Airline passengers in some smaller Canadian cities should get a break on fares next year as Air Canada vowed Thursday to respond to lower fares promised by WestJet when it launches its new regional service next year.

"We know that the regional challenges will require some level of response from us and that is natural, normal and healthy competition and we're certainly prepared for that," Air Canada CEO Calin Rovinescu said Thursday during a conference call about the airline's improved third-quarter results.

WestJet CEO Gregg Saretsky mused Wednesday about lowering fares when it launches WestJet Encore next year with a few Bombardier Q400 aircraft.

Rovinescu said Air Canada is prepared for its rival's efforts to expand its market opportunities, but won't sacrifice the company's overall yields.

"Our objective for next year will be to continue to improve on the progress we made this year and we certainly have no intention of conceding anything on the yield side."

Results beat expectations

Air Canada beat analysts' expectations Thursday as it reported a return to profitability in the third quarter by flying planes at record levels and benefiting from lower costs and foreign currency gains.

The Montreal-based company earned $429 million, or $1.54 per diluted share. That compared with a net loss of $124 million, or 45 cents per diluted share, for the same period last year.

Air Canada's adjusted net income was $230 million, or 82 cents per share, up from $193 million, or 68 cents per share, in the third quarter of 2011.

Analysts had been looking for 70 cents per share of adjusted earnings, according to Thomson Reuters estimates.

"I'm extremely pleased with these results, particularly in view of the challenges we incurred in the first two quarters of the year and the ongoing challenging economic times worldwide," Rovinescu told analysts.

Revenues increased 2.6 per cent to $3.3 billion as passenger revenues grew 3.1 per cent due to higher prices and traffic.

The airline's planes flew at a record 86.3 per cent full in the quarter. Pacific routes, especially to China and Japan were particularly strong in the quarter as revenues increased 13.9 per cent.

Air Canada said it expects its capacity will grow by 1.5 to three per cent next year as it launches a new low-cost carrier that will add seats to planes. It will also add two Boeing 777 aircraft. Most of the increased capacity will be directed at international routes, leaving domestic capacity steady.

That should allow the airline to maintain full flights in its mainline service without resorting to fare decreases. Increased baggage fees allows ancillary revenues to increase by 26 per cent in the third quarter.

David Tyerman of Canaccord Genuity said fuel costs will be a big factor in determining fares even as it faces increased competition on its regional service, which is a very small part of its overall network.

"I think the fares will go down on some or maybe all the routes that WestJet chooses to compete on," he said in an interview.

"I would think that at the end of the day that Air Canada will use some combination of meeting the competition and in some cases they may decide that they're just not going to compete on certain routes because they don't really have any good cost structure to do so."

Debt cut

Air Canada said its costs, excluding fuel and ground packages at Air Canada Vacations, in the quarter increased 1.6 per cent, in line with the company's August guidance.

Operating expenses decreased $65 million or two per cent, in part due to $124 million in savings from pension changes after the new collective agreement with pilots raised the retirement age beyond 60.

Rovinescu said the airline continues to make progress on reducing its costs structure but says becoming an ultra-low cost carrier isn't achievable with a unionized workforce.

"So for us to participate in that lower cost area, which is where the growth is, we've said that a certain portion of our fleet will participate in that growth," he said pointing to next year's launch of a low-cost carrier servicing leisure markets in the Caribbean and Europe.

Adjusted net debt in the first nine months of the year was cut by $308 million to $4.27 billion and the airline had $2.2 billion of cash on hand.

Cameron Doerksen of National Bank Financial said the results were a "modest beat" even though revenues were below forecast.

"As has been the case in previous quarters, Air Canada noted that it is experiencing yield pressure on short-haul routes in Ontario due to competitive pressure from Porter and on eastern U.S. transborder flights due to Porter and now the introduction by WestJet of flights to New York," he wrote in a report.