04-Sep-2013 8:00 PM

Croatia Airlines: loss-making, high-cost and in need of capital. Any takers?

Analysis

In part one of our report on Croatia Airlines, we looked at its network and considered its possible appeal to any prospective bidder if the Croatian Government proceeds with reported plans to sell a stake in its national carrier. Interest will likely focus on the international market from Croatia, where it has some strong market positions, although it would bring only limited additional European access to a major Asian or Middle Eastern carrier and faces growing LCC competition.

In this second and final part of our report, we examine Croatia Airlines' finances and cost base. The group is loss-making since 2008, with a high-cost CASK structure and liable to need fresh equity capital (on top of that provided by the government in a debt to equity swap in 2012).

Having considered any strategic interest in Croatia Airlines, potential bidders will need to assess the feasibility and timing of any return to profitability and factor in the likelihood of having to inject more cash into the company. It will be a challenging sale.

Another year, another loss in 2012

Croatia Airlines recorded another loss in 2012 (it has not achieved breakeven since 2007), with a net loss of HRK487 million (EUR65 million) in spite of a 6% increase in total operating revenues to HRK1,690 million (EUR225 million).

The net result was heavily weighed down by an impairment charge of HRK299 million (EUR40 million) relating to the revaluation of six Airbus A320 aircraft. However, the operating result was also negative, underlining the problem that operating costs were not covered by operating revenues. Moreover, revenues were 1% lower than planned and costs were 3% higher (relative to Croatia Airlines' own plan).

Croatia Airlines financial* and operating highlights: 2012 vs 2011

HRK million expect where stated	2011	2012	2012 vs 2011
Total operating revenues	1,595	1,690	5.90%
Operating result	-44	-58	33.30%
Operating margin %	-2.7	-3.5	-0.7 ppts
Net result	-113	-488	331.3%
Cash	25	37	46.1%
Total debt	1,251	458	-63.4%
Net debt	1,226	421	-65.6%
Equity	-142	147	-203.8%
ASK million	1,965	2,086	6.2%
RPK million	1,317	1,441	9.4%
Passenger load factor %	67.0	69.1	+2.1 ppts
Pax 000	1,879	1,952	3.9%
CASK HRK	0.83	0.84	0.5%
CASK ex fuel HRK	0.66	0.66	-1.0%
RASK HRK	0.81	0.81	-0.2%

The group's 2012 operating loss of HRK58 million (EUR8 million) was HRK14 million more than in 2011 and was its fifth successive negative result. It had been narrowing losses from 2009 to 2011 and so 2012 was an unwelcome reversal of this trend. In 2012, RASK fell slightly while CASK increased slightly.

Croatia Airlines revenues (right hand axis), operating profit and net profit (HRK million): 2007 to 2012

Further equity may be needed

Croatian Airlines' Group balance sheet saw some improvement in 2012, although it remains highly stressed. The Croatian Government, which directly owns 98% of the shares, swapped its debt for equity at the end of 2012, when the share capital of the company was increased by HRK862 million (EUR114 million). This was part of the restructuring plan, which runs to 2015.

This accounts for the lowering of debt and the restoring of a positive equity figure in 2012, but the year-end gearing ratio (net debt to equity) was still at the high level of 287%. Moreover, the group's cash balance of HRK37 million (EUR5 million) was equivalent to only eight days of revenues.

Any potential bidder is likely to need to consider injecting further new equity, particularly if the transaction is part of a plan to use Croatia Airlines' Zagreb hub as a base from which to increase connectivity with the rest of Europe, necessitating new aircraft orders at some point. This is likely to reduce the sum a bidder may be prepared to pay for all or part of the government's stake in the company. It would not even be a surprise for bidders to require that the government pays them to take the airline (thereby ending the government's need to support it).

Croatia Airlines development of cash and debt (HRK million): 2007 to 2012

Passenger growth again in 2011 and 2012, but load factors are low

Croatia Airlines has seen growth in passenger traffic in each of the past two years, after contracting from 2008 to 2010. In 2012, ASKs were up 6.2%, with RPKs up 9.4% and passenger load factor gaining 2.1 ppts to reach 69.1%. Its load factor has improved from just over 61% in 2009, but remains low by comparison with other AEA member airlines, for whom the 2012 average was 79.1%.

Load factors tend to be lower on short-haul routes, but Croatia Airlines' figure is lower than the AEA's 73.0% for routes within Europe. Any bidder will want to consider ways in which to improve its performance further, whether through improved feed, product enhancements, price stimulation, more targeted capacity management, or by other means.

Croatia Airlines ASK, RPK (million, left hand axis) and passenger load factor (%, right hand axis): 2007 to 2012

Passenger numbers were just short of 2 million in 2012, an increase of 3.9% versus 2011, less than the growth in RPKs. This highlights the increase in the average passenger haul of 4.4%, to reach 648km (this figure was 646km in 2007 and has seen only relatively minor annual changes since then), as international passenger growth outpaced domestic passenger growth.

Croatia Airlines passenger numbers domestic and international ('000): 2012 vs 2011

Region	2011	2012	2012 vs 2011
Domestic	493	501	1.7%
International	1,386	1,451	4.7%
Total	1,879	1,952	3.9%

Croatia Airlines passenger numbers ('000): 2007 to 2012

Revenues up 5.9% in 2012

The group's sales revenue grew by 7.4% in 2012, reflecting growth in scheduled passenger revenues, which accounted for 80% of total operating revenues. Charter and cargo revenues grew more rapidly, but were only a small part of the total. Other operating income, which accounted for 8% of the total and mainly consist of government support for maintaining domestic flights, fell by 7.8%. Total operating revenues grew by 5.9% and total RASK was just below flat (-0.2%).

Croatia Airlines sales revenue* by category (HRK million): 2011 and 2012

HRK million	2011	2012	2012 vs 2011	% of 2012 total
Scheduled passenger	1,256	1,352	7.6%	80%
Charter passenger	63	77	21.9%	5%
Cargo traffic	16	21	27.3%	1%
Other	105	97	-6.9%	6%
Total sales revenue	1,440	1,547	7.4%	92%
Other operating income	155	143	-7.8%	8%
Total operating revenues	1,595	1,690	5.9%	100%

Passenger traffic revenues (scheduled plus charter) grew by 8.3% in 2012. Geographically, the strongest sales growth was recorded in Croatia (up 38%), while US sales revenues fell by 47%. Although the domestic market accounted for only 26% of its 2012 passenger numbers, Croatia accounted for 41% of passenger revenues, underlining its importance as a point of sale. The rest of Europe accounted for 53% of sales, of which Germany represented 9%.

Croatia Airlines passenger traffic revenue by geography (HRK million): 2011 and 2012

HRK million	2011	2012	2012 vs 2011	% of 2012 total
Croatia	424	584	38.0%	41%
Germany	135	135	0.2%	9%
USA	152	80	-47.0%	6%
Other	609	629	3.2%	44%
Total passenger revenue	1,319	1,429	8.3%	100%

Croatia Airlines passenger traffic revenue by geography (HRK million): 2009 to 2012

Costs up 6.7%

Total operating costs grew by 6.7%, a little faster than ASK growth, so that unit costs (CASK) grew by 0.5% in 2012. Flight operation costs, which accounted for 35% of the total, grew by 10%, largely due to a 13% increase in fuel costs. All other major cost categories grew more slowly than ASK growth, although growth in passenger service costs and general/administration costs outstripped capacity growth. Labour costs grew by 4.2%.

The company's restructuring plan aims to reduce costs by HRK50 million in 2013 and to introduce a redundancy scheme for 250-290 employees.

Croatia Airlines operating costs* (HRK million): 2011 and 2012

HRK million	2011	2012	2012 vs 2011	% of 2012 total
Flight operations	562	618	10.0%	35%
Aircraft & traffic services	362	374	3.3%	21%
Promotion & sales	218	231	6.4%	13%
Maintenance	145	155	6.9%	9%
Depreciation/amortisation	140	130	-7.1%	7%
Passenger service	102	113	11.6%	6%
General & admin	90	104	15.4%	6%
Other	20	22	7.4%	1%
Total costs	1,639	1,748	6.7%	100%

Croatia Airlines fuel and labour costs* (HRK million): 2011 and 2012

HRK million	2011	2012	2012 vs 2011	% of 2012 total
Fuel	337	380	12.8%	22%
Labour	281	293	4.2%	17%
Other costs	1,021	1,076	5.3%	62%
Total costs	1,639	1,749	6.7%	100%

Average fleet age over 11 years

Croatia Airlines' fleet totalled 13 aircraft at the end of 2012, unchanged from 2011. There were seven A320 family aircraft and six Dash Q-400s. In 2012, Croatia Airlines leased one A320 and all of its six Dash Q-400s. The A320 lease expires in Dec-2013. The 2011-2015 restructuring plan sees a reduction in the number of routes, fleet restructuring in favour of lower-capacity aircraft and the sale or lease of one or two Airbus aircraft.

The average fleet age was 11.1 years, with the Airbus fleet average age closer to 14 years. This is something of a competitive disadvantage relative to the major European LCCs with whom Croatia Airlines competes on international routes and whose fleet ages tend to be in the single digit number of years.

According to the CAPA Fleet Database, the fleet had reduced by one A320 as of 4-Sep-2013 (perhaps the leased aircraft due to expire in Dec-2013) and Croatia Airlines expects to take delivery from lessors of two A320s in each of 2013 and 2014.

Croatia Airlines fleet as at 31-Dec-2012

The fleet's average daily utilisation increased by 1.3% in 2012 to 8.1 hours, but this remains low compared with major LCCs such as Ryanair and easyJet. Croatia Airlines' short average sector length to some extent hinders its ability to increase utilisation, but this figure leaves scope for improvement nevertheless.

Croatia Airlines fleet utilisation: 2012

CASK growth outpaced RASK growth 2007 to 2012

The chart below shows the development of Croatia Airlines' unit revenues (total revenue per available seat kilometre, RASK) and unit costs (cost per available seat kilometre, CASK) from 2007 to 2012 (indexed to 100 in 2007). Since 2007, the last year in which it made an operating profit, RASK has grown by 11% while CASK has grown by 19%. Croatia Airlines has done a reasonable job in containing the growth in ex fuel CASK, but even this has grown faster than RASK (up 13% from 2007 to 2012).

Since 2009, the year of heaviest operating losses, the track record has been stronger, with RASK up 23% and CASK up 13% (ex fuel CASK up only 3% and down in each of 2011 and 2012), but this has still not been enough to restore profits. Given the unpredictable nature of fuel costs, any new owner will want to focus on the group's ability to reduce ex fuel CASK more sharply.

Croatia Airlines index of unit revenues (total revenue per available seat kilometre, RASK) and unit costs (cost per available seat kilometre, CASK): 2007 to 2012 (indexed to 2007 = 100)*

Croatia Airlines is among Europe's high-cost airlines

The following chart places Croatia Airlines against other European carriers on CASK versus average sector length. This positions it squarely among the legacy carriers, with a significantly higher cost base than the LCCs. Its short average sector length would naturally lead to higher CASK than an equivalent carrier with longer-haul operations and it appears to be more efficient than SAS, but there are a number of legacy carriers with unit costs that are significantly lower, even after taking account of their longer average sector lengths. Again, a focus on CASK is vital.

Unit costs (cost per available seat kilometre, EUR cent) and average sector length for selected European legacy and low-cost carriers: 2012*