22-Apr-2013 8:00 AM

Modest achiever Korean Air to increase North American strength, tap new markets & look for partners

Analysis

South Korea's largest carrier, Korean Air, is modest - too modest. It punches above its weight and is a formidable carrier being the largest Asian airline in North America. Asian carriers are increasingly favouring North America: in the short term its economy is doing better than Europe's and in the long term competition will be lighter owing to fewer carriers.

Geography is on its side given Korea's relative proximity to North America. Korea is not as close as Japan is, but Japanese carriers face a higher cost base, nearly twice that of Asiana and Korean.

Korea is also an efficient springboard from China, where Korean Air is the largest foreign carrier after Dragonair and rival Asiana, allowing it to tap sixth freedom markets as Chinese carriers sluggishly respond to that huge potential. Korean Air is increasing North American capacity, including with A380s, but also looking to new markets around Asia.

Summary

Korean Air is the largest Asian airline in North America and is increasing its capacity in the region.
Korean Air's acquisition of a 44% stake in Czech Airlines for a light EUR2.64 million is its boldest move yet.
Korean Air is seeking new markets in Africa and the Middle East, with services to Nairobi, Saudi Arabia, and plans for a third African destination.
Korean Air is looking to increase its premium revenue by 15% in 2013.
Korean Air's operating margin of 2.2% is a concern, especially with increasing competition from LCCs in the region.
Korean Air's partnerships and equity stakes are notable, but it needs to unshackle its LCC, Jin Air, to compete effectively in the changing market.

Korean Air is being adventurous compared to lagging Asian peers, launching services to Nairobi and Saudi Arabia and seeking connecting opportunities with local SkyTeam partners. Korean Air will have a new challenge seeking synergies from its purchase of Czech Airlines, another SkyTeam carrier. The plan may require definition.

Korean Air, buying CSA, emboldened with cash and position as SkyTeam anchor

Korean Air's Apr-2013 acquisition of a 44% stake in Czech Airlines for a light EUR2.64 million is the carrier's boldest, if unclear, move yet. It is the first time a Korean carrier has acquired a large stake in a foreign carrier.

Korean Air flies to Prague with a four-weekly 777-200 service in northern winter, increasing the service to a four-weekly 747-400 offering in northern summer, catering primarily to tourists. Further capacity or frequency additions from Korean Air will likely result from the deal, complementing Czech's plans to open a service to Seoul Incheon.

New flight timings are likely as Korean Air arrives into Prague at 16:50 and departs at 18:30, limiting connections from Prague to Europe while connecting passengers to Prague may face lengthy layovers. The service departs Seoul Incheon at 12:45 and arrives back at 11:15, giving Korean a wide range of connections from Seoul but more limited options inbound to Seoul.

Formal management of Czech will be hands off, with Korean saying it is not interested in managing the carrier. But undoubtedly Korean's wishes for synergies as a partner and stakeholder will weigh in heavily at Czech, which will feel pressured and perhaps even that Korean is indirectly managing the airline. Korean views the deal as allowing it to gain better access to Europe by using Czech's Prague hub as a springboard for the continent, eliminating backtracking.

But Czech Airlines is a small player in Europe, ranking 35th on available capacity within the continent. It accounts for a fraction of 1% of total capacity. It covers a spread of main destinations (but noticeably has withdrawn from London) and seldom serves a city more than twice daily, although for Korean's connecting purposes this may be sufficient. Czech in summer 2013 is planning frequency increases and will operate to 42 destinations in 24 countries.

CSA Czech Airlines Europe/CIS route map: Apr-2013

Its largest routes (such as Moscow, Paris and Milan) are out of local nuances but also hub opportunities, with SkyTeam carriers based in Moscow (Aeroflot), Paris (Air France) and Milan (Alitalia).

CSA Czech Airlines top 10 international routes ranked on seat capacity: 24-Jun-2013 to 30-Jun-2013

Czech is a short-haul carrier following its suspension of New York JFK services due to financial issues. Czech will shortly lease two A330s from Korean Air that it will use to fly between Prague and Seoul Incheon, although reports indicate a return to New York may be considered.

While Korean Air is bold in North America, it is light in Europe. Between Asia and Europe, Korean Air is the 14th largest carrier. North America accounts for 16% of Korean Air's international seats while Europe is only 6%.

Korean Air international capacity (seats) by region: 24-Jun-2013 to 30-Jun-2013

So the two are small in their individual markets but hoping they can be stronger together. As for taking an equity stake to realise that potential, the strategy is less clear.

Czech Airlines was desparate, with the country's finance minister (the Czech Republic is the largest shareholder) Miroslav Kalousek telling Reuters, "We only had two options: either find a strategic partner or consider liquidation of CSA". The Czech Government says it invited the 52 largest international carriers to bid for Czech Airlines and that Korean Air's bid was the sole offer.

The stake was inexpensive and Korean Air is in relatively healthy financial standing. Korean is also looking to flex its muscles, gaining attention globally and within its SkyTeam alliance for the deal.

SkyTeam in recent years has inducted a number of Asian members, including the continent's largest, China Southern, so some see Korean's purchase of Czech as it wanting to secure its influence within the alliance as its overall contribution lessens proportionally with new members (which also include China Eastern, Vietnam Airlines, China Airlines, Xiamen Airlines and soon Garuda Indonesia). It is also an opportunity to remind the alliance, which is heavy on influence from Air France-KLM and Delta, of Asia's contribution in aviation. It remains to be seen how this pans out.

Korean Air becomes MAI partner, showing agility but with limited immediate benefits

A mere day before Korean's stake in Czech was confirmed, the carrier signed an MOU with Myanmar Airways International (MAI). The MOU covers mutual cooperation in several areas including passenger, safety and operations.

Korean Air has daily A330-200 service to Yangon, which it launched in Sep-2012. Myanmar Airways is an entirely international carrier flying mainly to Southeast Asia. Its sole scheduled North Asian destination is Guangzhou although the carrier has a charter to Osaka Kansai and is considering serving Kunming.

Although MAI is the country's sole international carrier, foreign carriers have far greater capacity in and out of Myanmar. Korean Air is the eighth largest foreign carrier currently serving Myanmar.

Myanmar Airways International routes ranked on seat capacity: 24-Jun-2013 to 30-Jun-2013

Myanmar top 10 international carriers ranked on seat capacity: 24-Jun-2013 to 30-Jun-2013

MAI has a fleet of seven A320 family aircraft according to CAPA's Fleet Database. It flagged in Sep-2012 its intention to form partnerships to help the market as Myanmar prepares to undergo significant growth. MAI is applying for IATA membership and is also interested in a partnering with Japan's All Nippon Airways, which also now serves Yangon.

MAI already partners with Air France, which provides MAI with assistance in flight attendant training and aircraft maintenance, Jetstar Asia (codeshare to Singapore), Thai Airways (codeshare to Bangkok), MAS (codeshare to Kuala Lumpur) and Qatar Airways (codeshare to Doha).

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So the partnership with MAI is less exclusive but does show some agility from Korean Air in a region where inertia can be rife. There could be opportunities for Korean to develop the relationship, but it will be competing with many carriers. For the medium term it will likely be minor but welcome for Korean Air to get its foot in the door - although as the industry has shown, partnerships are not always forever.

Korean Air re-launches service to Saudi Arabia, enters Nairobi and seeks new markets

Korean Air's search for new markets is well underway. The carrier in Nov-2012 resumed services to Jeddah via Riyadh after a 15 year absence. The three weekly service is operated by A330-200s. The carrier attributed its resumption of services to Korean construction companies winning contracts in Saudi Arabia. In addition to the construction market growing, the housing and power plant sectors are also growing.

Saudia joined SkyTeam in 2012, paving the way for future cooperation between Korean Air and Saudia should they choose. Saudia's most northeastern Asian point is Guangzhou.

The Saudi Arabia service was preceded with the Jun-2012 launch of thrice-weekly services between Seoul Incheon and Nairobi, the hub of SkyTeam's Kenya Airways.

As CAPA previously wrote:

The timing of the service, loaded into global distribution systems for service until 27-Oct-2012, facilitates connections at either end of the flight. The outbound flight from Seoul, departing in the evening, allows for connections across Korean Air's network to Nairobi, although given the geography of Korean Air's Seoul hub, connections will be strongest around North Asia as other points will require backtracking through Seoul. Given overall limited flight options between Africa and Asia, Korean Air may see passengers on circuitous itineraries. At 5431nm, Korean Air's route to Nairobi will be one of its longest, and one of the longest for the A330 globally.

Korean Air Seoul-Nairobi flight details: 31-Jan-2012

Flight Routing Timing Equipment Frequency

KE959 Seoul Incheon-Nairobi 22:15-05:30+1 A330-200 Tuesday, Thursday and Saturday

KE960 Nairobi-Seoul Incheon 10:30-04:50+1 A330-200 Wednesday, Friday and Sunday

Source: CAPA - Centre for Aviation & airline schedules
The early morning arrival time in Nairobi allows for onward connections on Kenya Airways' network. On the return Nairobi-Seoul flight, although Korean's flight leaves mid-morning, Kenya Airways has a number of regional flights arriving into Nairobi around 5:00 and 6:00 that will allow for potential transfers to Seoul. The early morning arrival in Seoul allows for onward connections on Korean Air's network.
Kenya Airways early morning services to Nairobi from selected African destinations as at 30-Jan-2012

Departing Arriving Arrival time Frequency Region

Johannesburg OR Tambo Nairobi 05:45 Daily Southern Africa

Entebbe Nairobi 06:20 Daily Central Africa

Addis Ababa Nairobi 06:00 Twice weekly East Africa

Dar es Salaam Nairobi 06:25 Daily East Africa

Brazzaville Nairobi 05:35 Twice weekly Central Africa

Kigali Nairobi 05:25 Three times weekly Central Africa

Accra Nairobi 05:30 Daily West Africa

Mombasa Nairobi 06:30 Daily East Africa (domestic)

Source: CAPA - Centre for Aviation & Innovata

Kenya Airways offers the third largest amount of seats across its African network while Korean Air offers the tenth largest across Asia-Pacific

Flight	Routing	Timing	Equipment	Frequency
KE959	Seoul Incheon-Nairobi	22:15-05:30+1	A330-200	Tuesday, Thursday and Saturday
KE960	Nairobi-Seoul Incheon	10:30-04:50+1	A330-200	Wednesday, Friday and Sunday

Departing	Arriving	Arrival time	Frequency	Region
Johannesburg OR Tambo	Nairobi	05:45	Daily	Southern Africa
Entebbe	Nairobi	06:20	Daily	Central Africa
Addis Ababa	Nairobi	06:00	Twice weekly	East Africa
Dar es Salaam	Nairobi	06:25	Daily	East Africa
Brazzaville	Nairobi	05:35	Twice weekly	Central Africa
Kigali	Nairobi	05:25	Three times weekly	Central Africa
Accra	Nairobi	05:30	Daily	West Africa
Mombasa	Nairobi	06:30	Daily	East Africa (domestic)

Korean Air in Mar-2013 entered another new market, Colombo and Male, operating the two together on three weekly services. The Maldives is a popular leisure destination for Chinese passengers and Colombo is gaining popularity following Sri Lanka's post-civil war revival. British Airways in Apr-2013 resumed services to Colombo with an additional sector to Male. Singapore Airlines is currently running a tidy sixth freedom business from China to the Maldives via Singapore.

Korean Air during 2013 plans to increase Asian frequencies from Seoul Inchon to Xiamen, Dalian and Tokyo Narita as well as Busan to Tokyo Narita. The Tokyo Narita-Korea market is seeing new competition from LCC AirAsia Japan so it remains to be seen how Korean Air (the largest operator between Korea and Japan) goes, especially once Japanese LCC capacity increases.

A destination in South Africa (likely Johannesburg) is expected to be Korean Air's third African destination. North Asian competitors Air China and China Southern are considering serving South Africa while China Eastern is considering codesharing on Etihad Airways' services. Surprisingly notable traffic goes between South Africa and Japan but primarily through Hong Kong and Middle East hubs, which Korean Air could target.

Korean Air is one of the few Asian carriers to serve Latin America, and the only one amongst Japanese and Korean carriers. JAL used to serve Sao Paulo via New York (it now relies on codeshare partners). Korean Air still serves Sao Paulo via Los Angeles with three weekly 777-300ER flights and plans to add Los Angeles-Lima service as well.

North America remains core market for Korean Air

International passengers comprised 56% of Korean Air's 4Q2012 operating revenue. Including domestic revenue, which accounts for another 5% of revenue, traffic to North America is about a third of total passenger revenues.

Average yields to North America tend to be low compared to other regions, but this is offset by the relatively low cost and efficient nature of long-haul flying compared to short-haul markets like China and Japan. While the cargo sector overall remains weak, North America trends above and freight can be carried in belly sections of aircraft in addition to Korean Air's freighter fleet.

Korean Air revenue breakdown: 4Q2012

Korean Air passenger revenue by market: 4Q2012 vs 4Q2011

Korean Air (and Asiana) use their Seoul hubs to especially target China-North America sixth freedom traffic. The Chinese carriers are still growing their long-haul operations while North American carriers do not yet serve secondary points in China whereas Asiana and Korean Air serve second and third tier cities that they link to multiple North American destinations.

In terms of network, ANA and JAL provide competition but their stronger focus on O&D traffic to Japan and high cost base is a limiting factor. (ANA and JAL's average cost base is inflated by their large domestic operation, which is not as efficient as long-haul flights.)

Select Asian and US carrier CASK comparisons: 2012

Korean Air in 2006 overtook JAL as the largest Asian carrier based on North American seat capacity. In addition to Korean Air's growth, JAL cut back on its long-haul network as finances severely soured. Between 2003 and 2012 Korean Air grew North American capacity by about 50% while smaller challengers Asiana grew its North American capacity by about 85%, and Cathay Pacific 125%.

ANA, Asiana, Cathay Pacific, JAL and Korean Air seat capacity to North America: 2003-2012

Korean Air in 2013 will deploy its A380 to Atlanta on some sectors while increasing frequency to Dallas, Las Vegas, Seattle and Vancouver in North America. The increase to Dallas follows American Airlines' plan to open Dallas-Seoul Incheon service.

The Atlanta service is popular not only for connections to Delta's mega hub there but Atlanta's geographic proximity to manufacturing plants in Alabama and Georgia respectively for South Korea's largest auto manufacturer, Hyundai and Kia.

In addition to increasing capacity, Korean Air wants to see growth in premium cabins, which comprise about 30% of passenger revenue. The carrier told the Wall Street Journal it is targeting a 15% increase in premium revenue in 2013 to KRW1.624 trillion (USD1.5 billion). While Korean carriers lag behind on developing premium products, they have made large but quiet leaps and offer an international standard product.

Korean Air in mid-2012 flagged the possibility of a joint venture with Delta. Delta is the only remaining US carrier linking the mainland with Asia that is not part of a JV; American is with JAL and United with ANA. Tensions were tight between Delta and Korean Air when Delta tried to woo Korean Air competitor JAL from oneworld to SkyTeam and form a JV.

The US-Korea market is open skies, a prerequisite from US regulators to approve JV ATIs. Delta appears lukewarm to the prospect, commenting in late 2012 that it sees Tokyo Narita, its main Asian hub, being over-saturated and seeing as likely a shift of Tokyo capacity to Seoul. International markets tend to take a backseat with US carriers. Virgin Australia has been pressing for more integration between the US and Australia, but Delta has made notable innovative moves relative to the US industry by investing in Brazil's Gol and Virgin Atlantic.

Korean's interest in North America received public attention in early 2013 with its plan to construct a 73-story building in Los Angeles, making the building the largest in the US west of the Mississippi River.

Back to profit but with a 2.2% operating margin, a concern as LCC competition increases

Korean Air ended 2012 demonstrating capacity discipline with load factors and yields increase in both the domestic and international markets. 2012 saw Korean Air post its highest ever load factors and RPKs for the fourth quarter. While territorial disputes between Japan and China stole headlines, another territorial dispute between Japan and Korea saw the Japanese market decline 9% in 4Q2012.

Cargo, comprising 27% of revenue, saw drops across the board and, unsurprisingly, in Europe especially. The outbound market from Korea, which manufacturers a number of technical items, decreased 5% in 4Q2012 despite that being the popular holiday season when demand for goods is high.

Transit shipments to North America increased 16% but Japan decreased 28%, leading to an overall transit decrease of 7%. Load factors went up 2.4ppt but yields declined 0.6%, a result of the carrier's strategy to maintain load factors by capacity control.

Korean Air cargo traffic trend: 2009-2012

Financially, Korean Air returned to a net profit in 2012 although its operating profit was down about 30% as a 4% increase in revenue was outpaced by a 5% increase in cost. Foreign currency exchange gains almost singularly led the carrier to a net profit.

Korean Air non-consolidated income statement: 2012 vs 2011

Korean Air's 2.2% margin is low for Asia and this is a concern given the amount of change occurring in North Asia, led primarily by increased LCC activity. Korean Air has its own wholly-owned LCC, Jin Air, but Jin Air's growth remains stunted as Korean Air favours its full-service model.

Jin Air, like other Korean LCCs, does not follow a strict LCC model and this results in an inflated cost base that will not be able to match Japanese LCCs like AirAsia Japan and Peach, which already link Japan with Korea. Korean LCC Jeju Air has flagged its intention to change and become more low cost. Jin Air will undoubtedly have to respond.

The concern is that untapped growth potential for Jin Air will go to competitors if Korean Air does not unshackle Jin Air. Further LCC competition will come from AirAsia X's Kuala Lumpur-Busan service (complementing Kuala Lumpur-Seoul Incheon) and Scoot's Singapore-Taipei-Seoul Incheon service.

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Korean Air in 2013 plans to take two A380s, one A330, two 777s, two 737s, one 747-8F and one 777F, but retirements will see no net growth in aircraft numbers.

Its financial plan for 2013 calls for a massive 143% increase in operating profit and 3ppt improvement in operating margin to 5%. Although there is long-haul growth in North America, there is also changing competition there and closer to home around regional Asia, both with LCCs and the Chinese market not growing the way it used to. Korean Air's plan to match its 2013 strategy with financial goals remains to be seen.

Korean Air non-consolidated business target (KRW billion): 2013 vs 2012

Focus on partnerships and new markets, with definition, the right moves, but Korean Air must prepare to set Jin Air free

Korean Air is taking surprising bold steps for a region known for inertia. Nairobi, Male and Saudi Arabia are strong growth prospects few are latching on to.

Korean Air's willingness to engage in partnerships as well as equity stakes is to be noticed, but its purchase of Czech Airlines, albeit small financially, requires greater definition. While its partnerships are notable compared to peers, they are not as far-reaching as they could be.

Korean Air has shown overall strength in long-haul markets, but it must accept the status quo around short-haul Asia will undergo a structural transformation as LCCs take a greater share of traffic. Korean Air has put its foot in the LCC door just enough to say it is present but not enough to take advantage of its strong outbound market as well as regional demand. Korean Air can either be an effective participant or watch competitors take traffic, further hurting an already mediocre operating margin.