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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Pegasus Airlines is having a difficult year. Its 2Q2016 results revealed a year on year widening of its operating loss for the third successive quarter. A series of geopolitical and terrorist events in Turkey have weighed on demand for international travel in particular.
Although Pegasus slowed its capacity growth in 2Q, this did not arrest the trend of plunging unit revenue. In spite of low fuel prices, Pegasus has not been able to match the fall in RASK with a sufficient reduction in its unit cost.
In response to its weak 2Q and 1H results, Pegasus has issued a profit warning, lowering its guidance for FY2016 and implying an operating loss for the year. After a number of years of double digit passenger growth, it now targets an increase of only 5%-7% this year (it previously expected 13%-15%). A more cautious approach to growth makes sense in the current environment.
Despite low fuel prices that have carried the global airline industry to record margins, airberlin's 2Q2016 losses have widened. This was its fifth successive quarter of unit cost growth outpacing unit revenue growth (they both fell, but unit revenue fell faster). Airberlin improved its cost structure, but CEO Stefan Pichler said that 2Q "was more challenging than expected on volumes and yield". It now seems likely that 2016 will be yet another year of red ink for airberlin, which is 30% owned by Etihad.
Airberlin's ongoing restructuring continues to involve capacity and headcount cuts to improve cost efficiency. In addition, airberlin is seeking cost synergies by coordinating some support functions with Etihad Airways Partners airlines.
Still predominantly a short/medium haul operator, airberlin is expanding its long haul network with new routes in the US and the Caribbean. This long haul expansion, accompanied by the launch of a short/medium haul premium product, attempts to position airberlin more squarely as a full service network airline. This is a further move away from its LCC past, just as LCCs are encroaching on long haul in addition to short haul.
Lufthansa Group's detailed 2Q2016 results confirmed the headline numbers that it pre-released with a profit warning on 20-Jul-2016. After increasing its operating profit in 1Q, the group suffered a decline in 2Q. Among Europe's big three legacy airline groups, Lufthansa was the only one to report lower 2Q profits. In 1H2016, IAG again has the best operating margin of the three, followed by Lufthansa and then Air France-KLM. However, LCCs Ryanair and Wizz Air are more profitable than any of them.
Lufthansa's full 2Q report provides an opportunity to compare the capacity growth and unit revenue performance of each of the Lufthansa Group, Air France-KLM and IAG for 2Q2016. Unit revenue has been soft for some time for all three, but seems to be weakening further. Lufthansa cautioned that advance bookings, especially on long-haul, have declined significantly, citing repeated terrorist attacks in Europe and greater political and economic uncertainty.
Against this backdrop, IAG and Lufthansa have reduced their capacity growth plans, while Air France-KLM has retained its 1% ASK growth outlook for its network airlines. CAPA's analysis highlights the inverse relationship between capacity growth and RASK growth. Further capacity haircuts may follow.
The strongly seasonal nature of Jet2.com's schedule and the financial performance of the airline and its parent Dart Group were examined in a Jul-2016 analysis report by CAPA. That report also noted that all of the increase in passenger numbers since the year to Mar-2013 was attributable to traffic booked via Dart Group's package holidays business – Jet2holidays.com.
This report looks in some detail at Jet2.com's network and how it has changed in the three years since summer 2013.
Over the past three years Jet2.com has increased its peak summer weekly seat capacity by one third. By airport, the biggest share of this incremental capacity has been at Manchester. By destination, the lion's share of its growth has been to Spain, where there is now a capacity glut. Its markets have become increasingly competitive – not only due to other LCCs, but also because of the growth of airlines owned by integrated leisure groups such as TUI and Thomas Cook.
Jet2.com is more summer-biased than almost any European airline, in spite of a capacity cut last summer. This reflects its strong leisure focus and its interdependence with the tour operator Jet2holidays. In the year to Mar-2016 Jet2holidays supplied 40% of the UK LCC's passengers, up from 17% in FY2013, since when it has been responsible for all of the airline's traffic growth.
Dart Group owns and runs both Jet2.com and Jet2holidays as the single business segment Leisure Travel (95% of group operating profit). The underlying operating profit of the Leisure Travel segment more than doubled for the year to Mar-2016, reaching the highest margin since FY2009, thanks to yield growth and increased sales of higher-end package holidays.
Strong advance sales insulate Jet2.com and Jet2holidays from the impact of Brexit in the short term. Nevertheless, their strong dependence on summer leisure demand exposes them to any volatility that may result from growing geopolitical and macroeconomic risks. Moreover, an order for 30 new Boeing 737-800s marks a departure from Jet2.com's strategy of buying and operating old aircraft that are close to being fully depreciated. This may increase the pressure on the airline to deploy its assets on a more year-round basis.
The first of Europe's big three legacy airline groups to report results for 2Q2016, Air France-KLM improved its operating margin and still expects higher operating free cash flow for FY2016. However, it remains less profitable than the other two big legacy groups, IAG and Lufthansa, and is still reluctant to give a profit target for FY2016.
Air France-KLM's commentary on the outlook implies that it now expects to make a lower profit this year than previously anticipated, even if this is likely to be higher than in 2015. In effect, this completes a full set of profit warnings from the big three legacy groups, since IAG and Lufthansa have already signalled a lowering of their profit outlook for 2016.
By contrast, LCCs have generally been more positive in their 2Q reporting and outlook (with the notable exception of easyJet). All European airlines have highlighted a weakening outlook for unit revenue, due to industry capacity growth plus geopolitical and macroeconomic risks, but low cost airlines such as Ryanair and Wizz Air appear better placed to cope with this outlook, given their lower unit costs. At this point in the cycle, new Air France-KLM CEO Jean-Marc Janaillac will need to balance growth against productivity.