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Allegiant's business model seems to fly in the face of conventional wisdom. A fleet of old, fuel-inefficient aircraft, flying with low frequencies and at low daily utilisation rates in markets with a high degree of seasonality. Yet the ultra-LCC is consistently profitable and generates free cash flow (operating cash flow in excess of capital expenditure), unlike most of the airline industry.
Allegiant's Vice President for Fleet and Corporate Finance told CAPA's Airline Fleet and Finance Summit in Mar-2014 that his airline was "built to be different". Of course, no business proceeds entirely smoothly and Allegiant faces some challenges, including labour relations issues and successfully taking its business model outside the contiguous United States.
Nevertheless, its return on capital employed is consistently the envy of most carriers. How does Allegiant achieve its strong financial results and what can the rest of the airline industry learn from its approach?
At CAPA's Airlines in Transition 2014 conference in Dublin, the opening session included high profile industry figures debating a key area of airline industry transformation (or not): national ownership controls. The panel included IAG CEO Willie Walsh, Norwegian Air Shuttle CEO Bjorn Kjos, AirAsia co-founder and Dublin Aerospace Chairman Conor McCarthy, European Commission Director Aviation and International Transport Policy Matthew Baldwin and Irish Aviation Authority CEO Eamonn Brenan.
John Byerly, former Deputy Assistant Secretary for Transportation at the US State Department and a major negotiator in the EU-US Open Skies agreement, set the context for the discussion with a review of the "archaic" restrictions on foreign ownership and control. All panellists, airline executives and regulators alike, agreed that the current system is "stupid".
El Al's return to a net profit in 2013 should not be allowed to hide a wide range of challenges facing the newly appointed management team of CEO David Maimon and CFO Dganit Palti. The list is long: an ageing fleet, stagnant traffic growth, falling market share, a high cost structure, an open skies agreement between Israel and the EU, growing competition from European LCCs and network carriers such as Turkish Airlines and an under-capitalised balance sheet all need urgent attention.
El Al is clearly aware of its challenges. Its summer 2014 timetable sees more aggressive growth than for some years and it has reduced average headcount over the past two years. More importantly, its new LCC subsidiary UP commenced operations on 30-Mar-2014 with five destinations in Europe.
However, it is not yet clear whether UP will be a genuinely low-cost operation. Its establishment should certainly not be used as an excuse to avoid a radical cost restructuring programme in the core airline.
When it announced a return to profit for FY2013 in Dec-2013, SAS warned that 1QFY2014 would be “extremely weak”. Its prediction has proved correct. The SAS Group’s 1Q pre-tax loss (before non-recurring items) widened by 57%. It continued to make good progress with its 4Excellence Next Generation (4XNG) cost reduction plan, but highly competitive market conditions weighed heavily on unit revenues.
SAS President and CEO Rickard Gustafson commented that the quarter was “marked by overcapacity and lower growth, which put pressure on margins across the entire market.” In this respect, SAS may be contributing to its own problems as it plans faster growth than the market this summer.
Its cost cutting and product improvement credentials are strengthening with each passing quarter, but its capacity growth is clearly not being absorbed profitably by the market.
In 2013, Lufthansa showed the first signs that its SCORE restructuring programme may be having an impact on its results. While its operating result fell from its 2012 level, this was affected by restructuring costs and project implementation costs, which should produce benefits in future years. Adjusting for these one-off costs, underlying profitability improved for the first time since 2010, mainly due to lower unit costs.
Ahead of an imminent change of leadership at the top of the group, Lufthansa has also announced a couple of small, but fairly radical, changes. First, it will separately incorporate its FFP and, second, it will bring its aircraft depreciation policy more in line with market practice.
Lufthansa is now somewhere close to half way through SCORE. Outgoing CEO Christoph Franz, who will leave on 30-Apr-2014, can be credited with instigating the programme and delivering a fairly solid start. As with all restructuring programmes, their success or failure can only really be judged when they are complete and it will be the responsibility of new CEO Carsten Spohr to steer the group to the right result at the programme’s end in 2015.
CAPA is pleased to announce a strong and diverse line-up of airlines will be present at its upcoming aircraft fleet and air finance Summit in Singapore. The airlines will be joined by leading finance sector analysts and commentators in what is considered the most airline-centric air finance event on the calendar.
The CAPA Airline Fleet & Finance Summit, at Singapore's stunning Capella Sentosa, will showcase the latest financing trends and feature detailed fleet and finance updates from 15 airlines over two days, 25/26 March.
Aegean Airlines had a good 2013. Not only did it return to profit for the first time since 2009, but it recorded its best result since its 2007 listing on the Athens Stock Exchange. All the key indicators improved: double digit passenger growth, load factor gains, a sharp increase in revenue per ASK and a fall in costs per ASK. Moreover, on the strategic front, it finally completed the acquisition of Greek rival Olympic Air after first attempting this in 2011.
The challenge for Aegean will be to maintain the momentum in 2014.
The integration of the loss-making Olympic, while giving the potential for synergies, will inevitably absorb significant management attention. Meanwhile, keeping hold of RASK gains in the face of growing competition from LCC competitors (Ryanair will open bases in Athens and Thessaloniki in Apr-2014) and continuing to reduce CASK will also be crucial to showing that the 2013 result was not just a flash in the pan.
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.