02-Sep-2015 12:42 PM

Air Astana plans modest expansion in 2016 with Iran, Mongolia routes; more London, China capacity

Analysis

Kazakhstan's Air Astana is continuing to grow capacity despite weakening demand in its home market. The flag carrier has been increasing its reliance on lower yielding sixth freedom traffic as the devaluation of the Kazakh tenge has impacted outbound demand but cost reductions have enabled it to remain profitable.

Air Astana plans to launch services to Iran and Mongolia in 2016 while adding capacity on existing routes to China, Georgia, the Ukraine and the UK. London expansion comes on the heels of British Airways dropping service to Kazakhstan.

Air Astana plans to expand its fleet by five aircraft over the next four years to 35 aircraft, providing a platform for modest capacity growth. The first of 11 A320neo family aircraft will be delivered in 2016, kick-starting a major fleet renewal initiative.

Summary

Air Astana has been increasing its reliance on lower yielding sixth freedom traffic as the devaluation of the Kazakh tenge has impacted outbound demand but cost reductions have enabled it to remain profitable.
Air Astana plans to launch services to Iran and Mongolia in 2016 while adding capacity on existing routes to China, Georgia, the Ukraine and the UK.
The decline in revenues have been driven by a sharp drop in yields, which is due primarily to the devaluation of the tenge.
Air Astana has been reducing its dependence on the local market by pursuing transit traffic as part of an extended home market strategy which focuses on regional connections within Central Asia and the CIS.
Air Astana is planning to grow capacity by only 4% in 2016, with growth of 10% projected for 2017.
Air Astana plans to lease another four A320neo family aircraft, raising its total commitments to 11 aircraft.

Air Astana revenue and traffic growth slows as yields decline

Air Astana currently serves around 40 destinations with a fleet of 30 aircraft. It has seen consistent and profitable growth since it launched in May-2002, ending every year in the black since 2003.

But growth has slowed significantly since early 2014 as demand for domestic and outbound travel has been impacted by the devaluation of the Kazakh tenge. Passenger traffic grew by only 3% in 2014 to 3.8 million and by 4% in 1H2015 to 1.82 million. This follows passenger growth of nearly 70% from 2009 to 2013, equating to average per annum growth of about 17%.

Revenues were down 3% in 2014 and dropped another 9% in 1H2015. Revenues had grown by 73% from 2009 to 2013, reaching a high mark of USD967 million in 2013 before slipping to USD933 million in 2014.

Air Astana annual revenues (in USD million): 2009 to 2014

Air Astana's revenues were also down 9% through the first seven months of 2015, putting the carrier on a pace to generate USD850 million for the full year. This would represent a 12% drop compared to 2013 despite capacity still growing by about 12% over the two-year period, including 4% in 2014 and planned ASK growth of 8% for 2015.

The decline in revenues have been driven by a sharp drop in yields, which is due primarily to the devaluation of the tenge. Intensifying competition and a greater reliance on sixth freedom traffic also have contributed to the yield declines.

Air Astana battles currency devaluation

The tenge was initially devalued by almost 20% in Feb-2014, resulting in an immediate impact to Air Astana. The flag carrier quickly responded by slowing capacity growth.

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The Kazakh government decided to de-peg the tenge to the USD in mid Aug-2015, introducing a new free float policy. The value of the tenge immediately dropped by another 25%, leading to a more challenging short-term outlook for Air Astana. The tenge accounts for about two thirds of the Air Astana's revenues but only one third of its costs.

The initial devaluation has already led to much smaller net profits for Air Astana but the airline has been able to continue growing operating profits. It is confident it will continue to stay profitable despite the latest devaluation, enabling it to extend its profit streak.

Air Astana turned a net profit of USD19 million in 2014, its lowest annual profit since 2008, after incurring a USD36 million net loss in 1H2014 driven by a revaluation of debt following the initial devaluation of the tenge in early 2014. It reported a net profit of only USD8 million for 1H2015.

Reduction in costs enables Air Astana to continue growing operating profits

Air Astana was still able to increase its operating profits in 2014 by 35% to a record USD98 million. The carrier's operating profit in 1H2015 also more than doubled to USD24 million on a low base.

Through the first seven months of the year its operating profit was up to USD41 million, giving Air Astana a respectable 8.7% operating margin despite the challenging conditions.

Air Astana annual operating profits (in USD million): 2009 to 2014

While lower fuel prices have helped, Air Astana has also been able to reduce its non-fuel operating costs, enabling it to offset the lower unit revenues. Ex-fuel unit costs improved nearly 10% from USD 5 cents to USD 4.6 cents in the first seven months of 2015.

The lower unit costs have enabled Air Astana to keep its break-even load factor at 60% despite the reduction in yields. Air Astana's load factor has traditionally been low, a reflection of the Central Asian marketplace, and was at 64% through the first seven months of 2015.

Renegotiated contracts, higher employee productivity (including from pilots) and improved aircraft utilisation rates drove the reduction in unit costs. Air Astana has benefited somewhat from lower local tenge-denominated costs but not significantly due to inflationary adjustments.

Air Astana has been reducing its dependence on the local market

The de-pegging of the tenge was inevitable given Kazakhstan's heavy reliance on the energy sector and exports to Russia. Kazakhstan's GDP is projected to grow by only 2% in 2015, down from 4.3% in 2014 and 6% in 2013. Economic problems in Russia have significantly impacted Kazakhstan's manufacturing sector and the depreciation of the ruble essentially forced a change in the Kazakh currency policy.

Over the long run the free float should improve the position of Kazakhstan. But for now it significantly reduces the spending power of its citizens.

Air Astana has traditionally relied mainly on the domestic and outbound international markets. Five years ago the airline had virtually no transit passengers while inbound demand was limited.

But Air Astana has been working in recent years to reduce its dependence on the Kazakh market by pursuing transit traffic as part of an extended home market strategy which focuses on regional connections within Central Asia and the CIS. Inbound traffic also has grown boosted in part by efforts to develop tourism.

Air Astana also has reduced its domestic exposure in recent years by allocating most capacity expansion to the international market and phasing out its turboprop fleet. Only about 35% of its revenues are now generated by the domestic market.

Of the 65% generated from international flights, Air Astana now has a relatively even geographic split with 25% of revenues generated from European routes, 20% on Asian routes and 20% on regional routes including Russia. Asia has been the main area of growth in recent years, enabling Air Astana to reduce its reliance on Russia.

Domestic fares in Kazakhstan are still regulated

Without the reduced domestic and Russian exposure Air Astana would likely have struggled to maintain profitability over the last 18 months. The Russian market has been challenging due to the financial crisis while Kazakhstan's domestic market has become extremely challenging due to the tenge devaluation.

Domestic fares in Kazakhstan are regulated by the government. Airlines have been unable to raise fares as the currency has been devalued, making it virtually impossible to make money.

A potential deregulation of the domestic market could improve Air Astana's outlook for 2016 as well as the outlook for its local competitors, which rely much more on the domestic market. Air Astana has been able to raise outbound international fares to compensate for the tenge devaluation because the international market is not regulated. But outbound demand has naturally been impacted, forcing Air Astana to rely more on lower yielding transit passengers.

Air Astana has also seen a boost in inbound visitor traffic, aided by a new visa waiver scheme for 19 nationalities. But inbound business traffic has been impacted by the slowdown in Kazakhstan's economy. Inbound business traffic in the oil and gas sector has particularly been impacted.

New Iran and Mongolia services to enable Air Astana to continue growing transit traffic

Sixth freedom or transit traffic now accounts for about 15% of Air Astana's revenues and about 30% of its international passenger traffic. Air Astana CEO Peter Foster expects the transit portion will continue to grow as the airline expands, particularly in the short to medium term given the weaker tenge.

The capacity Air Astana is planning to add in 2016 is mainly targeted at new sixth freedom markets. Mr Foster said Tehran in Iran and Ulan Bator in Mongolia are now the only new destinations in Air Astana's business plan for 2016.

With Terhan, Air Astana sees huge potential in the China-Iran market. With Ulan Bator, it will plug into the fast-growing and relatively underserved Mongolia-Europe market.

Air Astana plans to launch both new destinations in spring 2016 with three weekly flights. Tehran will be served with Embraer E190s from Almaty, Kazakhstan's largest city and commercial centre, while Ulan Bator will be served with A320s from the capital Astana. Air Astana has developed hubs at both airports but as Astana now handles most European flights it is the more logical hub for the Ulan Bator service.

Air Astana has been looking at entering the Mongolian market for several years and initially announced services to Ulan Bator in 2011 before pulling the route prior to the planned launch. It again put the Ulan Bator in its network plan for 2014 but ended up postponing the route again.

Air Astana has always viewed Iran as a tremendous opportunity should the market open up given Kazakhstan's geographic position between Iran and Asia. As Iran opened in recent months, it quickly emerged as a high priority for Air Astana. Serving Tehran from Almaty is sensible as Air Astana has more capacity to China from Almaty than Astana.

Air Astana to add capacity to China

Air Astana is also planning to add capacity to China in 2016, taking advantage of a newly extended air services agreement between China and Kazakhstan. Air Astana will initially use new traffic rights to China to add capacity to its two existing mainland Chinese destinations, Beijing and Urumqi.

Beijing is currently served with eight weekly flights, including five from Almaty and three from Astana. Urumqi in western China is served with 12 weekly flights, including seven from Almaty and five from Astana.

Mr Foster said Chengdu, which has long been envisioned as Air Astana's next Chinese destination once the bilateral was extended, is now in the business plan for 2017. Air Astana also has talked previously about serving Shanghai but this is only now considered a possibility for the medium to long-term.

China is currently Air Astana's third largest international market based on seat capacity after Russia and Turkey.

Air Astana international seat capacity by country: 31-Aug-2015 to 07-Sep-2015

Air Astana seeks to double capacity to London

The 2016 network plan also includes more capacity to London Heathrow, Kiev in the Ukraine and Tbilisi in Georgia.

Kiev is currently served three times weekly from Almaty. Air Astana reduced capacity to Kiev by over 50% in 2014 due the conflict in the Ukraine but now sees improving market conditions.

Tbilisi is currently served with five weekly flights from Almaty and two from Astana, according to OAG data. Air Astana sees growing demand from Georgia, one of Air Astana's extended home markets which has enabled it to reduce its reliance on Kazakhstan. It already increased capacity to Georgia in Jun-2015 with the launch of the two weekly flights on the Astana-Tbilisi route.

London Heathrow is now served with three weekly flights from Astana. Mr Foster said a fourth weekly flight will be added in spring 2016 and the airline hopes to eventually add two more weekly frequencies to London for a total of six pending a new bilateral agreement between Kazakhstan and the UK.

British Airways is ending its three weekly flights on Heathrow-Almaty route in Oct-2015, leaving an opportunity for Air Astana to expand in a relatively mature market. But Air Astana will need to wait for Kazakh and UK authorities to forge a new air services agreement before expanding its Astana-London route beyond four frequencies.

Astana-Bangkok to be upgraded to year-round route

Air Astana also plans to transition Astana-Bangkok into a year-round service in 2016. Air Astana currently serves Bangkok with six weekly flights, including four on a Almaty-Bangkok-Almaty rotation and two on a Almaty-Bangkok-Ho Chi Minh-Almaty rotation. A seasonal twice weekly flight from Astana to Bangkok was launched in Dec-2014 but has so far only operated during the peak northern winter months.

Air Astana similarly launched one weekly flight from Astana to Seoul in Jun-2015, supplementing three weekly service from Almaty to Seoul. Air Astana has traditionally only used the Almaty hub to serve East Asia with the exception of China, which is more a regional destination as China borders Kazakhstan.

Ho Chi Minh, Kuala Lumpur and Kuala Lumpur are still only served from Almaty with Ho Chi Minh and Hong Kong served twice weekly and Kuala Lumpur thrice weekly. Capacity increases on any of these routes are not planned for 2016. But the next priority is adding back a third weekly flight to Hong Kong.

Air Astana is not planning to extend its network in East Asia with the exception of China. It views Singapore as a potential destination for the long-term.

Air Astana plans 4% capacity growth in 2016 but 10% growth for 2017

Overall Air Astana is planning to grow capacity by only 4% in 2016. Growth of 10% is projected for 2017 but in 2018 and beyond relatively moderate capacity growth of 4% to 5% p/a is planned.

2017 will see a bigger spike as Air Astana gears up for its role of host airline for EXPO 2017, which will be held in Astana in from 10-Jun-2017 to 10-Sep-2017.

In recent years most of Air Astana has focused most expansion in Astana due partially to capacity constraints at its larger hub in Almaty. Both airports are now operating above capacity but the constraints at Almaty are more severe and Astana is now constructing a new terminal which will double capacity by 2017.

Astana is already a more modern facility, providing a much better transit experience compared to the woefully outdated privately-operated airport in Almaty. Air Astana opened its own business class lounge in Astana in 2014 while it still has not yet been able to open a lounge in Almaty.

Almaty (ALA) currently has almost 50% more capacity than Astana. But Astana (TSE) will continue to grow faster, particularly ahead of EXPO 2017. Mr Foster also expects Astana will soon overtake Almaty as its largest hub for transit traffic.

In addition to Almaty and Astana, Air Astana has small mini-hubs in the western Kazakhstan cities of Atyrau (GUW) and Aktau (SCO). Both are linked with Istanbul and Atyrau is also the gateway for Air Astana's Amsterdam service. (Frankfurt, Paris, London are only served from Astana.)

Air Astana top 10 bases/hubs/stations ranked by seat capacity: 31-Aug-2015 to 7-Sep-2015

Air Astana to take delivery of first A320neo in 2016

The planned growth in capacity will be supported by a slightly larger fleet. Air Astana has only one delivery scheduled for 2016 but this will be a growth aircraft.

The aircraft being added in 2016 is being sourced from Air Lease and will be the first of 11 A320neo family aircraft, marking the start of a narrowbody fleet renewal programme. With the May-2016 delivery Air Astana has been able to secure a very early A320neo slot.

Air Astana currently operates 13 A320ceo family aircraft including one A319, eight A320s and four A321s. It committed in Jun-2015 to lease seven A320neo family aircraft from Air Lease, including two A320neos, one A321neo and four A321neoLRs.

Air Astana fleet summary: as of 2-Sep-2015

Aircraft	In Service	On Order*
Total:	30	10
Airbus A319-100	1	0
Airbus A320-200	8	0
Airbus A320-200neo	0	2
Airbus A321-200	4	0
Airbus A321-200neo	0	1
Airbus A321-200neoLR	0	4
Boeing 757-200	4	0
Boeing 757-200(ETOPS)	1	0
Boeing 767-300ER	3	0
Boeing 787-8	0	3
Embraer ERJ190-100LR	9	0

Mr Foster said Air Astana plans to lease another four A320neo family aircraft, raising its total commitments to 11 aircraft. All 11 of these aircraft will be delivered by the end of 2019, including nine replacement aircraft and two growth aircraft. The nine aircraft being replaced include Air Astana's five 757s and its four oldest A320ceo family aircraft.

Air Astana plans to keep its other nine A320ceo family aircraft as these are all currently three years old or less. The four aircraft being replaced are between seven and 16 years old, according to the CAPA fleet Database

Air Astana fleet plan: 2016 to 2019

Year	Deliveries	Returns
2016	+1 A320neo	N/A
2017	+2 A320/A321neo	-1 A321ceo
2018	+2 A320/A321neo	-2 A319/A321ceo
2019	+6 A321neoLR	-5 757-200
2019	+2 787-8	N/A
2019	+1 A320/A321neo	-1 A321ceo

Air Astana has only one growth aircraft planned for 2017 but expects to be able to grow ASKs by 10% that year by also improving aircraft utilisation rates, particularly for its 757 and 767 fleets as its E190 and A320 utilisation rates are already very high. It does not have any growth aircraft for 2018 but can squeeze some modest capacity growth as it replaces a smaller gauge A319ceo and further improves aircraft utilisation rates.

Air Astana to take delivery of nine aircraft in 2019

2019 will be a milestone year for Air Astana as it takes an unprecedented nine aircraft while phasing out six aircraft. The three growth aircraft include one A321neoLR as Air Astana plans to lease six of the new type to replace its five 757-200s, all of which will be returned in 2019.

Air Astana also plans to take two 787-8s in 2019, supplementing its three 767s which will remain in the fleet as they were only delivered in the last two years. Air Astana ordered three 787-8s directly from Boeing in 2012. The new type will give the airline the flexibility of launching new long-haul routes to North America or expanding its medium-haul operation to Europe and Asia.

Air Astana has talked about potential flights to the US but the reality is market conditions in 2019 and potentially fierce competition from Gulf carriers on US routes could lead the airline to use the new 787 on some of its longstanding 757 and 767 routes.

At the end of 2019 Air Astana will have an extremely young fleet of 35 aircraft with no narrowbody or widebody aircraft older than seven years.

Air Astana's fleet of nine E190 regional jets will be slightly older but the carrier is planning to replace all nine of the aircraft with the new generation E190-E2. Discussions with leasing companies holding E2 slots are Air Astana's next priority as it seeks to complete its fleet renewal initiative.

Fleet renewal to further improve Air Astana's position

Fleet renewal should enable Air Astana to further reduce its costs and improve its long-term position. The airline has significantly reduced its non-fuel cost base over the last two years. Given the huge gains already achieved with initiatives such as renegotiating contracts with suppliers and productivity improvements further cost reductions will be hard to achieve without the more efficient fleet.

The new fleet will also improve Air Astana's product, aiding its efforts to secure more business and transit traffic.

The Kazakh flag carrier has come a long way since its establishment in 2002, providing a rare high quality option for travel to Central Asia, a relatively small but growing region with relatively limited competition. Air Astana's continued profitability over the last two years is perhaps its biggest accomplishment to date as it has come despite a much weaker local economy and instability in some of its largest international markets.

A well designed strategy which has gradually reduced its reliance on Kazakhstan has enabled it to emerge unscathed through the recent challenging period. Air Astana is blessed to have an experienced and stable management team. Mr Foster will soon complete his tenth year at Air Astana, making him one of the longest-standing CEOs in all of Asia.

IPO is on the backburner but will eventually be revisited

Plans for an initial public offering, which the Kazakhstan government initially planned for 2012, has been delayed multiple times and has now been indefinitely postponed until market conditions are more favourable.

Eventually the government and BAE Systems, which own a 51% and 49% stake respectively, will sell. Given its track record of profitability and leading position in Central Asia, Air Astana should be well positioned once that time finally comes.