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CAPA Live Jun-2021. Wizz Air: "Every single airline is in trouble.”

Analysis

Talking at the CAPA Live on 9-Jun-2021, Wizz Air CEO József Varadi spoke with CAPA’s chairman emeritus Peter Harbison. Some of the key highlights can be found below. The next CAPA Live will be on 14-Jul-2021.

Some quotes from Mr Varadi:

- "Once the market starts lifting you will see the distress flowing through the system.

- "I think the industry was celebrating a few decades ago, that they got rid of the states, the governments, but now they are back into the game, even holding equity in airlines.

- "We are flying to 49 countries and there are no two countries that would apply the same measures on COVID.

- "Other than probably one or two airlines in Europe, I think everyone is in trouble.

- "There is no worse owner than the state."

PH: A very warm welcome to József Váradi, who's the CEO of Wizz Air. Haven't spoken to you for quite a while, József, but a lot has happened in the meantime. Let's kick off with big picture stuff. What's your overview, particularly of Europe, of the situation generally, and what are the big issues that you see coming up in the next three months?

JV: The consumer wants to fly. People are just fed up with being locked down and they want to go, they want to breathe fresh air, but at the same time, they are highly restricted by government-imposed restrictions. It is slowly changing, but it is not a straight line, it is more like a roller coaster.

“Looking at life today, I think it's very complicated. You certainly need to look at the consumer, whether the consumer wants to fly or not. Obviously, the consumer wants to fly, there is nothing wrong with the consumer. You can see some of the markets, US is really catching up. I think at the moment it is performing around 80% of its 2019 capacity levels. It's expected to exceed a bigger summer capacity relative to 2019.

“I think what it really tells you is that when the conditions are right, the consumers come back to the air, to the franchise of flying, very, very quickly and the conditions are really, the sense of safety. If you are vaccinated I think you feel safe to fly again, and two, there are no government-imposed restrictions on travel, so you can easily go.

“But that doesn't really apply to Europe at this point in time. I think the consumer's willingness to fly is totally there, it has remained intact. Actually, many of the people are just fed up with being locked down and they want to go, they want to breathe fresh air but at the same time, they are highly restricted by government-imposed restrictions. And in certain cases it's just almost impossible to travel.

“Now it is slowly changing, but it is not a straight line, it is more like a roller coaster. You see some countries easing restrictions, but still today you are seeing some countries actually hardening restrictions on travel, so I think it is still a very unpredictable, very volatile and we will see how that's going to go. I don't think Europe at the level of the US, certainly not from a domestic perspective. It is still complicated.”

PH: I think comparisons with the US are probably a bit difficult because it's probably the only major market that has got back to that level, China (and perhaps Russia) excepted. But one of the things, József, even in the US where they're getting back to fairly full flights and obviously there's a lot of demand there, getting back to close to 2019 levels, yields are still very well down. They're still down 20-30% average economy yields. What is driving that? Is it just too much capacity coming in too quickly or is it just uncertainty in terms of revenue management?

JV: I think the history of the industry is that, especially when it comes to recovery from difficult situations there is overcapacity, and as I said, it's hard because of the imbalance between supply and demand, you've seen the yield environment dragging and I think this is what you should be expecting.

"Pretty much everybody in the world is in the recovery phase, that will be too much capacity coming out to the market, which is probably the right thing for stimulating traffic and encouraging the consumers to come back into flying. But at the same time, from a financial, former standpoint, obviously this is going to put pressure on the industry.”

PH: I appreciate that, but that said, there's a lot of talk in the industry of massive pent-up demand. Now, if that pent-up demand is so massive, why do you have to discount to attract it in there?

"So what will be the structure of winners and who will be able to structure losers? Who would be the absolute losers, who will not survive this pandemic?....once the market starts lifting you will see the distress flowing through the system"

“I think you have to pay an element to the market. And if you're an airline, you need to come back to the market. And I think the more interesting question is actually, what's going to happen to the industry from the perspective of restructuring – how COVID-19 will restructure the industry. So what will be the structure of winners and who will be able to structure losers? Who would be the absolute losers, who will not survive this pandemic? And I don't think we are seeing it yet.

"Simply, I think COVID-19 has created a shield on the industry. So governments are not prepared to pull the plug because it's politically sensitive. They are highly motivated by maintaining employment in the economies, and at the same time, and you look at life from a lessor perspective, they don't have really any alternatives to base out of somewhere else. So even if the lessors don't get paid by the lessee, there are better options, keeping the lessee responsible for storing the aircraft or paying insurance for the aircraft.

“So I think this is a protective shield on the underperforming segment of the industry, but once the market starts lifting you will see the distress flowing through the system. And I think that's going to be stress [on] quite a number of businesses, and you will see quite a number of airline failures at that time. But I also think that many of the carriers will be able to survive based on state bailouts, will have a hard time to pursue that objective.

"So especially when it comes to those, simply, the servicing the debt they are undertaking, it's going to be a hell of a financial burden, and asking management we'd have to be more responsible for financial performance and how they are using taxpayers' money. So I also think that many of those airlines will repair their capacity and long-term growth as a result of the bailouts during the COVID-19 times.”

PH: That is going to be a problem for you. Obviously, you're one of the lowest cost – if not the lowest cost, ex-fuel – operator in the market, but if you're fighting against someone on an uneven playing field where they're being supported by government and governments have even got equity in the airline, they're not going to let that fail are they? So you really are up against it.

JV: I think it's certainly fair to say that the airline industry is becoming a game, the new toy or the world toy for politics and governments. I think the industry was celebrating a few decades ago, that they got rid of the states, the governments, but now they are back into the game, even holding equity in airlines.

"And we will see what that really means for the future because I think that this is not going to stop with financial aid. It's going to be bringing more administrative burden and more taxes, possibly, and all those schemes will be created such that it [will] probably further destroy level playing field of the market.

"So I think this is problematic, and this is worrying that now governments are back into the industry again, but at the same time, I also think that especially short haul flying is a commodity, and in commodities, lowest-cost prevails, lowest cost wins. And we are the lowest-cost producers. And this is the best strategic angle you can take on the industry.

“So even if the market is not fully functioning and it's not perfect, I still think that you have a way to go and that way is stronger than any of the others.

"And in any event our business is not a market share game; our business is a market stimulation game. So we are bringing new passengers, new travellers into the franchise of flying, and we try to hold them there for more frequencies and more frequent travel. So this is our business and I don't think that our business is going to be detrimented by government taxes, although it may curtail some of the upsides of the industry.”

PH: Are you surprised that the European Commission hasn't taken a more aggressive role? Looking at Italy, for example, where son of Alitalia – one of its many sons over the decades – looks like reappearing, presumably with the EU's support. Were you, and Ryanair has been very vociferous about this, are you looking at trying to challenge through the European Commission? Get them to be more active? 

JV: You can say a lot of things for the European Union, but during the COVID times it's been largely dysfunctional in many ways, not only in terms governing industries like the airline sector, but also stepping up with unified measured when it comes to fighting COVID and all those measures. We are flying to 49 countries and there are no two countries that would apply the same measures on COVID. So if we can't deal with that, how do you expect the Union to deal with matters like state aid? 

“But I don't think this problem is down to Alitalia only, you can list, 2000 airlines in, in Europe that you can question the action of the government. And why it was the invite was done the way they did it why it was so uneven and unequal relative to the rest of the market. And I don't know whether this is going to get sorted from a legal point of view, but certainly if you look at it from a governance perspective it's been very disappointing.”

PH: József, going back to your point about a lot of airlines struggling, are there any airlines in particular you would see likely be in trouble in the next 12 months?

JV: Other than probably one or two airlines in Europe, I think everyone is in trouble. And that's not really the question. The question is, who's going to survive on the basis of state bailout, because I doubt most of these airlines will be bailed out by the market."

"Governments seem to be stepping up and they seem to be protecting their handpicked carriers, and they are discriminating in favour of those carriers versus the rest of the market. So I think it is more down to the governments, who they like, what they want to do, how they are politically motivated when they put resources, financial resources into the industry. But seriously, other than one or two airlines, essentially the entire industry, every single airline is in trouble.”

PH: It's not a nice thought, is it? And yet there really doesn't seem to be much going on in terms of restructuring. It seems to be pretty much, well, let's just keep going. Let's borrow some more money and keep hoping that things will get better.

JV: There is no worse owner than the state. We are talking about in excess of a hundred billion dollars put into the industry, and that money has nothing to do with restructuring the industry to make the industry a better place, but it is just covering status quo.

“I think it just underpins the green statement that there is no worse owner than the state. They are horrible owners, essentially that investment is tested by the market. They simply just don't know how to invest on the basis of market terms.

"I think that's a complete nonsense because essentially all this money, and it's a huge amount of money, maybe we are talking about in excess of a hundred billion dollars put into the industry. And that money has nothing to do with restructuring the industry to make the industry a better place, but it is just maintaining status quo.

"And it is a lot of waste in the system. So I would almost say that the vast majority of the financial data had just been wasted and will be wasted in the future.”

PH: Specifically on one point, there's fairly serious talk again about having price floors in certain markets, and you know which ones I'm talking about. To some extent that's a protectionist measure, how do you see that working out? Do you see that as a likelihood, as something obviously that would threaten somebody who wants to be very aggressive on pricing?

JV: Oh, let's not be naïve, of course there will be price floors. I think the EU environment will be dragging, because of overcapacity. This is the sheer functionality of supply and demand or the imbalance of those. So yeah, of course, the moment the airlines receive money they are no longer rational, they are becoming perfectionists. They are throwing good money after bad money.

"And of course, you can expect a lot of that to happen, so I wouldn't be naïve here. I wouldn't assume that now everyone is taking a step backwards and looking at life on a structural basis and designing a new business plan, how to make the airline a better airline for the next 10 years. I think everyone is surviving, everyone is throwing money back into the market. They are trying to defend what they have.

"And simply because of this political influence in the system, protecting basically the status quo, no one is restructuring the business and they are just trying to keep going.”

PH: If you look out two years or so, particularly with the almost certain absence of a lot of the business travel market, which has obviously underpinned full service carriers very substantially. To what extent are you – I know formally you're no business travel carrier, although you do carry a lot of business travellers – are you, to take a parallel, for example, maybe JetBlue, going to modify your plans a little bit, just to take account of the business travel market, that's going to be much more price sensitive?

JV: I'm not sure that's the way we are looking at life. And we have always assumed that short haul travel is a commodity and lowest cost experience, and basically lowest flyers will be key to the long-term success of the market.

"What we know about the business traveller is that the business traveller pays a lot of money in good times and pays nothing in the bad times. So if there is an economic crisis, the first thing corporates do – they cut travel budgets.

"So it is a fairly cyclical segment of consumers, and if you really look at what has been happening over the course of the last 15 months, certainly from a European perspective, VFR travel by far has been the most resilient. If people have to go for work they figure it out. And no matter what restrictions you are putting on these people, they just find a way to sneak out and continue to travel. 

“So we have been leading on that traffic flow. And luckily, in a way, our side has been the most exposed to VFR traffic in the entire industry, and we are less exposed to the business traveller. But business travel is great, but it's an economic upturn, but it's pretty severe when it comes to an economic downturn.

"And I think this is the period we are going through here. So it's a huge cyclical traffic flow. So, I don't think it should be taken by surprise to anyone. This is just the way it is, and it has been this way for decades and decades. So going from one crisis to another, we all know that the business traveller will go away, but they come back few years down the line, 3, 4, 5 years down the line, they will come back.”

PH: But you're in a good position to cater for that market. You have low costs, you're going to be operating when things do improve a little bit, you're going to be operating with higher frequency into many of these markets, whereas the full service carriers, in many cases, are going to be cutting back on capacity, particularly on short haul. Doesn't that really open a door for you that probably wasn't there to that extent before?

JV: It is very important that we stay focused on the business we are into. We know how to deliver a very efficient intra-European or short-haul point-to-point traffic at very low cost by minimising complexities of the execution of the business. Business travel can put significant strains on your business model. It can come with higher cost of operation, these airports, hub airports or main capital airports tend to be more expensive, you may have to keep the aircraft on the ground for a longer time, which will start eating into your core business model. So I think you have to be careful with regard to all these temptations.

“It does, but obviously, we see a lot of doors getting open for us, so we are actually seeing a lot more opportunities than capacity, than we have for exploiting those opportunities. So we remain very selective with that regard, and I think it is very important that we stay focused on the business we are into. We know how to deliver a very efficient intra-European or short-haul point-to-point traffic at very low cost by minimising complexities of the execution of the business. And we just need to stick to it.

"Let's not forget that the business travel market might be attractive for some time, but it can put significant strains on your business model. It can come with higher cost of operation, these airports, hub airports or main capital airports tend to be more expensive, operationally more constraints, so you may have to keep the aircraft on the ground for a longer time, which will start eating into your core business model. So I think you have to be careful with regard to all these temptations.

“And I think we have resisted some of the temptations, but we are highly encouraged by entering new markets and rolling out the business model. But we have been good at history and simply I'm... As the CEO of this airline I find more courage to enter new markets, new airports, new regions, and roll out what we have and what we have done, as opposed to necessarily entering into new market segments, like the business travel segments. And of course the more complexities and higher cost.”

PH: Just on that topic, you have opened up a substantial number of new city pairs during this turndown too, and obviously not with high levels of capacity, but is that a trend that you're going to continue, even though I think you've reduced the fleet size at the moment, or you have a reduced fleet size; is that where you see the near future, having more and more city pairs?

JV: Our fleet has been growing during the pandemic. In Mar-2020, we had 121 aircraft; today we have 140 aircraft. We are in the business of opening new routes, opening new bases, opening new countries, carrying the flag of low-cost in new territories, and that won't change. We have had dozens of airports coming to us pretty much begging for capacity because we are one of the very few airlines in Europe that can commit to structural capacity growth in new markets. And we've been able to come up with airport arrangements, which wouldn't been available to us under normal circumstances

“No, the fact of the matter is that our fleet has been growing during the pandemic. So in Mar-2020, we had 121 aircraft; today we have 140 aircraft.

"So we have been growing substantially in this period, and obviously, that's being strategic because this fleet growth gives us a few things.

"One, we continue to up-gauge our fleet from A320 to A321, and as a result because of the higher gauge, our unit cost is falling.

"And secondly, our fleet actually is getting younger, believe it or not. And we know that operating a younger fleet is delivering lower cost than an ageing fleet. And when you put that in context of a restart or a recovery post-COVID-19, in which most of the airlines will rely on an ageing fleet because they cancelled aircraft orders or deferred aircraft deliveries, we will have a substantial competitive advantage coming out of this investment, but we have been making short term and you can argue this is a short-term pain for long-term gain. And I think it's been very deliberate and it's been very strategic.

“With regard to coming to new markets, I think this is our business, this is what we have done all the time, year after year. We are in the business of opening new routes, opening new bases, opening new countries, carrying the flag of low-cost in new territories and that won't change.

"But clearly, this strategy got boosted during the last period, given the pandemic, because we saw quite a number of withdraws of other airlines from markets. And also, we've got a large number of dozens of airports coming to us pretty much begging for capacity because we are one of the very few airlines in Europe, actually, that can commit to structural capacity growth in new markets. And we've been able to come up with airport arrangements, which wouldn't been available to us under normal circumstances. And obviously, you're going to take advantage of that. So, because of that, we just accelerated that strategy. But in any event, we are in the business of opening new markets, new bases, new countries.”

PH: Just going back to the aircraft, obviously, sustainability is an issue too. Environmental sustainability is an issue with newer much more fuel-efficient aircraft. And one of the big problems with the low cost carrier, of course – there's always fuel prices. Brent Crude's gone through USD80 a barrel just recently, doubled almost in the last 10 months or so. How much does that greater fuel efficiency of the new aircraft help to offset that pretty substantial increase in cost?

JV: Your best natural hedge against a fuel price, oil price exposure is the technology. You can’t gain on hedging just by financially hedging your position, the only way you can structurally gain positions if you are changing technology. And this is what we have been doing.

“I see a scene that your best natural hedge against a fuel price, oil price exposure, is the technology what you are deploying in your fleet, and newer technology gives you lower fuel burn, and as a result there is no better hedging than that.

"I mean, let's not be naive, financial hedging already gives you a short-term protection against fuel spikes, but quite likely you pay the same price for that when the price comes down. So structurally, you can’t gain on hedging just by financially hedging your position, the only way you can structurally gain positions [is] if you are changing technology. And this is what we have been doing. If I look at an A321 neo, the fuel burn of that aircraft [is] 18-20% lower than an A320ceo, so it is a huge advantage. I think we are building in the market relative to our competitors.”

PH: You have probably one of the strongest cash positions of airlines within Europe anyway, but at the same time you saw fit to raise more money just recently. Why are you doing that? Is that because you're anticipating a longer length of this problem than previously?

JV: It is not necessarily because we needed the money for sheer liquidity purposes, but much more that we wanted to have the money to be able to deal with any kind of scenarios, even a scenario like the entire business model gets grounded completely for a long, long time. We still want to be in business coming out of that. This airline can be grounded completely as of tomorrow and we would still be in business three years from that

“Oh no. I have no idea for how long this is going to go, if you asked me 15 months ago, I would have said, this was a problem for six months. Even if you asked me six months ago, I would've said that by this time it would be largely operational and we are still not. So I just don't know.

"And I think I have stopped speculating when this is all going to end and we don't control our destiny here. I think we all can be very smart about this and believe just the same stuff and we can form all sorts of opinions on that basis, but I've seen the business I'm in and I'm responsible for this, it's an airline facing significant uncertainties and quite an unpredictable operating environment. So we have to play insurance policies on the situation.

“So it is not necessarily because we needed the money for sheer liquidity purposes, but it is much more that we wanted to have the money to be able to deal with any kind of scenarios you can imagine, even a scenario like the entire business model gets grounded completely for a long, long time. We still want to be in business coming out of that. And if you look at the liquidity we have on hand today, this airline can be grounded completely as of tomorrow and we would still be in business three years from that.”

PH: That's quite a statement. Well, it's comforting in a way, isn't it? Let's hope that that's not going to be the case, but obviously, things aren't going to open up very substantially in Europe in the next three months. And that obviously does create issues for you. I know you're not only a low cost carrier, you have to be, and are, very agile. So you've probably got less proportionally, less capacity in the market than most of the other carriers in Europe.

JV: It's very interesting to see a pattern. In a high-demand environment when the market becomes largely unrestricted versus a restricted market, low-cost carriers significantly outperform the industry. In a constrained, demanding environment legacy carriers outperform the low-cost industries. In 2020, we were operating around 80% of our 2019 capacity. Today, we are already at around 90% of our 2019 capacity. Quite likely we're going to be above our 2019 capacity in a month or two from now

“I think if you look at the capacity curve versus demand in the market, and whole industry supplied capacity versus the demand, I mean, it's still very interesting to see a pattern.

"So in a high-demand environment, when the market becomes largely unrestricted versus a restricted market, low-cost carriers significantly outperform the industry. In a constrained, demanding environment legacy carriers outperform the low-cost industries. Which I think just underpins how irresponsible these carriers are. So they are prepared to throw a lot of money in a market, which [is] actually still very dysfunctional, and you see low-cost carriers being rational, and they are adjusting capacity to changing demand. But when there is an offside coming to the market, low-cost carriers simply are just much quicker to grab that opportunity than the legacy carriers.

“And these are tested, [to] do even better than the other low-cost carriers. So last year in 2020, we were operating around 80% of our 2019 capacity. Today, we are already at around 90% of our 2019 capacity, so we are ramping up. We are seeing a less constrained environment going into peak summer, and quite likely we're going to be above our 2019 capacity in a month or two from now, and lastly – just showing the reality that when there is a market, you go for it, and [when] there is no market you become financially responsible. It's an opposite logic applied by legacy carriers.”

PH: I think you've been on record, correct me if I'm wrong - obviously, you will - that you're not going to get back to seeing 2019 yields until probably another year from now, next summer, 2022. In that environment what is your fundamental strategy? Is it really to lay on the capacity strongly again, just to try to make sure that you've got the market covered? I mean, you're going to be losing money anyway. It's just a matter of how much you lose.

JV: Our strategy to create shareholder value and being financially responsible means slightly different things given the current times. We are scheduling flights and operating the fleet against cash-positive contributing outcome. What we do has to contribute to cash

 “Well maybe, maybe not. I think we remain financially responsible and we have always been financially focused and much less market-focused or market-share-focused. That's another language and that's not a language I'm speaking, I think that’s the language other CEOs of other carriers are speaking, but our strategy is no different to the subject what we have always been pursuing, our strategy to create shareholder value and being financially responsible means slightly different things given the current times.

"We are scheduling flights and operating the fleet against cash-positive contributing outcome. So, what we do has to contribute to cash. So it has to be a better option than keeping the aircraft on the ground, I think that's the measure what you are putting in place.

“But if I look at our operations today, we are largely overall cash neutral, so we are not losing cash. So we are preserving our cash position. It's just showing how strong we are from a liquidity perspective and from a cost perspective, because obviously your resilience increases significantly should you operate this business at lower costs than your competitors?”

PH: József, when we last talked you were on the brink of setting up the Abu Dhabi operation, which opens up an entirely new market, which does necessarily to some extent involve connectivity over that hub, particularly into the South Asian market. Things have changed dramatically there, both in Abu Dhabi and the South Asian market. Do you have any feel for, in your discussions with the Abu Dhabi people, what the time frame is going to be before things start to look better in that respect?

JV: Abu Dhabi has probably become a better proposition looking from a long term strategic perspective because COVID will force the industry to restructure. From a strategic perspective, I'm very upbeat on Abu Dhabi, and clearly, I think that this is a right move for Wizz Air, and we will see significant returns on our investment

“Well, first of all, I think I should say that the strategic passion for Abu Dhabi has not changed. I would even say that probably it has become a better proposition, looking at it from a long-term strategic perspective, simply because I think COVID will force the industry to restructure. And we may have market opportunities we would not have had otherwise.

"So, from a strategic perspective, I'm very upbeat on Abu Dhabi, and clearly, I think that this is a right move for Wizz Air and we will see significant returns on our investment. Short-term is difficult because Abu Dhabi remains a closed market. I think we are hearing various plans that shortly within maybe a few months their market will open up.”

"One of the things we have clearly learned during the last 15 months is being agile. There is no better strategy than profitability and creating shareholder value, and wherever we see the opportunity to create more shareholder value we seem to just move capacity against those opportunities

“I think it is still to be seen, but we take the time to sort the strategic fundamentals out during this period to make sure that we are getting access to markets, and whenever the market is ready to go we can go with that immediately and we can scale up the business very quickly. One of the things that we have clearly learned during the last 15 months is being agile, but also being agile in terms of moving operational capacity. So moving up and down very, very quickly, we have a very flexible work force. We are very flexible in decision-making in a way. And to some extent you can argue that it is opportunistic and yes, it is opportunistic, because we are not really into this paradigm of strategic markets and all sorts of things.

“We have not pursued a better strategy than profitability is clear, but there is no better strategy than profitability and creating shareholder value, and wherever we see the opportunity to create more shareholder value we seem to just move capacity against those opportunities.

"So we have been incredibly quick and efficient with regard to moving capacity around that, but not only aircraft, but moving people with the aircraft, pilots, and cabin crew. And I think this will continue to be the case going forward, at least for the next period of time, because I don't think we are still seeing the full potential from our perspective of COVID-19, because the recovery phase of the industry will be very interesting and, as discussed at the beginning, we shall see who will make it and who won't, and what markets will be left behind, and what additional opportunities we are going to be seeing then.”

PH: It's very comforting to hear you say that József, because to some extent, we seem to be a voice in the wilderness saying the same thing, that I hope there is a recognition that people who should know these things, that something's got to change very dramatically. But obviously you're going to help in that process and perhaps lead the way.

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