11-Sep-2015 6:54 PM

SAS capacity cuts help return to 9M operating profit as Hong Kong launch signals expansion for 2016

Analysis

Scandinavian airline flag SAS followed up on its reduced operating loss in 1H2015 with a healthy increase in profit in 3Q2015. This was sufficient to take its 9M2015 operating result back into profit after making a loss a year earlier. As in 1H2015, SAS' yield benefited from a better balance of supply and demand compared with last year. This helped unit revenue to grow faster than unit cost, in spite of a significant currency headwind on costs.

SAS' capacity cuts this year, led by charter operations and the long haul network, seem to have had a beneficial effect on unit revenue in spite of falling load factor. Long haul expansion, starting this autumn with a new Stockholm-Hong Kong route and continuing in 2016 with three new US routes, will lead to ASK growth next year and this may put some downward pressure on unit revenue.

Summary

SAS reported a healthy increase in profit in 3Q2015, taking its 9M2015 operating result back into profit after making a loss a year earlier.
The airline's yield benefited from a better balance of supply and demand compared to last year, resulting in unit revenue growing faster than unit cost.
SAS' capacity cuts this year, particularly in charter operations and the long-haul network, have had a positive effect on unit revenue despite a fall in load factor.
The airline's long-haul expansion plans, including new routes to Hong Kong, Los Angeles, and Miami, will lead to ASK growth in 2016, potentially putting pressure on unit revenue.
Currency-adjusted passenger revenue per ASK increased by 3.6% in 3Q2015, reflecting the positive impact of capacity cuts and a more constrained market capacity environment.
SAS expects its pre-tax profit for FY2015 to be "clearly positive" provided that the economy does not weaken and there are no further exchange rate deterioration or unexpected events.

SAS' Q3 operating result rose 19%

In 3Q2015 (May to July, SAS' financial year ends in October), SAS' net income jumped by 61% to SEK800 million. This result was helped by gains on fixed asset sales (SEK35 million), lower net interest charges (by SEL66 million) and a lower tax bill (by SEK19 million). The operating result before non-recurring expenses and results from affiliated companies increased by 19% to SEK1,082 million. Revenue grew by 2.6% and the 3Q operating margin gained 1.3 ppts to 9.9%.

The operating profit achieved in 3Q was sufficient to offset a loss in 1H, bringing SAS' 9M2015 operating result back into profit to the tune of SEK217 million, compared with an operating loss of SEK628 million for 9M2014. Its 9M2015 operating margin was just 0.8%, but this was 3.1ppts better than the same period a year earlier.

SAS results summary 3Q and 9MFY2015 versus 3Q and 9MFY2014

SEK million	3Q2014	3Q2015	Change	9MFY2014	9MFY2015	Change
Revenue	10,697	10,973	2.6%	27,040	28,747	6.3%
Operating costs*	-9,786	-9,891	1.1%	-27,668	-28,530	3.1%
Operating result*	911	1,082	18.8%	-628	217	-134.6%
EBIT margin %	8.5	9.9	1.3ppts	-2.3	0.8	3.1ppts
Net income	496	800	61.3%	-416	439	-205.5%

Total ASKs down 2.9%, load factor down 1.8ppts in 3Q

SAS reduced total ASKs (scheduled plus charter traffic) by 2.9% in 3Q, modestly accelerating its 2.3% capacity cut of 1H to give a 9M ASK cut of 2.5%. The capacity cut was driven by a significant reduction in charter operations.

According to our calculations, charter ASKs were down by 15.9% year on year in 3Q and by 24.6% in 9M2015. Their share of SAS' total ASKs fell from 12% in 3Q2014 to 10% in 3Q2015 and from 9% in 9M2014 to 7% in 9M2015.

Total passenger numbers fell by 4.8% and RPKs by 4.9%, so that passenger load factor lost 1.8ppts to 81.6% in 3Q. This continued the 1.9ppt load factor fall in 2Q, which had reversed a load factor gain of a similar magnitude in1Q, so that 9M load factor was 0.8ppts lower at 74.9%.

SAS total passenger traffic 3Q and 9M FY2015

Scheduled ASKs fall by 1.1% in 3Q due to long haul cuts

Scheduled ASKs were cut by 1.1% year on year in 3Q, but scheduled RPKs fell at the faster rate of 3.5%. Load factor for scheduled operations, which do not include the high utilisation charter operations, lost 1.9ppts to 79.9%. Charter flights had a 3Q load factor gain of 1.8ppts to 95.9%, according to our calculations.

For 9M2015, SAS' scheduled ASKs were down by 0.4% and scheduled load factor was down 0.5ppts to 73.5%, but its charter load factor was up by 0.8 ppts to 94.1%. Scheduled load factor managed an increase in the final month of the quarter, Jul-2015 (load factor up 0.4 ppts to 86.9%), but it fell again in Aug-2015 by 0.7ppts to 80.5%.

Charter may not be profitable for SAS, which explains its continued reduction in charter activity, but their falling share of total operations is increasing the spotlight on its relatively low scheduled load factor (its mid 70s year to date load factor compares with an average of 81% for the Association of European Airlines).

SAS' capacity cut in scheduled operations in 3Q was driven by its long haul network (ASKs -4.1%), while ASKs to Europe/intra-Scandinavia were almost flat (-0.1%) and the three domestic markets saw modest growth (+0.9%). RPK growth was weaker than ASK growth (and so load factor reduced) in all regions in 3Q, although the domestic market saw stronger growth in traffic versus capacity in the 9M period.

SAS scheduled passenger traffic, yield, unit revenue and unit cost 3Q and 9M FY2015

SAS scheduled passenger traffic by route sector

Currency adjusted passenger RASK up 3.6% in 3Q

Currency-adjusted scheduled passenger revenue per ASK increased by 3.6% year on year in 3Q, continuing the positive development of the first two quarters. This 3Q passenger RASK performance was slower than the increase of 6.8% in 2Q and 6.7% in 1Q, but the 9M currency adjusted growth of 5.5% marks a welcome change from FY2014 and reflects the positive impact of capacity cuts by SAS and a much more constrained market capacity environment.

It seems that capacity constraint has enabled SAS to drive up yields (+6.2% year on year for 9M2015 on a currency adjusted basis) and yield growth has more than offset falling load factor to raise currency adjusted unit revenue.

SAS' Revenue was up 2.6%

SAS' total revenue grew by 2.6% in 3Q2015, in spite of the ASK cut. Scheduled passenger revenue was up by 5.2%, a strong outturn compared with the 1.1% reduction in scheduled ASKs. This was driven by growth in currency adjusted yield, as discussed above, and further enhanced by positive foreign exchange effects. Charter revenue fell by 15.3%, slightly less than the 15.9% cut in charter ASKs.

Exchange rate movements had a positive impact on revenue of SEK272 million. According to our calculations, total revenue per ASK (RASK) increased by 5.6% year on year in 3Q and by 9.1% in 9M.

SAS Group revenues 3Q FY2015 versus 3Q FY2014

(SEK million)	3Q FY2014	3Q FY2015	Change	% of 3Q FY2015 revenues
Passenger revenue	8,062	8,484	5.2%	77%
Charter revenue	795	673	-15.3%	6%
Cargo and mail revenue	304	293	-3.6%	3%
Other traffic revenue	503	528	5.0%	5%
Other operating revenue	1,033	995	-3.7%	9%
Operating revenue	10,697	10,973	2.6%	100%

Operating costs up 1.1%, inflated by currency impacts

SAS' total operating costs increased by 1.1%, faster than the change in ASKs, but slower than the growth in revenue. Fuel costs fell by 4.6%, faster than the 2.9% cut in total ASKs, thanks to lower market prices for jet fuel, partly offset by currency movements (stronger USD versus SEK) and by SAS' fuel hedging programme.

Non fuel costs increased by 3.0%, in spite of the capacity cut. There were particularly sharp increases in selling costs (+16.3%), handling costs (+20.2%) and aircraft leasing costs (+25.5%). Initiatives to outsource those ground handling activities that remain within the group are ongoing, including letters of intent with Wideroe and Aviator.

Labour costs, which were the biggest cost category (24% of the total, just ahead of fuel costs), fell by 4.3% on a 9.7% reduction in average headcount compared with 3Q2014.

SAS reported that its cost reduction programme achieved SEK250 million of savings in the quarter and expects a SEK1.0 billion impact in FY2015. It may charge up to SEK450 million in pilot restructuring costs across FY2015 and FY2016. The total currency impact on operating costs was SEK874 million, which was SEK602 million greater than the positive impact on revenue.

According to our calculations, total operating cost per ASK (CASK) increased by 4.1% year on year in 3Q and by 5.8% in 9M (in both cases, less than the increase in RASK).

SAS Group operating costs* 3Q FY2015 versus 3Q FY2014

(SEK million)	3Q FY2014	3Q FY2015	Change	% of 3Q FY2015 costs
Payroll expenses*	-2,494	-2,386	-4.3%	24%
Selling costs	-553	-643	16.3%	7%
Jet fuel	-2,458	-2,344	-4.6%	24%
Government user fees	-1,068	-1,093	2.3%	11%
Catering costs	-227	-241	6.2%	2%
Handling costs	-441	-530	20.2%	5%
Technical aircraft maintenance	-577	-603	4.5%	6%
Data and telecommunications costs	-266	-274	3.0%	3%
Other expenses	-823	-775	-5.8%	8%
Leasing costs for aircraft	-525	-659	25.5%	7%
Depreciation, amortisation and impairment	-354	-343	-3.1%	3%
Total operating expenses*	-9,786	-9,891	1.1%	*100.0%*
Total ex fuel	-7,328	-7,547	3.0%	76%

SAS Group development of operating expenses* 3QFY 2014 to 3Q FY2015

SAS' FY2015 pre-tax profit will be "clearly positive"

For FY2015 as a whole (year to Oct-2015), SAS expects to cut total ASKs by around 2% (compared with -2.5% for 9M2015), mainly due to charter capacity cuts. This compares with previous guidance at the time of its 1H results in Jun-2015, when it expected to cut ASKs by between 1% and 2%. Its slightly more conservative capacity plan makes sense given the positive impact on yield from greater capacity discipline (although capacity cuts also make it harder to cut unit costs).

Concerning the outlook for profit before tax and non-recurring items, SAS has reiterated that it expects this to be "clearly positive" provided that the economy does not weaken and subject to continued capacity reduction and lower jet fuel trends and no further exchange rate deterioration or unexpected events.

Long haul expansion plan is evidence of SAS' more confident mood, but carries risks

The Sep-2015 launch of a five times weekly Stockholm-Hong Kong service signals the start of a new phase of long haul expansion by SAS, as indicated by the company in Jun-2016. This compares with its capacity reduction on long haul so far in 2015 (ASKs -1.8% in 9M2015), which are partly reflect the cabin upgrade programme for its A330 and A340 fleet. In addition to upgrades and improvements to its wide body fleet, it will also add new aircraft starting with two A330E deliveries this autumn.

See related reports:

The new Hong Kong route will be followed by a daily Stockholm-Los Angeles operation in Mar-2016 and two Miami services in autumn 2016 (four times weekly from Oslo and three times weekly from Copenhagen). In addition, SAS will increase frequencies on services to Shanghai, New York, Chicago and San Francisco in Oct-2015. Long haul expansion will lead to ASK growth in 2016, possibly in the range of 3% to 5%, although this has not yet been decided, according to SAS CEO Rickard Gustafson on a conference call with analysts.

It is not difficult to make out the influence of low cost competitor Norwegian Air Shuttle, and its growing long haul network, on SAS' decision to launch/grow on some of these routes. We will analyse its long haul network and its competition with Norwegian (and Finnair) in a future report.

SAS is in a more positive mood than at any time for a number of years, having improved its cost structure and more clearly defined its focus on Scandinavia's frequent travellers. Its more optimistic tone is exemplified by its long haul expansion plans by one of Europe's shortest haul legacy airlines (as defined by average trip length).

Nevertheless, this is a strategic shift and not without risks to SAS, given growing long haul competition from local and global airlines, uncertainties surrounding the global economy and the ongoing need to keep a focus on Scandinavia and Europe, which provided 77% of its revenue in 2014.