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Aeroflot is the national airline of Russia with its main base at Moscow Sheremetyevo International Airport. Formerly wholly-state owned, the airline has been partially privatised and continues to be the dominant carrier in the country, accounting for about 20% of the Russian passenger market. The Russian Government continues to hold 51.17% of the airline's equity. Legal entities and individuals own the rest. Aeroflot operates an extensive network of domestic services within Russia, as well as international services to Europe, Asia, the Middle East and North America. Aeroflot is Russia’s largest air carrier; it accounts for over 42% of international scheduled and 13.7% of domestic traffic in Russia (with its subsidiaries, around 20%). Aeroflot is a member of SkyTeam.
Aeroflot has been a leading voice behind consolidation in the Russian airline industry, and has supported the Government's plan to address the fragmentation of the airline industry that has been a central feature since the fall of the Soviet Union. Aeroflot has taken over management control of four Russian airlines including Rossiya, Orenair, Vladivostok Avia and SAT Airlines.
Location of Aeroflot main hub (Moscow Sheremetyevo Airport)
Aeroflot share price
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The last of Europe's stock market-listed airlines recently reported financial results for 2014, providing the opportunity to compare levels of profitability. Ranking them by operating margin, there is a wide range of performance from healthy double digit to negative figures.
LCCs typically performed better than legacy airlines. Most of the higher margin airlines improved in 2014, while most of those at the lower end of the scale suffered a fall in margins. Convergence of business models does not show itself in convergence of financial performance.
Beyond the listed airlines, Europe has a large number of mainly small and unprofitable airlines, which drag down the aggregate margin of the continent's airline sector. Europe's traffic growth and load factors are relatively healthy by world standards, but its margins are held back by its fragmented market structure.
Alitalia's new-found Asia strategy appears to be stimulating competitive responses. Alitalia has announced new services to Seoul, a return to China and expanded services to Japan. More Asian markets could be on their way. After much delay, Korean Air will double its presence in Italy by de-coupling Milan and Rome, served on a triangular routing, and then increasing capacity.
Korean Air has carried 25% of the Korea-Italy market, so it has left much traffic to others, mostly to sixth freedom airlines like Lufthansa and other Europeans. Alitalia part owner Etihad hopes Alitalia's eastwards expansion will allow it to claw back at the gains Lufthansa and other carriers have made in Italy.
Growth from China to Italy looks more organic than competitive. Air China will become the largest airline in the Italy-Asia market while the China-Italy market will welcome a third Chinese player as Hainan Airlines starts twice-weekly Chongqing-Rome service.
The Aeroflot Group suffered a 31% drop in its operating profit and reported a net loss in 3Q2014, the seasonally strongest quarter. Although the net result was weighed down by foreign exchange movements and non-recurring items, the underlying profitability of the Group suffered due to RASK falling while CASK increased.
Demand on international routes has suffered as a result of the geopolitical backdrop, forcing Aeroflot to focus its growth in the domestic market.
Geopolitical events also led to the cessation of Aeroflot's fledgling LCC subsidiary Dobrolet in Aug-2014. However, the Group has acted rapidly in launching a new low cost venture, Pobeda, which started operating between Moscow Vnukovo and Volgograd this week.
Europe's airlines: 1H2014 results season shows improving trend, but cost reduction is the key driver
Europe's airlines appear to be following a course to improved profitability, based on the 1H2014 results of the largest publicly quoted airline groups. Profits remain slender in most cases, but margins are improving in aggregate. Individually, financial performance varied widely, with LCCs both leading (Ryanair) and lagging (Norwegian) the operating profit margin rankings in 1H2014.
The European market offers volume growth, but is characterised by price pressure, with RASK falling for the majority of the larger airline groups and this points to the need for additional caution in capacity growth. The LCCs collectively enjoyed higher growth than the FSCs in 1H2014 and also achieved a more stable RASK performance (although not in all cases).
Profit improvement is largely being achieved through cost savings and CASK reduction. Although fuel prices are high on a longer term historic perspective, they are enjoying a period of relative stability and this has helped the cost picture. Although Europe's airline sector remains only thinly profitable, these 1H results hold out the prospect of better full year results in 2014 versus 2013.
The Aeroflot Group fell into loss in 1H2014, its first 1H loss since at least 2008. Although the result was affected by a significant level of non-recurring expenses, the underlying operating result was still significantly lower than last year. Aeroflot continues to grow faster than the Russian market and its focus on increased frequencies, rather than new routes, has helped the Group to grow its RASK (revenue per available seat kilometre). Unfortunately, this growth in RASK was outpaced by growth in CASK (cost per available seat kilometre).
The current geopolitical backdrop is clearly providing Aeroflot with some serious challenges. Demand for international flights has been weakened and EU sanctions forced the suspension of operations of Aeroflot's nascent LCC Dobrolet. Plans by the Russian government to reduce its stake in Aeroflot to 50% plus one share may now meet with delays as investors are likely to want to wait for the geopolitical situation to become more stable.
Russia’s parliament, the Duma, recently adopted a bill allowing Russian carriers to offer different fare classes and non-refundable tickets. The law will enter into force 60 days from its official publication, effectively creating the conditions to allow low-cost carriers to establish in the domestic market. Meanwhile, Aeroflot's planned new LCC subsidiary, Dobrolet, is nearer to its planned launch, reported to be in May-2014 with a service from Moscow to St Petersburg.
At Aeroflot's Capital Markets Day (13-Mar-2014), it provided more details of Dobrolet's business model (close to a pure LCC) and of its planned network development (11 destinations in 2014, rising to 36 after five years). With plans to price its tickets at a discount of 20% to 40%, we assess if and how it can achieve the necessary cost savings to ensure profitability.