Lufthansa’s union strike is impacting 98 per cent of the carrier’s flights, with cancellations hitting almost all short- and long-haul destinations. The half-day strike in March, had affected 40 per cent of the carrier’s flights with cancellations of 700 flights. The union’s reaction does not come as a surprise. Lufthansa had clearly stated its intentions in 2012 with the Score program, targeting 3500 job cuts in order to generate savings of €600 million and revenues of €300 million through other activities. Other European groups such as Air France/KLM and IAG are facing similar issues with the unions reacting to their cost restructuring programs. IAG’s restructuring program is targeting 4500 job cuts to generate €450 million of savings and Air France/KLM’s program is targeting 5000 job cuts to reduce its net debt to €2 billion. Union disputes will be the main challenge that legacy carriers will have to face moving forward with their programs.
The question that is arising is – are these strategies vital for the groups’ survival? Since 2008 the groups have been experiencing losses in millions due to three major challenges: fuel prices that remain at high levels, strong competition from low-cost carriers (LCC) within Europe such as Easyjet and Ryanair that have been generating more than £200 million profits year-on-year after 2009, and strong competition coming from the Middle East from carriers mainly including Emirates, Etihad, Qatar Airways and Turkish Airlines that are expanding strongly due to the availability of cash and the strategic intent to position Abu Dhabi, Dubai, Doha and Istanbul on the global map, feeding traffic from the east to the west and vice versa.
Lufthansa should be implementing multiple strategies to face each of these challenges. The airline can dent its fuel bill by optimising operational performance. In the short term, Lufthansa has implemented a paperless cockpit, going digital and equipping its pilots with the hardware, software and applications to make optimum choices in terms of operational performance. Furthermore, investments on aircraft connectivity will allow optimal operational performance by linking the engines and other aircraft systems to the high bandwidth connectivity for operational data streaming, real-time health monitoring, and maintenance interaction with aircraft systems, thus saving on fuel costs and eliminating maintenance costs. Connectivity in the cabin linked to the in-flight entertainment system will allow the carrier to generate revenues through online advertising and retail spending as well.
Lufthansa can face LCC competition within the region by leveraging on Germanwings operations. Similarly IAG is leveraging on Iberia Express and planning 100 per cent acquisition of Vueling while Air France/KLM is leveraging on Transavia and its other French subsidiaries, Regional and Brit Air.
In the long-haul market Lufthansa can face competition from the Middle East by forming partnerships. A potential partnership with Turkish Airlines can strengthen the carriers’ bottom line. The other groups are also making similar steps, with IAG aiming to cooperate with Qatar Airways and Emirates and Air France/KLM with Etihad. In the West, regulatory environment still restricts cross border mergers as European carriers can acquire only up to 25 per cent shares in a US carrier. This is a hurdle for European airlines that are witnessing acquisitions taking place from Middle Eastern carriers within Europe, e.g. Etihad acquiring 29.2 per cent in Air Berlin, as well as expansion strategies that are aiming to tap into the US market by transferring passengers through Europe to the Middle East and beyond. Air Berlin and Etihad cooperation is an example. Air Berlin is also undertaking a restructuring program aiming at generating €250 million savings through 1000 job cuts. The carrier is restructuring its network introducing new connections to the US complementing Etihad’s network by bringing traffic from the US to Europe that will be transferred to the East through Abu Dhabi.
Smartphone proliferation, georeference and social media platforms have driven the desire of the consumer to be connected 24/7. To meet the demand of its passengers, the airline industry is currently undergoing a dynamic change.
The commercialisation of satellites has allowed prices to fall and connectivity to be considered a viable investment by aircraft operators. ATG (air-to-ground) and Ku band are currently the main offerings on the market, in terms of connectivity.UScarriers are leading the market, with JetBlue Airways, United/Continental, Southwest Airlines and Delta Air Lines already providing connectivity on several of their aircraft. InEurope, Norwegian Air and Icelandair are the early adopters. Suppliers are also strongly investing in the connectivity market with Inmarsat, Viasat, Panasonic, on Air and Gogo standing out from their competitors having spent between $1 and $1.5 billion each.
However, in-flight connectivity is still facing the challenge of high prices, low speed, limited capacity and coverage. The Ka band that Inmarsat is investing in is expected to be the next generation of global service connectivity that will address the four challenges mentioned above.
While the ultimate goal is to provide seamless connectivity for the passenger, the high start-up costs are restraining investments. An investment of approximately $100,000 to $150,000 per aircraft is required for ATG, while $300,000 to $350,000 is required for Ku band. Aircraft operators need to evaluate the revenue and cost sharing models that allow them to break-even faster while generating additional ancillary revenues in the medium-term. The airline industry is looking at new revenue and cost sharing models, for example Google and Blackberry have been sponsoring free connectivity on board. Ancillary revenues from online advertising and retail spending can generate up to $500,000 per year for a single-aisle aircraft with 150 passengers and 85% load factor depending on adoption rates. It is important to note that high revenues are not generated from wifi charges – as 85% of passengers on average are not willing to pay for wifi usage – but are dependent on adoption rates, which will only reach its maximum when wifi is offered for free.
This post was first published on the Air Transport Publications Airlines industry blog. See the post here:
Airport capacity constraints, strong air traffic growth and increasing competition among airports globally will drive investments on airport IT infrastructure. This is expected to reach $300 million compound spending over the forecast period of 2012 to 2020. Implementing technology solutions in airports, such as wifi, bluetooth, near field communication (NFC), and radio frequency identification (RFID), as well as launching applications that enable interaction with the passenger, is vital to maximise operational efficiency, improve the passenger experience and the quality of service offered to airlines. Airports should track, record and measure real-time passenger data, in relation to passenger PEDs (portable electronic devices) within the airport environment in order to understand their behaviour, better interact with them and improve key performance indicators (KPIs).
Airports have set new operational and commercial KPIs with passenger experience at its core, aiming to minimise waiting times at various touch points, improve airline on-time performance, decrease average turnaround time, and overall improve non-aeronautical revenues.
Geolocation and smartphone proliferation is key. It will enable airports to build relationships with passengers and reach their targeted KPIs. Ultimately, the airport should integrate passenger information recorded in the zones and terminals with information captured in other areas and from other airport systems. The airport can then interact with the remaining stakeholders and share information to improve services offered to passengers, and eventually move towards a collaborative decision-making (CDM) terminal environment. However, completely integrated and interactive business intelligence platforms are not yet recognised as viable solutions, due to perceived constraints and cost of implementation. The lack of cooperation among airport stakeholders is another hurdle in realising the full benefits of a new technology in practice.
There is potentially plenty to be gained though. Our return on investment (ROI) methodology is showing that strong revenues are generated from an increase in retail spending, which is a result of operational excellence and interaction with the passenger through wifi, bluetooth-enabled portable devices and location-based services. So while operational excellence in a hub airport environment can cost up to $10 million, it can increase retail spending by up to five percent per year allowing for a break-even point in the third year of operations.
Airports will need to re-position themselves in the supply chain and become the entity that will ensure efficient collaboration of the stakeholders and operational excellence in order to satisfy the traveller. All stakeholders can benefit from more efficient operations, as a result of integrated information, real-time decision-making and situational awareness.
This post was first published on the Air Transport Publications Airports industry blog. See the post here:
Liberalisation of the Indian air transport industry creates opportunities for domestic and international operators
India is among the countries along with China, Brazil, UAE, that will experience the strongest air traffic growth globally. Air traffic is forecasted to grow around 12% year on year, driven both by an increase in the regional demand, as middle class and GDP is growing, and an increase in international traffic, as India is becoming a global gateway and main target for foreign direct investments. A strong example is that of the UK where governments’ initiatives are aiming at softening barriers on trade and visa requirements (from UK to India) positioning UK as the ‘main partner of choice’ for India. Furthermore, 14 greenfield airport projects have been granted approval and airport expansion investments are expected in the constraint airports of Mumbai and Delhi in order to cater for the air traffic growth.
Currently aircraft installed base in the country is around 500 expected to double up to 2020. MRO spending is expected to grow along, positioning India n the medium and long term as one of the biggest Asian MRO markets worth over $2B annually by 2020.
In addition to the strong air traffic growth year on year, Indian airlines are eager to fill the gap in capacity that Kingfisher has created due to its severe cash crunch. Kingfisher’s grounding has been a result mainly of mismanagement and wrong decisions making, e.g. acquisition of Air Deccan, of cost inefficiencies in place and high debt exposure.
Indigo, following the European and US low cost model of easyjet and Southwest, with its single Airbus narrowbody fleet is focusing on serving the Indian market; with 64 aircraft installed base and around 200 on order, Indigo is set to cover mainly the domestic Indian market in the short term and expand its reach to countries in close proximity in the medium term, e.g. Singapore, Thailand, Malaysia. We do not see any intention from Indigo to enter the long haul market, as the long haul low cost model has proven to be unsuccessful and as major UAE competitors are price competitive and offer ‘good value for money’ service and comfort on board. Strong cash flow, low operating costs due to low labour cost, economies of scale generated by maintenance and procurement contracts for a single aircraft fleet, are mainly driving the success of Indigo.
Air India seems to be following the Kingfisher path. The airline has been consistently posting net losses since 2008 despite decreasing employee number to half and increasing air traffic year on year. Air India will need to benchmark its European counterparts in cost restructuring strategies in order to be able to survive in the medium term. We believe the company should be serving the Indian market leveraging on its low cost subsidiary Air India Express, while serving the long haul market with the widebody fleet of the main airline. Furthermore, the company should consider deploying cost cutting measures leveraging on the softening of the DGCA’s regulations in the medium term, e.g. approval of EFBs (Electronic flight bags) in the cockpit that can significantly reduce the airline’s operating costs, and strategic partnerships, leveraging on the liberalisation of the Indian market.
International airlines have already expressed their interest in tapping into the Indian market. For example, Etihad is in the process of acquiring 24% stake in Jet Airways, making this the first possible foreign investment in the Indian airline market. Etihad’s choice of Jet Airways as a potential partner leaves Kingfisher available to other players in the market as a potential acquisition target. However, there are few airlines in the market, other than the UAEs that can currently take on board the high level of debt that Kingfisher carries. Moreover, difficulties in doing business within the country and delays in government decision making, capacity constraints and inadequate infrastructure restrain the growth of the market.
Ryanair has been consistently reporting substantial net profits year on year (in exception of 2008) and I estimate that the airline is set to report a 5% increase in profit after tax in its full year results in March 2013, in comparison to last year.
Ryanair finds short term solutions to grow. However, the low cost carrier faces difficulties in growing in the long term. Ryanair’s growth is being constrained primarily by the EU’s denial to approve the Aer Lingus take-over (e.g. in 2006/2007, in 2009 and in 2013) that would allow the carrier to expand its fleet, overcoming the lack of new aircraft deliveries that has been already constraining its growth, and benefit from economies of scale, that would further reduce its unit cost and increase revenues.
As more consolidation is expected to take place in the next two years and once airline groups see benefits from their restructuring programs, expected in 2014, competition in the short haul market will intensify, pushing average fares downwards. Ryanair in the short term should seek to grow inorganically through other acquisitions benefiting from the fact that European airlines are currently valued below net asset value (NAV).
Aer Lingus, on the other hand, has successfully marketed itself in the market in order to attract other potential buyers. Aer Lingus has managed to generate net profits in the last 3 years (2010-2012), expanded its code share partnerships, e.g. Jet Blue expected in April, added frequencies to US and expanded network and is still marginally valued below net asset value (NAV). The company is an attractive target for carriers that are eager to have a foothold in the European market and feeding traffic back to Asia through the Middle East, such as Etihad.
Liberalisation efforts and the launch of the 'low cost carrier' (LCC) business model, enabling affordable air travel, have driven air traffic demand and intensified competition in the air transport industry. Although demand has been rising year on year and airlines have become more sophisticated in delivering value to passengers, profits have been elusive. This is due to the impact of external factors on operating costs over which airlines have very little control. Some of these factors include the global economic crisis and the slowing of economic growth, physical disasters and fluctuating fuel prices, currently at an average of US $120/barrel versus US $ 80/barrel 5 years ago, representing 30% of total operating costs, versus 14% a decade ago. Total fuel expenses in 2012 reached US $200bn from US $44bn a decade ago. Airlines' net profit margins have rarely exceeded 3%, making them the worst performers in the air transport value chain. Exceptions within the last five years have been North American airlines reaching -6.0% net post tax profit margin in 2008, and Asian carriers reaching 8.0% in 2010. As a result, in the last five years the airline industry has witnessed strong consolidation in an attempt to generate profits from synergies, cost efficiencies and economies of scale. 2008 was the worst year for the airline industry with 108 airlines ceasing operations. Since then, in total, 375 airlines ceased operations, twice the number of airline start ups. The implementation of major restructuring programmes has also been key in achieving sustainable profitability. Restructuring has been taking the form of cost-cutting, fleet modernisation, as well as streamlining of route networks and revenue management systems, among other measures. Regional Assessment of Restructuring Efforts Europe – group restructuring, hybrid business models and LCC inorganic growth European airlines have been the worst performing, generating marginal net profits in the last few years while several airlines such as Spanair and Malev went bankrupt in 2012. Big airline groups, such as Lufthansa, Air France/KLM and IAG, implemented major restructuring and cost reduction programmes in the beginning of 2012 in order to survive in the medium term, increase market shares and boost consumer confidence. These airline groups have been strengthening their low cost and regional subsidiaries; Iberia Express and potentially Vueling for IAG, Germanwings for Lufthansa and Transavia for Air France/KLM. They have been rationalising their fleet and optimising their network while increasing connections from regional hubs in an attempt to compete on price and gain back their market shares from the LCCs. The main airlines will be focusing on the long haul and premium traffic segments where profit margins are higher, leveraging on their strong presence in key European hubs, such as Lufthansa in Frankfurt airport and Air France/KLM in CDG and Schiphol. Furthermore, unable to substantially decrease fuel costs through hedging, IAG, Lufthansa and Air France/KLM are aiming to decrease operating costs by reducing staff numbers by 13,000 by 2014, while generating savings of €450 million for IAG and €200 million for Lufthansa and reducing net debt by €4 billion for Air France/KLM by 2015. On the other hand, European LCCs have been generating profits. For example, EasyJet is expecting £255 million while Ryanair estimates £394 million - £418 million as profits after tax in 2012. Their success hinges on low cost operation processes that allow for the lowest unit cost in the market. Low cost carriers are attempting to grow inorganically, such as in the case of Ryanair and Aer Lingus, by leveraging on their strong cash flow and capturing larger market share from the big airline groups that are facing financial difficulties. However, constraints imposed by regulatory authorities due to competition rules and additional charges imposed by the ETS on the short haul routes are restraining the growth of low cost carriers in Europe. Frost & Sullivan expects more consolidation to take place within Europe in the next few years and competition in the short haul market to intensify once airline groups see the benefits from their restructuring programmes by 2014. North America – Strong consolidation and transcontinental joint ventures Since 2008, consolidation in North America has been strong. For example Delta/North West, United/ Continental and Southwest/AirTran Airways merged in order to overcome financial difficulties through cost cutting and economies of scale, while others such as American Airlines could not avoid Chapter 11. Furthermore, major airlines have been strengthening international collaboration through alliances and have been forming transatlantic joint ventures, e.g. Delta Air Lines acquired 49% stake in Virgin Atlantic. Frost & Sullivan expects more consolidation to take place in North America with a potential merger between American Airlines and US Airways, while the big 3 players will be aiming to strengthen their position globally through collaboration with foreign partners within the alliances. Russia and CEE – undeveloped business models and privatisation efforts Along with China and the Middle East, Russia is one of the countries, that is experiencing strong air traffic growth, estimated at above global average 5.7% (CAGR 2012-2031) The capacity of Russian carriers increased by 25% in 2011 as a result of the strong expansion strategies of several legacy Russian airlines. On the other hand, the growth of Russian carriers is being hampered by EC regulatory restrictions, aiming to create a single aviation market establishing the "EU designation clause." In Russia, network carriers are still operating and growing individually, few partnerships are in place, networks are still heavily focused on Moscow and the LCC business model is not as strongly developed. The market shares of LCCs in Russia are lower and growth is restrained mainly due to regulatory restrictions that need amendments in order to allow LCCs to operate as in Europe. Furthermore, the low level of internet sales, underdeveloped secondary airports and the high concentration of population in several urban communities dampen LCC expansion. Frost & Sullivan believes that in the next few years, Russian legacy airlines will consider entering one of the alliances to boost their long haul traffic, while LCCs will expand by taking advantage of regulatory changes, through meeting underserved demand and leveraging infrastructure investments taking place at secondary airports in Russia. LCCs are expected to grow and expand the short haul network, adding capacity and linking domestic destinations, while competition will be strengthened with the entrance of foreign LCCs in the Russian market. Russian LCCs are anticipated to evolve through hybrid business models, where legacy carriers will be launching their own low cost subsidiaries. For instance, Aeroflot recently expressed its willingness to launch its own LCC subsidiary. The regulatory air transport landscape in Russia will need to adapt to the new air transport environment and enable the development of domestic LCCs in order to compete with low cost incumbent carriers such as EasyJet that announced the launch of flights linking London (Gatwick) and Manchester with Moscow (Domodedovo). EasyJet is one of just four carriers that are permitted to fly between the two countries under existing bilateral agreements. Ryanair has also expressed an interest to serve the Russian market and the renegotiation of bilateral agreements between Ireland and Russia is expected to happen soon. CEE airlines will be increasingly looking for private investors, preferably selling directly to a single large investor or a number of investors, aviation or non-aviation related, rather than going for an Initial Public Offering (IPO) as the domestic equity market is not strong and the airlines do not have a good track record. Africa - Major legacy airlines are connecting the African region and growing organically on the domestic front while aiming for greater international presence through foreign partnerships The air transport industry in Africa is still underdeveloped in comparison to other regions but is expected to register strong growth in the next decade. By 2030, Africa's fleet will double to 1,210 aircraft, 60% being additions to existing fleets. The major legacy airlines are growing domestically through regional partnerships and through the launch of low cost subsidiaries, and internationally through foreign partnerships. Some prominent examples of this trend include South African airlines launching Mango as its low cost subsidiary to serve the market within Africa and strengthening its partnership with Emirates and Qantas to grow in the Middle East and Asia. Ethiopian Airlines partnered with the Togolese carrier ASKY to better serve East Africa and joined Star Alliance in order to benefit from strengthened partnerships with the Alliance's Asian members. The LCC business model has been making strides through the launch of low cost subsidiaries by legacy carriers including Mango by South African Airways, and through the launch of independent LCCs such as Fastjet. Frost & Sullivan believes that the main focus of African carriers will be to capture a higher percentage of the domestic market and to expand to China, India and Latin America in order to take advantage of the 'Southern Silk Road' linking Africa, Asia, Latin America and the Middle East. Strong GDP growth of around 10% (CAGR 2012-2017) robust air traffic growth of 10% in 2012, high aircraft utilisation rates and large aircraft orders and deliveries between 2012 and 2016 in the Asia-Pacific (APAC) region are key drivers that will enable large carriers, such as Singapore airlines (SIA), to successfully implement organic growth plans. Furthermore, LCCs are expanding rapidly by leveraging on deregulation, the use of internet as a distr Asia – Legacy carriers expanding through regional and low cost subsidiaries ibution channel, low-cost labour and escalating air traffic demand, driven mainly by higher average disposable incomes and an expanding middle class. The penetration of LCCs in APAC increased from 1.1 % in 2001 to 14.0 % in 2008. Legacy carriers are responding with the launch of their own LCCs. A notable example is that of Singapore Airlines Limited (SIA) which launched Tiger Airways in 2004 and two subsidiaries thereafter in Australia and the Philippines. By entering the low cost market, SIA was able to capture market share, create synergies and implement best practices in low cost operations in both type of businesses. SIA recently launched the long-haul LCC, Scoot, in an attempt to decrease dependence on declining premium and business class revenues. Latin America – Large carriers are entering alliances and forming mergers while domestic carriers are going bankrupt The region has witnessed consolidation through mergers, such as that of LATAM and Avianca-Taca, that is expected to operate under one brand by 2013. Alliances are enabling Latin American carriers to grow and strengthen cooperation with North American carriers. Prominent examples of this development include Aeromexico strengthening its partnership with Delta within Skyteam, Aerolineas Argentinas joining the same alliance in 2012, AviancaTaca strengthening cooperation with US Airways within the Star Alliance, LATAM co-operating with American Airlines within One World. Up to now, LATAM has been benefiting from both its One World membership through LAN and its Star Alliance membership though TAM. By 2013, LATAM will need to decide on joining one of the alliances as a merged entity. Middle East – United Arab Emirates (UAE) carriers and Turkey are driving the market through organic and inorganic growth strategies Airlines in the UAE, such as Emirates, Etihad and Qatar, have a unique business model due to their ownership structure being 100% owned by their respective governments. Emirates has been growing mainly organically by increasing the frequency of flights to European destinations, while Etihad has been growing inorganically through codeshare agreements (33 up to 2012) and share acquisitions (in four airlines up to 2012), with such trends expected to intensify in the short-term. UAE carriers are looking into penetrating the different markets through acquisitions that will allow them to overcome the ownership and control rules that are still troubling the global airline industry. For example, in the European region, Etihad purchased a 29% equity stake in Air Berlin in 2012, investing US $255 million with a 5 year horizon. The acquisition allowed Etihad to tap into the German market, competing with Lufthansa, and leverage on Air Berlin's network and partnerships. Furthermore, Etihad is eager to enter two other strong European markets - France and Netherlands - through a potential partnership with Air France/KLM. Recently, Etihad acquired a 3% stake in Aer Lingus and is aiming to increase it as the Irish government is looking to sell its 25% stake. This acquisition will allow Etihad to enter the Irish and UK markets through Aer Lingus' strong network. Now is the right time for foreign carriers to enter the financially troubled European region as the big European airline groups, including IAG, Lufthansa, Air France/KLM are reporting substantial revenue losses and are being undervalued in the stock market. In the APAC region, Etihad recently increased its stake in Virgin Australia to 10%, while its counterpart Emirates has been in talks with loss making Qantas to strengthen cooperation. Etihad is also eager to co-operate/collaborate with Chinese airlines, such as Hainan and China Eastern airlines, and acquire stakes in Indian airlines, such as Jet Airways. The company has been launching routes to secondary cities in China and recently entered into a codeshare agreement with China Eastern to expand its network. Frost & Sullivan expects that UAE carriers will be seeking partnerships in the fast growing regions of Latin America and Africa with airlines such as LATAM or AviancaTaca and Kenya Airways or Royal Air Maroc. Turkish Airlines (THY) has been growing organically in the period 2006-2010 expanding both its Airbus and Boeing fleets, taking advantage of its strategic location in Istanbul and feeding traffic to and from East and West. THY is aiming at expanding its reach by strengthening cooperation with other carriers within alliances, such as star alliance and AACO (Arab Air Carriers Organisation). Frost & Sullivan expects that THY will partner with Lufthansa within star alliance, competing with the other two alliances that are attracting UAE carriers. Moving Forward Airline operating costs are expected to decrease slightly in the next 2 years as expectations of an increase in oil supply by Saudi Arabia and new oil supply from the US can drive down fuel bills. However, the implementation of new environmental measures, that Frost & Sullivan expects to come into force in 2014, such as the ETS that can add 1% to an average return fare, will pose an additional burden on airlines. In the meantime, biofuel usage in aviation will remain on the fringe, as it still remains an expensive alternative. Airlines that want to overcome the high cost and undersupply of biofuels in the market will need to take individual measures, such as Lufthansa which is collaborating with Algae Tec to build a facility in Europe that will produce algae on a large-scale suitable for conversion into aviation kerosene and conventional diesel fuels and such as Delta Air Lines that acquired in Pennsylvania an oil refinery. Airlines will need to implement cost-cutting programmes that will most likely entail job losses as this, along with the fuel costs, is the highest operating cost for an airline. Airline privatisation is expected to intensify as governments become unable to finance unprofitable businesses, especially in Europe, Africa and the US. Successful privatisations have been taking the form of capital restructuring, selling directly to one large investor or a number of investors, aviation or non-aviation related, initial public offering (IPO) in the case of strong domestic equity markets, optimisation of route network and fleet rationalisation by leasing aircraft and forming a single fleet that will allow lower maintenance costs. As the industry is still very inefficient, consolidation will intensify in the next few years, driven by legacy and LCCs, in the form of mergers and acquisitions, as well as strategic partnerships. The implementation of major restructuring programmes is also key in raising profitability. Unification of revenue management processes across an airline group's global locations, co-ordination of flight schedules and redeployment of aircraft are some of the steps that airline groups will have to adopt for sustainable profit generation. Regulations do not yet allow full ownership or effective control of airlines by foreign investors and this is still a deterrent to foreign direct investment. Nonetheless, restrictive bilateral agreements and congested airports make small shareholding stakes increasingly attractive, particularly in Europe. For example, over the past couple of years, Etihad acquired stakes in both Aer Lingus and Air Berlin. Similarly, Air China has expressed an interest in acquiring a stake in LOT, while TAP Portugal and Scandinavian SAS are still "in play" as acquisition targets. Frost & Sullivan expects financial benefits by airline group restructuring to be realised from the end of 2013 onwards, with union agreements and organisational restructuring being enforced and group synergies being realised. Many weaker airlines will be forced to cease operations, while others will become acquisition targets for foreign investors that are willing to expand inorganically and benefit from valuable route networks. The LCC model will gain greater momentum as more airlines launch operations in Africa (Fastjet), and Asia, and bid for legacy carriers, such as in the case of Ryanair and Aer Lingus. Furthermore, alliances are going to provide the platform for strong cross border partnerships. For instance, within Skyteam, KLM has formed a strong partnership with Delta, Air France with Alitalia and Kenya Airways, while Etihad is entering the game as an external player. Within One World, Iberia, BA and Qantas are strengthening cooperation, while Emirates and Qatar are becoming important players. Within Star Alliance, it is expected that Lufthansa will build a partnership with Turkish airlines.
Low-cost carriers are reporting profits and bidding for legacy carriers while airline groups struggle with losses, consolidation and restructuring
Globally, 2012 has been a hard year for airlines. Profits decreased to half in comparison to last year; IATA estimates revenues to close at just $4.1Billion by year-end. High average oil prices at above $100/barrel and unexpected events – such as Sandy that caused airlines losses of around $100Million – caused profit margins to fall to 1.6% and strongly buffeted the airlines industry.
Struggling with the economic and financial crisis, European carriers are expected to be the worst performers generating total losses of around $1Billion. A number of airlines went bankrupt in 2012, such as Spanair and Malev, while big airline groups implemented major restructuring and cost reduction programmes in the beginning of the year to survive in the long term. IAG, Lufthansa and Air France/KLM are aiming to reduce staff by 13,000 within 2014, generate savings - €450Million for IAG and €200Million for Lufthansa – and reduce net debt – €4Billion for Air France/KLM – by 2015. At the same time, they are leveraging on their low cost subsidiaries, Iberia Express and potentially Vueling for IAG, Germanwings for Lufthansa and Transavia for Air France/KLM, in order to face strong competition coming from the low cost carriers.
The current air transport environment in Europe has been benefiting low cost airlines. A combination of factors – increasingly price sensitive business and leisure passengers, national carriers going bankrupt, legacy carriers significantly cutting down capacity to decrease losses and charter carriers reducing their fleet size – have allowed low cost carriers to grow and be the only segment able to offset oil prices and generate profits. Easyjet is expecting to generate £255Million as profit after tax by year end while Ryanair estimates £394Million-£418Million. Their success hinges on low cost operation processes that are in place and allow for the lowest unit cost in the market.
Looking at low cost carriers piling up cash and bidding for legacy carriers, as in the case of Ryanair and Aer Lingus, it is clear that the rules of the game have changed. However, constraints imposed by regulatory authorities due to competition rules and additional charges imposed by the ETS on the short haul routes versus the postponement of the scheme on the long haul routes, are restraining the fast growth of low cost carriers. We expect more consolidation to take place in the next years and competition in the short haul market to intensify once airline groups see benefits by 2014 from their restructuring programs.
Air transport associations, authorities, organisations and airlines have been strongly positioned against the Emissions Trading Scheme (ETS) as it would be a cost burden to airlines, calculated to add 1% to an average return fare, and would decrease up to 1% air traffic volumes. “Intensifying price competition, that does not allow carriers to pass on the cost to passenger, high oil prices at above $100/barrel, marginal yearly industry net profits (forecasted by IATA to reach 4bn$), that can easily turn into losses by the end of the year with unexpected events, such as Sandy that caused to airlines around 100Million$ losses, and profit margins that have rarely exceeded 3%, make airlines extremely sensitive to any decision that can hurt their bottom line.
The European Commission postpones implementation of the ETS until 2013, when the International Civil Aviation Organization (ICAO) will take control of the issue during its assembly.
That is a relief to European airline groups, such as IAG, Lufthansa and Air France/KLM, which are currently under strict restructuring and cost reduction programs, expected to reduce staff in total of 13.000 by 2014, generate €450Million (IAG) and €200Million (Lufthansa) savings by 2015 and reduce net debt by €4bn (Air France/KLM) by 2015, while leveraging on their low cost subsidiaries: Iberia Express and potentially Vueling for IAG, Germanwings for Lufthansa and Transavia for Air France/KLM. US airlines are also benefiting as almost 23% of Revenue Passenger Kilometres (RPKs) are currently generated between the two regions: Europe and North America. Chinese airlines will too take advantage from this decision as they are increasingly penetrating the European market by launching new routes and increasing frequencies, as well as planning acquisitions in the near future, e.g. Air China expressed an interest to acquire stakes in Polish Airlines LOT.
The consensus regarding the impact of the air transport industry on the environment should be reached at the ICAO assembly next year and Frost & Sullivan expects implementation of new measures to take place in the beginning of 2014. In the meantime, biofuel usage in aviation will remain on the fringe, as biofuels are still under limited and unsustainable production, remaining an expensive alternative competing with oil prices per barrel, and government funding decreasing. Additionally, the postponement will enable negotiations between the EU and third countries, such as China and Russia, and allow more liberalisation and consolidation to take place.
Both AF/KLM and Lufthansa reported operating profits in Q3 2012, being consistent with last year’s financial results. Q3 has traditionally been a well performing quarter for the airline industry; therefore profits should not be overestimated. On the other hand, taking into account that the profit forecast by year end for the European airline industry has been revised downwards, large European airline groups have showed resilience mainly due to the implementation of their restructuring plans which boosts consumer confidence and drives their market shares up.
There are four major challenges that the European airline groups are still going to face: persistent high oil prices, which are being hedged in order to minimise or at least maintain fuel cost at a certain level; strong low cost carrier growth that is gaining market shares in the short and medium haul segments; strong Middle East competition entering Europe through organic and inorganic growth strategies; and finally deteriorating cargo traffic.
Airline groups are responding by strengthening their low cost and regional subsidiaries through fleet rationalisation and network optimisation, increasing connections from regional hubs, in an attempt to compete in price in the market and gain back their market shares, e.g. Lufthansa with Germanwings and AF/KLM with Transavia, Regional and Brit Air. The main airlines will be focusing on the long haul traffic and premium traffic where profit margins are higher leveraging on their strong presence in key European hubs, e.g. Lufthansa in Frankfurt airport and AF/KLM in CDG and Schiphol. Regarding the cargo traffic, the new southern ‘silk road’ connecting the growing regions of Asia, Africa and Latin America, will impact severely cargo revenues in European airlines demanding fast freight fleet restructuring.
I expect that AF/KLM will be strictly implementing Transform 2015 focusing on decreasing its net debt by 4bn EUR. The successful negotiation of agreements with the unions and reduction of overstuffing indicate the company’s commitment. However, 2014 seems too of a short time to achieve its ambitious plan. AF/KLM is set to implement its cost cutting program while attracting partners and investors from the Middle East, e.g. Etihad, and strengthening cooperation with existing members in Skyteam. Lufthansa being in a better financial situation, expecting profits by end of year, allows the company to focus on its multi hub strategy generating group synergies rather than looking for external partners. Having invested in modernising its fleet to reduce fuel costs in the longer term and having sold bmi loss making business, Lufthansa is set to achieve savings by reducing staff costs.
For the full year 2012, I expect AF/KLM to report similar losses as last year while marginally decreasing its net debt and Lufthansa to report similar profits as last year. In 2012 restructuring plans are focusing on stabilising financial results of the groups in an attempt to avoid further deterioration of the airlines’ bottom line. We expect financial benefits to be reported by end of 2013 onwards with union agreements and organisational restructuring being enforced and group synergies being realised. Furthermore, alliances are going to provide the platform for strong cross border partnerships, e.g. within Skyteam, KLM has formed a strong partnership with Delta, Air France with Alitalia and Kenya airways, while Etihad is entering the game as an external player. Within one world, Iberia, BA and Qantas are strengthening cooperation while Emirates and Qatar are becoming important players.
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2012 will be a tough year for airlines globally. With fuel prices at unsustainable levels and the threat of a major breakdown in the Eurozone area looming, airlines need to take action. Yet the most pressing issue is the lack of sustainable profitability in an industry used to negative results.
The 68th International Air Transport Association (IATA) Annual General Meeting (AGM) took place in Beijing this year, with discussions focusing on the key factors that impact airline profitability and operating costs. This is nothing new. In the 68 years of the AGM net profit margins have rarely exceeded 3%, making airlines the worst performers in the air transport value chain.
For a third year in a row IATA members witnessed modest profit margins, albeit driven by the Asian carriers. Overall airline profits, in all regions apart from the Middle East, are expected to fall in comparison to 2011, falling from $8bn to $3bn in total. However Global GDP, a key driver of air traffic growth, and passenger numbers are expected to grow, while average jet fuel prices for the year are expected to be lower.
The industry is witnessing a paradox: even though demand is on a constant rise and airlines become more sophisticated in delivering value to passengers, profits are elusive. This is due to the impact of external factors, over which airlines have very little control, such as the global economic crisis and physical disasters. Operating costs are heavily dependent on jet fuel price fluctuations, with fuel currently representing 35% of total operating costs which is up from 15% a decade ago.
Even though its impact is still limited, the European Emissions Trading Scheme (ETS) has also been a major topic of discussion at this year’s AGM, as it is expected to add 1% to an average return ticket price. Fears of a full blown trade war between foreign and EU aviation authorities are exaggerated, with the EC expected to back down and postpone implementation to 2013, when ICAO will take control of the issue during its assembly.
As the industry is still very inefficient, consolidation will intensify in the next few years. Consolidation in the form of mergers and acquisitions, as well as strategic partnerships, allow the creation of synergies, cost efficiencies and economies of scale. The implementation of major restructuring programmes is also key in raising profitability. Unification of revenue management processes across an airline group’s global locations, co-ordination of flight schedules and redeployment of aircraft are some of the steps airline groups have to take for sustainable profit generation.
Last month IATA published its 2011 revised estimates, showing an expected 60 per cent decrease in airline industry profits, over 2010. No doubt airlines are in a far worse position in 2011, following a large rebound in 2010. The European and North American sovereign debt crisis, rising fuel prices, turmoil in the Arab world and Japan’s earthquake, all had a negative impact on air traffic growth and on the financial results of European carriers with international route networks. In the first half of 2011 IAG and Lufthansa, two of the largest European airline groups, reported marginal operating profits. Low cost carriers have also experienced the negative impact of an adverse operating environment, with Easyjet reporting a loss for the first half of 2011.
More bad news to follow for the sector, as January 2012 will mark the start of aviation becoming part of the EU Emissions Trading Scheme, resulting in higher costs for European airlines. According to EC DG Clima, direct costs for airlines are calculated to be between €1.50 or $2.10 per passenger each way for a long haul flight from Europe to the US. We believe that this represents an additional cost that airlines are not able to handle during a recession period and passing it on to the passengers could impact demand adversely.
At the same time European airlines are in the process of modernising their fleet, ordering new generation aircraft in order to increase fuel efficiency and reduce their overall costs. As fuel costs represent more than 30% of the airline’s total costs and fuel prices are expected to stay at high levels, fleet modernisation becomes a priority. However, raising cash to finance large capital expenditure projects, as with fleet modernisation, at a time when the European finance industry is in the process of restructuring, is challenging to say the least. This is partly the reason French banks, who for the most part of the last 20 years were the primary lenders to airlines, have retreated from the aviation sector. We firmly believe airlines are set to face a harsh winter that will have a negative impact on their profitability. This is why consolidation will intensify and we will see smaller players exiting this market.
In its 9 month financial results, Lufthansa Group reported a EUR288 million net profit, showing more resilience in a tough operating environment than its European peers. This amount represents a 45 per cent decrease in comparison to 2010 figures, yet it is still better than industry expectations of global industry performance. Last month IATA published its 2011 revised estimates, showing a 60 per cent decrease in airline industry profits. No doubt airlines are in far worse position in 2011, following a large rebound in 2010. The European and North American sovereign debt crisis, rising fuel prices, turmoil in the Arab world and Japan’s earthquake, all had a negative impact on the financial results of European carriers with international route networks.
In addition, the Group does not have positive contributions from some of its other airline subsidiaries, with the exception of Lufthansa airline and Swiss. Germanwings, Austrian Airlines and British Midland have been consistently underperforming, with the latter being up for sale for over a year. More bad news to follow for this sector, as January 2012 will mark the start of aviation becoming part of the EU Emissions Trading Scheme, resulting in higher costs for European airlines. Specifically for Lufthansa’s cargo operations, a decrease in freight traffic is certain, following Frankfurt Airport’s announcement of a night flight ban. The airline estimates the impact to be in the range of EUR 10 million, but we believe this is still optimistic. On the positive side, over the last few months the Group proactively readjusted network capacity which is now set to grow only 3 per cent this year, from 9 per cent previously planned.
Even in these adversary times, Lufthansa is still in a good position to grow. Having invested over EUR 2 billion in expanding and modernising its fleet as part of an effort to decrease unit costs and increase fuel efficiency, the airline is set to take advantage of any upside in demand. Another of the Group’s businesses, Lufthansa Technik, is expected to generate stable revenues and profit year-on-year, maintaining its Original Equipment Manufacturers (OEM) partnerships in the Maintenance, Repair and Operations (MRO) business and taking advantage of opportunities to expand in Asia.
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