05-Sep-2013 10:13 AM

SAS: confidence grows after sharp increase in 3Q profits

Analysis

SAS made a bigger profit in 3QFY2013 (May-Jul) than in the same period a year ago, building on the positive momentum developed in 2Q, when it narrowed its losses after reporting wider losses in 1Q. Its '4Excellence Next Generation' restructuring plan delivered further savings in the quarter and SAS has made good progress with most of the key savings and liquidity measures identified in the plan. It has confidently reiterated its FY2013 target of positive earnings.

SAS has also announced plans to order new long-haul aircraft and should complete the sale of Wideroe and the outsourcing of ground-handling in the near future. Focusing the network around the needs of frequent flyers and investing in cabin refurbishment should provide some differentiation from, and appeal relative to, LCC competitors on both short-haul and long-haul. Nevertheless, SAS is still a high-cost carrier and remains vulnerable to price-based competition.

Operating profit up 47% in 2Q

In 3QFY2013 (May to July), SAS reported EBIT before non-recurring items up by 47% to SEK1,198 million (EUR139 million) and net income up 58% to SEK844 million (EUR98 million). Revenues were just below flat (-0.4%), as lower load factor and yield and adverse currency effects combined to offset capacity growth (ASKs up 7.7%). Currency-adjusted revenues grew by 3.3%. The improvement in profit margins was mainly due to fuel and labour costs reducing their share of revenues.

SAS Group 3Q2013 financial results

Reduction in net debt

SAS' net debt fell from SEK7.8 billion (EUR902 million) at the end of Jan-2013 to SEK5.8 billion (EUR670 million) at the end of Jul-2013, helped by asset disposals, improved operating cash flow and lower capital expenditure. Its 'financial preparedness', or overall liquidity as a percentage of the group's fixed costs was 20% at the end of Jul-2013, in line with its target. Further improvements in liquidity are expected by the end of FY2013 as a result of expected Wideroe sale proceeds (SAS expects to complete the planned disposal at the end of Sep-2013).

SAS Group financial preparedness and net debt 1QFY2013 to 3QFY2013

Capacity growth driven by Europe; load factor dips

SAS increased its capacity (ASK) by 7.7% year on year in 3Q and by 5.7% in the first nine months of FY2013. Growth in RPKs was 5.6% in 3Q and 3.8% for the nine month period, slower than capacity growth. Load factor fell by 1.4 ppts to 72.5% for the nine months. Capacity growth was particularly focused on Europe, where ASKs were up 8.8% for the first nine months (but traffic was up only 4.9%) and where SAS added 32 new routes. On intercontinental routes, ASKs were up 5.3% and traffic up 5.8%. Domestic capacity was cut by 1.4% in the nine month period.

SAS Group scheduled traffic data 3Q2013 (May-Jul) and 1H2013 (Nov-Jul)

Growth in Europe was even stronger for the two month period Jun-2013 to Jul-2013, when capacity was 14% higher than last year and traffic grew by 11%. SAS President and CEO Rickard Gustafson told analysts on the webcast to discuss the 3Q results that the summer's European growth spurt had been profitable.

Growth in the intercontinental segment focused on the USA, with more frequencies and a new route to San Francisco. According to Mr Gustafson, SAS has around 100 weekly flights to North America, compared with Norwegian's total of around 30 once it is fully up and running.

While Norwegian's long-haul operations add to the competitive pressures, Mr Gustafson argues that it has always been a competitive environment and he believes SAS has a "pretty strong value proposition", which aims to serve frequent flyers with a transparent pricing structure, a strong schedule and efficient connections through partners and its own network. Moreover, he says SAS is investing in its product and looking for new growth long-haul opportunities including routes from Stockholm and Oslo.

SAS tailoring of its network to the needs of Scandinavian frequent flyers, in order to differentiate itself from LCCs, led to a year on year increase of 46% in tickets sold to passengers that belong to SAS' EuroBonus FFP in the Jun/Jul-2013 period.

Scandinavian Airlines passenger traffic data by route area

RASK declines were expected

SAS says that the fall in load factor and yield in 3Q FY2013 was expected as a result of its capacity expansion. However, for the nine month period, currency-adjusted yield increased by 1.0% and was a little better than expected. Currency-adjusted RASK fell in 3Q (by 4.8%) and for the nine months (by 2.3%), but this weak trend was in line with SAS' expectations. It managed to improve operating profits because currency-adjusted CASK fell more rapidly (-9.0% and -6.8% respectively). SAS expects a negative RASK trend for the full year.

Scandinavian Airlines scheduled passenger traffic, yield, RASK and CASK*

Currency-adjusted passenger revenues grew by 5.3% year on year in 3QFY2013, less than the 7.7% increase in ASKs, but consistent with the increase seen in 1H. For the nine month period, currency-adjusted passenger revenues also grew by 5.3%.

SAS Group passenger revenue growth year on year by quarter FY2013 (currency adjusted)

SAS' cost reductions mainly due to fuel and labour

In spite of capacity growth, SAS' operating costs before depreciation and leases fell by 5.0% year on year on 3Q FY2013, continuing an improving trend that saw costs fall in 2Q after increasing in 1Q. The fall in costs in 3Q was helped by a 13.5% reduction in fuel costs, itself mainly due to the impact of hedging and a stronger SEK/USD exchange rate.

Labour costs fell by 7%, more rapidly than the 4% cut in average headcount and reflecting progress with the '4Excellence Next Generation' (4XNG) restructuring programme. SAS says that the programme achieved savings of SEK580 million (EUR67 million) in the quarter.

SAS Group operating expenditure* growth year on year by quarter FY2013

Currency-adjusted CASK fell by 9.0% year on year in 3Q and by 5.8% excluding fuel. For the nine month period, currency-adjusted CASK was down by 6.8% (-4.4% ex fuel and stripping out the impact of new pension arrangements on 2Q costs). It is worth noting that nine month RPK growth of 3.7% outpaced passenger growth of -0.4%, implying that average sector length grew by around 4%. While CASK reduction is to be welcomed, increased average sector length is typically accompanied by lower CASK (and lower RASK).

SAS ex fuel unit cost growth year on year by quarter FY2013 (currency adjusted)

SAS Group operating costs before non-recurring items (SEK million) 3QFY2013

SEK million	May-Jul 2012	May-Jul 2013	Change
Payroll	3,166	2,943	-7.0%
Fuel	2,722	2,354	-13.5%
Government charges	1,113	1,109	-0.4%
Other operating expanses	3,005	3,102	3.2%
Total before depreciation & leases	10,006	9,508	-5.0%
Leases	411	480	16.8%
Depreciation	432	426	-1.4%
Total	10,849	10,414	-4.0%

Fleet modernisation

The replacement of SAS' McDonnell Douglas and 737 Classics with A320s and 737 Next Generation aircraft continues and the MD aircraft should have all exited the fleet by 2014 (the MD80s will be replaced by Oct-2013). It has 30 A320NEO on order, with the first delivery expected in 2016. It also plans to install new seats on its existing short-haul fleet.

SAS took a step towards the modernisation of its long-haul fleet during the quarter with the signing of a MoU with Airbus for eight A350-900s and four A330-300Es. The first delivery is expected in 2015. SAS also plans to upgrade the passenger cabins on seven A330 and A340 aircraft including installing new seats and IFE throughout the cabin and fully flat business class seating by 2015.

SAS Group fleet at 31-Jul-2013

SAS Group fleet by airline at 31-Jul-2013

4XNG plan is having an impact

SAS made progress with its 4XNG restructuring plan in the first nine months of FY2013, with SEK1,350 million of savings. It expects the plan to generate FY2013 savings of SEK1.5 billion (around EUR175 million). Overall, the aim is to implement cost reductions of about SEK3 billion (around EUR350 million) in the 2013-2015 period, and to divest assets and implement a funding plan to improve liquidity by a total of approximately SEK3 billion.

The cost savings include new collective agreements, which were signed in Nov-2012 and fully implemented in the spring of 2013 and led to productivity gains in 3Q FY2013. New pension terms were also agreed in Nov-2012, consisting of a defined contribution scheme for most employees. The new pension agreements have been fully implemented in Sweden and Denmark and should be finalised in Norway in the fourth quarter.

SAS Group planned cost savings 2013-2015 under '4XNG' plan

The centralisation of administration to Stockholm includes the reduction of around 1,000 full time equivalent employees and all those leaving in FY2013 have been identified. The restructuring of IT aims to halve IT costs by 2016 and SAS has already made progress with some outsourcing agreements.

The fifth and final area of cost savings under 4XNG is in Commercial and Sales. The outsourcing of call centre activities proceeded according to plan in 3Q. SAS is restructuring and centralising its sales function and improving network efficiency through improved aircraft utilisation and greater flexibility through the use of wet leases. Improvements in daily aircraft utilisation rates have accelerated through the year so far, with 3Q seeing a year on year increase of 6.7%.

SAS Group aircraft utilisation growth year on year by quarter FY2013

Liquidity measures include asset disposals totalling SEK2.7 billion and a bond issue amounting to SEK300 million. The sale of Wideroe was agreed in Feb-2013 and is expected to complete in Sep-2013 with an impact of SEK1 billion on liquidity. The refinancing of aircraft and engines has already had a positive liquidity impact of SEK1.7 billion.

SAS Group liquidity measures 2013-2015 under '4XNG' plan

SAS is in the final stages of negotiation with Swissport over the disposal of its ground handling activities, having signed a Letter of Intent in mar-2013. The deal is part of the 4XNG strategy, but its impact is not included in the cost savings or liquidity improvement targets under 4XNG. The main rationale for SAS is to increase the proportion of variable costs in its cost base.

A subtly more confident outlook

On the webcast to analysts, Mr Gustafson referred to the "continued competitive pressure throughout the last six months". He added that southern European markets were "pretty tough", that demand was flat in central Europe and so capacity was being redirected to "our part of Europe". While this was putting pressure on yields and RASKs, and would likely continue into the winter, this had been built into SAS' plan. Mr Gustafson's response is to continue to deliver on the restructuring programme and to invest in SAS' customer proposition.

For FY2013, SAS has subtly turned slightly more positive, saying that it "now expects …to report an EBIT margin in excess of 3% and a positive income before tax, EBT, …provided that no significant unforeseen event occurs...". Previously, it said that "a positive EBIT margin, exceeding 3%, and a positive EBT is possible to achieve".

To achieve its 2013 targets will be evidence that the 4XNG programme is starting to work. Even if SAS can continue to lower its unit costs, it is likely to remain a higher-cost carrier than most European airlines (even allowing for its shorter average sector length). It will need a tailwind to progress from there to its 2015 target EBIT margin of 8%.

Unit costs (cost per available seat kilometre, EUR cent) and average sector length for selected European legacy and low cost carriers 2012*

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