05-Oct-2014 2:00 PM

Croatia Airlines' privatisation is back on the agenda, helped by restructuring and return to profit

Analysis

Croatia Airlines celebrated its 25th anniversary this summer, after reporting a return to profit in 2013 and a narrowing of losses in the seasonally weak first half of 2014. It also underwent a recapitalisation in 2013 and the Croatian government now appears to be ready to restart the on-off privatisation of the airline.

Potential acquirers will be encouraged by the improving profit trend, driven mainly by cuts in unit costs (CASK). However, Croatia Airlines still has one of the highest levels of CASK in Europe.

Moreover, the balance sheet may be out of intensive care after the recapitalisation, but it is in need of further strengthening, given that the airline has four Airbus A319s due for delivery in 2015 and is considering a further order of aircraft to fill the gap between its Airbus fleet and its Bombardier Q-400s.

In this first of two reports, we analyse Croatia Airlines' finances and its track record of unit revenue versus unit cost. This analysis will be followed by a second report looking at its network and market position.

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According to press reports, Croatia's government plans to resume the privatisation process for Croatia Airlines in spring 2015, with Ministry of Maritime Affairs, Transport and Infrastructure to devise a tender process by the end of Oct-2014 (Jutarnji list, 19-Sep-2014). The government hopes to appoint external advisors by the end of 2014, before a three month consultation process.

Croatia Airlines returned to profit in 2013 for the first time since 2007

In 2013, Croatia Airlines recorded both a positive operating and net result for the first time since 2007, before the global financial crisis. Its consolidated net profit was just HRK1.4 million (EUR0.2 million) and its operating profit of HRK20.8 million (EUR2.7 million) represented an operating margin of just 1.3% of sales, but the margin improvement was 4.8 ppts versus 2012. Sales revenue fell by 7.3% to HRK1,444 million (EUR189 million).

Croatia Airlines consolidated financial* and operating highlights: 2013 versus 2012

HRK million except where stated	2012	2013	2013 vs 2012
Sales revenue	1,546.9	1,433.9	-7.3%
Total operating revenues	1,690.1	1,583.0	-6.3%
Operating result	-58.4	20.8	-135.6%
Operating margin %	-3.5	1.3	4.8 ppts
Net result	-487.8	1.4	-100.3%
Net debt	421	229	-45.6%
Equity	147	357	142.6%
ASK million	2,086	1,922	-7.9%
Passenger load factor %	69.1	68.8	-0.2 ppts
CASK HRK	0.84	0.81	-3.0%
CASK ex fuel HRK	0.66	0.64	-2.5%
RASK HRK	0.81	0.82	1.7%

Croatia Airlines last reported a profit in 2007, but racked up heavy losses in the period 2008 to 2012, putting heavy stress on its balance sheet.

Croatia Airlines consolidated revenues (right hand axis), operating profit and net profit (HRK million): 2007 to 2013

Balance sheet has been strengthened, but liquidity needs improving further

A recapitalisation to the extent of HRK206 (EUR27 million) was carried out during 2013. This was effectively achieved through the conversion of debt into equity. The Croatian government owned 97% of the shares of the company at the end of 2013. Mainly as a result of this recapitalisation, net debt was almost halved to HRK229 million at the end of 2013 and equity increased from HRK147 million to HRK357 million.

The capital restructuring and the absence of further losses in 2013 has relieved some of the strain on the consolidated balance sheet, but Croatia Airlines' liquid assets remain slight. The gross cash balance increased from HRK37 million to HRK52 million.

This level of liquidity at the end of 2013 was equivalent to only 12 days of revenues (although this was an improvement from the eight days of revenues at the end of 2012). It should be noted though that to some extent, this low cash balance reflects the low season timing of the year end. The 1H2014 accounts reveal HRK163 million of cash at the end of Jun-2014, around six weeks of revenues.

Croatia Airlines development of consolidated cash and debt (HRK million): 2007 to 2013

ASKs were down 7.9% in 2013

Croatia Airlines is part way through a restructuring plan for the period 2011 to 2015, although the final version of the plan was not approved by the Croatian Competition Agency until Jun-2013. The plan, including the state-backed recapitalisation, was approved just before Croatia joined the European Union, which may have taken a tougher stance on state aid.

As part of the plan, the airline cut capacity significantly in 2013, after seeing growth in the previous two years, reducing ASKs by 7.9%. Capacity was also negatively affected by an eight day pilot strike in May-2013. RPKs fell by 8.2% and the load factor dipped by 0.2 ppts to 68.8%. This followed load factor gains totalling almost 8 ppts over the three previous years.

This level of load factor remains low by industry standards, although it is more in keeping with that of regional airlines, and this should be an area for future focus.

Croatia Airlines ASK, RPK (million, left hand axis) and passenger load factor (%, right hand axis): 2007 to 2013

Passenger numbers fell by 7.9% in 2013, a similar rate to the drop in RPKs since average trip length was broadly stable. The passenger decline was slightly heavier in international markets, where it was -8.8%. This reversed the trend of 2012, when international passenger numbers (+4.7%) grew faster than domestic traffic (+1.7%).

By country, the biggest rates of fall in passenger numbers were Macedonia (-19.4%), UK (-16.2%), Bosnia & Herzegovina (-13.1%), Italy (-11.5%) and Netherlands (-11.3%). Croatia Airlines' passenger numbers to Belgium increased by 41.9% in 2013, reflecting a capacity increase to Brussels by two thirds in the summer schedule (since reversed in the summer of 2014).

Croatia Airlines passenger numbers ('000) domestic and international: 2013 vs 2012

Region	2012	2013	2013 vs 2012
Domestic scheduled	501	474	-5.4%
International and charter	1,451	1,323	-8.8%
Total	1,952	1,797	-7.9%

Croatia Airlines passenger numbers ('000): 2007 to 2013

Sales down 7.3% and total operating revenue falls 6.3% in 2013

Sales revenue fell by 7.3% in 2013 and total operating revenue was down 6.3%, less than the cut in ASKs. Although scheduled passenger revenue was down by 8.3%, this was mitigated by a 2% increase in charter revenue, flat other revenue and a 4% increase in other operating revenue, of which the largest part is government support for maintaining domestic flights. Cargo revenues fell by 15.1%.

Passenger revenue performance was bolstered by the impact of new revenue management systems and a codeshare arrangement with Star Alliance partners. United Airlines was added to Croatia Airlines' list of codeshares in Dec-2013. Passenger revenue per RPK was actually slightly up (+0.5%), but the load factor decline meant that passenger revenue per ASK was flat. Total operating revenue per ASK was up 1.7%.

Croatia Airlines sales revenue* by category (HRK million): 2012 and 2013

HRK million	2012	2013	2013 vs 2012	% of 2013 total
Scheduled passenger	1,352	1,241	-8.2%	78%
Charter passenger	77	78	2.0%	5%
Cargo traffic	21	17	-15.1%	1%
Other	97	98	0.1%	6%
Total sales revenue	1,547	1,434	-7.3%	91%
Other operating income	143	149	4.1%	9%
Total operating revenues	1,690	1,583	-6.3%	100%

Passenger revenue was down across all geographical regions, although it held up best in Croatia (-4.4%), while USA revenues fell the most heavily (-11.1%).

Croatia Airlines passenger traffic revenue by geography (HRK million): 2012 and 2013

HRK million	2012	2013	2013 vs 2012	% of 2013 total
Croatia	443	423	-4.4%	32%
Germany	156	141	-9.4%	11%
USA	154	137	-11.1%	10%
Other	676	617	-8.7%	47%
Total passenger revenue	1,429	1,319	-7.7%	100%

2013 costs were down 10.7%

Operating costs fell by 10.7% in 2013, faster than the fall in capacity and revenues. This was helped by a 12.5% decline in fuel costs, while non-fuel costs were down by 10.1%, more than the cut in capacity as a result of lower prices.

Labour costs fell by 6.4%, more than the 4.6% reduction in average headcount, but less than the capacity cut. The only cost category to grow in 2013 was maintenance, reflecting increased third party services and higher de-icing costs.

Total cost per ASK (CASK) fell by 3.0% and ex fuel cost per ASK was down 2.5%.

Croatia Airlines operating costs* (HRK million): 2012 and 2013

HRK million	2012	2013	2013 vs 2012	% of 2013 total
Flight operations	618	566	-8.5%	36%
Aircraft & traffic services	374	354	-5.5%	23%
Promotion & sales	231	212	-8.4%	14%
Maintenance	155	157	1.1%	10%
Depreciation/amortisation	130	83	-36.1%	5%
Passenger service	113	87	-23.7%	6%
General & admin	104	94	-10.1%	6%
Other	22	11	-49.3%	1%
Total costs	1,748	1,562	-10.7%	100%

Croatia Airlines fuel and labour costs* (HRK million): 2012 and 2013

HRK million	2012	2013	2013 vs 2012	% of 2013 total
Fuel	380	332	-12.5%	21%
Labour	293	274	-6.4%	18%
Other costs	1,076	956	-11.2%	61%
Total costs	1,749	1,562	-10.7%	100%

Croatia Airlines 1H2014 losses narrowed

The pattern of lower capacity, cost cutting and improved profitability appears to have continued into 1H2014. In the first six months of this year, Croatia Airlines reduced its net loss by more than a half and narrowed its operating loss by almost two thirds. Its 1H capacity cut was only modest, with ASKs down just 0.4% year on year, but passenger numbers and RPKs were down 1%, leading to another dip in load factor (down 0.4 ppts to 64.7%).

The narrower 1H operating loss was primarily due to a further reduction in CASK, which fell by 4.5%. Sales revenue per ASK fell by 1.9%, suggesting some price pressure in Croatia Airlines' markets, but a strong contribution from other operating revenue meant that total revenue per ASK was up 2.0%.

Croatia Airlines consolidated financial* and operating highlights: 1H2014 versus 1H2013

HRK million except where stated	1H2013	1H2014	1H2014 vs 1H2013
Sales revenue	596.0	582.0	-2.3%
Total operating revenues	672.8	683.2	1.5%
Operating result	-77.4	-29.8	-61.5%
Operating margin %	-11.5	-4.4	7.1 ppts
Net result	-77.7	-37.2	-52.1%
ASK million	890	886	-0.4%
Passenger load factor %	65.1	64.7	-0.4
CASK HRK	0.84	0.80	-4.5%
CASK ex fuel HRK	0.67	0.64	-4.5%
RASK HRK	0.76	0.77	2.0%

Fleet numbers reducced from 13 to 12 aircraft

Croatia Airlines operated a fleet of 13 aircraft in 2013: four A319s, three A320s and six Q-400s. The fleet's average daily utilisation fell from 8.1 hours in 2013 to 7.9 hours in 2013, a drop of 2.5%, further widening the gap with major LCCs such as Ryanair and easyJet.

In 1H2014, total block hours increased by 3%, although the fleet was smaller by one aircraft, suggesting that daily utilisation rose once more. The very seasonal nature of Croatia Airlines' business (its Feb-2014 seat capacity was only 60% of its Aug-2013 capacity, according to OAG data) provides a challenge in maintaining high average utilisation rates.

One operating leased A320 was returned to the lessor in Dec-2013, reducing the year end fleet to 12 aircraft. The six Q-400s are on operating leases, while the remaining A320 family aircraft are owned by Croatia Airlines. According to the CAPA Fleet Database, the fleet remains at this year end size currently. Its average age is 10.5 years.

Croatia Airlines plans to explore fleet options following the completion of its restructuring programme in 2015, according to CEO Krešimir Kučko (IATA, 21-Aug-2014). Mr Kučko said: "One item on the agenda is new aircraft. In particular, we are interested in obtaining something in the 100-seat market as a means of bridging the gap between our turboprop fleet and the Airbus fleet. This would really help us to consolidate our position in the market and realize the full potential of our new network strategy."

According to the CAPA Fleet Database, the airline has four A319s on order, with delivery expected in 2015. These were originally due for delivery in 2013 and 2014, but were delayed as part of the restructuring programme.

Croatia Airlines fleet utilisation 2013

CASK is now on a downward path, while RASK continues upward, a healthy trend

The most encouraging aspect of 2013's return to profit and the narrowing of 1H2014 losses is that Croatia Airlines now appears to be on a downward CASK path after seeing its unit costs increase from 2009 to 2012. RASK has been trending upwards since 2010.

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 2013 (indexed to 100 in 2007).

Croatia Airlines index of unit revenues (total revenue per available seat kilometre, RASK) and unit costs (cost per available seat kilometre, CASK) 2007 to 2013 (indexed to 2007 = 100)*

Restructuring is having a a positive impact but CASK remains one of the highest in Europe

The following chart shows Croatia Airlines on a scatter plot of CASK versus average trip length, in comparison with other European airlines. CAPA's analysis shows that it has one of the highest levels of CASK in Europe. This partly reflects its very short average trip length and small aircraft, but it sits above the trend line on the chart, suggesting that its cost base is higher than it needs to be.

The restructuring programme is starting to have an impact, but Croatia Airlines cannot afford to let up in its drive for lower costs. In our second report on the company, we will look at its network and competitive position.

Unit costs (cost per available seat kilometre, USc) and average sector length for Croatia Airlines and selected other European airlines 2013*