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Cargojet to sell 777 aircraft, defer cargo conversions as demand slips

Canadian airline Cargojet said Monday it plans to sell two Boeing 777-300 aircraft it had planned to convert into freighters and is postponing orders for other large-aircraft modifications to preserve cash as the weak global economy lowers demand for shipping goods.

The all-cargo carrier, which reported a CA$16.3 million ($12 million) decline in gross margin for the fourth quarter because the normal year-end bump in shipping volumes didn’t materialize, said it expects to finalize the 777-300 sale early this quarter for $53.5 million and defer the delivery of two more 777-300s to help weather the current economic downturn. It didn’t disclose who will buy the aircraft.

Cargojet (TSX: CJT), expected to be one of the first carriers to deploy the passenger-to-freighter version of the 777, reiterated that DHL will be the launch customer for four remaining 777 aircraft being added to increase international, long-haul capability and revenue.

Cargojet operates 34 freighter aircraft, including 21 medium-size Boeing 767s and 13 Boeing 757s for regional routes. Its core business is operating a domestic overnight network between 16 major Canadian cities for integrated express carriers and international airlines, such as Amazon (NASDAQ: AMZN), DHL Express, Purolator and UPS (NYSE: UPS).

Cargojet’s four 777-200 planes will be retrofitted by startup Mammoth Freighters with a wide cargo door, reinforced flooring to support heavy containers and a cargo loading system. Cargojet said it expects deliveries to begin in the first quarter of 2024 and run through the first quarter of 2025. 

The pullback on fleet expansion negatively impacts Israel Aerospace Industries, which was slated to produce four 777-300s. The purchase of one -300 has been postponed indefinitely, and the second remaining plane was pushed back to the second quarter of 2025.

The two airframe engineering firms are vying to manufacture the first 777s converted from passenger to cargo configuration. All 777 freighters operating today were purpose-built by Boeing. Acquiring used passenger jets that have been converted to cargo configuration is less expensive than a new plane, which has the advantage of having a slightly larger payload.

Cargojet said its strategy is to better time its capital commitments as the global economy teeters on recession, saying it reserves the option to activate the production slots reserved with Israel Aerospace Industries.  

“Management is currently maintaining all its existing rights for the aircraft conversion slots and will continue to closely monitor the duration and severity of this economic cycle to allow optionality on fleet ramp, if necessary. Management has a solid track record of securing feedstock aircraft should new opportunities emerge,” it said in the financial documents.

“As passenger airlines retire B-777 to move up to B-787 aircraft, the feedstock market for B-777 is expected to remain strong, allowing Cargojet to initially divest its feedstock of B-777s freeing up liquidity immediately,” the airline explained.

CEO Ajay Virmani said Cargojet previously cancelled a planned purchase the third 777-300 originally targeted for IAI and is likely to sell the remaining plane it owns. “We are still in the market should things improve.”

Cargojet also said it is deferring the purchase and conversion of two 767-200s from 2023 to 2024. The combined savings in capital expenditures from the deferred orders amounts to $295 million, much of it to be realized in 2024.

The airline still plans to add four 757-200 and three 767-300 freighters to the fleet this year, noting that they are all secured by customer contracts. One of those 767s will be purchased when it comes off leases in November.

Mammoth Freighters, established in 2021 with backing by funds managed by Fortress Investment Group, recently inducted its prototype 777-300 into its overhaul hanger in Fort Worth, Texas, where the existing interior will be stripped for flight testing. Two 777-200 Long Range aircraft for Cargojet, including the prototype designated to prove conformity with Federal Aviation Administration standards, previously were placed in separate production lines.

Mammoth hopes to have at least one of the -200 rebuilds completed by the end of the year, with FAA certification anticipated in the first quarter of 2024. 

FAA reviews for all types of aircraft builds are taking longer than in the past because of resource constraints.

Rebalancing costs for slower growth

Fourth-quarter results were disappointing after executives in November had expressed confidence they wouldn’t experience a decline in volumes, unlike many all-cargo airlines, because their business was heavily tied to express carriers with daily network needs regardless of cargo volumes. The minimum guarantees in long-term transport contracts provide a good buffer against industry ups and downs, but that hasn’t stopped customers from dialing back trips.

DHL, for example, redeployed two 767 cargo jets that operated between its Cincinnati hub, Vancouver, Canada, and Shanghai, China, to another route when demand plummeted late last year, but aircraft utilization was lower than before.

Mammoth Freighters has a large conversion center for 777 aircraft in Fort Worth, Texas. (Photo: Mammoth Freighters)

Management said the amount of cargo shipped and the number of hours flown per aircraft is also expected to decline in 2023 as high inflation causes consumers to spend less.

Growth “won’t be like a hockey stick that we have seen in the past three years for sure. It will be in the mid-single-digits probably,” Cargojet CEO Ajay Virmani said on a call with analysts.

Cargojet generated $196.3 million in revenue, which was only up 6% versus the same three months in 2021 when fuel surcharges aren’t counted. Management said domestic revenue was essentially flat when other cost pass-throughs were excluded because of the decrease in e-commerce and B2B volumes — and would have been lower if not for automatic rate increases for inflation permitted under long-term contracts. Revenue for turnkey leases — aircraft plus crews and maintenance — increased because of new scheduled routes around the world and ad hoc activity. The charter business is more cyclical than the long-term partnerships with express operators.

The gross margin fell to $45.6 million, with adjusted operating income before accounting considerations down 8.4%. Adjusted free cash flow, an indicator of financial strength, declined $2.9 million — partly explaining why the company deferred more capital expenditures on aircraft.

The results show Cargojet had difficulty correcting for one-time costs — hiring and training pilots for new routes, overtime and temporary labor — associated with rapid growth to keep up with the surge in shipments during 2021 and early 2022. Onboarding costs for new hires were especially significant.

“With 2022 being a record year for year-over-year growth we just couldn’t grow fast enough to service our customers the way they wanted to be serviced. So, when you can’t grow fast enough you do everything pretty much at any cost. Now that’s overstating it, but we ran very high cost for overtime and for training. And to some extent for temporary employees,” said CFO Scott Calver.

Earlier in the pandemic, Cargojet was able to hire pilots laid off by passenger airlines who were already certified to fly 757s and 767s, and who only required a few days of training, as opposed to months, he explained.

Net income was negatively impacted by a write-down in the value of warrants for Amazon and DHL. Cargojet, which derives 30% of its revenue from DHL, last year issued warrants to the express carrier allowing it to acquire up to 9.6% of its shares if it reaches certain revenue milestones. Amazon has the ability to acquire up to 13.9% of Cargojet. 

Cargojet, in context, still had a banner year in 2022, ending with adjusted earnings before interest, taxes, depreciation and amortization of $242.6 million — more than double 2019 profits.  

In January, Cargojet announced that Canada Post and courier subsidiary Purolator had extended their transport contract through September 2029. The agreement continues to commit the customers to minimum guaranteed volumes. Cargojet in November also renewed its contract with UPS for another five years, taking it through 2030.

Click here for more FreightWaves/American Shipper stories by Eric Kulisch.


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