Is This a Game-Changer for Canada’s Airlines?

In Canada, much to the chagrin of many foreign companies, there are all sorts of government controls that protect domestic business.

Agriculture is one of the big culprits. All sorts of commodities are at least indirectly subsidized by the government, including sugar, milk, and pork. Telecoms are also protected, since an operator needs to be majority-owned by Canadians in order to operate, with the notable exception of a wireless carrier that has less than 10% market share. The Canadian government has even gone as far as blocking foreign takeovers of companies whose assets are considered too important to fall into foreign hands.

Another industry that is heavily protected from foreign competition is Canada’s airlines. Due in part to a 1944 conference on civil aviation, the most recent changes to Canada’s aviation ownership rules came into effect in 1996, when the feds declared that no foreigner could own more than 25% of an airline. This restriction, combined with the merger of Air Canada (TSX: AC.B) and Canadian Airlines back in 2001, makes Canada’s domestic skies a duopoly, as Air Canada shares the skies only with Westjet (TSX: WJA).

For consumers, this has led to Canadian domestic flights being some of the most expensive in the world. Both Westjet and Air Canada are well aware of the lack of competition, and price tickets accordingly. As demand has recently spiked — both companies have recently recorded record load factors — so have prices. This bad news for customers is great news for airline bottom lines. Both Air Canada and Westjet have been delivering good results, and Air Canada in particular has seen its share price go up accordingly.

But is it all about to come to an end?

It’s only a matter of time before another operator comes to Canada. Demand is high, and so are prices. It’s the perfect environment for another player to enter the arena.

A new company called Jet Naked plans to do just that.

The company, which is headed by some impressive talent, including Westjet’s co-founder Tim Morgan, plans to offer flights at up to 40% off the current prices charged by incumbents. The new airline will cut costs at every opportunity, much like Europe’s Ryanair or Spirit Airlines in the U.S. Passengers will choose from a low base fare, and then add amenities like checking luggage or beverage service, each at an extra charge.

Jet Naked isn’t so far away. The company has already secured three Boeing-737 jets, and is looking to acquire $30-$50 million in start-up financing. Revenue is expected to be $120 million in its first year of operation, rising to $750 million by the end of the third year.

Jet Naked isn’t the only new player to be entering the market either. Several regional players are currently attracting start-up capital. The regional market is obviously underserved, since even the incumbents are expanding their regional exposure.

What to expect?

At this point, not much is going to change. A new player is years away from making any significant dent in the domestic market. Five years from now, however, things could be considerably different.

If there’s another significant economic slowdown and demand for air travel starts to wane, that’s when things will start to get dicey for Westjet and Air Canada. Things are looking good for the airlines at this point, but previous experience tells us that they can go south in a hurry when economic conditions change.

New competitors combined with a poor economy could be terrible news for Air Canada in particular. The company has a strong union and a high cost base, and it runs many routes that just aren’t profitable. The last thing either company needs is an upstart competitor messing things up.

If serious competition shows up on the scene, it’s time to sell the airlines. It’s that simple.

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Fool contributor Nelson Smith has no position in any stock mentioned in this article.

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