Turkish Airlines: capacity and network growth stay strong in 2013; profit growth is more challenging
In 2013, Turkish Airlines' growth in its underlying operating profit stalled as its margin slipped by 1.4ppts. The competitive environment increased the pressure on unit revenues in the latter part of the year and the carrier was unable to contain unit costs sufficiently to drive profits upwards. The weakening of the Turkish lira had the effect of inflating both revenues and costs when reported in TRY, but this does not change the underlying weaker development of RASK versus CASK. Currency losses and higher interest charges resulting from increased borrowing led to a fall in the net result in 2013.
Operationally, Turkish Airlines remains very successful, with sales enjoying another year of growth in excess of 20% and load factor making further gains. However, the fall in operating margin in 2014 and an uncertain outlook into 2014 show that converting this into sustained profit growth is proving to be less than straightforward.
Pegasus Airlines is Turkey's self-styled ‘network low-cost carrier’. It operates many of the features of the classic LCC business model: low fares, single cabin class, modern fleet, focus on internet distribution and a short/medium-haul network. But it also offers network feed (27% of international passengers in 2013) and product features that, until recently at least, have been less typically associated with LCCs in Europe. These include belly cargo, assigned seating and the use of both GDS and travel agents.
In spite of these ‘deviations’ from the purist LCC model, Pegasus has the second lowest unit costs among European airlines, bracketing it with Ryanair and Wizz Air in the ultra-LCC category.
In 2013, Pegasus increased its core operating profit by 40%, although currency movements hit the net result and a trend of rising CASK in recent years will need to be controlled. Although partly driven by exchange rate movements, and offset by a rising RASK trend, CASK increases do not sit well with any version of the LCC model.
Iberia’s 2013 pre-exceptional operating loss was an improvement on its 2012 result, but it has now seen six successive years of losses and has accumulated more than EUR1.1 billion of operating losses since 2008. Over this period, capacity cuts have not been matched by cost reduction, but revenues have tumbled more rapidly.
This reflects the difficulty in cutting the significant fixed costs in the airline business, particularly in a highly unionised legacy carrier, and the lag between the reduction of capacity (and revenues) and the removal of costs.
It has been a long path, and the end has not been reached, but the 2013 results suggest that the restructuring of Iberia may now be having a beneficial impact on its financial performance. Moreover, recent productivity agreements with unions give some reassurance that industrial relations are also on an upward path. Sustainable levels of profitability are far from assured, but, with a return to profit slated for Iberia in 2014, they can at least now be contemplated.
IAG returned to profit in 2013 after a dip into red ink in 2012. The improved results were driven mainly by unit cost reduction and by a first contribution from LCC Vueling after its acquisition on 26-Apr-2013. The group’s operating profit of EUR770 million was better than the target of EUR740 million set in Nov-2013 and broadly in line with analysts' forecasts. It was much better than the target set in early 2013, before the Vueling acquisition, to beat 2011's EUR485 million. Deducting Vueling’s contribution, the like for like operating result was EUR602 million compared with a EUR23 million loss in 2012.
Inevitably, challenges remain. IAG must implement its new labour agreements with Iberia pilots and cabin crew and conclude negotiations with Iberia ground staff. It must manage BA's long-haul expansion and switch to higher gauge aircraft, while retaining control of its costs. Regarding Vueling, the key will be to allow it to keep its independence and low-cost culture, while allowing it to pursue its rapid growth.
The signs are growing that IAG can meet these challenges.
A record first half (six months to 31-Dec-2013) result of NZD180 million (USD151 million) before taxation, representing a 7.7% margin, was Air New Zealand's reward for finding better balance: exiting from loss-making routes, higher trans-Tasman load factors than competitors, and a more streamlined fleet. Air NZ increased profitability on flat revenue despite decreased capacity.
CEO Christopher Luxon is not resting on his laurels and is committed to growth in capacity and revenue while decreasing costs, although cost targets are for now opaque.
The domestic and Pacific Island networks are stable while trans-Tasman shows the wear from the weakening Australian dollar. But Air NZ has the advantage of efficiency with the highest load factors in the market. International has shown a strong improvement following exits from loss-making routes. Further gains will come from growth, creating scale and reducing unit costs, and partnerships, such as with Singapore Airlines.
Allegiant Air’s strong top-line financial performance in FY2013 was belied by cost creep that is continuing into 2014 driven by maintenance expense and investments in yet-to-be revealed non-airline initiatives.
With Allegiant’s guidance of unit cost increases for FY2014, no US airline is escaping some level of cost escalation during the year. Similar to sentiments expressed by other carriers, Allegiant concludes it is making the necessary investments now to ensure a profitable future.
Even as Allegiant’s core business model – transporting cost-conscious travellers from small US markets to large leisure destinations – has essentially remained intact during the past couple of years, the carrier has also undertaken initiatives that are creating challenges in its cost performance in FY2014. While the company’s financial fundamentals still remain strong, wildcards in its cost structure remain, including negotiating labour deals amid increasing tension between management and employees.
As anticipated by the company, Aer Lingus’ 2013 operating result was below that of 2012. The profit recovery from heavy losses in 2009 had been driven by mainly unit revenue growth, but, in 2013, RASK growth was outpaced by CASK growth. Unit revenues were particularly weak on short-haul in the second half of the year, reflecting fierce price competition in European markets. Strong growth in revenues from Aer Lingus’ new contract flying business helped, but not enough to drive earnings growth.
Against this backdrop, a concerted push on cost reduction is necessary and Aer Lingus has recognised this priority in a new profit improvement programme, dubbed CORE. Although revenue initiatives are also part of it, the weak pricing environment of 2H2013 underlines the need for a competitive cost base and CORE includes a EUR30 million cost reduction target over two years. With savings largely expected to come from the payroll, the quality of industrial relations will be a key feature in the programme’s success.
Air France-KLM’s 2013 results saw its operating result return to profit for only the second time in six years, but the operating margin of just 0.5% (and another net loss) highlights that its Transform restructuring programme still has work to do. A return to profit in the passenger business was instrumental in the improved group result, while the cargo segment remained in loss and the maintenance division continued to produce healthy results.
2014 will see a modest increase in ASKs of around 1% overall, down 2% on medium-haul and up 2% on long-haul. The strongest area of growth will be Latin America and the group’s position in that market should be enhanced by a newly announced partnership with GOL (including the acquisition by Air France-KLM for USD52 million of a 1.5% equity stake in the Brazilian carrier) that broadly mirrors SkyTeam partner Delta’s relationship with GOL.
The North Atlantic JV within SkyTeam delivers significant unit revenue benefits, but the deal with GOL expands Air France-KLM's options. This, and its indication that it is seeking to deepen its relationship with Etihad, are further signs that SkyTeam cannot satisfy all its needs.
Questions are being raised over exactly when numerous long-haul markets introduced by Hawaiian Airlines during the last three years will reach maturity and cease being a drag on the carrier’s network.
The airline’s tempered capacity growth during FY2014 is a welcome sign. But other metrics are not as encouraging. Hawaiian has refined unit costs guidance upwards for 2014, citing several factors including the launch of its new inter-island turboprop operator Ohana, aircraft reconfigurations to support a new extra-legroom product and a rise in labour costs resulting from the hiring of additional pilots to comply with new US flight and duty time rules.
Hawaiian is beginning to field requests about when it will be in a position to consider shareholder returns. The carrier doesn’t expect to generate positive free cash flow until 2015, which can be an eternity for investors eager to see some return on their investment. The company assures that it is ending a period of heavy investment that will pay off over the long term. But in the short term Hawaiian may find itself having to defend its strategy to impatient shareholders.
Norwegian Air Shuttle’s 2013 net profit fell by 30% in the face of rapid capacity expansion, the launch of its first long-haul routes, delays to Boeing 787 deliveries, the negative impact on demand of good summer weather and a very price competitive market place. In short, anything but a run-of-the-mill year. The upshot was that, while its unit cost (CASK) fell in line with its target, its unit revenue (RASK) dropped more rapidly.
The granting by Irish regulators of an air operator’s certificate and operating licence to Norwegian’s Dublin-based long-haul operator and its recent order for four more 787s (bringing the total to 14: eight 787-8s and six 787-9s) are positive steps in its expansion into long-haul markets, where it has a cost advantage against legacy carriers. Nevertheless, there are some lower cost rivals on short-haul, where most of Norwegian’s business still lies.
The downward pressure on RASK looks likely to continue in 2014, particularly given Norwegian’s planned capacity growth of 40% (in ASK terms). A return to profit growth will therefore, it seems, need a further significant CASK cut.
Finnair’s 2013 results saw an unwelcome return to losses at the operational level, although the net result remained positive (just) due to non-operating items. In spite of achieving its Phase 1 cost savings target six months early and establishing a creditable track record of lowering its ex fuel CASK in recent years, unit revenue weakness remains a less predictable wildcard.
Most of the group’s organisational restructuring, including the outsourcing of maintenance and catering, the reorganisation of its travel services business and the switch to an all Airbus fleet, is now complete. Further cost savings will depend on the outcome of employee negotiations, a process that led to a strike warning in 4Q2013. Although it did not materialise, the strike threat then contributed to a particularly weak quarterly result, with both RASK falling and CASK rising in the quarter.
In 2014, it will be crucial to demonstrate that management can return both of these indicators to a healthy path and restore the group to profit.
Flybe’s trading statement for 3QFY2014, while not giving details of costs and profitability, suggests it is making good progress with its restructuring programme. In the UK airline, revenues per seat grew by 2.3% and costs per seat (excluding fuel and restructuring costs) fell by 5.2%. In addition, its confidence appears to be growing that it will achieve the cost reduction targets in its Turnaround Plan.
In a sign that Flybe’s new CEO Saad Hammad is not content simply to cut, Flybe has recently announced seven new international routes from Birmingham. It has no competitors on four of these routes, but faces LCC competitors on three. Even after cost reduction, Flybe will still have a significant disadvantage in unit costs against the LCCs.
Its challenges involve attempting to build on its strong market share in the UK regional domestic market to expand in international markets without confronting the LCCs too frequently, while seeking new opportunities across Europe for contract flying on behalf of other airlines and continuing to take costs out of the business.