Air Astana plots Asian growth and joint ventures after record year despite currency challenges

Air Astana rebounds from currency devaluation but network trimmed. IPO still planned

The 11-Feb-2014 currency devaluation, essentially done to make Kazakhstan competitive with Russia, whose rouble was declining, required Air Astana to re-value its debt, incurring a paper USD48 million loss almost instantly. Its 1H2014 operating profit was down 28% to USD11.7 million.

But a rebound saw its 9M2014 profit up 25% to USD79.5 million. CEO Peter Foster expects to end 2014 with a 30% higher operating profit than in 2013.

Air Astana annual profit: 2002 to 2013

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Source: CAPA - Centre for Aviation & company reports

By the end of Feb-2014 Air Astana had implemented a cost-saving programme that included cutting routes and postponing expansion.

See related reports: Air Astana delays expansion, faces short-term challenges. But long-term outlook remains bright

Air Astana cuts capacity to Russia and Ukraine

Amsterdam-Atyrau frequency was reduced while Kazran and Samara in Russia were also reduced. Also in Russia, Astana-Orenburg and Atyrau-Moscow were suspended. Air Astana did not grow in Moscow in 2014 but plans to do so in 2015.

Russia is still Air Astana's largest market, accounting for about 25% of total international seats. Air Astana serves seven Russian points.

In summer 2015 Air Astana expects to be above summer 2013 levels, meaning a full rebound from 2014's difficulties. Air Astana is also considering new cities in Russia with population sizes around two to five million.

Air Astana international seat capacity by country: 15-Dec-2014 to 21-Dec-2014

Source: CAPA - Centre for Aviation and OAG

Air Astana also has made adjustments in the Ukraine market, which it entered in 2013 following the collapse of Aerosvit. Almaty-Kiev has been reduced from six times weekly to three weekly while three weekly Astana-Kiev service has been suspended. Point-to-point Ukraine-Kazakhstan traffic has effectively disappeared and Air Astana has been unable to maintain its previous size only with connecting traffic.

Air Astana sees a silver lining in Russia issues

Air Astana was worried in early 2014 that the weak tenge would dampen demand. But there has been something of a silver lining in that Air Astana believes the Russian downturn has made Kazakhstan - close to Russia but different enough - attractive.

Air Astana also benefitted from previously planned measures, including new 767s that brought a 6% cost saving, and 2013's re-negotiation of leases for three A320s. "Things came into play when they were needed," CEO Peter Foster reflects.

Fuel is now a worry. Air Astana uplifts 70% of its fuel locally and hedges half of its foreign fuel requirement, so approximately 15% of overall fuel. "We've been caught on our hedges," Mr Foster says. "Those hedges are now underwater." Air Astana had been somewhat insulated during 2014 as contracted refineries took the hit on lower fuel prices. This is catching up on Air Astana but will be offset by lower fuel prices.

Air Astana has paid dividends since 2006 to its shareholders, the government and BAE Systems. It still expects to eventually access capital markets in advance of its re-fleeting and expansion. Mr Foster expects Air Astana will need approximately USD800 million to fund future aircraft deliveries, including USD300 million for three 787s and USD500 million for 11 next-generation narrowbodies.

Re-fleeting decision to be made in 2015

Air Astana's 787s are due for delivery in 2019 while a narrowbody decision (A320neo family or 737 MAX) will be made in 2015 for delivery in 2018. Air Astana will later look at replacing its Embraer regional jets.

Air Astana Fleet Summary: as at 12-Dec-2014

Source: CAPA Fleet Database
Firm orders include those placed directly by the operator and by lessors assigned to the operator, from 8-Dec-2014 onwards.

Air Astana's planned 11-aircraft narrowbody order will replace its 757 fleet of five and older (c.1999) A321s with some growth planned for medium-haul services. Air Astana has retrofitted its 757s with lie-flat business class seats and personal entertainment screens in economy, and as such could extend the 757s' life to 2018 or 2019. Like other niche carriers, Air Astana has found the 757 to be unique and a challenge to replace. "They do a jolly good job for us," Mr Foster said.

Air Astana is looking at the 737 MAX 9 and Mr Foster said of the A321neo LR that "it has been suggested" the carrier could be the launch customer for the type. Delivery could occur in 2018.

Air Astana expects the new narrowbody's range to cover all of Europe from Astana (where its European flights mostly depart), all of China from Astana and Almaty, most of Southeast Asia from Almaty and possibly some Southeast Asia from Astana. Air Astana serves China from its two hubs while other Asian points are mostly served from Almaty, which is southeast of Astana and therefore closer to Asia. (Air Astana in Dec-2014 launched Astana-Bangkok service, complementing existing Almaty-Bangkok service. Hong Kong, Kuala Lumpur and Seoul Incheon are served from Almaty.)

See related report: Air Astana to replace 757s with A321neos, eyes new generation 757 (797?) as long-term solution

Launch of Air Kazakhstan could be a benefit to Air Astana

Kazakhstan officially has a few dozen licensed airlines, but effectively the competition comes down to Air Astana, SCAT and Bek Air. Late 2015 could see the entry of government-backed Air Kazakhstan, but Air Astana views this as a positive development.

Air Kazakhstan plans to operate Bombardier Dash 8-Q400 turboprops, smaller than the regional jets Air Astana operates, and be able to serve more regional destinations than Air Astana can - or wants to. Although a deal is far from sealed, Mr Foster wants to see the carrier launched and assumes Air Kazakhstan will find mutual benefit in a partnership with Air Astana.

Air Astana benefits from being the only airline in the domestic Kazakh market with a premium product. Air Astana's reputation also means it can attain a yield premium, but Air Astana's domestic fares are capped by the government.

2014 will show 2-3% capacity growth, 2015 will expand by 7%

Air Astana initially planned 14% ASK growth in 2014 but following the currency devaluation decided to keep capacity at 2013 levels. It has since made some small adjustments and will end with 2-3% growth.

Planned 7% growth for 2015 will be above GDP levels, requiring Air Astana to tap transfer markets. Air Astana expects to grow at 7% the next five years except in 2017, when Kazakhstan hosts Expo-2017. That year Air Astana expects to grow by 14%.

Flights to Paris to be launched while Prague may be postponed

Air Astana has already announced plans to grow in Tel Aviv and Europe in 2015. As CAPA wrote in Jun-2014:

Europe is now a focus for expansion as the EU finally lifted restrictions on Air Astana in Apr-2014. Kazakhstan has been on the EU blacklist since 2009 (and other Kazakh carriers remain on the blacklist). Over the past five years Air Astana had an exemption which allowed it to maintain 16 weekly flights to the EU but it could not add new flights. Air Astana is now finally free to add flights to the EU, which currently only accounts for 12% of its international seat capacity.

Air Astana has elected not to immediately open new scheduled destinations in Europe. But the carrier is using its new EU rights to operate summer charters to Barcelona, Heraklion and Rhodes, which helps to partially offset the reduction in 757/767 utilisation levels. (Air Astana also has enhanced its charter programme to Antalya in Turkey, which was not impacted by the EU ban as Turkey is not in the EU.)

Meanwhile Air Astana has already unveiled plans to launch Paris and Prague in 2015 although has not yet set launch dates. Both routes will likely be served from Astana given the carrier's focus on using the Astana hub for Europe.

The focus is on launching Paris, and ideally moving from its allocated terminal one to terminal two, where there are airline and rail connecting opportunities. Prague may be pushed back or served over a limited period of time, reflecting the seasonality of the market, which has strong point-to-point traffic with Kazakhstan.

Air Astana international seat capacity by region: 15-Dec-2014 to 21-Dec-2014

Source: CAPA - Centre for Aviation and OAG

Growth in Asia planned in Chengdu, Seoul, Shanghai and Tokyo

Air Astana is shifting Asian growth from what will be strong outbound Kazakhstan markets to strong inbound markets. Even though Air Astana is launching Astana-Bangkok flights in Dec-2014, there are surprisingly some inbound group tours ex-Thailand.

Traffic ex-Korea is quickly growing and Air Astana has increased from two weekly Almaty-Seoul Incheon flights on the 757 to three weekly on the 767. Winter is normally a slow season for Air Astana, but winter 2014/2015 shows strong traffic from Seoul.

Air Astana hopes to introduce Seoul service from Astana, complementing Almaty services, but needs the bilateral to be expanded. Also needing expansion, and likely to be concluded in early 2015, is the China-Kazakhstan bilateral that will open Chengdu and Shanghai.

Air Astana has swapped the 757 on Hong Kong with the 767 on Kuala Lumpur. Neither route needs the 767 but the smaller aircraft type was placed on Kuala Lumpur as it is longer, reducing unnecessary expenses.

In 2016 Air Astana hopes to launch 767 service to Tokyo, but Mr Foster says the carrier will almost certainly need a partnership with All Nippon Airways and Japan Airlines, neither of which serve the region. Air Astana will likely link Tokyo with Almaty given an expectation that Japanese will like the golfing opportunities in Almaty while business passengers will be willing to continue to Astana on a connecting service.

Mumbai and Mongolia's Ulaanbataar are prospective destinations as well. Air Astana believes it can have a role in Frankfurt-Ulaanbataar traffic but current schedules do not enable Air Astana to get to Ulaanbataar and back in time for the Frankfurt flight. The Frankfurt flight could have its timings changed but this would then limit connecting opportunities beyond Frankfurt.

The Maldives (possibly linked with Sri Lanka) and Denpasar (Bali) are prospective charter destinations but Air Astana has not yet found the charter season to be long enough to warrant service.

Air Astana seeks joint ventures with Asiana and Etihad. Has no interest in global alliance

Air Astana partners with Asiana, which in Dec-2014 flies twice weekly to Almaty. Korean Air does not serve Kazakhstan.

The Asiana partnership, amongst other things, gives Air Astana offline access to North America on Asiana's trans-Pacific network. Mr Foster hopes to grow the relationship to a joint venture.

Air Astana is also seeking a JV with Etihad covering the Astana-Abu Dhabi route, which Mr Foster says is too small to be served competitively between the two. Emirates does not serve Kazakhstan from Dubai although sister LCC flydubai does, with its narrowbody. Mr Foster again envisions a cost and revenue sharing JV, which he believes will "reduce the incentive to manipulate onward inventory to the detriment of the code".

The possible Etihad JV will be more focussed around transfer traffic than Asiana. Air Astana does not envision a global partnership with Etihad but rather one around the Gulf and Middle East and perhaps Africa. Saudi Arabia would be particularly good to have onward access to, but Mr Foster worries Saudi's restrictive policies may limit third-country codeshares.

Air Astana re-looked at options for joining a global alliance. An evaluation was recently done with Seabury but Mr Foster says the conclusion was unequivocally clear against a global alliance. "There's no reason for us to have to limit ourselves to one group of people," Mr Foster says.

It is a position Air Astana enjoys given limited competition in the region. There is no other competing hub: Istanbul is too far west while Moscow is too north for many of Russia's southern cities. Air Astana will seek the best of all worlds without, for example, feeling it has to give special pro-rated fares to alliance members.

Dynamic partnerships, as Air Astana calls them, are also with Turkish Airlines and Air India in addition to Asiana and Etihad. There are also blocked space codeshares with KLM and Austrian. Mr Foster also expects shortly to announce a partnership with Bangkok Airways that will help improve Air Astana's Bangkok flights. (Air Astana already interlines with Bangkok Airways, which provides access to Air Astana with offline destinations in Thailand and neighbouring countries.)

Transfer traffic grows, but Almaty airport and bilaterals are limiting

Air Astana's transfer business has developed partially by design and partially accidentally. Air Astana did set out on an "extended home market" strategy to bring traffic to its under-served neighbours, increasing its catchment area from the 17 million people in Kazakhstan to 60 million in neighbouring countries. But some passenger flows that have emerged were not predicted.

"We're carrying traffic we didn't realise existed," Mr Foster says. Driving much of the recent increase in transfer traffic has been Urumqi-Tashkent. Local flights were suspended and have resumed, but Air Astana still carries transfer traffic.

The carrier is now thinking more strategically about new transfer opportunities in under-served markets, such as Beijing-Dubai and Hong Kong-Istanbul. Given Air Astana's limited size, a small group tour can mean a boost in passengers it would otherwise have flown without. With an average 66% load factor in 2014 (including a higher 75% load factor in business class), there are empty seats to sell. Mr Foster however is mindful of maintaining yields, noting "we've never been a load factor-driven airline".

Air Astana does not see itself having the scale to offer intercontinental-intercontinental connections, which it views as low-yielding for the existing mega carriers. "We would be on the bottom end of it," Mr Foster says. But if it wanted to actively pursue this market, it faces the logistical challenge of managing dual hubs in Almaty and Astana.

From a passenger point of view the hubs are dual, but from within the company Almaty is the bigger operational base as only two E190s and one A320 are based at Astana.

Air Astana is exasperated with Almaty airport given the airport's limited size and antiquated facilities that are "wholly inadequate" for transfer passengers. "Almaty airport doesn't seem to be able to come up with any plan for expansion," Mr Foster said. Air Astana does see its traffic shifting more and more from Almaty to Astana but still needs an updated Almaty airport. Astana will be the focus for growing sixth freedom traffic.

Almaty is in the running with Beijing to host the 2022 winter Olympics. If Almaty is successful, Mr Foster expects the Olympic Committee's decision to "absolutely impel the government to step in and force change" at Almaty airport.

The Olympic Committee considers overall facilities. The current Almaty airport will not meet their specifications but the committee could award Almaty the games with an undertaking that the airport must be expanded.

Visa liberalisation has helped with transfer traffic growth

Where Air Astana has had support is in the liberalisation of visas, precluding visitors from having to arrange a visa in advance. Visa-free policies exist for 10 major markets. Air Astana has had to push the government to do this. Visa-free status makes transfer traffic easier but also allows Air Astana to introduce a Kazakhstan stop-over, sometimes necessary because of how flights connect. In the year to 30-Sep-2014 (before visa liberalisation) Air Astana booked 900 hotel room nights in Kazakhstan but will increase this to 1,200 in the year to 30-Sep-2015. Based on double occupancy, Air Astana equates full use of these rooms to 8,000 passenger segments. Air Astana does not pay for unused nights. Average length of stay is two nights.

Air Astana's growing transfer business involving its neighbouring countries has however drawn the ire of those nations. Azerbaijan, Kyrgyzstan, Tajikistan and Uzbekistan are not expanding bilateral access, leaving Air Astana with no capacity expansion possible.

The good news however may be Air Astana's low load factor, although it would still like to grow in many markets. Reports have said Austria and Kazakhstan will meet to expand their bilateral, but this presumably will be done for the benefit of Austria; Mr Foster says Air Astana is not interested in serving Austria.

Air Astana is not involved in carrying much freight to/from Kazakhstan (or via the country), and is not interested in this segment. Kazakhstan produces almost no goods that require transport by air while transfer cargo is limited by a number of factors, including the government requiring transit cargo to be cleared in Kazakhstan.

Outlook: Air Astana is coming of age. Slowing growth but still positive outlook

Air Astana is set to close 2014 with record performance. But were it not for the tenge's devaluation, Air Astana would likely have done better, with Mr Foster expecting an operating profit around USD100 million.

Many expect a further devaluation of the tenge. Air Astana implied it would respond as it did to the previous devaluation by making changes rather than asking for handouts.

Air Astana wants to maintain a commercially-driven orientation; Mr Foster stresses "I would rather die than request government subsidies." Although another devaluation will not be pleasant, Air Astana has shown it can respond - and has new opportunities lined up.

2014, although successful, will leave something of a missed opportunity (albeit from factors beyond Air Astana's control) in terms of network growth. Air Astana expects to get back on track in 2015 although growth in the medium term will be tapered. This reflects Air Astana becoming mature and growing off a larger basis than previously.

Central Asia continues to be a small but growing part of the world, and one devoid of serious competitive threats to Air Astana. Maintaining steady growth and not having an over-ambitious strategy will continue to serve Air Astana well.