SriLankan Airlines turnaround hinges on fleet renewal, yield improvements and oneworld

This is the second in a series of analysis reports on the Sri Lankan market. The first instalment examined the benefits oneworld provides SriLankan as the carrier uses the alliance and several new codeshare partnerships with oneworld members to expand virtually. This report focuses on SriLankan's outlook and turnaround plan.

See related report: SriLankan Airlines raises global profile and expands oneworld presence in South Asia

SriLankan expects more large losses in the short-term

SriLankan has been unprofitable since 2008, when a 10-year management contract with Emirates ended. The Sri Lankan government took back control of the flag carrier in 2008 and reacquired Emirates' 44% stake in 2010.

SriLankan had been consistently profitable the last several years under Emirates management but has since struggled, incurring about USD700 million in losses over the last five years. The carrier incurred a loss of about USD220 million in the fiscal year ended 31-Mar-2014, based on preliminary unaudited figures. Passenger numbers were up 16% to almost 4 million but revenues were up only 3% to about USD840 million.

SriLankan tells CAPA that for the fiscal year ending 31-Mar-2015 it is projecting a margin of negative 23%, which represents only a slight improvement over the negative 26% margin for FY2013/14. Revenues are expected to increase by 7% to 8% in FY2014/2015 as yields improve.

While the forecast improvement for the current year is small, SriLankan is confident the positive trend will continue over the next few years with its margins gradually improving. Losses are envisioned through 2016, the last year of its current five-year business plan, but SriLankan could finally be in position to break-even from about 2017.

Yield improvement is key driver in turnaround plan

The turnaround effort includes several cost reduction initiatives without reducing head count. But significant revenue and yield improvements are also envisioned.

SriLankan sees higher yields partially being driven by capacity discipline. The carrier expanded significantly in the first part of its five-year business plan, growing its fleet from 14 to 22 aircraft. But the growth came at a cost as losses ballooned and yields were unsustainably low.

The carrier's fleet plan for the next five years for now does not include any growth as the number of units remains at 22 aircraft. Capacity will still increase as the fleet is renewed with slightly larger aircraft but the increments will be modest. For example, seat capacity for FY2014/15 is projected to be up only 2% to 3% compared to FY2013/14. The hope is that the capacity discipline will help push up yields and revenues.

SriLankan expects reduction in transit traffic

The carrier also plans to rely less on the transit market, which typically comes with lower yields compared to point to point passengers. SriLankan has traditionally relied heavily on connecting traffic, with India and the Maldives being its two largest transit markets. India and the Maldives are also its two largest markets overall, accounting for almost 40% of the carrier's total seat capacity.

SriLankan Airlines international capacity share (% of seats) by country: 5-May-2014 to 11-May-2014

Source: CAPA - Centre for Aviation & OAG

But rapid growth in inbound demand as Sri Lanka has emerged as a popular tourist destination, as well as growth in outbound leisure and labour traffic, is changing the dynamics of the Sri Lankan market. SriLankan aims to reduce the share of transit traffic from about 50% to 45% this year.

The carrier is already seeing signs of positive yields trends. In Jan-2014 the carrier's yield for the first time exceeded USD6 cents per RPK. Recent growth in premium traffic has helped drive the surge in yields.

SriLankan expects oneworld, which it formally joined on 1-May-2014, will further help push up its premium traffic and yields. Product improvements, some of which are being introduced in parallel with its ascension into oneworld, are yet another driver.

Fleet renewal to drive down costs

Fleet renewal is the biggest single component of the turnaround plan as it reduces costs, improves efficiencies while also raising product standards. SriLankan's current fleet is a hodgepodge of configurations and in-flight products, making it confusing for passengers. Offering a more standard product should aid efforts to improve yields and better leverage its membership of oneworld.

The renewal of SriLankan's widebody fleet will begin in 4Q2014 with the delivery of three A330-300s. SriLankan initially signed an MOU with Airbus in Jun-2013 for the acquisition of six A330-300s and five A350-900s. At the same time it said it committed to leasing two A350-900s for a total of seven aircraft. (SriLankan now says it has so far signed operating leases covering all six of the A330-300s and the first three of its A350-900s, with a decision on the remaining four A350-900s to be made later.)

SriLankan expects the first A330-300 to be delivered in Oct-2014, with two more to follow by the end of 2014. The carrier says the final three aircraft from the order should be delivered in 18 to 24 months (late 2015 and early 2016). The first A350-900 is also expected in 2016 (2Q2016 or 3Q2016) but the carrier is expecting deliveries of its seven A350s to be spread out over the period through to 2021.

No growth aircraft are part of the current plan

SriLankan intends to use the A330-300 equipment to replace its A340-300s on a one-for-one basis. The A350-900s will replace its A330-200s, also on a one-for-one basis.

The acquisition of growth aircraft will be considered but only after 2016, when the current five year business plan concludes. In the interim SriLankan expects slight incremental capacity growth as the carrier plans to configure its A330-300s and A350-900s with almost 300 seats.

For now SriLankan is content with maintaining and not growing its current widebody network, which primarily includes Europe, the Middle East and North Asia. Some flights within South Asia and to Bangkok are also operated with widebody aircraft. (Narrowbodies are used for most South Asia and Southeast Asia flights and a small portion of Middle East flights.)

Deferring any consideration of widebody fleet or network growth is sensible given the carrier's current unprofitability. Once the fleet is renewed and the carrier is in a better financial position, expansion will likely be considered.

Once it is ready to pursue network expansion SriLankan expects to focus on Asia-Pacific. The carrier sees Asia-Pacific, including Australia, as its primary growth market. While no new Asian or Australian destinations are likely within the next couple of years (Australia is under consideration more for the medium to long-term), SriLankan is currently evaluating upgrading its Hong Kong service to non-stop. The carrier recently transitioned its Beijing and Shanghai flights to non-stop but for now continues to serve Guangzhou and Hong Kong via Bangkok.

In Europe, if growth aircraft are eventually acquired the priority will be to consolidate and add incremental capacity to its existing destinations. New destinations in Europe or the launch of services to North America, which is currently served using codeshare agreements via Europe, are not even a consideration in SriLankan's long-term network strategy.

SriLankan's widebody fleet is ageing and lacks uniform cabin product

SriLankan's widebody fleet currently consists of seven A330-200s and six A340-300s although one of the A340s is currently listed as grounded in the CAPA Fleet Database due to damage caused by a tail strike from Jul-2013.

SriLankan Airlines fleet summary: as of 9-May-2014

Aircraft	In Service	In Storage	On Order*
Total:	21	1	13
Airbus A320-200	8	0	0
Airbus A321-200	1	0	0
Airbus A330-200	7	0	0
Airbus A330-300E	0	0	6
Airbus A340-300	2	1	0
Airbus A340-300X	3	0	0
Airbus A350-900XWB	0	0	7

Source: CAPA Fleet Database
Note: Firm orders include those placed directly by the operator and by lessors assigned to the operator.

The A330-200s are between nine and 15 years old, including four which are between 14 and 15 years of age. All but one of the aircraft has been retrofitted with lie-flat business class seats and seatback in-flight entertainment monitors in both cabins.

Three of SriLankan's A340s are between 19 and 20 years old while the other three A340s are between 13 and 14 years old, according to the CAPA Fleet Database. On average the A340 fleet is about 16 years old while the A330 fleet is about 13 years old.

SriLankan Airlines average fleet age: as of 9-May-2014

Source: CAPA Fleet Database

The three older A340s will be replaced in 4Q2014 while the newer three aircraft will be returned as the final batch of three A330-300s is delivered in late 2015 and early 2016. Two of the three newer A340s have been retrofitted and feature lie-flat seats in the business cabin.

As a result SriLankan will continue to operate until 2016 one A340 with an old product, which is not ideal as it will keep SriLankan from entirely transitioning to a standard widebody product. This one A340 is particularly an odd ball aircraft as it was previously operated by Cathay Pacific and is still in Cathay's original three-class configuration, including a small first class cabin with old generation lie-flat seats and a large business class cabin with recliner style seats. SriLankan only sells business and economy, allowing business class passengers on this aircraft to select the first class cabin (with business class service) on a first come first serve basis. This is another complication in the hodgepodge of premium products that SriLankan should be looking to eliminate sooner rather than later.

But SriLankan does not see retaining until 2016 the one aircraft with an older product as a big issue as it is now only operating this particular aircraft on medium-haul routes to China and Japan. SriLankan sees the ex-Cathay A340, which has the least dense seat count of all its widebody aircraft, as particularly ideal for the Colombo-Tokyo route given the economy/business mix in this market.

SriLankan's priority is to make sure the long-haul network has a standard lie-flat business product. This will be achieved by the end of 2014 as the three oldest A340s are replaced with the new A330-300s. Flights to Europe (London, Frankfurt, Paris and Rome) are now mostly operated with retrofitted A330-200s but on some flights A340s are used, providing a non-standard product.

SriLankan to replace older A320s with A321s and reconfigure newer A320s

SriLankan's narrowbody fleet currently consists of eight A320s and one A321. Of the eight A320s, three are older V2500-powered aircraft in 150-seat configuration including 12 business class seats. The other five A320s are CFM56-powered aircraft, including four newer aircraft (four years or less) in 140-seat configuration with 20 business class seats and one older aircraft in 150-seat configuration with 12 business class seats.

SriLankan's only A321 is also currently configured with 12 business class seats along with 165 economy seats. This aircraft was delivered used to SriLankan in early 2014 from CIT and was previously operated by Qatar Airways, according to the CAPA Fleet Database.

Further complicating the product offering, SriLankan also currently wet-leases an all-economy A321 from sister carrier Mihin Lanka. This aircraft is currently used on one of SriLankan's two daily flights between Colombo and Bangkok.

SriLankan has decided 16 business class seats is the optimal configuration for its A320 and A321 routes. The carrier plans to transition to a standard 16-seat business class configuration on its narrowbody fleet by retrofitting its A321 and four 140-seat A320s and by replacing its four 150-seat A320s with A321s as their leases expire.

SriLankan has already committed to leasing two additional A321s, which the carrier says will be delivered in Jun-2014 and Oct-2014 and be used to replace 150-seat A320s on a one for one basis. The carrier is now seeking to acquire two additional A321s (preferably used aircraft that are less than six years old) to replace the remaining 150-seat A320s. SriLankan's 150-seat A320s are now leased from Aircastle, AWAS, CIT and Sahaab, according to the CAPA Fleet Database.

SriLankan to increase seat pitch in A320 business class

The four 140-seat A320s are leased from Air Lease (three aircraft) and CIT (one aircraft). They were all delivered to SriLankan as new aircraft in 2011 and early 2012.

SriLankan intends to retrofit the business class cabin in these aircraft from 20 to 16 business class seats. The 120-seat economy section will remain intact as the divider between the cabins will not be moved. SriLankan instead plans to make use of the extra space by providing additional legroom in the business class cabin.

The decision to go with a roomier narrowbody business class is a response to feedback from passengers who have complained there is insufficient legroom, particularly for overnight flights. SriLankan operates some of its A320 flights on the Abu Dhabi, Bangkok and Singapore routes as overnight sectors (its A321 is also used on an overnight sector from Muscat to Colombo). These flights are all roughly four hours in duration. Its A320 fleet is also used on shorter flights within South Asia which are generally between one and three hours in duration.

SriLankan says it also plans to retrofit its A321 to expand the business class cabin and offer the same 16-seat configuration as the A320. The carrier did not initially have time to retrofit this aircraft and therefore put the aircraft into service using the inherited Qatar Airways configuration, resulting in a further mismatch of products across its narrowbody fleet. But SriLankan is keen to resolve this by retrofitting the aircraft and the two additional A321s being acquired in 2014, along with all future A321s. This should allow the carrier to offer within the next year or two a standard narrowbody product.

SriLankan will eventually acquire A321neos but is in no hurry to place an order

Over the long term SriLankan aims to transition its narrowbody fleet to A321neos. An order for new-generation narrowbody aircraft is not expected in the near term although the carrier is open to start considering lease proposals for A321neos. SriLankan has only been committing to relatively short lease periods on its A321ceos - approximately three to four year - in order to leave open the possibility of transitioning to A321neos.

SriLankan generally sees the A321/A321neo as the ideal size for its narrowbody routes. This will allow for capacity expansion without increasing the number of units. As is the case with the widebodies, SriLankan's business plan does not currently envision any expansion in the size of its narrowbody fleet. But, depending on market conditions, it may later consider acquiring one or two growth aircraft.

SriLankan's cautious approach to fleet expansion is sensible as the carrier is better off focusing on using oneworld membership to expand virtually, particularly given its recent unprofitability. It is also a sensible strategy to focus on yields and try to capitalise on the investments in product improvements and alliance membership. But market conditions are tough and competition is intense, making any effort to increase yields challenging.

Turning around SriLankan will not be an easy accomplishment. Joining oneworld and renewing the fleet are two important steps.

But SriLankan still has a long road ahead before it can simply reach break-even.