Eastern Europe Outlook: Faster growth, but only the toughest survive

There are also some uncertainties shrouding the outlook, in the form of geopolitical risks, which appear to have a higher concentration in Europe's eastern half. The Ukraine crisis continues to dampen demand for travel both into and out of that country and Russia, which is also affected by economic sanctions. In 2015, total passenger numbers in Russia look set to be lower than in 2014 after several years of growth. At the 9M2015 stage, Russia's passenger numbers were down by 2.6% year-on-year, in spite of continued strong growth in domestic markets (up 16.2%), thanks to a slump in international traffic (down 15.3%).

Other geopolitical events could affect air travel in 2016. The civil war in Syria and the campaign by western powers and Russia against terrorist organisations in Syria and Iraq leaves Turkey exposed to the risk of demand shocks. Any escalation of conflicts in these and/or neighbouring countries could have a negative impact not only on air travel in Eastern Europe, but also possibly on a global scale.

Current forecasts by Turkey's airport authority DHMI for passenger numbers in Turkey foresee growth of 8.3% in 2016, following 6.2% in 2015, and Eurocontrol forecasts that Turkey will enjoy a growth rate in the number of flights in 2016 of 5.7%, more than twice that of Europe as a whole.

In Greece, growth in air travel continues to defy the feeble macroeconomic environment. According to forecasts published by Aegean Airlines in Sep-2015, and so largely based on year to date actual figures from the Hellenic Civil Aviation Authority, total passenger numbers in Greece will be up by 10% in 2015. This is driven by double digit rates of growth in the domestic market and in the international market from Athens, only partly offset by more sluggish growth in the international market from regional airports. The Greek market, stimulated by Ryanair's establishment of a base in Athens and network growth from Aegean Airlines, will remain heavily dependent on inbound tourism.

Turkey is the largest and one of the fastest growing aviation markets in Eastern Europe. Its largest airline is flag carrier Turkish Airlines (only partially government owned), followed by LCC Pegasus Airlines. Growing capacity at double digit rates in both cases, they have both experienced downward pressure on unit revenue in 2015, but have managed to improve their operating profit (at the 9M2015 stage) thanks mainly to lower fuel prices.

Turkish Airlines, which is also the biggest airline in the eastern half of Europe, has been growing fastest on routes to North America and it will launch a daily Istanbul-Atlanta service in May-2016. The biggest part of its network in ASK terms is Europe, where it is also growing at a double digit rate and where it has significantly more direct connections than any of the three Gulf based super connectors Emirates, Qatar Airways and Etihad. Turkish Airlines' growth will not stop in 2016, when it plans to increase its fleet by 10% to 331 aircraft, although the 12% increase in its fleet's seat capacity will be slower than the 18% increase in 2015.

Pegasus plans to grow its fleet by 12 aircraft, or 18%, to 79 narrowbodies in 2016, only a little slower than the 22% growth in the fleet in 2015. The largest part of Pegasus' network is to Europe (around a half of ASKs), where it grew mainly through additional frequencies in 2015, but it has also added new routes to destinations in the Middle East. Yield decline has placed some pressure on Pegasus' margins in 2015, but its main strength as one of only three ultra low cost airlines in Europe (only two in Eastern Europe) positions it to withstand such pressure while remaining profitable.

The second largest airline group in Eastern Europe is the Aeroflot Group. Aeroflot more than doubled its operating profit for 3Q2015 and 9M2015, helped by low fuel prices, but mainly thanks to its growing share of a consolidating market and the positive impact this had on unit revenue. The Aeroflot Group increased passenger numbers by 13.3% in 9M2015, significantly outgrowing the market. Already Russia's largest airline group, it is benefiting from the weakness of domestic rivals and capacity cuts in Russia by foreign competitors. A previous plan to buy a majority stake in bankrupt number two airline Transaero was halted, but Aeroflot is to take over some of its suspended rival's routes and aircraft, which will further extend its market leadership.

Moreover, a successful first year for Aeroflot's LCC subsidiary Pobeda (launched in Dec-2014) and a plan to merge three of its regional airlines (Rossiya, Donavia and Orenair) under the Rossiya brand help to sharpen Aeroflot's multi-brand strategy. The new Rossiya should provide cost saving opportunities and a more focused brand for the group's regional airline activities.

The Aeroflot brand is the leading Russian airline in the premium segment, Pobeda leads in the budget segment and Rossiya will now be the leader in the regional market segment. The group's published fleet plan will see a net increase of 16 aircraft, or 6%, in 2016 before the addition of up to 34 aircraft from the former Transaero fleet.

Wizz Air is Eastern Europe's other ultra LCC, alongside Pegasus, but the two airlines largely operate in different markets. Wizz Air has had a significant 2015, carrying its 100 millionth passenger in late Oct-2015 (just 12 years after its launch), completing a successful IPO, placing an order for 110 A321neo aircraft (and purchase rights over an additional 90) and achieving a record 1H2015 profit.

Building on its very low cost base and strong ancillary revenues, Wizz Air is able to offer low fares and stimulate demand growth. Its focus on Central/Eastern Europe, which is under-penetrated by air travel compared with Western Europe, offers strong growth potential. It faces growing competition from Ryanair, Europe's biggest airline and the only airline in Europe with lower unit costs than Wizz Air.

Nevertheless, Wizz Air is the leading airline in its chosen geographic market and, moreover, it has built this position profitably while always competing with Ryanair. Its fleet plan should help to keep unit costs on a downward path, as A321 deliveries alongside its predominantly A320 fleet will increase the average number of seats per aircraft by 7% from 180 in FY2015 to 193 in FY2018 and A321neo deliveries will start in 2019; yield dilution is however a risk that should not be ignored. In FY2017 (March year end), Wizz Air plans to increase its fleet by 16% to 78 aircraft, following a 22% increase in FY2016.

Aegean Airlines' business is proving fairly resilient in the face of a difficult environment in Greece, characterised in 2015 by capital controls, bank closures, economic contraction and an uncertain political climate. In spite of these challenges, its passenger numbers were up 17% for 9M2015 and its 9M2015 operating result was at the same level as in the same period for the previous year. However, Aegean is having to work harder by growing revenue to achieve the same profit. Moreover, even maintaining the same profit has required a considerable helping hand from lower fuel prices.

Aegean's key challenge remains the very soft pricing environment in Greece, the result of economic weakness and strong competition from Ryanair, the country's second biggest airline. In 2014, Aegean was the highest margin full service airline in Europe and should remain close to the top of this category in 2015. However, it cannot let up in the battle to remain competitive with ultra LCC Ryanair, which will continue to intensify in 2016.

LOT Polish Airlines is moving from its restructuring phase, which involved state aid cleared by the European Commission in late 2014, to a phase of renewed growth. With a significantly improved cost structure, LOT has said that it plans to double its annual passenger numbers to 10 million in 2020. The main growth driver will be its long haul network, with a focus on Asia and North America, as it seeks to be the leading airline connecting its part of central Europe to the rest of the world. In 2016, LOT plans to add Tokyo Narita, Seoul and Bangkok to its existing Beijing service in Asia.

Even after launching these new routes, LOT's long haul network will have only seven destinations (it may add two more in 2016 and plans a total of 10 to 12 by 2020) and it will continue to need partners for access to much of the world. LOT is a member of the Star Alliance, but is not part of the immunised North Atlantic joint venture within Star, and has expressed frustration with its position in the alliance. It will review its partnership options, including Star membership, and may make some changes in 2016.

LOT plans to grow its current fleet of 41 aircraft to a total of between 62 and 78 by 2020. It only has two Boeing 787-8s currently on order, but is considering orders for widebodies, narrowbodies, regional jets and turboprops. Decisions on at least some of these orders may be taken in 2016. LOT's long-running privatisation story will also continue in 2016, when the government may finally make progress in selling at least part of its 99.8% stake. There may also be clarification of the leadership of the airline in 2016. CEO Sebastian Mikosz left LOT in 2015, replaced by Marcin Celejewski, but only as acting CEO.

LOT has not been the only Eastern European flag carrier seeking a private investor. As many state-owned airlines have struggled with their financial performance and with sometimes interfering government shareholders, so they have been attracted to the idea of opening up to private capital. In late 2015, airBaltic appeared to have secured investment by German investor Ralf Dieter Montag-Girmes of EUR52 million for a 20% stake, with the Latvian government agreeing to invest a further EUR80 million.

airBaltic, fresh from its own restructuring programme, may also be a beneficiary in 2016 of the demise in 2015 of neighbouring airlines Estonian Air and Air Lituanica. The Croatian government continues to seek an investor in Croatia Airlines, with Aegean Airlines, Lufthansa and Turkish Airlines reported to have expressed interest. A decision on privatisation or recapitalisation is expected by summer 2016.

The world's airline industry as a whole is set to report operating margins for 2015 that are consistent with previous cyclical peaks. In spite of this relatively healthy industry backdrop, supported as it is by low fuel prices, the eastern part of Europe also witnessed the liquidation of Cyprus Airways in 2015, in addition to the two Baltic airlines already mentioned. The smaller and weaker airlines in the region will be hoping that 2015's historically strong industry margins are not a precursor to a cyclical downturn in 2016. Continued low fuel prices may act as something of a lifeline to those airlines struggling to regain sustainable levels of profitability, although this factor may also add to downward yield pressure.

Certainly, if there is any sign of a cyclical downturn in the airline sector in 2016, potential investors are likely to pause and this will shine an even brighter spotlight on these airlines' restructuring programmes. Rather than consolidation through acquisition, the Eastern European region may then see a further phase of consolidation through market exit.