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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At its Capital Markets Day in late Nov-2014, Flybe asserted that it "does not compete with low cost carriers, flag carriers or mid-haul leisure airlines". Moreover, our analysis shows that it rarely competes with other regional airlines. In fact, Flybe faces no competition of any kind on 78% of its city pair routes in its Dec-2014 schedule. Moreover, it is Europe's largest independent regional airline and Europe is the world's largest regional market.
In spite of these advantages and what looks to be a relatively efficient cost base by comparison with other European regional airlines (according to our analysis), Flybe has yet to re-establish sustainable levels of profitability. Much has been achieved since the change of senior management in 2013, but the regional airline's fundamental CASK disadvantage will remain a challenge even as it increases its focus on turboprops rather than regional jets.
The Aegean Airlines Group's string of good financial results continued with 3Q2014 operating profit increasing by more than a quarter compared with the same period a year earlier (based on proforma figures with Olympic in the comparable). Aegean is growing its capacity at a double digit rate, with particularly strong growth in the domestic market and on international routes from Athens, just as Ryanair is expanding rapidly in Greece. This has led to downward pressure on yields and RASK, but Aegean has successfully cut CASK even more quickly to drive up its margins.
Competition between Aegean and Ryanair looks set to intensify in 2015, when the battle may extend to Cyprus, regardless of whether or not one of them is successful in biding for Cyprus Airways.
As Aer Lingus will testify, having Ryanair as your nearest and biggest competitor focuses the mind. Aegean will need to prove that its recent good run can be extended.
Oman’s Minister of Transport and Communications Dr Ahmed bin Mohammed bin Salim Al Futaisi announced in early Nov-2014 that Oman may open its market to a private LCC. This follows flag carrier Oman Air's decision not to establish its own LCC subsidiary.
Speaking to the Times of Oman newspaper Dr Al Futaisi announced that the government is “conducting a study to introduce a new airline, like budget airline”.
The Minister's intention is that at least one new operating licence, and possibly more, would be awarded to a private operator through a tender process. A similar approach has already been tried in Saudi Arabia, in both rounds of its liberalisation efforts, with mixed success.
easyJet's most recent annual results, for the financial year ended Sep-2014, confirmed its position as one of Europe's most profitable airlines. Its pre-tax profit of GBP581 million was 22% higher than last year and its operating margin of 12.8% was up 1.1 ppts from last year. Among European airlines, easyJet ranks second only to Ryanair's 16.5% margin for the same 12 month period. According to its own measure of return on capital employed, it ranks first among leading European airlines and in the first quartile of companies from all sector's in the UK's benchmark FTSE 100 stock market index.
Significantly, these results seem to have silenced easyJet's founder and largest shareholder Sir Stelios Haji-Ioannou, who has also been its greatest critic in recent years since resigning from the Board in 2010. The proposed annual dividend will be 36% higher than last year and Sir Stelios' family stands to receive GBP63 million. One of the rare successes in the airline sector, CAPA analyses easyJet's strengths, weaknesses, opportunities and threats in this report.
France's traditionally conservative aviation policy has meant that air services have focussed around Paris. The result is that there are few large airports outside the capital.
Moreover, the privatisation of France’s airports has been a long drawn out, stop-start process, which involved Aeroports de Paris at one end of the scale and a number of secondary level airports serving small cities at the other.
Sat patiently in the middle have been the primary level airports (only one of which handles more than 10 million ppa despite that designation).
But with the forthcoming privatisation of Toulouse Blagnac airport their time may have come at last.
After four successive quarters of year on year declines in its underlying operating result, Pegasus Airlines reported an increase in 3Q2014. Its operating margin was at the same level as 3Q2013, after falling in 1H, and second in Europe only to Ryanair (of those to report thus far).
As always, Pegasus' results are complicated by foreign exchange, especially as Turkey's currency has weakened against EUR and USD. Expressed in its functional currency of EUR, rather than its reporting currency of TRY, Pegasus' CASK (cost per available seat km) edged up slightly in 3Q, reversing the decline of 1H. Fortunately, RASK (revenue per available seat km) also increased at a similar rate, ending a four quarter falling trend. This was helped by a relative slowing of its capacity growth in addition to less aggressive pricing by Turkish Airlines at Sabiha Gökçen.
Pegasus has reiterated its FY2014 guidance, although there now seems to be scope for it to do better. Our suggestion after 2Q results, that Pegasus may have turned a corner and be ready to leave the path of deteriorating margins, seems to be gaining credibility.