04-Nov-2013 2:00 PM

South African Airways needs to move forward with new strategic plan, starting with Buenos Aires cut

Analysis

South African Airways (SAA) faces a pressing need to start moving forward with its new strategic plan, which includes pursuing expansion within Africa and cutting unprofitable long-haul destinations such as Buenos Aires. The new business plan, which was initially completed in Apr-2013, represents a critical step in finally fixing the long floundering carrier. But SAA has not yet implemented any major components of the plan although most of the pieces have secured the required layers of approval.

Under the new strategic plan, SAA will increase operations within Africa while cutting unprofitable long-haul routes and potentially hand more domestic routes to low-cost subsidiary Mango. SAA could also start operating alongside new partner Etihad on the Johannesburg-Abu Dhabi route, using the capacity freed up from axing highly unprofitable long-haul services, as it increases its reliance on partnerships to provide a stronger network beyond Africa.

The continued delays in implementing the long-term turnaround plan are costly as SAA continues to bleed. It needs to move quickly to build on its position in the intra-Africa market, with more flights from South Africa and a possible new base in West Africa, as competition within Africa is starting to intensify. SAA also needs to finally move forward in acquiring new widebody aircraft, which were identified in the plan as essential for a sustainable long-haul operation.

Summary

South African Airways (SAA) needs to implement its new strategic plan, which includes expanding within Africa and cutting unprofitable long-haul routes.
SAA has not yet implemented any major components of the plan, despite securing the required approvals.
The delay in implementing the plan is costly for SAA, which continues to incur losses.
SAA's long-haul routes, particularly to Buenos Aires, Beijing, and Mumbai, are unprofitable and need to be addressed.
SAA should focus on building partnerships with other airlines, such as Etihad and Emirates, to strengthen its network.
SAA needs to acquire new widebody aircraft to replace its aging fleet and improve long-haul performance.

SAA's new business plan has been ready for six months

SAA's management team initially presented the strategic plan to the Government in Apr-2013. A final version of the plan was subsequently presented to South Africa's Parliament in Sep-2013.

The plan was drafted in early 2013 by a team led by SAA interim CEO Nico Bezuidenhout. Monwabisi Kalawe took over as the carrier's new permanent CEO in Jun-2013 and Mr Bezuidenhout returned to Mango, where he has been CEO since the LCC subsidiary launched in 2006.

Mr Bezuidenhout and the progress he made in shaping a new long-term strategy for SAA provided welcome stability after former acting CEO Vuyisile Kona was suspended in Feb-2013. Mr Kona had replaced Siza Mzimela, who had been CEO for less than two years until she resigned in Oct-2012 along with most of SAA's board.

SAA has been in nearly constant turmoil over the past decade, with several restructurings, all of which failed to go deep enough to turn around the flag carrier. The new turnaround plan is widely viewed as stronger and deeper. But as CAPA has previously reported, the government's interventionist style has historically made implementing new business plans extremely challenging. If the government does not start to give SAA management more freedom without the constant threat of intervention, Mr Kalawe could end up struggling to restructure and turn around the carrier.

But the delay in implementing the turnaround plan so far does not appear this time to be driven by an intervening government. While some elements of the plan are still subject to further debate or approvals - such as a re-capitalisation and a new group structure for SAA, Mango and SA Express - most of the components have been approved by the board and government. Mr Kalawe has now had time to transition to the new job and should push forward with implementation. SAA does not have time on its side.

SAA has not yet moved to cut any long-haul routes

For example, SAA has approval to cut two of its long-haul routes. Three of the carrier's long-haul routes were identified for cuts in the new business plan and two have been approved.

SAA's long-haul network is highly unprofitable and has been for a long time. But some routes are too strategically important or too politically sensitive to be cut. SAA has not proposed cutting any of its remaining European routes, which now include Johannesburg to Frankfurt, Munich, London Heathrow and Paris. Cape Town to London was already cut in 2012 - a controversial but necessary move.

Over the last several years SAA has been reducing its focus on Europe and adding to Asia and Latin America. SAA now has more capacity to Asia and Latin America, which account for about 13% of its international seats, than Europe, which accounts for about 12%. But all three of its Asian routes (Beijing, Hong Kong and Mumbai) and both of its South American routes (Buenos Aires and Sao Paulo) are unprofitable.

South African Airways international capacity (seats) by region: 4-Nov-2013 to 10-Nov-2013

Buenos Aires should get the axe

Buenos Aires is on the chopping block but SAA has not yet moved to cut the route although it is highly unprofitable and clearly not of strategic importance. Argentina is not a growth market like Brazil and does offer SAA any opportunities for connections. In Brazil, SAA has TAM as a new codeshare partner. With TAM, SAA can serve Buenos Aires along with other destinations in South America via Sao Paulo.

Sao Paulo also has not been performing well and could be reduced to daily from the current 11 frequencies. SAA still wants to maintain a service to Brazil as Brazil is the economic powerhouse of Latin America and the Sao Paulo route provides a key link to another BRICS market. But Buenos Aires, which was resumed in 2009 and has never been profitable, is not seen as critical.

The Argentineans, including leading travel agents, have been lobbying SAA and the South African Government to retain the service. They are concerned the extra six hours of total transit time that will result when passengers are forced to fly via Sao Paulo will impact demand in the Argentina-South Africa market. But the reality is SAA cannot afford to continue covering losses on the route. Argentina could request that Aerolineas Argentinas launches services in the Argentina-South Africa market, which was also served by Malaysia Airlines until early 2012, but Aerolineas is not likely to fair any better and also has been struggling to improve its financial position.

SAA has said it has not moved yet on ceasing any long-haul routes as it has not yet finished the process of consultation and engagements with stakeholders. But the delays in moving forward with Buenos Aires and other route cuts are costly. The carrier did all the proper analysis several months ago in completing the new business plan. It should not even open the door for possible intervention and move to implement the planned cuts.

SAA will not give up on China despite challenges

Beijing, which was launched in 2012, also has not been performing well. SAA could be better off accessing mainland China via its Johannesburg-Hong Kong service, which is also unprofitable and could benefit from more connecting passengers. But a direct service to Beijing is too important politically and the government would not approve it being cut.

Unlike with Buenos Aires, the long-term scenario for Beijing is more favourable as China is a large and growing trading partner with South Africa while Argentina-South Africa trade is small and not too significant. SAA is looking at options for improving the performance of Beijing, including schedule adjustments, partnerships with Chinese carriers and change of aircraft type.

The carrier could potentially acquire a 777 as an interim solution for Beijing until new-generation widebody aircraft are available. It is nearly impossible for the route to be profitable with the current A340-600.

Mumbai route to survive despite low yields

SAA's daily Mumbai service is the only remaining non-stop flight between India and South Africa as Jet Airways dropped its Johannesburg service in 2012. Even without any non-stop competition and a new codeshare with Jet that was implemented earlier this year, the route has remained unprofitable for SAA. But at least for now Mumbai is not on the chopping block.

South Africa-India is a big market as there is a large Indian community in South Africa and India is a growing source market for South Africa's tourism sector. But the market is low yielding and very price sensitive. Most passengers flying between South Africa and India do not mind transiting in East Africa or the Gulf to save a couple of hundred dollars. South Africa-India would be an ideal market for a long-haul low-cost carrier but at least for now there are no long-haul LCCs in Africa or South Asia.

SAA has the potential option of serving India via Etihad and Jet. SAA forged a codeshare partnership with Etihad in May-2013 and with Jet in Apr-2013. SAA was already in the process of negotiating with Jet when Etihad started talking to Jet about a tie-up and equity stake.

Jet is now planning to use Abu Dhabi as a hub and significantly bolster its Abu Dhabi-India operation, which will grow to include 23 routes. SAA has already started using Etihad to serve 12 destinations beyond Abu Dhabi in Asia, the Middle East and Turkey. Adding Etihad and Jet codeshare connections to India via Abu Dhabi would be a logical extension but could make its direct service from Johannesburg to Mumbai, where SAA offers domestic connections to the rest of India via Jet, unnecessary.

SAA will retain Mumbai for now, hoping the new Jet codeshare and domestic connections on the Indian end will improve the route's performance. But there is also a concern that Jet will start favouring connections via Abu Dhabi (on Jet to Abu Dhabi then Etihad for the long-haul sector) rather than via Mumbai (on Jet to Mumbai then SAA for the long-haul sector) for India-South Africa passengers. Ultimately SAA may be better off abandoning the non-stop and instead look to move its South Africa-India passengers via Abu Dhabi.

SAA could serve Abu Dhabi

SAA is looking to re-deploy the capacity from planned cuts in its long-haul network for additional medium-haul Africa flights and to potentially launch Johannesburg-Abu Dhabi. Etihad currently operates one daily flight to Johannesburg. As SAA expands its relationship with Etihad it is logical for SAA to also operate Abu Dhabi so that not all the passengers from the partnership end up on Etihad metal for the long-haul sectors. Other Etihad partners now similarly operate alongside Etihad on their hub-to-hub routes, including airberlin, Air Serbia, Air Astana, Air Seychelles, Garuda Indonesia and Kenya Airways. (As in the case with SAA, Etihad does not have equity stakes in Air Astana, Garuda or Kenya Airways but has stakes in airberlin, Air Serbia, Air Seychelles.)

SAA is now carrying the Etihad code on its flights in the South African domestic market and to international destinations within southern Africa. Johannesburg-Abu Dhabi could potentially support additional capacity, particularly if the Etihad-SAA-Jet partnership is expanded. In comparison, Emirates currently operates three daily flights between Johannesburg and Dubai.

As is usually the case with Etihad and its partners, Etihad taking a stake in SAA is a scenario which has been raised. But the South African Government does not want to give up control and Etihad will not invest without having some control. South Africa's intervention style in this case provides a bad match. Etihad could end up instead investing in its other African partner, Kenya Airways, which would not bode well for SAA.

SAA could use more and stronger partners

SAA's long-haul network also includes two destinations in the US, New York JFK and Washington Dulles, and Perth in Australia. Perth is part of SAA's partnership with Qantas, which operates Sydney-Johannesburg and codeshares with SAA on Perth-Johannesburg. New York is strategically important and is the hub for JetBlue, which is a codeshare partner of SAA. Washington could potentially be cut as it is a more challenging market commercially and SAA struggles to get access to connecting seats at Dulles from Star partner United.

SAA has found JetBlue to be a better partner than United but JetBlue does not have a large operation at Dulles, which is a United hub. SAA has a similar issue with Lufthansa in terms of quality of short-haul feed in Europe and with Lufthansa only generally giving SAA low yielding economy passengers on SAA-operated Germany-South Africa long-haul sectors.

But the Star relationship is better with the Lufthansa Group than United. This is partly driven by the fact that United does not serve South Africa while Lufthansa and SWISS serve Johannesburg and need access to SAA seats from Johannesburg to domestic destinations and international destinations in southern Africa.

SAA is committed to staying in Star and using Star's European members to provide coverage in Europe. But SAA is also open to forging new European partnerships outside Star, as it has done with Etihad and JetBlue. The strategy essentially is to be a prostitute and to go to bed with whichever carrier is the best fit in each market, regardless of alliance membership.

SAA needs more partners to cover Europe, as it has used JetBlue in the US to supplement (or even surpass) United. Part of Europe could also potentially be covered by SAA's Middle Eastern partners, Etihad and Emirates.

Etihad does not yet codeshare with SAA to Europe with the exception of Istanbul. SAA is unlikely to start using Etihad to Western Europe but could potentially use Etihad to serve Eastern Europe, including Russia - the only BRICS market SAA does not serve with its own metal. SAA is interested in a codeshare link to Russia but the Russian Government now prohibits third-party/country codesharing. South Africa is looking at lobbying Russia for an exemption for SAA.

SAA is also open to extending its codeshare with Emirates, which pre-dates the Etihad partnership but has never included any destination beyond Dubai. Previously there had not been any discussion with Emirates of an expanded partnership. But the Etihad-SAA deal, which is not exclusive, has stirred the pot and Emirates is now potentially interested in extending its partnership with SAA.

Emirates is by far the largest foreign carrier in South Africa with a 10% share of total seat capacity. SAA has a leading 39% share while British Airways also has a 10% share but this includes regional international services operated by its South African franchise partner, Comair.

South African international capacity share (% of seats) by carrier: 4-Nov-2013 to 10-Nov-2013

A bigger and stronger network of partners is an important element of the new SAA strategy as the carrier does not have the funds to invest in its own long-haul expansion. Even with cutting some long-haul destinations, the SAA long-haul operation will likely remain unprofitable. The long-term solution is fleet renewal.

SAA still has not yet decided on A340 replacement

SAA currently operates a fleet of 17 A340s and five A330s, according to the CAPA Fleet Database. A new generation widebody acquisition has been planned for several years but has been dealt repeated setbacks. The latest setback came in 2H2012, when the A350 was selected by a fleet committee but the tender process was never completed as the board never endorsed or approved the Airbus proposal.

South African Airways Fleet Summary: as of 3-Nov-2013

Aircraft	In Service	In Storage	On Order*
Total:	52	2	18
Boeing 737-800	12	0	0
Boeing 737-300(F)	2	0	0
Boeing 737-200(F)	1	0	0
Airbus A340-600	9	0	0
Airbus A340-300X	2	0	0
Airbus A340-300E	6	0	0
Airbus A340-200	0	1	0
Airbus A330-200	5	1	0
Airbus A320-200	4	0	18
Airbus A319-100	11	0	0

The new strategic plan called for SAA to quickly launch a new tender process for new-generation widebody aircraft and award a contract by Aug-2013 for deliveries from 2017. But SAA has still not started the new tender process for the widebody requirement, which is between 28 to 35 aircraft. Meanwhile the window to secure delivery slots for 2017 has closed and SAA is most likely now looking at deliveries from 2018 at the earliest.

This delay is costly as the longer the carrier is forced to rely on the A340 for its long-haul flights the longer its long-haul operation will remain in the red. SAA needs to move forward and acquire new widebody aircraft as soon as possible. While SAA can improve its long-haul performance with some tinkering, without renewing its widebody fleet profitability is simply not achievable.

SAA looks to further expand in Africa but cut Kigali and Bujumbura

The other major component of the SAA business plan involves an increased focus on Africa. This includes more intra-Africa capacity from Johannesburg and a second base in West Africa, where it would be more efficient to access regional destinations.

SAA has reportedly applied for more flights from South Africa to several African countries, including Angola, Namibia, Mauritius, Sudan, Tanzania and Zimbabwe. Several of these flights can be added in the short term.

The business plan also envisions a few new Africa destinations along with the suspension of some services that have not been profitable. For example, the thrice weekly A319 service from Johannesburg to Kigali in Rwanda with continuing service to Bujumbura in Burundi, has been identified as a route to be cut. As is the case with Buenos Aires, SAA has not yet moved to cut Kigali/Bujumbura, which was launched in early 2012. All the required approvals to terminate Kigali and Bujumbura have been secured and the delay in implementation is costly as the route continues to be unprofitable.

The West African hub is more a medium-term solution as SAA has just started reviewing potential bases. The review reportedly includes Gabon, Ghana, Nigeria, Senegal and Togo. As the study will take several months to complete, a West African hub will not likely be established until 2015.

SAA's window to solidify its position in Africa is closing

SAA needs to move forward with its Africa expansion as quickly as possible. While SAA has significantly grown its African network in recent years, competitors have expanded faster.

Ethiopian Airlines and Kenya Airways have particularly pursued rapid expansion, with Ethiopian having also established a West African hub in Togo, using its subsidiary ASKY. Ethiopian is now the largest intra-Africa international carrier and based on current seat capacity the Ethiopian Group is about 26% larger than SAA (when including capacity from ASKY).

Top 10 carriers in intra-Africa international market as ranked by capacity (seats): 4-Nov-2013 to 10-Nov-2013

Rank	Airline		Total Seats
1	ET	Ethiopian Airlines	85,710
2	SA	South African Airways	84,265
3	KQ	Kenya Airways	65,055
4	AT	Royal Air Maroc	39,233
5	MS	EgyptAir	38,224
6	TU	Tunisair	31,080
7	LN	Libyan Airlines	26,358
8	KP	ASKY Airlines	20,358
9	UU	Air Austral	16,080
10	W3	Arik Air	14,661

Regional services within Africa are currently the only profitable part of SAA's network. SAA needs to leverage its strength in Africa, which essentially are its traffic rights in markets that have traditionally been protected, and expand in the intra-Africa market. It needs to act fast as the intra-Africa international market is starting to become more competitive, albeit at a slow pace.

LCCs are starting to penetrate the international intra-Africa market but in most markets SAA should still enjoy at least a few more years without significant competition. Only one of SAA's African international destinations, Dar es Salaam in Tanzania, now has LCC competition. That came only in Oct-2013 when new pan-African LCC fastjet began three weekly flights to Johannesburg.

Like almost all of SAA's African destinations, Dar es Salaam has traditionally been a high yielding route with extremely high fares. There are still huge barriers to entry but gradually they will be removed and competition will come to South Africa's short-haul international market. Johannesburg-Harare, which generates even higher yields and profits for SAA than Dar es Salaam, could be the next route with LCC competition as a new LCC project is in the works that would utilise a Zimbabwean air operators' certificate.

SAA now has a window to solidify its leading position in the southern Africa international market and also expand its medium-haul services to west, central and east Africa before competition increases.

For the short-haul market, capacity to other southern Africa countries can be increased by focusing less on South Africa's domestic market, which is slightly unprofitable for SAA. While SAA will retain a leading presence on South Africa's two main domestic routes, connecting Johannesburg to Cape Town and Durban, it could reduce capacity in smaller markets where it is not able to serve profitably.

For example, SAA continues to operate Johannesburg-Port Elizabeth even through Mango entered the route earlier this year. SAA has not yet withdrawn from the market and has been slow to axe unprofitable domestic routes and shift capacity to regional international markets such as Harare.

SAA needs to act fast

SAA does not have the luxury to continue delaying the implementation of solutions aimed at improving profitability. The carrier, which already has a debt-ridden balance sheet, continues to incur losses. SAA reported a loss of ZAR1.32 billion (USD143 million) for the fiscal year ending 31-Mar-2012 (FY2012) and was again in the red in the fiscal year ending 31-Mar-2013 although it has again delayed publicly reporting its financial results for FY2013. SAA for now continues to be propped up by a ZAR5 billion (USD510 million) loan guarantee from the government which was put in place in late 2012 and expires in Sep-2014.

The outlook for SAA remains bleak as long as it does not move forward with restructuring its network and other critical elements of its new business plan. The road ahead is challenging regardless but by sitting idle it will be impossible to fix the problems that have dragged down the flag carrier for several years.