start flying two additional routes this summer for DHL to the Caribbean and Central America, temporarily filling in for other DHL contract carriers that are sending planes in for service.
Cargojet is also reducing costs related to training, overtime, temporary labor and supplies. Further, it is targeting improved savings from a greater ability to plan maintenance after two years of pell-mell flying during the red-hot pandemic market. Virmani said the installation of a second 767 flight simulator in November will allow the airline to train all pilots at its Hamilton hub, which will provide significant cost savings in travel, hotel and other expenses incurred using a facility in the U.S.
And the all-cargo operator is identifying opportunities to shift excess domestic capacity to charter flying or dry leasing to another airline. The reallocation of the four to five surplus Boeing 757s would significantly offset aircraft costs and depreciation expense.
“Cargojet is not immune to the softening industry trends as well as the macro factors of slower economic growth, higher interest rates and persistent inflation. Therefore, our team is focused on realigning every aspect of our cost structure with the current demand levels, including realigning our network, significantly improving productivity in our maintenance and operational areas and cutting all discretionary expenditures while maintaining industry best on-time-performance,” Virmani said in the earnings report.
He assured investors that the downcycle would be short because of the permanent rise in e-commerce and the company’s long-term strategic contracts that mitigate volume and pricing risks.
“Despite the current softer economic conditions, the long term macro trends that drive our business remain firmly intact. E-commerce, continued demise of shopping malls, further pressure on business district shopping stores driven by remote work and passenger airlines shifting to narrow body aircraft will continue to lead to increased air-cargo volumes. Cargojet is well positioned with a strong balance sheet and a solid liquidity position to ride this volatile economic environment. With some of the world’s biggest package delivery companies as our customers, we expect to resume growth as the economic cycle turns the corner,” he said.
Cargojet’s domestic overnight revenue of $62 million was nearly flat year over year, a 27% increase from before the COVID crisis. The aircraft rental-as-a-service business is up 300% since 2019 to $48.5 million.
More than three-quarters of Cargojet’s capacity on the domestic network is devoted to contract customers with minimum volume guarantees, and none are expected to go below their commitments, according to management.
Ad hoc charter business fell more than half as few cargo owners required emergency airlift as they did the previous three years when industrywide capacity was extremely constrained because shippers sought alternatives to ocean shipping delays.