Analysis Reports

Ryanair CEO Michael O'Leary has predicted that Europe's airline industry is moving "inexorably" towards five airline groups –Lufthansa, IAG, Air France-KLM, Ryanair and easyJet – controlling 80% of the continent's traffic.

Other leading airline executives, including IAG's Willie Walsh, Lufthansa's Carsten Spohr and easyJet's Johan Lundgren have also talked of the likelihood of consolidation.

The exit of weaker airlines will be an important mechanism for increasing the concentration of Europe's airline market structure. Mergers and acquisitions are also likely to play a part. Mr O'Leary has even predicted specific deals that he expects to happen in the next five years. In his view, these include the purchase of Norwegian and TAP Air Portugal by IAG, the sale of Wizz Air to Lufthansa, and Alitalia's eventual acquisition by Air France-KLM.

The modestly increased pace of European consolidation over the past couple of years is the result of market exits and the acquisition of capacity from bankrupt airlines by large airline groups. However, the airlines that have left the market had only a small share of seats. Europe's airline industry is fragmented compared with North America's and will remain so even if the deals predicted by Mr O'Leary were to happen.

There has been flux in the Mexico City-US market during the past year as the low cost operators Southwest, Alaska and JetBlue have either entirely pulled out of Juarez International airport, or in the case of JetBlue, reallocated flights to points of strength in its network. 

All of those airlines benefitted from slot divestitures required by regulators for SkyTeam partners Aeromexico and Delta to launch their transborder joint venture in 2017. Although Mexico City tilts more towards business passengers, overcapacity has been an overhang in the US-Mexico market for some time, and pricing on those routes has been pressured. 

Given those conditions, it is no surprise that airlines are opting to pull capacity from Mexico City; but the result is a dwindling presence of US low cost airlines in Mexico’s capital. 

The US domestic airline market is arguably the most mature in the world, which means traffic stimulation opportunities are more limited than in other emerging regions.

But ultra low cost airlines believe that market concentration in the US creates opportunities to lure the infrequent traveller into taking more trips, and they’ve grown rapidly in the market during the last decade. 

US full service airlines have also opted to court the infrequent traveller through the introduction of segmented fares, featuring a basic economy option. Although segmented fares seemingly allow those airlines to compete more effectively with ULCCs, they’re really a way for American, Delta and United to drive customers into higher fare buckets, and ultimately grow their revenue.

At the same time, segmented fares are evolving as US major airlines seem to be moving towards deploying a higher number of premium seats in the US domestic market as fare segmentation spreads. 

The country’s largest lower cost airline, Southwest, has also declared that it is preparing to launch new ways to drive revenue in 2020 as it regularly fields questions about its response to product segmentation in the market place. 

Over the next 12 months, Ryanair plans to move to a group structure "not dissimilar to that of IAG". Under Ryanair Holdings PLC there are now four airlines, each with its own AOC. These are the Ireland-based Ryanair, Poland-based Ryanair Sun, Austria-based Laudamotion and the newly created Ryanair UK.

Under the new structure the four airline subsidiaries will each have its own CEO and management, reporting to a small senior management team led by group CEO Michael O'Leary. Ryanair Sun (to be rebranded as Buzz) and Laudamotion already have their own CEO, but the other two subsidiaries will need to appoint new heads. The holding company will focus on efficient capital allocation, cost reductions, aircraft acquisitions and small scale M&A opportunities.

This report compares Ryanair's proposed structure with that of IAG and also takes a quick look at the other two large airline groups in Europe: Lufthansa Group and Air France-KLM.

Ryanair's new group structure is yet to be implemented and no doubt it will evolve. Nevertheless, at first sight, it looks pragmatic and seems unlikely to match IAG in two key areas: competition among subsidiaries for capital investment and the consistent use of different brands for different markets.

In 2018 Turkey's aviation market confirmed its rebound from the setbacks of 2016, when geopolitical and terrorist events had weighed on demand, particularly in international markets. As in 2017, passenger growth outpaced seat growth in 2018, and this was led by the international market.

The healthy demand environment was positive for the unit revenues of the country's two leading airlines. Both the flag carrier Turkish Airlines and the ultra LCC Pegasus Airlines reported 2018 operating margins that were their best for some years and, again, very similar to one another.

For 2019, Turkey's airport authority DHMI forecasts that passenger traffic growth will be slower than in 2018, but still comfortably above the European average rate. With both the leading airlines apparently locked into the same profit cycle, it seems only the transfer of Turkish Airlines' hub from Atatürk to the new Istanbul Airport (again pushed back, now to 5/6-Apr-2019) could set them on radically separate margin trajectories.

That wild card aside, macroeconomic and geopolitical drivers are likely to determine whether or not Turkish Airlines and Pegasus Airlines can achieve further margin improvement this year.

Japan Airlines' (JAL) subsidiary Zipair will become the thirteenth widebody LCC in Asia Pacific in 1H2020 and the first in Japan. Zipair will initially operate two routes within Asia, from Tokyo to Bangkok and Seoul, before expanding into the long haul market in 2021.

JAL is taking a relatively conservative approach with a five-year business plan that includes only two additional aircraft per year, resulting in 10 787s by the end of 2024. Zipair’s first two 787s are -8s from JAL that will be converted in 2H2018 to a high density two class configuration.

Zipair and the AirAsia X Group will be the only all-widebody low cost operators in Asia Pacific. Feed is typically a crucial component of the long haul low cost market; AirAsia X relies on its sister short-haul airline group AirAsia and Zipair can use Jetstar Japan.

AirAsia X is now the largest airline group in Japan’s emerging medium/long haul market, operating 10 routes. AirAsia X has ambitious plans for Japan, including several routes to the continental US, which JAL will likely try to combat using Zipair.

If trends in air freight activity still retain their historic ability to act as an early warning indicator for the global economy, there may be grounds for some concern. According to data from IATA, air freight traffic fell year-on-year for the third consecutive month in Jan-2019 and reached their slowest rate of annual growth in close to three years. Freight load factor and yield are also sliding.

IATA noted that the softness in air cargo traffic went beyond what might have been expected following a temporary surge in activity from the global inventory restocking cycle. This drove strong growth in 2017, but the trend has been weakening since mid-2018. There is a clear divergence between air freight and passenger trends.

In the global financial crisis of 2008-2009 air freight activity fell earlier, and more deeply, than passenger activity. In the post-crisis period, air cargo helped to lead the recovery.

Since then, its share of world airline revenue has reduced somewhat and the industry has become more profitable. Nevertheless, airlines would certainly not welcome a slide in cargo revenue. Nor would they, or would any industry, want the deteriorating air freight outlook to have wider implications for the world economy.

US value airlines have grown their combined position in the market to nearly 12%. Alaska, through its acquisition of and merger with Virgin America, and JetBlue, through organic growth after opting out of the bidding contest for Virgin America. 

Those operators have made some network tweaks during the past year in order to leverage their respective strengths and improve revenue performance. Alaska has made adjustments in certain California markets and JetBlue has placed less emphasis on its focus city in Long Beach, increasing its presence in the US transcontinental market. 

Southwest, which is the market share leader in the US and still the country’s largest lower cost carrier, is focusing much of its network attention in 2019 on the long-awaited launch of services to Hawaii, which will pressure Alaska and other airlines operating in the market. But Hawaii is a logical extension for Southwest, which is launching service from California airports where it has a strong position. 

As Southwest Airlines inches closer to launching flights to, from and within the Hawaiian islands, there’s no shortage of speculation about how the airline’s entry into the market will affect overall dynamics. 

Southwest is launching flights at a time when current operators between the US and Hawaii cite a period of overcapacity in the market, and there’s no doubt the pricing pressure created by that excess supply will continue once Southwest firms up its initial schedule and injects promotional fares onto those routes. 

Although Southwest could shake up the inter-island market from a commercial perspective, Hawaiian Airlines has already weathered numerous competitors in the market and obviously has a strong local following. In the short term, passengers will benefit from solidly lower fares until a new competitive equilibrium settles in. 

 In early 2018, when the US and the governments of the UAE and Qatar reached a truce over the years-long subsidy debate between American, Delta and United and Emirates, Etihad and Qatar, many questioned how long the cease fire would last.

The answer was: barely a few months. American argued that fellow oneworld member Qatar Airways could be violating aspects of the agreement through its stake in Air Italy, which was adding services from Milan to Miami and New York JFK.

The argument continues to simmer, but proving that Qatar is in fact violating the terms of the truce could prove difficult.

Nonetheless, it did appear to many foreign governments that the highly influential Big 3 were trying to turn the clock back to an era where national airlines were protected from competition, regardless of the wider national interest.