easyJet: accelerating growth to take share from legacy airlines in strong easyJet airports

easyJet to apply for EU AOC in early 2017

easyJet has confirmed that it is in the process of establishing a new European Union-registered AOC. CEO Dame Carolyn McCall has also confirmed that easyJet's HQ will remain in the UK.

Although its preference would be for the UK to negotiate continued full internal access to the European single aviation market, it cannot control this process and there is some uncertainty about how this might turn out. The UK government plans to trigger Article 50 in Mar-2016, but the process of leaving the EU will then take two years, and negotiating its future relationship could take longer.

easyJet expressed confidence that its network would not be affected by Brexit. Its plan for an EU AOC was to secure intra-EU traffic rights in the event that its UK AOC could no longer operate on intra-EU routes post-Brexit.

It has conducted a review of where to locate the new airline and expects to make a formal AOC application in early 2017. It has not announced any further details of the holding structure for the operation, which would need to retain EU ownership and control.

As illustrated in a previous CAPA report, easyJet is potentially the most exposed airline to any loss of internal single European aviation market traffic rights (35% of easyJet's ASKs were on routes within the European Common Aviation Area/Switzerland in the year to the end of the summer 2016 schedule).

See related report: Brexit follow-up Part 1: airlines' ASK exposure today, and the possible changes to market access

easyJet seat capacity growth to accelerate to 9% in FY2017

Regardless of the details of the post-Brexit world, easyJet is planning to accelerate its growth. It has identified the growth potential in its leading European markets by country for the period 2016 to 2021.

For most of these countries it expects compound average growth in passenger numbers of approximately 3% pa, varying from 2.4% pa in Italy to 3.8% pa in Switzerland (see chart below).

Expected passenger growth CAGR: 2016-2021

Source: easyJet FY2016 results presentation 15-Nov-2016.

However, easyJet believes that it can achieve profitable growth considerably in excess of these rates. The airline plans 9% seat growth in FY2017 - a little higher than the 8% growth previously pencilled in - and envisages growth of up to 9% pa in subsequent years. This compares with 6% in FY2016 and 5% in each of the two years prior to that.

98% of easyJet capacity touches airports where it is number one or number two

This growth plan is based on the strength of its network and the opportunity that it expects to use this to grow market share from higher-cost legacy airlines.

According to data presented by easyJet in its FY2016 annual results presentation, 98% of its seats in FY2016 touched an airport at which the airline is either number one (83% of its seats), or number two, by seat capacity (15%).

EasyJet seat capacity split by position at airport touched at either end of route: FY2016

Note: September year end.
Source: easyJet FY2016 results presentation 15-Nov-2016.

In FY2017 its 9% growth plan equates to an additional 7.1 million seats, of which 5.5 million (approximately 80%) will be on routes involving an airport where easyJet is number one, and 1.6 million seats in airports where it is number two. In other markets overall growth will be flat in FY2017.

Opportunity to take share from legacy airlines on point-to-point routes

easyJet has identified a significant market where point-to-point capacity is still controlled by airlines that are not low cost airlines.

According to easyJet more than one third of the seats at its top 20 airports are operated by non-LCCs on point-to-point routes. This market segment adds up to 77 million seats - slightly more than the capacity controlled by other LCCs at these airports.

Of the 77 million non-LCC point-to-point seats, 63 million are at airports where easyJet is the number one or number two airline. For easyJet the growth opportunity is in taking share from these non-LCC operators, rather than from the other LCCs in its top 20 airports.

Nevertheless, as CAPA has suggested previously, easyJet is also facing an increasing challenge from its lower cost rival Ryanair in primary airports.

See related report: easyJet: how the pricing model is being challenged as Ryanair moves into its territory

easyJet argues that capacity constraints in its airport network help to defend its position. Approximately 80% of its seats touch an airport that is slot-constrained during peak hours. Having a strong presence at such airports gives it access to additional slots when they become available. Moreover its fleet upgauging allows further growth, even without adding to its slot holdings.

Seat capacity split at easyJet's top 20 airports

Source: easyJet FY2016 results presentation 15-Nov-2016.

FY2017 growth to focus on easyJet's larger markets

easyJet aims to grow and strengthen its position in markets where it is number one both at the airport and on the route; for example in the UK and Switzerland. On average the profit contribution from a number one airport and route position is more than 50% higher than from a number two position on both, according to the airline.

In addition, where it is number two behind a legacy airline it aims to take advantage of growth opportunities - for example, in France. Elsewhere easyJet will grow in specific catchment areas, such as Amsterdam, Venice and Berlin.

It will also invest in what it calls 'lean' (lower cost) bases - for example, Barcelona. These can offer 25% lower labour costs as a result of lower social charges and taxation.

In absolute terms easyJet's FY2017 capacity additions will be highest in the UK (4.1 million seats), followed by France (2.4 million) and Spain (1.7 million seats). It will also add capacity in Switzerland, Italy (1.4 million seats each), Germany (0.6 million seats) and the Netherlands (0.5 million seats).

easyJet's 9% seat growth in FY2017

Note: September year end.
Source: easyJet FY2016 results presentation 15-Nov-2016.

Increased capacity growth may add to pressure on unit revenue

As evidence of its ability to develop its route portfolio, easyJet cites the fact that 54% of its top 25% most profitable routes in FY2016 were not in its top 25% in FY2012.

Nevertheless, easyJet's acceleration of capacity growth is not without risk, particularly in the light of the current weak unit revenue environment.

In FY2016 easyJet estimated that the total European short haul market grew by 6%, and by 8% in easyJet's markets. The airline's own capacity growth was 7% - slightly slower than market growth in its markets.

Falling revenue per seat led to a fall in profit in FY2016

In spite of growing a little more slowly than the market, easyJet suffered a 6% fall in revenue per seat in FY2016. Although lower fuel prices (net of hedging) allowed a reduction in cost per seat, this fell by only 2%.

EasyJet FY2016 highlights

GBP million except where stated	FY2015	FY2016	Change
Revenue	4,686	4,669	-0.4%
Operating profit	688	498	-27.6%
Operating margin %	14.7	10.7	-4.0ppts
Profit before tax	686	495	-27.8%
Return on capital employed %	22.2%	14.6%	-4.7ppts
Seats million	75.0	79.9	6.5%
Pax million	68.6	73.1	6.6%
Load factor %	91.5	91.6	+0.1ppts
ASK bn	83.8	87.7	4.6%
RPK bn	77.6	81.5	5.0%
Revenue per seat GBP	62.48	58.46	-6.4%
Cost* per seat GBP	53.33	52.26	-2.0%
Ex fuel cost* per seat GBP	37.35	38.31	2.6%

Note: September year end.
*Cost at the level of profit before tax.
Source: CAPA - Centre for Aviation, easyJet FY2016 results statement.

As a result of easyJet's inability to cut cost per seat as quickly as revenue per seat it suffered a 28% fall in profit before tax: from GBP686 million in FY2015 to GBP495 million in FY2016.

This was the first decline in profit before tax that Dame Carolyn had presided over since becoming easyJet's CEO.

EasyJet operating profit, profit before tax and revenue (GBP million): FY2009 to FY2016

Note: September year end.
Source: CAPA - Centre for Aviation, easyJet annual results statements.

First fall in return on capital employed and operating margin under Carolyn McCall

EasyJet's operating margin fell by 4.0ppts to 10.7% and its return on capital employed (ROCE) fell by 7.6 ppts to 14.6% in FY2016.

This ROCE level remained ahead of easyJet's hurdle rate of 12% (the minimum that it targets), and comfortably ahead of what it calculates to be its 7.9% weighted average cost of capital.

Nevertheless, the fall in ROCE was the first since it introduced the measure as a key financial target after Dame Carolyn's arrival. Moreover, the fall in operating margin was the first since before her arrival in FY2009.

EasyJet operating margin, return on capital employed (%) and revenue per seat (GBP): FY2009 to FY2016

Note: September year end.
Source: CAPA - Centre for Aviation, easyJet annual results statements.

Revenue per seat weakened by "unprecedented external events" in FY2016…

Approximately one third of the revenue per seat decline in FY2016 (-6.4%, or -6.9% at constant currency) could be attributed to the immediate impact of terrorist events in Sharm El-Sheikh, Paris, Brussels Nice and Turkey, but capacity growth (partly stimulated by low fuel prices) was also a contributory factor.

Revenue per seat was further weakened by the negative demand impact of increased holiday costs for outbound UK consumers, resulting from the post-Brexit vote weakening of GBP and exacerbated by disruption due to weather, ATC strikes and airport issues also.

EasyJet estimates that the combined adverse impact on its profit before tax of what it called "unprecedented external events" was GBP150 million. It also suffered a net GBP88 million headwind from foreign exchange movements (mainly on costs), although it benefited by GBP160 million from lower fuel cost per seat.

…but set to fall again in FY2017

Although the degree and relative significance of all these factors will vary, none of them is likely to disappear entirely in FY2017. Together with higher capacity growth by easyJet, 9% in FY2017 versus 6% in FY2016, unit revenue will remain under pressure.

Indeed, easyJet expects revenue per seat in 1H2017 to fall at a mid to high single-digit percentage rate, at constant currency. It fell by 7% in FY2016, so this guidance raises the prospect of a bigger drop in FY2107.

EasyJet could record another drop in profit in FY2017

Historically, easyJet has rarely experienced a fall in revenue per seat (see chart above). Since CEO Dame Carolyn McCall joined towards the end of FY2010 it has risen every year until last year, FY2015, and has now fallen in two successive years for the first time since it fell three years running from FY2002 to FY2004. In FY2002 easyJet's operating margin increased, but it then fell for three years.

Revenue per seat is not a predictor of margins, but easyJet has rarely sustained a margin increase beyond one year without an increase in revenue per seat. Its outlook for FY2017 is that it will have a third successive year of falling revenue per seat. Its outlook also anticipates that cost per seat will fall by 3% at constant currency - less than the guided fall in 1H revenue per seat.

Another fall in easyJet's profitability looks to be on the cards in FY2017, even if it continues to generate returns above its cost of capital. With signs gathering that Europe's airline sector may have passed a cyclical peak, the continent's second biggest low cost operator will be hoping that it weathers any downturn more successfully than Europe's legacy airlines.