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Air Astana delays expansion, faces short-term challenges. But long-term outlook remains bright

Kazakhstan’s Air Astana has delayed capacity expansion in response to challenging local market conditions brought about by the rapid devaluation of the Kazakhstan tenge. The carrier has been unprofitable in 1H2014 but market conditions have started to improve and it still aims to end the year in the black, keeping intact its decade-long profit streak.

Air Astana, which was initially planning 14% ASK growth in 2014, will now keep capacity flat for the entire year. Aircraft utilisation rates will decrease as Air Astana continues to expand its fleet in 1H2014.

Capacity growth and network expansion will resume in 2015, with new routes to Paris, Prague and Tel Aviv. Air Astana’s long-term outlook remains bright as it benefits from its position as the leading carrier in Central Asia and as the recent lifting of EU restrictions enables the carrier finally to pursue expansion in Europe.

Air Astana's profitability impacted by de-evaluation of Kazakhstan tenge

Air Astana has steadily expanded since it launched in 2002 and has posted annual profits every year since 2004. The carrier turned a net profit of USD51 million in 2013, a 16% decline compared to 2012, as passenger traffic increased by 14% to 3.7 million and revenues increased by 11% to USD967 million.

Air Astana annual profit: 2002 to 2013

But the carrier has had a challenging 1H2014 driven by the 11-Feb-2014 devaluation of the Kazakhstan tenge. The tenge, which is pegged primarily to the US dollar (and to a lesser extent the Euro and Russian rouble), was devalued by 19% in a move aimed to keep Kazakhstan companies competitive including with Russian suppliers.

But the devaluation forced Air Astana to revalue its debt, resulting in a USD52 million hit to its profit and loss statements from 1Q2014. Air Astana has reported a loss of KZT9.444 billion (USD56 million) in 1Q2014, compared to a loss of KZT537 million (USD3 million) in 1Q2013.

Air Astana was also hit hard by the de-evaluation as 64% of its revenues are in tenge. Air Astana CEO Peter Foster says the carrier could not raise domestic fares and has only increased international fares slightly, resulting in a significant drop in yields in US dollar terms.

“This year is going to look bad because there was a devaluation of the tenge in February,” Mr Foster told CAPA earlier this month on the sidelines of the IATA annual general meeting in Istanbul. “That knocks a complete hole for 2014.”

Air Astana pushes back plans for capacity growth

Air Astana has responded by freezing capacity levels, which has allowed it to push up load factors to partially offset the lower yields. Air Astana now expects a 73% average load factor for 2014, up from a 66% load factor in 2013 and an initial planned load factor of 67%.

Mr Foster says ASKs will now be flat for all of 2014. He says expansion will instead be pursued in 2015 with projected ASK growth of 11%.

As CAPA analysed in Nov-2014, Air Astana originally planned to grow capacity (ASKs) by 14% in 2014. Air Astana had been planning to add capacity to several existing destinations, with a focus on its regional network within Central Asia and the CIS, and launch service to Ulan Bator in Mongolia.

See related report: Air Astana plans more rapid growth in 2014 but Kazakhstan airline market shows signs of slowing down

Following the tenge devaluation Air Astana quickly moved to shelve all its plans for capacity expansion and instead decided to focus on squeezing its existing capacity with the hope that higher load factors can offset some of the yield declines. This was a sensible move as raising fares would have reduced demand and led to an unacceptable drop in load factors, particularly given the devaluation of the tenge has decreased the purchasing power of Kazakhs.

Market conditions have improved after a “hopeless” 1Q2014. But Air Astana will sensibly again resist adding any capacity in 2H2014. This should provide sufficient load factors and yields to put the carrier back in the black for 2H2014 and potentially for the full year as well, allowing Air Astana to extend its profit streak to an impressive 11 consecutive years.

“April recovered a bit, May did quite well and the summer will be strong. It does look like the market absorbed the de-valuation fairly well and notwithstanding the USD52 million hit we took we think we will probably just about break even for the year,” Mr Foster says. “I think we will just sneak over the line.”

Air Astana reduces aircraft utilisation rates

The decision to hold off on increasing capacity has come at the expense of efficiency and unit costs as Air Astana has had to reduce aircraft utilisation rates. The carrier had already committed to increasing the size of its fleet to support the planned 14% increase in ASKs and it was impossible to make any adjustments to its 2014 fleet plan when the de-evaluation suddenly occurred in February. But Air Astana did have some flexibility with labour costs and for example has been able to save by electing not to renew short-term contracts for some of its expatriate pilots.

Mr Foster says utilisation rates are currently on average 15% lower than 2013. For the 757/767 fleet the utilisation rate has slipped from about 15hrs to 13hrs; on the A320 family fleet it has dropped from about 13.3hrs to 12hrs; and on the Embraer 190 fleet it has been reduced from about 9.6hrs to between 8.4hrs and 8.5hrs.

But Mr Foster points that Air Astana previously achieved utilisation rates above the industry average and in 2013 had the third highest utilisation rate among all E190 operators. As a result the new rates are “still not bad compared to the industry”.

The reduction in aircraft utilisation rates should also be temporary as the 11% ASK growth now planned for 2015 will be achieved without adding any aircraft. Air Astana’s current fleet plan does not envision taking delivery of any aircraft or retiring any aircraft in 2015, which will give the carrier the opportunity to recover utilisation rates and put in most of the capacity it initially planned to add in 2014. Air Astana also only plans to add one aircraft, a leased A320 family aircraft, in 2016. (The three 787s it has on order are not slated to be delivered until 2017 and 2019.)

According to the CAPA Fleet Database, Air Astana currently operates a fleet of 31 aircraft consisting of 14 A320 family aircraft, five 757s, three 767-300ERs and nine Embraer E190 regional jets.

Air Astana fleet summary: as of 26-Jun-2014

The carrier plans to take delivery within the next couple of weeks of the last 767-300ER from its three-aircraft order. But as this aircraft enters service it will phase out an older model 767-300ER, which according to the CAPA Fleet Database is 17 years old and is currently leased from ILFC.

Air Astana took delivery of an initial two new model 767-300ERs in late 2013, with one aircraft replacing an older 767-300ER and the other being set aside for growth (although this growth has now been delayed, leading to a reduction in its 767 utilisation levels). Air Astana has noticed a 6.5% to 7% improvement in fuel burn with its first two new-build 767-300ERs, which come with winglets and improved engines. The new 767s are in the same configuration as Air Astana’s older model 767s but the new aircraft have a much better interior product including seatback in-flight entertainment monitors in both cabins and lie flat business class seats.

So far this year Air Astana has taken delivery of one E190 and three A320s. One E190 and one A320 were also delivered at the end of 2013. But three older A320s have been returned. The switch to new A320s and new 767s, once the transition is completed, will give Air Astana an average fleet age of about five years.

Dubai to be Air Astana’s only new destination for 2014

The only new destination planned for 2014 is Dubai, which will give the carrier a network of 40 destinations including two in the Middle East. But launching Dubai does not represent new capacity as Air Astana is simply switching its Astana-Abu Dhabi service to Dubai.

Air Astana network summary: as of 26-Jun-2014

Total non-stop passenger destinations 39
Domestic 12
Africa 0
Asia Pacific 11
Schengen Europe 2
Other Europe 13
Latin America 0
Middle East 1
North America 0

Air Astana previously served Dubai but in late 2010 moved to Abu Dhabi following a bilateral spat between Dubai and Kazakhstan, which has been reluctant do authorise Emirates to enter the market.  In retaliation Air Astana was essentially kicked out of Dubai although Abu Dhabi has worked out well for the carrier thanks to a codeshare with Etihad.

Air Astana and flydubai brokered a deal earlier this year which has now been approved by Kazakh and Dubai authorities. The deal paves the way for flydubai to launch services to Almaty and for Air Astana to resume services to Dubai.

flydubai has not yet set a launch date for Almaty but has announced Almaty as a new destination. While flydubai codeshares with Emirates and has a hybrid product it will not have the same kind of impact in Almaty as Emirates would because it is a narrowbody operator and focuses mainly on the point to point market.

Air Astana meanwhile plans to launch daily service to Dubai from Almaty on 1-Sep-2014, replacing its current daily service on the Almaty-Abu Dhabi route. Air Astana will continue to serve Abu Dhabi from Astana, which it currently serves with four weekly flights, and maintain a presence in the Almaty-Abu Dhabi market through its codeshare with Etihad. According to OAG data, Etihad currently serves Almaty-Abu Dhabi with three weekly flights and also operates one weekly frequency on Astana-Abu Dhabi.

Air Astana plans European expansion

Air Astana has a split hub strategy with about two-thirds of its current international capacity at the commercial centre Almaty. Most of the remaining international capacity is at the capital Astana. Air Astana also has a small mini-hub in the western Kazakhstan city of Atyrau, where it serves Istanbul and Amsterdam along with domestic connections to Astana and Almaty. Istanbul is served from all three gateways as well as from Aktau while Amsterdam is only served non-stop from Atyrau (with six weekly flights).

Air Astana consolidated its London operation at Astana on 1-Jun-2014 as it shifted its two weekly Almaty-London flights to Astana. Air Astana, which had already launched one weekly Astana-London flight in Oct-2013 (as it dropped its one weekly flight to Hamburg), now has three weekly flights on Astana-London as well as a daily Astana-Frankfurt service.

Almaty, which is further to the east, continues to serve as the hub for Asia with the exception of mainland China, which is served from both hubs. Regional destinations within Central Asia and the CIS are also generally offered from both hubs. The two hubs make it difficult to pursue Europe-Asia traffic but Air Astana does not compete in this market and instead focuses on higher yielding regional connections for feeding its European and Asian network.

Europe is now a focus for expansion as the EU finally lifted restrictions on Air Astana in Apr-2014. Kazakhstan has been on the EU blacklist since 2009 (and other Kazakh carriers remain on the blacklist). Over the past five years Air Astana had an exemption which allowed it to maintain 16 weekly flights to the EU but it could not add new flights. Air Astana is now finally free to add flights to the EU, which currently only accounts for 12% of its international seat capacity.

Air Astana capacity share (% of seats) by region: 23-Jun-2014 to 29-Jun-2014

Air Astana has elected not to immediately open new scheduled destinations in Europe. But the carrier is using its new EU rights to operate summer charters to Barcelona, Heraklion and Rhodes, which helps to partially offset the reduction in 757/767 utilisation levels. (Air Astana also has enhanced its charter programme to Antalya in Turkey, which was not impacted by the EU ban as Turkey is not in the EU.)

Meanwhile Air Astana has already unveiled plans to launch Paris and Prague in 2015 although has not yet set launch dates. Both routes will likely be served from Astana given the carrier’s focus on using the Astana hub for Europe.

Air Astana plans Tel Aviv launch in 2015; bullish on Ukraine despite current setbacks

Mr Foster says Air Astana also plans to launch services to Tel Aviv in 2015. There is a sizeable local market between Kazakhstan and Israel, catering mainly to medical and pilgrimage traffic. Air Astana also sees a niche in offering a one-stop product in the Israel to China and Southeast Asia markets. Currently most passengers heading between Asia and Israel have to backtrack through Istanbul or hubs in Europe.

The new Tel Aviv service will most likely operate from Almaty as all its Southeast Asia flights and most of its China flights operate from the Almaty hub. 

Air Astana also sees an opportunity to grow transit traffic between China/Southeast Asia and the Ukraine. As in the case of Israel, there are limited non-stop flights from the Ukraine to Asia. Passengers have traditionally transited Moscow but the souring of Ukraine-Russian relations will likely lead to passengers avoiding Moscow stops. Istanbul and Europe is an option but is inconvenient. “We think when things settle down, which they undoubtedly will, the Ukraine will have marvellous potential. Our location for the Ukraine is perfect,” Mr Foster says.

Kazakhstan enjoys good relations with both Russia and the Ukraine, putting Air Astana in an enviable position to grow in both markets.

For now Air Astana’s Ukraine flights are struggling and the carrier has reduced services on the Almaty-Kiev route from six to five weekly frequencies and on the Astana-Kiev route from four to two weekly frequencies. But the carrier is bullish on the Ukrainian market over the medium-term and is confident the market will recover by the end of 2014, if not sooner, and expects to be operating daily flights on both of its Kiev routes by mid-2015.

Air Astana only launched Kiev in 2013, following the collapse of Aerosvit, as it previously saw the Kazakhstan-Ukraine market as oversupplied. Aerosvit and Ukraine International Airlines at one point were aggressively selling in the Kazakhstan market flights beyond Kiev. Air Astana now sees an opportunity to reverse the tides and use Astana and Almaty as a hub for Ukrainian passengers.

Air Astana is well positioned for 2015 and beyond

Air Astana should ultimately be able benefit from its strong position in the Ukraine and in other CIS and markets. It is also well placed to continue being the leading international carrier for the Central Asian region, where demand is growing but there is still a lack of carriers operating to Western standards. While Air Astana is taking a break in 2014 from expanding its regional operation within Central Asia – following several years of rapid growth – it will likely return to adding capacity to neighbouring countries in 2015 as part of its extended home market strategy.

Domestic expansion is not likely as the carrier instead plans to work closely with planned start-up Air Kazakhstan, which like Air Astana will be 51% owned by the Kazakh government. Air Astana has reduced its domestic operation in recent years as it phased out turboprops and is keen to focus primarily on the international market with the exception of some domestic trunk routes. Air Kazakhstan plans to launch services in 2015 with an initial fleet of three Bombardier Dash 8 Q400s, with the expectation of expanding to 10 Q400s over the next three years.

Air Astana clearly faces some challenging headwinds in 2014. The sudden devaluation of the tenge has had a huge impact and thrown a wrench into capacity expansion plans. But market conditions are now improving and the carrier should again be profitable in 2H2014. Full year profits are also possible, extending its streak to 11 years, although the recent spike in fuel prices could dent those prospects.

Even with a small loss or break even result for 2014 Air Astana is well positioned to recover in 2015. Network and capacity growth will resume, allowing the carrier to improve efficiency as it returns to its normal aircraft utilisation levels. The expansion in the EU will mark a major milestone.

Market conditions should improve sufficiently in 2015 for the carrier to meet its revised goal of an initial public offering in 2016. Air Astana initially looked at an IPO in 2012 but has had to delay the initiative mainly because of internal issues with its 49% shareholder, BAE Systems, although recent market conditions have also clearly not been favourable for an IPO.

See related report: Kazakhstan’s Air Astana poised to complete several milestones in 2012 including IPO

The IPO eventually should succeed given Air Astana's strong position in a growing emerging market. Air Astana has carved out a niche in Central Asia, a market with relatively limited competition but high growth prospects. There will be setbacks and challenges – as is the case with most emerging markets – but the overall long-term outlook is bright.

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