Financial

LOT majority stake attracts airline interest, but restructuring and potential synergies will be key

Recent legislation allows the government of Poland to sell a majority stake in state-controlled national carrier, LOT Polish Airlines (LOT). According to media reports, LOT has appointed Rothschild as its privatisation adviser and a number of carriers have indicated their interest in investing. A lifeline loan from the government in Dec-2012 has been approved by the European Commission, partly conditional on a new restructuring plan expected in Jun-2013.

With losses for each of the four years 2008 to 2011 and a fifth loss expected for 2012, LOT’s cost base is too high for its revenue-generating capabilities. Moreover, it is inefficient versus the LCCs that compete on short/medium-haul, which accounts for 88% of LOT’s seat capacity and where its ageing 737 fleet needs replacing.

A handful of long-haul monopoly routes are finally benefitting from new 787s, but it is difficult to find many other features for LOT’s advisers to highlight. Interest in buying LOT will depend very much on the pricing and potential synergies a buyer might bring to the table.

IATA raises profit forecasts - the world’s airlines can now upgrade from an espresso to a sandwich

Speaking at IATA’s AGM in Cape Town in early Jun-2013, IAG CEO Willie Walsh expressed his optimism about the airline industry: “Anybody who looks historically at what has happened to try to forecast what’s going to happen in the future should forget about it and start with a blank sheet of paper. I genuinely think we’re an industry that for the first time will start exceeding our cost of capital” (Bloomberg 3-Jun-2013).

At the same time, IATA raised its 2013 industry net profit forecast from USD10.6 billion to USD12.7 billion, an increase of 67% on 2012, but still only 1.8% of revenues. As IATA CEO Tony Tyler put it, 2013 airline profits will be around USD4 per passenger, “less than the price of a sandwich in most parts of the world”. Moreover, IATA’s forecast represents a return on capital of 4.8%, well below the 7%-8% cost of capital (the return expected by investors).

At least this year’s sandwich should be more than the espresso coffee covered by last year’s profits. But it's not yet time to break out the champagne.

Volaris makes a move to leapfrog other Mexican LCCs with potential IPO

Now that the dust appears to be settling in Mexico’s aviation industry after rapid changes during the last decade, the country’s surviving upstarts are taking the next steps in their evolution through initial public offerings. Interjet opted to postpone its IPO in 2011 to await for more favourable market conditions, which must be improving given that its LCC rival Volaris has filed preliminary prospectuses for listings on both the New York and Mexican stock exchanges.

Volaris’ moves to go public follow a recent declaration by fast-growing Brazilian carrier Azul that it is planning an IPO following its acquisition of fellow regional carrier TRIP in 2012. But the similarities end there as growth in Brazil’s domestic market is slowing in parallel to cooling GDP growth. Brazil is also a much bigger domestic market served by only two LCCs while three LCCs continue to compete in Mexico, which has the second biggest domestic market in Latin America after Brazil. 

Volaris and its Mexican LCC counterparts are still moving to seize on available growth opportunities within the country as a large swath of Mexico’s residents still travel by bus. The calculus is offering fares similar to those charged by bus companies to Mexico’s burgeoning middle class, which has been on a steady growth trajectory since 2000.

Austrian Airlines: a perennial loss-maker undergoing radical restructuring

Austrian Airlines has not made an operating profit since 2007 and has been consistently the weakest Lufthansa Group carrier in terms of margins and passenger growth. It is more exposed than its sister companies to short/medium-haul markets, where price-based competition is fierce, and its long-haul network is relatively light.

However, it has strong market positions on its long-haul routes and is looking to grow this area of its business with an additional Boeing 777, approved by the parent company. Moreover, its recently completed rationalisation of its narrowbody fleet from 11 Boeing 737s to seven Airbus A320 family aircraft will both reduce its exposure to short/medium-haul markets and allow it to serve them more efficiently.

Meanwhile, the centre-piece of its radical restructuring programme, the transfer of flight operations into its regional subsidiary Tyrolean Airways (effective from Jul-2012), and the concentration of administrative operations at Vienna should lead to further cost savings if legal challenges can be repelled.

Azul's IPO is at a challenging time for economic and traffic growth in Brazil - but offers potential

Nearly five years after inaugurating service, Brazilian carrier Azul is capping off its rapid and highly successful growth with a planned initial public offering. Azul, led by former JetBlue founder and chief David Neeleman has quickly built up a position of strength in the domestic market place through a strategic acquisition it executed during 2012 of fellow Brazilian regional carrier TRIP.

The combination helped Azul flesh out its network and build what it hopes is the necessary scale to withstand the changes its has witnessed in the Brazilian market place during its brief history, ranging from significant growth to a slowdown in traffic expansion as the country’s GDP has slowed during the last couple of years.

The timing of the decision by Azul’s management to take the company public is interesting given that Brazil’s second largest carrier Gol recently warned that inflation in Brazil keeps rising and that it is uncertain if the country will attain its projected 2.5% GDP growth during 2012.

But in making its case to potential investors Azul is attempting to make clear distinctions between itself and Gol by citing yield advantages and merger synergies of BRL200 million (USD96 million) to BRL300 million (USD144 million) during 2013.

SWISS: is the star in the Lufthansa Group starting to fade?

Since its takeover by Lufthansa in 2007, SWISS has outpaced its parent’s passenger growth and has been the most profitable carrier in the Group. SWISS’ long-haul network, significant for a carrier of its size, reflects the combination of a small domestic market with an affluent population. Moreover, its long-haul market position is strong.

Playing to its strengths, ASK growth of 2.7% in 2013 will focus on long-haul, specifically driven by SWISS’ new Singapore route and additional capacity on New York and Beijing, while short/medium-haul capacity is reduced.

On the other hand, operating profit has been on a declining trend since 2007. For some years, unit costs have been falling, but unit revenues have been falling faster. Moreover, analysis of its unit costs reveals its CASK to be among the highest in Europe. While the Lufthansa Group expects to beat 2012’s operating result this year, SWISS is only targeting a similar result to last year, suggesting that its period of over-achievement may be ending.

Turkish Airlines 1Q revenues grow 28% as losses narrow, but unit costs will be key to FY result

Turkish Airlines cut its 1Q2013 operating loss from TRY173 million to TRY23 million (EUR9.7 million), almost breakeven in the traditionally weakest quarter. Revenues grew 28% on capacity up 21%, with particularly strong growth to Africa, Middle East and Europe. The improved result was driven by unit revenue growth (RASK) as unit costs (CASK) were held flat in spite of higher fuel prices. Earlier this year, the carrier said it did not expect a unit revenue increase for FY2013, so this represents a good start to the year, and ex fuel unit costs will need to remain under control over the rest of the year.

Much of Turkish Airlines’ success has been built on an efficient workforce and the geographic location of the Istanbul hub, which facilitates a global connecting strategy. Both of these elements were visible in 1Q2013, with labour cost growth slower than capacity and transfer passenger growth outpacing the total. Nevertheless, a strike called on 15-May-2013 (albeit with limited impact) and the relentless competitive presence of the Gulf carriers are reminders that this success cannot be taken for granted.

Ryanair: Europe's lowest cost producer wins again, reporting record profit of EUR569 million

Ryanair reported a record net profit of EUR569 million for FY2013, 13% up on last year, and its operating margin of 14.7% is comfortably the highest among European airlines. Even after returning EUR1.5 billion in cash to shareholders over the past five years, the LCC had EUR3.6 billion in cash at the end of Mar-2013, equivalent to almost nine months of sales.

Results like these, achieved in the teeth of the weakest economic backdrop in Europe for decades, underline the strength of Ryanair’s low-cost model. Already Europe’s lowest cost producer, and with relatively little scope to cut unit costs, earnings growth in recent years has been driven by the pricing power resulting from tighter capacity expansion than in the past, aided by restructuring and capacity cuts by many competitors.

These conditions should help Ryanair make progress towards its target of a 20% market share over the next five years, after which a possible order for the Boeing 737MAX may be the key to longer term earnings growth.

easyJet sets course for record FY profits - and another clash with Sir Stelios...

easyJet’s 1H2013 pre-tax result improved by GBP51 million to a loss of GBP61 million. This puts it comfortably on course to achieve the current consensus forecast for record pre-tax profits of GBP410 million in FY2013. It may also be on another collision course with founder and largest shareholder Sir Stelios Haji-Ioannou over aircraft orders.

CEO Carolyn McCall believes easyJet can take further market share from non-LCCs on point-to-point routes. At its top 20 existing airports, where easyJet has 46 million seats (a share of 22%), she puts this potential additional market at 86 million seats. This analysis appears to pave the way for a large aircraft order after easyJet completes a review of its future fleet strategy later this year, although it insists that no decision has yet been taken.

This would not please Sir Stelios who said: “Good things happen to airlines that don’t order more aircraft.” Under Ms McCall's guidance easyJet's share price has more than doubled over the past year and not just because it didn't grow. It may be time for Sir Stelios to let go.

IAG profit guidance is dropped after first quarter loss, but can it still reach its previous target?

These are challenging times for IAG. The only one of the European Big Three to report a wider operating loss for 1Q2013 and to see net debt increase year-on-year, it also took significant new labour restructuring provisions in connection with Iberia. It has also dropped its previous ambitious target of exceeding 2011’s EUR485 million operating profit in 2013 for the time being.

The first quarter operating loss was affected by two factors whose negative impact should fall away over the rest of the year: first, the lag between Iberia’s capacity cuts and headcount cuts and, second, by a mirror image factor at British Airways, namely headcount increases ahead of the introduction of the A380 and 787 later this year.

Nevertheless, five years after the global financial crisis and more than two years into the British Airways/Iberia merger, IAG will need to show it can still match its previous 2013 profit target if it is to allay growing doubts over its ability to reach its 2015 goal of EUR1.6 billion in operating profit.

Air France-KLM: it may be unfair to compare its 1Q2013 with Lufthansa's, but…

Two of the European Big Three reported 1Q2013 results within two days, so we can’t resist a comparison. Air France-KLM’s quarterly operating loss of EUR530 million was EUR171 million below Lufthansa’s. Air France-KLM shaved net debt from EUR6.0 billion at the end of 2012 to EUR5.9 billion; Lufthansa’s net debt is less than one third of this. AF-KLM’s 1Q RASK grew by 1.2%; Lufthansa’s by 2.8%.

Air France-KLM makes losses in Europe, where Lufthansa now claims a profit. In an attempt to fix this, Air France-KLM has Transavia for some leisure routes, Hop for French regional point-to-point and some hub feed, Air France’s provincial bases strategy (under review) for non-hub French routes and both Air France and KLM for everything else. Lufthansa has Germanwings for non-hub routes and Lufthansa for hub feed in Germany.

For FY2013, Air France-KLM isn’t saying whether it can improve on 2012’s EUR300 million operating loss, only that it aims to cut unit costs (ex fuel and currency) and net debt, whereas Lufthansa aims to beat last year’s EUR524 million profit.

Lufthansa juggles more balls more quickly as it reports unchanged 1Q2013 operating loss

Lufthansa on 2-May-2013 reported a 1Q2013 operating loss of EUR359 million, an identical loss as in the same period in 2012. All the main business segments improved their operating result, but restructuring costs weighed on the group result.

The quarter was characterised by capacity cuts, yield and load factor increases, and restructuring aimed at future profit improvements. Labour unrest, never far from the surface, returned during the quarter. Recent union agreements have reduced the risk in this area, although talks with the pilot union are on-going.

Pricing was generally fairly healthy, with yield and load factor growing, but weakness was again apparent in Asia-Pacific. On the analyst conference call to discuss 1Q2013 earnings, Lufthansa CFO Simone Menne did not rule out the possibility of using new partnerships as a more offensive solution to Lufthansa’s Asian problems, than the more defensive approach of capacity cuts and cabin mix changes.

Management will need to keep juggling these and other key issues – such as the ‘new’ Germanwings, office closures and headcount reductions – if it is to have a chance of reaching its FY2015 operating result target of EUR2.5 billion.