18-Jul-2019 8:06 AM

Ukraine International Airlines shrinks as 737 MAXs are delayed

Analysis

Ukraine International Airlines (UIA) is taking a break from expansion in 2019 following a three-year period of rapid growth despite challenging market conditions and political instability. The privately owned flag carrier has more than doubled in size since 2014, when Ukraine plunged into crisis, and is now more than 70% larger than its pre-crisis levels.

Sixth freedom has accounted for most of the growth, although UIA has also benefitted from recovering local demand. Approximately half of UIA's traffic now consists of transit passengers.

However, UIA is expecting a traffic decline in 2019, resulting in a large drop in market share as foreign LCCs pursue rapid expansion. UIA was initially planning flat capacity for 2019, but is now projecting a decrease of 5% to 6% due to the 737 MAX grounding.

Summary

Ukraine International Airlines (UIA) is projecting a decrease in capacity of 5% to 6% in 2019 due to the grounding of the Boeing 737 MAX fleet.
UIA has experienced rapid growth since 2014, more than doubling in size and becoming over 70% larger than its pre-crisis levels.
The airline has been unprofitable in four out of the past five years, with operating losses of UAH2,758 million (EUR86 million) in 2018.
UIA faces intensifying competition from foreign low-cost carriers (LCCs) in Ukraine, with LCCs accounting for 18% of international seat capacity in the country.
UIA follows a low fare network model and relies heavily on sixth freedom traffic, but struggles to compete with LCCs due to the cost gap associated with its hub and spoke model.
UIA plans to focus on stabilisation and improving the performance of its existing long haul routes, rather than expanding its network further.

Summary

UIA projects that its capacity will be down 5% to 6% in 2019, ending a rapid growth phase that included three consecutive years of high double digit capacity growth.
UIA was initially planning flat capacity for this year but had to cut its summer 2019 schedule following the 737 MAX grounding.
UIA was initially planning to take delivery of three 737 MAX 8s in 2Q2019 but the MAX grounding has led to a freeze in deliveries, and consequently a capacity shortfall.
UIA is contending with the rapid expansion of LCCs in Ukraine, particularly from Ryanair and Wizz Air.
UIA is a network airline, relying heavily on sixth freedom traffic, but has a low fare strategy that helps it compete with LCCs.

Ukraine International Airlines CEO Yuri Miroshnikov discusses the impact of the 737 MAX grounding, intensifying LCC competition in Ukraine, the decision to take a break from expansion, and its future fleet plan.

Ukraine International Airlines has expanded rapidly since the 2014 crisis

UIA has been the market leader in Ukraine since early 2013, when Aerosvit collapsed. UIA and Aerosvit were similarly sized airlines - both carrying approximately 3 million passengers and accounting for approximately 15% shares of the Ukrainian market - although only Aerosvit operated long haul services.

UIA's traffic increased by over 53% in 2013 as it took over Aerosvit routes and aircraft.

However, UIA's traffic dropped by 24% in 2014 due to the crisis that erupted after Russia annexed Crimea by military intervention.

UIA's traffic recovered in 2015, reaching slightly higher than 2013 levels. The airline pursued rapid expansion in 2016, 2017 and 2018, recording high double digit passenger growth in all three years.

UIA carried a record 8 million passengers in 2018, representing a 14% increase compared with 2017 and a 63% increase compared with 2015.

Ukraine International Airlines annual passenger traffic and year-over-year growth: 2012 to 2018

UIA has been unprofitable in four out of the past five years

The rapid expansion impacted profitability and UIA slipped into the red in 2017 and 2018. The airline reported operating losses of UAH638 million (EUR21 million) in 2017 and UAH2,758 million (EUR86 million) in 2018.

UIA was profitable in 2012, 2013 and 2016 - with 2016 marking a turnaround following losses in 2014 and 2015 due to the political crisis.

UIA is still impacted by the crisis as it is unable to serve Russia, Crimea and parts of eastern Ukraine (where there is still unrest). However, market conditions have been improving.

Ukraine's GDP grew by 3.3% in 2018, representing the highest growth since 2011. Ukraine's economy shrank significantly in 2014 and 2015 and grew by only slightly more than 2% in 2016 and 2017.

UIA contends with intensifying LCC competition

UIA's longstanding CEO, Yuri Miroshnikov, told CAPA TV in a 4-Jun-2019 interview on the sidelines of the IATA AGM that market conditions in Ukraine were now "relatively favourable". However, he acknowledged that competition had been intensifying due to rapid expansion by foreign LCCs.

There are also a growing number of Ukrainian charter airlines, although UIA has maintained its status as the only local scheduled airline since Aerosvit's collapse.

LCCs accounted for 18% of international seat capacity in Ukraine in the first seven months of 2019, according to CAPA and OAG data. The international LCC penetration rate in 2018 was only 12% and in 2017 it was just 7%. There are no LCCs competing in Ukraine's domestic market, although some of the charter operators operate domestic services.

In the current summer season foreign LCCs account for slightly more than 20% of international capacity. Wizz Air is the largest LCC in Ukraine and has more than an 11% share of international seat capacity (includes Wizz Air UK). Ryanair is the second largest, with more than a 6% share (includes Laudamotion).

Six other LCCs currently serve Ukraine - Air Arabia, airBaltic, flydubai, Onur Air, Pegasus and Vueling. However, combined they have a less than 6% share of international seat capacity.

Ryanair and Wizz Air have been expanding rapidly

UIA currently has a leading 34% of international seat capacity based on CAPA and OAG data for the week commencing 8-Jul-2019. Foreign airlines account for roughly half the market as several Ukrainian charter airlines combined account for approximately a 17% share.

However, the foreign share has been growing rapidly due to expansion from LCCs. Wizz, Ryanair, Pegasus and airBaltic are all among the top 10 foreign airlines in Ukraine.

Ukraine: top 10 foreign airlines ranked by seat capacity, week commencing 8-Jul-2019

Rank	Airline	IATA	ICAO	Seats	Capacity Share
1	Wizz Air	W6	WZZ	53,274	10.9%
2	Turkish Airlines	TK	THY	25,580	5.2%
3	Ryanair	FR	RYR	24,948	5.1%
4	LOT Polish Airlines	LO	LOT	17,230	3.5%
5	Belavia	B2	BRU	14,693	3.0%
6	Ernest Airlines	EG	ERN	13,324	2.7%
7	Lufthansa	LH	DLH	13,040	2.7%
8	Pegasus Airlines	PC	PGT	10,862	2.2%
9	Austrian Airlines	OS	AUA	9,780	2.0%
10	airBaltic	BT	BTI	7,128	1.5%

Over the past year Wizz's capacity in the Ukraine has increased by nearly 50%, from 19,000 to 28,000 one-way seats (includes a small number of new flights operated by Wizz Air UK). The Wizz Air Group now has significantly more capacity in Ukraine than when it had a Ukraine-based affiliate, which operated from 2008 to 2015.

Ryanair only began serving Ukraine in Sep-2018 and has since expanded to more than 13,000 weekly one-way seats (includes a small number of flights operated by its Laudamotion subsidiary).

Latvia-based airBaltic also more than doubled its capacity in Ukraine over the past year, but Turkey-based Pegasus has reduced capacity slightly.

Wizz Air, Ryanair, Pegasus and air Baltic one-way seat weekly capacity from Ukraine: Sep-2011 to Sep-2019

While UIA is still larger than all the LCCs combined, the LCCs are now carrying more local traffic than UIA because half of UIA's traffic consists of sixth freedom passengers. Sixth freedom traffic became a major part of UIA's strategy following the crisis.

UIA follows low fare network model

UIA has been trying to reduce its costs to compete more effectively against LCCs but there is still a large cost gap, given UIA's network model.

"We are fighting every day and every minute", Mr Miroshnikov told CAPA TV. "It's not easy to achieve the [CASK] level of LCCs operating a hub and spoke model, which require certain infrastructural elements which cost you money. But, we are working on every possible option to reduce our costs."

"Basically, what we are doing is we are saying to the market and we are delivering the principles of a low price network carrier. So, we are not low cost; we are low price."

UIA does not want to adopt a dual brand model

LCC competition in the Ukraine is expected to continue to intensify over the next few years following the adoption of a new policy by the Ukrainian government, which aims to attract LCCs to regional airports.

Other flag carriers in the CIS region have established LCC subsidiaries or units - including Aeroflot, Azerbaijan Airlines and, most recently, Air Astana - in response to new LCC competition, or in an attempt to fend off LCCs before they arrive.

Mr Miroshnikov told CAPA that UIA is not interested in following with its own dual brand strategy: "We don't believe this is a direction that will have a meaning for us".

Without an LCC subsidiary or brand, UIA will inevitably lose market share. However, the airline is now more concerned about improving its financial position and sustainability.

UIA begins a stabilisation phase

UIA had already decided at the beginning of this year to take a break from expansion in 2019 and focus on "stabilisation". The airline initially expected flat capacity for 2019 with the capacity generated by five aircraft deliveries (three 737 MAX 8s and two E195s) being offset by the retirement of its last batch of 737 Classics.

However, Mr Miroshnikov said UIA now expects a 5% to 6% decline in capacity for 2019 due to the global grounding of the 737 MAX fleet. UIA's original target of again carrying 8 million passengers is also no longer achievable.

"From time to time it's not bad to have a break and to stabilise the situation", Mr Miroshnikov said. "The only negative surprise for us this year is that due to MAXs it doesn't look like stabilisation; it looks like a little reduction of capacity."

UIA's international capacity share drops 9ppts this summer

UIA's current system-wide seat capacity is down by approximately 6% compared to Jul-2018 levels, according to CAPA and OAG data. This includes a 9% decline in international seat capacity and a slight increase in the domestic market, which accounts for only approximately 14% of UIA's total seat capacity.

Total international seat capacity in Ukraine is up approximately 25% compared to last summer, according to CAPA and OAG data. UIA's share of international seat capacity in Ukraine therefore has dipped from 43% in Jul-2018 to 34% in Jul-2019.

In 2018 UIA's international seat capacity grew by 26%, slightly outpacing a 24% increase in the total market. From 2015 to 2018 UIA's growth rate was broadly the same as the overall market, enabling it to maintain market share despite challenging conditions.

737 MAX grounding leads to capacity shortfall

Some of the market share decline in 2019 is due to the MAX grounding - although even if it had not been for the grounding UIA's share would have still dropped by six or seven percentage points.

UIA did not have any 737 MAX aircraft when the global grounding of the MAX fleet was implemented in Mar-2019. However, it had committed to acquiring three 737 MAX 8s for delivery in 2Q2019. These three aircraft are now sitting in the US and will not be delivered until after 737 MAX 8 is recertified.

UIA has had to adjust its 2019 summer schedule as it initially expected all three 737 MAX 8s to be operating for the peak season. The airline has not leased additional 737NGs or wet leased aircraft to fill the void, which has forced it to cut back on its scheduled operation.

UIA is also not operating any charters or wet leasing out any of its aircraft this summer, which it initially was considering pursuing, using spare capacity. Ukraine has a very large charter market but this is mainly served by smaller airlines specialising in this segment.

"Luckily we had a little of spare capacity in house", Mr Miroshnikov said, but adding there was not enough spare capacity to fill the entire void created by the deferral of the three 737 MAX 8 deliveries.

Like other 737 MAX operators, UIA is now concerned about the grounding continuing into the winter season. "It's starting to influence winter plans and starting to influence even next year plans", Mr Miroshnikov said. "We now need clarity in terms of timeframe and the future of this aircraft."

UIA has 41 aircraft this summer, serving 64 destinations

UIA is currently operating 41 aircraft, made up of 28 737NGs, seven E-jets, three 767-300ERs and three 777-200s. A year ago, in Jul-2018, UIA's fleet in service consisted of 44 aircraft, according to the CAPA Fleet Database.

UIA uses its widebody fleet on five long haul routes; the 737NGs (737-800s and 737-900s) and E-jets (E190s and E195s) are used on short/medium haul services.

Ukraine International Airlines fleet summary: as of 15-Jul-2019

Aircraft	In service	In storage	On order
Boeing 737 MAX	0	0	1
Boeing 737-300	0	1	0
Boeing 737-500	0	3	0
Boeing 737-8	0	0	2
Boeing 737-800	24	0	0
Boeing 737-900ER	4	0	0
Boeing 767-300ER	3	1	0
Boeing 777-200ER	3	0	0
Embraer ERJ190-100 STD	5	0	0
Embraer ERJ195 AR	1	0	0
Embraer ERJ195 LR	1	0	0
Total:	41	5	3

UIA currently has 54 international and 10 domestic destinations (based on OAG schedule data for the week commencing 8-Jul-2019). Its network is focused mainly on Europe, where UIA has 43 destinations and is contending with the intensifying LCC competition.

UIA has only four destinations in the Middle East, four in Asia, one in Africa and two in North America. Bangkok, Beijing, Delhi, New York and Toronto are its long haul routes. UIA's only other Asian destination is Almaty in Kazakhstan, which is a medium haul route of approximately six hours.

Kiev-Almaty is UIA's longest narrowbody route and is operated with the 737-900ER. All of UIA's European and Middle Eastern routes are four hours or less with the exception of Dubai, which is approximately five hours. Its only African destination, Cairo, is also less than four hours.

Ukraine International Airlines departures by length of flight: week commencing 15-Jul-2019

UIA has always relied heavily on the 737 family

Given its network, UIA does not need the range of the 737 MAX. However, the airline has been looking forward to the efficiency improvements generated by the 737 MAX 8 and was counting on the first three MAX 8s to replace 737-300/400 Classics, which were phased out in Nov-2018.

The 737 has been the backbone of UIA's fleet since it launched operations in 1992. UIA began operating 737NGs in 2009 and for a decade expanded its 737NG fleet, gradually replacing 737 Classics and pursuing growth.

Mr Miroshnikov, who has been UIA's CEO since 2004, explained that UIA decided to phase out 737 Classics in autumn 2018 and to make do with a smaller fleet for the offpeak winter months, with the idea that the three 737 MAX 8s would be delivered in time for the summer 2019 schedule. When the 737 MAX grounding occurred in Mar-2019 it was too late to review this decision and reactivate any of the 737 Classics.

He said that despite the uncertainty on when UAI will be able to start operating its 737 MAX 8s - and restore capacity - the airline is still committed to the 737 MAX and is not changing its fleet renewal plan. Although the first three 737 MAX 8s were intended to replace 737 Classics, the airline intends to acquire more 737 MAX 8s to replace its older 737NGs, as well as for some growth.

UIA has a relatively old fleet

UIA's 737NGs, which were mainly acquired secondhand, have an average age of 10 years. UIA's overall average fleet age is nearly 12 years.

Ukraine International Airlines average fleet age by aircraft type: as of 15-Jul-2019

The airline has four 737-800s that are less than two years old, including three that were delivered in 1Q2018. However, UIA also has six 737-800s that were manufactured in 2000 and 2001 (making them nearly 20 years old).

Four of its 737-900ERs were manufactured in 2009 and two in 2013, according to the CAPA Fleet Database.

Its five E190s were added in 2013 as new, or almost new, aircraft (some were briefly operated by Aerosvit before Aerosvit's collapse). The two E195s were added in 2Q2019 and are both 12 years old.

The two E195s have not helped filled the void left by the 737 MAX deferrals because they were already in the fleet plan for 2019 and were acquired to partially replace the 737 Classics that exited the fleet in late 2018.

While the three 737 MAX 8s were primarily replacing the last of the 737 Classics, the 737 Classics operated to some domestic airports that cannot accommodate 737-800s or 737 MAX 8s. Mr Miroshnikov said the two newly acquired E195s are mainly being used in these markets.

While UIA could potentially acquire more E-jets to fill the void created by the 737 MAX grounding, Mr Miroshnikov said this is not being considered at the moment. He said UIA is also not considering the new re-engined E2 family of regional jets and said the hope is that at some point Ukraine's regional airports will be upgraded to support 737-800s and 737 MAX 8s.

UIA renews its widebody fleet

The 737 MAX grounding and resulting capacity shortfall on short/medium haul has also not led UIA to re-examine its widebody fleet plan. UIA still plans to phase out its ageing 767 fleet, which is 26 to 27 years old, this winter.

UIA is currently operating its remaining 767s to Bangkok and Delhi as well as a limited number of selected short/medium haul flights. The airline is now using its fleet of three 777-200ERs, which were acquired in 2018, on Beijing, New York and Toronto. Mr Miroshnikov said the three 777s - which are 14, 17 and 18 years old - "are performing quite well".

He said UIA intends to acquire a fourth 777, which will provide sufficient capacity to operate its five long haul routes without needing any 767s. He added that UIA "would like to consider a fifth 777 but we don't have the (route) targets yet to consider".

UIA to take a break from long haul network expansion

UIA's long term business plan envisages second and third destinations in China as well as a second destination in the US. However, the airline plans to focus initially on improving the performance of its five existing long haul routes, hoping that they will eventually be able to support year-round daily services.

"For our New York, Toronto, Bangkok, Beijing and now Delhi flights we still have a lot of homework to be done before we are finally satisfied with these routes and would look further to grow", Mr Miroshnikov said.

UIA is still relatively inexperienced in the long haul market, having added its first widebody aircraft in 2013 following the collapse of Aerosvit. (UIA's 767s were previously operated by Aerosvit).

Bangkok was launched at the end of 2013, New York JFK in 2014, Beijing in 2015, Toronto in 2018 and - most recently - Delhi on 1-May-2019. All these routes were previously served by Aerosvit. UIA also served Colombo, another former Aerosvit route, from late 2016 until Mar-2019.

Beijing and New York are served daily in summer but are reduced to five weekly flights in winter. Toronto is served with two to four weekly frequencies, Bangkok with three to six weekly frequencies, and Delhi with four to six weekly frequencies (depending on the time of year).

Short haul network growth also slows

UIA has generally been more successful with expanding its short and medium haul network. Izmir is its most recent new international destination and it was launched on 15-Jun-2019 as a daily service.

Izmir is UIA's third destination in Turkey along with Ankara and Istanbul. Turkey is UIA's fourth largest international market this summer after Israel, Italy and Germany.

Ukraine International Airlines leading international markets by seat capacity: week commencing 15-Jul-2019

Mr Miroshnikov said there are no other international destinations planned for 2019, explaining that UIA does not have the capacity to consider more network growth.

Hiatus in expansion should improve UIA's profitability

The decision not to grow capacity in 2019 was sensible, given the competitive environment and the impact that prior expansion had on the airline's bottom line.

The unplanned 5% to 6% reduction of capacity due to the 737 MAX grounding could have a silver lining, given the intensifying competition from LCCs, particularly in the European market - which accounts for more than 70% of UIA's international seats.

UIA could expand in the long haul market as it does not have the same capacity constraints with its widebody fleet. However, any long haul expansion is risky and unlikely to be profitable. The airline's decision to phase out ageing 767s and focus on improving the performance of its existing long haul routes is sensible.

UIA should focus on yield improvements in both the short and long haul segments.

Increasing yields, which are likely needed for UIA to return to profitability, will not be easy, given the intense competition in the Ukraine. However, this will become more achievable with disciplined capacity.