Low Cost Carriers (LCCs)
A key structural change in aviation over the past decade has been the proliferation of low-cost carriers (LCCs). The low-cost model has overwhelmingly been the favoured mode of airline start-up over the period, and their spread around the world, into both short- and long-haul markets, has caused a fundamental shift in the competitive dynamic of the industry.
'Classic' characteristics of the low-cost model include:
- High seating density;
- High aircraft utilisation;
- Single aircraft type;
- Low fares, including very low promotional fares;
- Single class configuration;
- Point-to-point services;
- No (free) frills;
- Predominantly short- to medium-haul route structures;
- Frequent use of second-tier airports;
- Rapid turnaround time at airports.
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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.
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.
Just as Rome was not built in a day, the battle among the airlines at its main airport will also take its time to play out.
A year ago, CAPA examined the growing levels of competition at Rome Fiumicino. The fight was not only between the disruptive LCCs and the well-established, but struggling, Alitalia. It was also increasingly between the LCCs themselves. At that time, Ryanair had just entered the airport for the first time, Vueling was about to establish a new base and to inject massive capacity growth there and easyJet also planned strong growth. Alitalia faced further erosion of its market share.
A year on and the battleground continues to be fiercely contested. Vueling plans further huge growth this summer, Ryanair is to transfer more routes to Fiumicino from Ciampino and easyJet, while taking a relative pause for breath, is still set to grow capacity at a double digit rate this summer. Alitalia's share continues to fall, but at least it has ensured its survival after receiving an investment by Etihad.
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.
Both Ryanair and easyJet recently reported strong progress during the quarter ended Dec-2014. Both demonstrated that losses in the traditionally weak winter period are narrowing. Ryanair even looks set to report a profit for its winter half year and raised its guidance for FY2015 (March year end).
Ryanair cautioned that high levels of fuel hedging would limit profit growth in FY2016, especially as it expects lower fuel costs to add to downward pressure on fares. easyJet too has fairly high levels of fuel hedging. Nevertheless, both look well positioned to take further market share from higher priced legacy carriers, building on initiatives around product and service quality and targeting business travellers (although they are at different stages in these areas).
Where there is a marked contrast between Ryanair and easyJet is in average revenue per passenger. Ryanair's lower costs allow it to sustain lower fares profitably. For many years, the two have mainly attacked different markets, but head to head competition between them is on the increase. In this report, we analyse the extent of their overlap.