Consolidation in the North American marketplace has now been a mainstay for a decade, beginning with the combination of US Airways and America West and culminating with US Airways and American closing their merger in late 2013.
Those tie-ups, along with the Delta-Northwest merger, Continental’s pursuit of United and Southwest’s acquisition of AirTran, have resulted in four airlines controlling approximately 47% of North America’s capacity (ASMs).
The process of consolidation and rationalisation has inevitably created some openings. This potentially offers space for ULCCs and other more niche airlines to capture a larger place in the market. This report looks at some of the recent developments and at where the industry may be heading.
The topic of ULCCs in the US market place will feature in a high level panel session at CAPA's Americas Aviation Summit in Las Vegas on 27/28 April, 2105.
Turkey is home to two of Europe's fastest growing airlines. Turkish Airlines increased ASKs by 16% in 2014 and LCC Pegasus Airlines grew by 20%. From a standing start as a scheduled carrier ten years ago, Pegasus' share of seats in Turkey reached 19% in 2014. Turkish remained the country's largest airline, but its market share of just under 54% in 2014 was unchanged from 2010. The main battlegrounds between the two are on international routes to/from Europe and in the domestic market, where Pegasus has grown particularly rapidly.
Until 2013, Turkish Airlines more or less left Pegasus alone at its home base of Istanbul Sabiha Gokcen, where the LCC is the number one airline. Since then, however, Turkish has outgrown its rival at Istanbul's number two airport. Turkish now overlaps on city pairs that cover 97% of Pegasus seat capacity from Sabiha Gokcen.
It is no coincidence that Pegasus' unit revenue and operating profit margin have dipped since this onslaught. Neither has Turkish emerged unscathed. Both plan further rapid growth this year, but appear to be holding a truce in the price war.
According to airberlin's preliminary results, it narrowed its underlying operating loss (before restructuring and one-off costs) for 2014. It made progress with cost restructuring, but missed its planned turnaround because unit revenues were weak. After restructuring and one-offs, its net loss will be worse than in 2013.
With only one year of (very small) net profit since 2007, it seems that loss-making can be a hard habit to break. More recent data show an improving unit revenue trend and airberlin expects 2015 to be much better than last year.
Nevertheless, this cannot hide the enormity of the challenge facing new CEO Stefan Pichler (appointed 2-Feb-2015) in restoring airberlin to profit. The fourth CEO in as many years has launched another redesign of the company's business model, aiming for a positive result in 2016.
Reporting a strong increase in its 2014 profits, the Aegean Airlines Group has confirmed its position as Europe's most profitable legacy airline (by operating margin). Double digit capacity growth, increasing competition from LCCs (Ryanair in particular) and the fragile Greek economic backdrop led to a reversal of the unit revenue increase that Aegean enjoyed in 2013. However, it managed to offset lower RASK with even lower CASK.
In 2014, Aegean completed its first full year following the acquisition of Olympic Air. The Olympic acquisition brought Aegean a domestic PSO network, the flexibility to deploy turboprops on thinner domestic routes and more options in adapting capacity and frequency to optimise connectivity between domestic and international routes.
With Olympic's 2013 revenue around one quarter that of its parent in 2013, this was a significant acquisition for Aegean. It seems to have absorbed it without breaking its stride.
Aer Lingus grows FY operating profit, but needs further cost cuts. Meanwhile, IAG bid inches forward
Aer Lingus grew its operating profit in 2014, although the net result fell into loss due to a one-off pension scheme payment. Unit revenues increased across the network, helped on European routes by modest capacity reduction, but also achieved on the North Atlantic in spite of double digit growth.
However, unit costs increased too, albeit a little more slowly than unit revenues, and have been rising for five years. In 2014, this was partly explained by costs of further long haul growth before assets are fully utilised. Nevertheless, Aer Lingus has rightly identified unit cost reduction as a priority to drive margin expansion.
This will be vital, regardless of the outcome of IAG's bid for Aer Lingus at EUR2.55 per share (EUR2.50 in cash and EUR0.05 in dividends). The Irish government, holder of 25% of the company, now seems to be inching towards the IAG deal. However, there could be a sticking point in its recent request that IAG extend beyond five years the commitments it has offered over the continued use of Aer Lingus' Heathrow slots on Irish routes.
Air France-KLM back to operating loss; warns lower fuel may be offset by low unit revenue & currency
Air France-KLM marked its first decade with a return to loss at the operating level in 2014. A pilot strike over the development of LCC Transavia took EUR425 million off the operating result, which would otherwise have been positive and higher than in 2013. The dispute was settled and Air France-KLM's generally good history of labour relations suggests that it is unlikely to be repeated in 2015.
Nevertheless, the settlement required management to compromise its plans for Transavia and this may make it harder to push through further important restructuring across the group. Moreover, even without the impact of the strike, the year was characterised by ongoing unit revenue weakness, particularly in long-haul markets such as Latin America.
Air France-KLM does not see this market environment improving. Indeed, it has suggested that the benefits of lower fuel prices in 2015 may all be eaten up by falling unit revenue and currency movements. The group has abandoned its previous EBITDAR growth targets, but is cutting its investment plans and is accelerating its unit cost reduction. There is more turbulence ahead.
Pressure from having to pull capacity from Venezuela and overall economic weakness in many regions within Latin America pressured Copa Airlines’ financial results for 2014; but the airline still delivered a respectable 19.8% operating margin for the year and posted a decrease in unit costs.
Many of the elements that dragged down Copa’s financial results in CY2014 remain intact – continued pressure on yields by moving a significant amount of capacity from Venezuela and weakened economies in Latin America. The airline has not made any adjustments to its projected 7% capacity growth for CY2015, but its expansion of supply is at a lower rate than 2014, and most of the growth stems from network changes Copa undertook in CY2014.
Although Copa’s yield and unit revenue challenges will persist in the near future, overall the company remains in good financial shape to withstand the macroeconomic pressures weakening its results.
Air Canada is maintaining a reasonably positive outlook on demand in early 2015 across all geographies, with the exception of certain pockets of pressure including some areas in Western Canada where the energy sector is a significant economic driver.
The airline’s results in 2014 reflect its business adaption during the last couple of years of increasing its leisure passenger mix and long-haul flying, which pressure yields. But Air Canada stresses the incremental capacity driven by the longer stage lengths and change in passenger composition is low-cost incremental capacity that improves margins and profitability.
Air Canada largely proved the validity of that theory in CY2014 as operating margins and adjusted profits increased for the year. The airline is facing some cost pressure in CY2015 due the falling value of Canada’s currency against the USD, but believes its foreign denominated revenues create some hedge against some of its expenses paid in USD.
Norwegian's 2014 losses marked a dramatic slump after seven years of net profits (five years of operating profit). There had been some warning signals in 2013, when Norwegian's profits declined versus 2012, due to rapid capacity expansion, the launch of its first long-haul routes, delays to Boeing 787 deliveries and a very price competitive market place.
In 2014, most of these factors continued to weigh on Norwegian, for whom the weakening of the NOK was an additional challenge. A difficult year always seemed likely. Nevertheless, the size of its loss was worse than expected. Unit cost reduction failed to keep pace with the drop in unit revenues.
After another year of debt-fuelled fast capacity growth in 2014, Norwegian will take something of a breather in 2015, when its growth will be much more cautious. This should help unit revenues, but its 2015 CASK target suggests that it does not expect significant cost efficiency improvements other than from lower fuel prices.
Finnair's net loss for 2014 was its first since 2011, but its fifth in the seven years since 2008. Over the past decade or so, losses have been more common than profits. Its niche in connecting Europe with Asia via Helsinki has placed Finnair among Europe's top twenty airline groups, although Finland ranks outside the top twenty countries by population.
But converting this niche into sustainable profitability is proving a major challenge. Whenever Finnair makes progress with cost reduction (and it has made major strides with labour productivity), it seems that revenue pressures wipe out those benefits. In 2015, Finnair anticipates a further drop in unit revenue, reflecting the highly competitive nature of its markets.
This year will also present opportunities for Finnair to build a more solid base. It will be the first full year under new labour agreements and with a number of product improvements in place. It will also see its first A350 delivery. Lower fuel prices are a stroke of luck, but Finnair needs to ensure it can be profitable without relying on this good fortune.
Icelandair: Atlantic niche drives strong growth in 2014, but 2015 profit growth relies on lower fuel
Icelandair Group grew rapidly again in 2014. International passenger numbers were up 15%, hotel bookings were up 8%, revenue grew by 9% and net profit grew by 18%. Traffic growth was driven by a disproportionate increase in connecting passengers travelling between Europe and North America via its Reykjavik hub.
Icelandair's success in this niche has lifted the number of trans-Atlantic transfer passengers it carries from 1.4% of total AEA North Atlantic traffic in 2009 to 4.2% in 2014. With two new destinations (Birmingham and Portland) and 14% international capacity growth planned for 2015, the airline is sticking to this strategic course. Moreover, it anticipates further profit growth this year.
However, the main reason for higher expected profits in 2015 is lower fuel prices. This is fortunate, given higher wages and the costs of additional capacity. Transfer traffic is typically attracted by discount pricing and growing LCC competition on routes to Iceland, particularly from Europe, will increase downward yield pressure. Icelandair will be hoping that fuel prices do not jump upwards once more.
The late Jan-2015 profit warning from Flybe, the UK's largest regional airline, is a reminder that no restructuring programme ever follows a smooth path. Over the past couple of years, the airline has made good progress with cost reduction, repaired its balance sheet with fresh equity and a Gatwick slot sale, trimmed its network, exited a loss-making Finnish joint venture and rebalanced its fleet plan towards turboprops. In spite of its focus on the UK regions, it has also entered London City, London Southend and London Stansted.
However, the competitive response to its London City entry has been stronger than it anticipated and, although most of its network faces no airline competition, LCCs are its main competitors on routes where there are other airlines. This puts pressure on yields (although the impact on revenues is partially offset by Flybe's raised load factor). In addition, leasing costs associated with Embraer 195 jets that Flybe no longer wants are weighing on its results.
In this report, we consider these issues in the context of a review of Flybe's strengths, weaknesses, opportunities and threats.