22-Nov-2013 7:14 PM

Air Astana plans more rapid growth in 2014 but Kazakhstan airline market shows signs of slowing down

Analysis

Air Astana is planning another year of double-digit capacity growth in 2014 as the Kazakhstan flag carrier expands its 767, A320 and E190 fleets. The carrier will focus on further expansion in the CIS and Central Asia region, but new 767-300ERs will also enable some capacity growth across its long-haul network.

ASK growth of 15% is expected for 2014, following 16% growth in 2013. But Air Astana plans to slow down expansion in 2015, ending a period of five consecutive years of expansion at a pace of approximately 15% per annum.

Market conditions have become less favourable in 2013, impacting load factors and profit margins. The prospect of increased competition, including the possible opening of Kazakhstan’s domestic market to Russian carriers, clouds Air Astana’s medium to long term outlook.

Air Astana remains profitable but sees margins gradually slip

Air Astana has been by far the most successful carrier in Central Asia, growing rapidly and profitably since launching in 2002. The carrier, which is 51% owned by the government with the remaining 49% stake held by BAE Systems, has been profitable every year since 2004.

Air Astana currently operates a fleet of 27 aircraft across a network of 27 international and 12 domestic destinations. The carrier generated USD870 million in revenues in 2012, a 12% increase from 2011. Revenues were up another 12% in the first three quarters of 2013 to USD718 million, including a 12% increase in passenger revenue to USD685 (see background information).

But the carrier’s net profit margin has slipped steadily since posting a record 12% margin in 2010. The carrier’s profit margin was 7% in 2012 and Air Astana CEO Peter Foster says “this year we will be doing well to get 6%”.

Air Astana turned a profit of USD40 million for the first three quarters of 2013, matching the profit from the same period of 2012. Mr Foster told CAPA on the sideline of the 15-Nov-2013 Association of Asia Pacific Airlines meeting in Hong Kong that for the full year the carrier’s net profit “will likely be equal to or marginally lower than last year”. Air Astana ended 2012 with a profit of USD61 million, matching the profit from 2011.

“This year we are seeing, really for the first time, that traffic growth is not keeping up,” Mr Foster says. The carrier has been growing since 2010 at a clip of 15% per annum without encountering any challenges in filling up the additional seats, until this year. While yields are stable Mr Foster says average load factors are down this year between 2 and 3ppts.

Kazakhstan market cools off

While there has been some increase in competition in the domestic and regional Central Asian markets the main driver of the reduction in load factors has been weaker demand for both inbound and outbound travel. “It’s really demand. It hasn’t been a bumper year for the Kazakhstan market,” Mr Foster says.

Air Astana in recent years has successfully ridden the coattails of rapid economic growth in Kazakhstan, where it is the only carrier with IOSA certification and is generally seen as the only carrier operating to Western standards. Air Astana also has successfully positioned itself as the leading carrier for Central Asia and has rapidly grown transit traffic, leveraging its growing regional network.

But Kazakhstan’s GDP growth slowed to 5% in 2012, following growth of over 7% in 2010 and 2011. GDP growth is projected to remain in the 5% to 6% range for 2013.

Kazakhstan annual GDP growth (% change): 2010 to 2014

The slowdown in demand throws a wrench into an IATA report from the end of 2012, which projected Kazakhstan would be the world’s fastest growing domestic and international market over the next five years. IATA projected 20.3% annual growth for domestic air travel in Kazakhstan and 22.5% annual growth for international air travel.

See related reports:

A slowdown in passenger traffic growth at Air Astana makes it highly unlikely the IATA projections will be met as the flag carrier accounts for over 60% of Kazakhstan’s domestic market and about 50% of the country’s international market.

Kazakhstan international capacity share (% of seats) by carrier: 18-Nov-2013 to 24-Nov-2013

Air Astana passenger traffic was up 11% in 1H2013 to 1.7 million. The carrier’s passenger traffic will likely be up in the low double digits for the full year 2013 and again in 2014 but will slow down in 2015, when the carrier expects to take a hiatus from double-digit capacity expansion. “I think 2015 will be a year of consolidation,” Mr Foster says.

Air Astana fleet to expand by 20% over the next 13 months

The 15% capacity growth for 2014 is already committed to and will be driven by expansion of the in-service fleet from 25 aircraft currently to 30 aircraft by the end of 2014. Air Astana’s 767 fleet will expand from two to three aircraft, its A320 family fleet will expand from 11 to 13 aircraft and its Embraer E190 regional jet fleet will expand from seven to nine aircraft. The carrier also operates five 757s, which are being retained although the carrier is now looking at acquiring A320neo and 737 MAX family aircraft as potential replacements.

Air Astana fleet summary: as of 22-Nov-2013

Aircraft	In Service	On Order
Total:	25	8
Airbus A319-100	1	0
Airbus A320-200	6	1
Airbus A321-200	4	0
Boeing 757-200	4	0
Boeing 757-200(ETOPS)	1	0
Boeing 767-300ER	2	3
Boeing 787-8	0	3
Embraer ERJ190-100LR	7	1

Over the next few weeks Air Astana plans to place into service two new 767-300ERs. A third 767-300ER is slated for delivery in May or Jun-2014. The carrier’s two older model 767-300ERs, which are 16 years old and are leased from ILFC, will be returned, providing net growth of one aircraft.

Mr Foster says Air Astana plans to use the extra 767 to up-gauge its daily Astana-Frankfurt flight from the 757. He says the larger 767 fleet will also enable the introduction of a fourth weekly flight to Kuala Lumpur. Air Astana is also now looking at adding a third frequency to Ho Chi Minh and is considering launching service to Singapore.

Air Astana now serves six destinations in East Asia using a mix of 757s and 767s – Bangkok, Beijing, Hong Kong, Kuala Lumpur, Ho Chi Minh and Seoul. Hong Kong and Ho Chi Minh were both added in 2H2012. Ho Chi Minh was initially served with two weekly flights via Bangkok but the carrier will begin serving the Vietnamese city non-stop from Almaty in Dec-2013. Air Astana configures its 757s with 166 seats, including 16 business class seats, while its 767-300ERs accommodate 218 passengers, including 28 business class seats.

Air Astana to add capacity to Europe by using new 767s on Frankfurt route

Some of the additional Asia flights will be operated with 757s as the additional 767 will mainly be used for Frankfurt, freeing up the 757 now used for Frankfurt. Air Astana is unable to add flights to Europe due to Kazakhstan being included on the EU blacklist. With an exemption the carrier is able to maintain the same number of flights to the EU, based on its 2009 schedule, and up-gauge or change routings but not increase total frequencies.

Air Astana currently serves Frankfurt daily and also operates three weekly flights to London Heathrow and six weekly flights to Amsterdam. Frankfurt is served from the capital Almaty, London Heathrow from a combination of Almaty and Astana and Amsterdam from Atyrau in western Kazakhstan.

Air Astana was able to upgrade London Heathrow from two to three weekly flights in late Oct-2013 by discontinuing its one weekly flight to Hamburg, which has a large Kazakh population. The carrier was given a third weekly slot pair at Heathrow after the Jun-2013 visit to Kazakhstan by UK Prime Minister David Cameron.

Air Astana is keen to expand in Europe but Kazakhstan must first pass an EU audit. The carrier was confident a couple of years ago that Kazakhstan was close to passing an audit but since then authorities appear to have not made significant progress towards meeting EU standards. “There is an ICAO TCB, Technical Cooperation Bureau, group in Kazakhstan. But I think realistically the best we can hope for is late 2014,” says Mr Foster.

With the EU restrictions in place, Air Astana has focused medium/long-haul expansion the last four years on East Asia. East Asia currently accounts for over 20% of the carrier’s seat capacity compared to only 12% for Western Europe.

The up-gauging of Frankfurt will enable the carrier to expand seat capacity to Western Europe by about 6%. But the focus will remain on expanding in East Asia, where Air Astana continues to see growing demand.

Air Astana international capacity share (% of seats) by region: 18-Nov-2013 to 24-Nov-2013

Air Astana pursues short-term expansion of A320 and E190 fleets

Air Astana ordered four 767-300ERs from Boeing in early 2012 and as part of the same deal converted a letter of intent from 2008 for three 787-8s. The carrier subsequently cancelled one of the 767 orders after deciding it can make do with just three widebody aircraft. The 787s are slated to be delivered from 2017.

Air Astana is also planning to take delivery within the next month of the last A320 from its order with Airbus. Mr Foster says the carrier also has committed to lease three additional A320s in 2014, including two from BOC and one from CIT. Both deals were signed earlier this year. Air Astana plans to return two older model A320s when their leases expire in 2014, giving the carrier a net addition of one aircraft for a total of 13 A320 family aircraft.

The 15% capacity growth for 2013 will also be partially driven by the expansion of the carrier’s E190 fleet. Mr Foster says the carrier plans to take one E190 directly from Embraer in Dec-2013 and has committed to leasing an additional E190 from Feb-2014, giving the carrier a fleet of nine E190s.

Air Astana continues strategy of building up frequencies on regional routes

Air Astana plans to use the additional E190s and A320s to continue adding frequency across its international regional network. The carrier has been gradually building up its five destinations in other Central Asian countries as part of its extended home market strategy. But most of these destinations – which include Baku in Azerbaijan, Bishkek in Kyrgyzstan, Dushanbe in Tajikistan, Tashkent in Uzbekistan and Tbilisi in Georgia – are still not yet served daily.

Mr Foster says most of the carrier’s regional routes will finally be up to daily by the end of 2014 with the exception of some of its newer services to secondary Russian destinations. Orenburg earlier this year became Air Astana’s eighth destination in Russia, joining Moscow, St. Petersburg, Kazan, Yekaterinburg, Omsk, Samara and Novosibirsk. Kazan and Omsk were added in 2012.

Air Astana also plans to add frequencies in 2014 to Kiev in the Ukraine, which was launched at the end of Mar-2013 and is now served with eight weekly flights including five A320 frequencies from Almaty and three weekly E190 frequencies from Astana. Kiev is a large destination which Air Astana had been keen to serve for some time but the carrier held back because of over-capacity. The collapse of AeroSvit in early 2013 provided an opening for Air Astana to serve the Kazakhstan-Ukraine market. “Kiev has been a fantastic market since we got into it,” Mr Foster says.

Air Astana is also now looking at potentially serving the Ukrainian cities of Lviv and Odessa. But a more likely route to be launched in 2014 is Ulan Bator in Mongolia.

Air Astana to likely launch Ulan Bator in 2014

Air Astana initially announced Mongolia as a new destination in 2011 but pulled the Astana-Ulan Bator route prior to launching it. Mr Foster says the carrier is now confident it can make the route work given the strength of the Mongolian market and its ability to offer connections beyond Astana.

“We will probably do Ulan Bator next year,” he says. “When you look around the region, when you look at economic growth prospects number one is Mongolia and number two is Kazakhstan.”

The bigger regional network and increased frequencies should allow Air Astana to further grow its transit traffic, cementing its position as the leading carrier in the Central Asia region. Air Astana for now plans to take a hiatus from expansion in 2015 as it is concerned it may have added more capacity than the market can absorb. But the carrier could discover in 2014 that the improved regional connectivity it will be rolling out leads to a further influx of transit passengers, allowing it increase traffic and improve load factors without relying more on the local Kazakhstan market. As CAPA reported in Jan-2013:

While Air Astana has benefitted significantly from Kazakhstan’s rapid growth, particularly domestically where it allocates about 55% of its seat capacity, the carrier has been working during the last two years on building its position to exploit the growth in all of Central Asia and parts of the CIS. Kazakhstan is well positioned geographically, located in the north end of Central Asia and just south of Russia. This puts its Almaty and Astana hubs in perfect position to connect Central Asia as well Russia.

Air Astana emerges as potential CSeries customer

Air Astana is now evaluating the Bombardier CSeries, which could be used by the carrier to accelerate expansion to its regional network in the medium to long term. Mr Foster says the ninth E190 being delivered in Feb-2014 “brings the Embraers to a temporary cessation” and the carrier is now evaluating both the re-engined E190-E2 and CSeries for its future smaller aircraft requirement.

“CSeries could make a big difference to us. Obviously we have a bunch of Embraers and it will therefore be a challenge. But Bombardier obviously understands the fact they will need to go into established Embraer customers with some very compelling offers,” Mr Foster says. “If they are going to gain traction for the CSeries they are going to have to make some very compelling offers to Embraer customers. After all the potential people for CSeries are mostly Embraer customers today.”

Mr Foster points out that Air Astana will only own two of its nine E190s. The rest of the aircraft are leased, which gives it more flexibility to switch types. But Mr Foster acknowledges Air Astana still has several years to go on its E190 leases. The carrier only began operating the type in 2011.

Air Astana continues to evaluate A320neo and 737 MAX

Air Astana also has been evaluating the A320neo and 737 MAX families for its 757 replacement requirement. The carrier plans to phase out its five 757s in the 2017 to 2019 timeframe. The new-generation narrowbody, which could be ordered in 2014, would also be used to gradually replace the carrier’s current fleet of A320s and for growth.

After its two older model 767s are returned over the next few months, Air Astana will have a relatively young fleet with the exception of the 757s. For now Air Astana has no choice but to continue operating 757s as current generation narrowbody aircraft lack the range for the carrier’s long thin routes.

Air Astana aircraft age by aircraft type: as of 22-Nov-2013

New generation narrowbodies and regional jets will eventually provide Air Astana with improved efficiencies and operating economics, opening up new short and medium-haul routes. Given Kazakhstan’s isolated geography new aircraft technology could prove to be a bigger game changer for Air Astana than carriers from more well-known markets.

Air Astana has bright outlook but there are challenges, including from Russian airlines

In a relatively short period of time Air Astana has built up an impressive regional network that positions it well for growth in the Central Asia and CIS regions. But there will also be challenges. Market conditions have become tougher over the last year, leading to a reduction in profit margins. Competition is also starting to increase as more carriers become tuned into the opportunities in Kazakhstan and Central Asia.

Air Astana has so far benefitted from not having any particularly strong local competitors. Foreign carriers however have been gradually pursuing expansion in the Kazakhstan market. Russian carriers, which account for about one-third of foreign carrier seat capacity in Kazakhstan, pose the biggest threat.

The Eurasian Economic Community is looking at establishing a common market which would allow carriers to operate freely around region, following the EU model. If implemented the Kazakhstan domestic market would be open to carriers from other Eurasia Economic Community countries, which include Russia, Belarus and Kazakhstan. Potentially Russian carriers would also be able to operate seventh freedom international flights from Kazakhstan.

The proposal is controversial with several opponents including Air Astana, which does not believe the market should be open until there is equalisation of opportunity and elimination of subsidies. Air Astana is completely self-sufficient and has been looking at an initial public offering.

Unlike in the EU, where subsidies are not legal, some major carriers in Eurasia are subsidised. Without the right rules in place, subsidised carriers could end up invading other markets, distorting the playing field. The playing field is also seen by some as un-level because carriers from bigger countries, principally Russia, have the scale and muscle to enter smaller domestic markets and kill off local competition.

The debate on whether to open up the Kazakhstan and broader Eurasian market is just starting. It will be a long and drawn out battle with huge implications.

Air Astana has a bright future, having successfully carved out a profitable niche in an often forgotten about yet rapidly growing corner of the world. The carrier is now well positioned to fend off increased competition from foreign and local carriers. But a large foreign carrier entering its home market would pose a serious challenge, as it would for virtually any flag carrier in a market the size of Kazakhstan.

Background information

Air Astana financial highlights: 3Q2013 vs 3Q2012 and 9M2013 vs 9M2012