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Croatia Airlines: Zagreb hub strength, but growing LCC competition & high CASK a challenge

Reports that Croatia Airlines' long running search for a strategic partner may be returning to the top of its agenda once more throw the spotlight on the Zagreb-based flag carrier. Croatia has enjoyed healthy growth in its aviation market in recent years, driven by strong inbound tourist traffic. However, Croatia Airlines' growth has not kept pace. It is still the biggest airline in this market, but its seat share has halved since 2008.

Codeshare relationships with fellow Star Alliance members help to shore up Croatia Airlines' position at Zagreb, where it is still the biggest airline. However, LCC competition dominates its other two international bases in Split and Dubrovnik. Competition in the very seasonal Croatia market is particularly fierce in the summer months.

Croatia Airlines has managed to remain in profit since 2013, when it recovering from a previous four year period of loss-making, but with wafer thin margins. A key challenge for Croatia Airlines is that it has a high level of unit cost, even by comparison with full service airlines, and with a very large gap to LCC unit cost levels.

Strong growth in tourist arrivals into Croatia

Croatia has enjoyed healthy growth in tourism throughout the current decade. In 2016 the number of tourist arrivals into the country was 13.8 million – an increase of 52% from 2010, and representing a compound average annual growth rate of 7% pa.

The growth rate is accelerating, with 9% increases in each of 2015 and 2016 and an increase of 13% in the first five months of 2017.

Croatia annual tourist arrivals: 2009 to 2017

Croatia Airlines' growth has been slower

The growth of Croatia as a tourist destination has provided a positive backdrop for Croatia Airlines. However, in the early years of this decade a period of growth for the airline was followed by capacity cut in 2013 as it underwent a restructuring programme to climb back out of making losses.

Since its return to profitability in 2013, Croatia Airlines has enjoyed steady growth in traffic. In 2016 it carried 1.9 million passengers, an increase of 4.8% on 2015 and 7.9% higher than its 2013 traffic figure.

Croatia Airlines ASK (million), passenger numbers (‘000) and passenger load factor (%) 2007 to 2016

Croatia Airlines' load factor reached best ever level of 70% in 2016

ASK growth was 5.0% in 2016, when its passenger load factor gained 0.3ppts to reach 70.0%.

Croatia Airlines' load factor had jumped by 8.3ppts, from 61.4% to 69.1%, between 2009 and 2012, but improved only by a further 0.9ppts from 2012 to 2016. Although it has reached its best ever level, its load factor remains significantly lower than the 80% plus that is now the industry average.

Figures for the seasonally weak 1Q2017 show a 1.1ppt year-on-year increase to 64.6%. If similar improvements can be achieved throughout the year, Croatia Airlines may be able to push further through the 70% barrier.

Croatia Airlines has lost market share

Although it has been growing since 2013, Croatia Airlines has not kept pace with market growth. From 2013 to 2016, when the airline's passenger numbers increased by 7.9%, tourist arrivals in the country grew by 26% and the total number of scheduled airline seats increased by 31% (according to data from OAG Schedules Analyser).

Croatia Airlines' share of total seats to/from Croatia is expected to be 27% in 2017. This compares with 30% in 2016, and comfortably over 50% as recently as 2009. In 2008 its share was 54% – twice its 2017 level.

Croatia: annual scheduled seat numbers for total market and Croatia Airlines 2007 to 2017

It is still the biggest airline in Croatia, but LCCs are gaining share

Croatia Airlines is still the biggest airline in Croatia, measured by seat capacity, but its 3ppt drop in seat share in 2017 is matched by a gain in the share of the remaining nine airlines in the top 10.

Number two easyJet is increasing its share of seats by 2ppt to 10% in 2017, and third ranked Eurowings' share is growing by 2ppts to 9%. In addition to easyJet and Eurowings, the top 10 contains four other LCCs: namely Ryanair, Norwegian, Vueling and Jet2.com.

The top 10 also includes Lufthansa, Turkish Airlines and Austrian Airlines, all of which are fellow Star Alliance members and codeshare partners of Croatia Airlines.

The combined seat share of LCCs in Croatia in 2017 will be 40%, up from 35% in 2016 (source: CAPA calculation based on data from OAG Schedules Analyser).

Competition is particularly strong in the summer months, due to the high levels of seasonality in the Croatia market. For Croatia Airlines the winter schedule is only 30% of its 12 month seat capacity, compared with an average of 34% for Europe as a whole (based on combining winter 2017/2017 and summer 2017, source: CAPA calculations from OAG data).

According to data in Croatia Airlines' annual report, its passenger share was 19% in Jul-2016 and 60% in Jan-2016.

Croatia: top 10 airlines by seat share, 2016 and 2017

 Airline

2016

2017

1.        Croatia Airlines

30%

27%

2.        easyJet

8%

10%

3.        Eurowings*

7%

9%

4.        Ryanair

6%

5%

5.        Norwegian

5%

5%

6.        Lufthansa

5%

5%

7.        Turkish Airlines

3%

3%

8.        Vueling

3%

3%

9.        Austrian

3%

3%

10.     Jet2.com

2%

3%

All others

28%

29%

Croatia Airlines' codeshares only partly defend against growing competition

The increasingly competitive landscape in Croatia is partly offset by Croatia Airlines' extensive codeshare partnerships. It codeshares with 12 other Star Alliance members in total: Air Canada, Air India, Austrian Airlines, Brussels Airlines, LOT Polish, Lufthansa, SAS Singapore Airlines, SWISS, TAP Portugal, Turkish Airlines and United Airlines. It also has a (more limited) codeshare with KLM.

These codeshare agreements help to feed Croatia Airlines' network and enable it to offer its passengers long haul connections. However, on the point-to-point, predominantly leisure routes that are increasingly the domain of LCCs, their potency as a defence against competition is probably limited.

Zagreb is its main hub, followed by Split and Dubrovnik

Croatia Airlines' main hub is Zagreb, which accounts for 35% of all of its seat capacity, followed by Split and Dubrovnik. Out of a network total of 60 routes, it operates 28 from Zagreb, 16 from Split and 12 from Dubrovnik.

It also operates international routes from Zadar, Pula and Rijeka (data based on week of 17-Jul-2017, source: OAG).

Croatia Airlines top ten airports by seats: week of 17-Jul-2017

Zagreb: Croatia Airlines has 50% of seats and LCCs have low share

Croatia Airlines is the biggest operator by seats at Zagreb, where it has a seat share of 50% in the week of 17-Jul-2017, according to OAG data. Lufthansa, Emirates, Turkish Airlines and Qatar Airways complete the top five airlines, and each has between 4% and 6% of seats at Zagreb.

The global networks of these four other airlines offer long haul connectivity that is lacking in Croatia Airlines' operations. In the case of Lufthansa and Turkish Airlines, this is in partnership with Croatia Airlines. Among the four global super connectors (the Gulf three and Turkish), only Etihad does not serve Croatia.

Emirates launched its daily Dubai-Zagreb service at the end of May-2017, together with interline connections via Croatia Airlines to the Croatian cities of Pula, Dubrovnik and Split.

Zagreb Airport is dominated by full service carriers, which account for 91.3% of seats, whereas LCCs have a share of 8.5%

Zagreb Airport: seat share by business model, week of 17-Jul-2017

Split: Croatia Airlines is number three, LCCs have 56% of seats

Croatia Airlines is the number three airline by seats at Split, where it has a seat share of 11.0% in the week of 17-Jul-2017, according to OAG data. EasyJet is number one, with 22.0%, and SAS is second, with 14.1%. After Croatia Airlines, Vueling has 6.6%, Norwegian 5.4% and Eurowings 4.8%.

The biggest category of airline at Split is LCCs, which account for 56.0% of seats.

Split Airport: seat share by business model, week of 17-Jul-2017

Dubrovnik: Croatia Airlines is number two, LCCs have 53% of seats

LCCs are also the biggest airline category at Dubrovnik, where their seat share is 52.5%.

Croatia Airlines is number two at Dubrovnik, with a seat share of 13.9%, behind easyJet, which has 16.8% of seats. Jet2.com is third, followed by Norwegian, Vueling and SAS, each with 5% to 6% (week of 17-Jul-2017, source: OAG)

Dubrovnik Airport: seat share by business model, week of 17-Jul-2017

Croatia Airlines' profitability has been modest, but positive, since 2013; improvement in 1Q2017

Croatia Airlines' prospects of attracting a strategic partner may be aided by improved profitability, so far, in 2017.

Croatia Airlines made a net profit of HRK9.0 million (USD1.3 million) in 1Q2017, compared to a loss of HRK86.3 million (USD12.4 million) in 1Q2016.

The airline has reported an annual profit in each of the past four years (2013 to 2016), but its results declined in 2016 versus 2015. Its 2016 net profit of HRK7.6 million was 48% lower than the HRK14.6 million reported for 2015, in spite of a 3.5% revenue increase – to HRK1,464 million, from HRK1,414 million in 2015.

Its 2016 operating profit was HRK8.3 million, representing a margin of just 0.6% of revenue compared with its 2015 operating margin of 1.3%. Throughout the past four years of positive results, Croatia Airlines' operating margin has remained slim, reaching 1.5% in 2013 and then remaining below that level.

Given its patchy record of profitability, the improvement in Croatia Airlines' 1Q2017 result is welcome.

Croatia Airlines consolidated revenues (right hand axis), operating profit and net profit (HRK million): 2007 to 2016

Since 2012, Croatia Airlines' CASK has fallen more quickly than RASK, but only thanks to lower fuel

According to CAPA's calculations, Croatia Airlines lowered its unit cost (cost per ASK, or CASK) by 3.4% in 2016. This was helped by a 17.0% reduction in fuel CASK, but the airline also achieved a fall in ex fuel CASK, which fell by 1.0% in 2016 after increasing by 4.6% in 2015.

Its total CASK fell by 9.8% from 2012 to 2016 after several years of increases previously from 2009 to 2012 (which were largely driven by growth in fuel CASK).

However, this unit cost reduction since 2012 has been driven entirely by a 46.0% fall in fuel CASK, while ex fuel CASK in 2016 was at the same level as in 2012.

Meanwhile, Croatia Airlines' revenue per ASK (RASK) fell by 4.5% from 2012 to 2016. The lesser drop in RASK compared with CASK over the period has kept the airline in profit, but only thanks to lower fuel prices, and only at very slim margins.

Croatia Airlines index of unit revenues (total revenue per available seat kilometre, RASK) and unit costs (cost per available seat kilometre, CASK) 2009 to 2016 (indexed to 2009 = 100)*

Croatia Airlines still has a high CASK level compared with other European airlines

The chart below shows how Croatia Airlines is positioned on a scatter plot of CASK versus average trip length, in comparison with the trend lines for other European airlines (these are separated into full service carriers, low cost carriers and ultra-low cost carriers).

This shows that Croatia Airlines continues to have one of the highest levels of CASK in Europe, even after taking account of its low average trip length. Its unit cost is more akin to that of a regional airline – not entirely surprising, given that seven of its fleet of 13 aircraft are turboprops (six Bombardier DHC-8-400s and one Fokker 28; together with four A319s and two A320s, according to the CAPA Fleet Database). Nevertheless, its main competitors are more cost efficient full service carriers and (particularly at Split and Dubrovnik) LCCs.

According to CAPA calculations, and after adjusting for average trip length, Croatia Airlines' CASK is 10% to 20% above that of FSCs, 45% to 50% higher than that of LCCs, and more than double that of ultra-LCCs.

A restructuring programme helped Croatia Airlines to reduce ex fuel CASK in the period 2010 to 2013 but, as noted above, the airline has struggled to reduce it further, and its overall CASK level has been driven by fluctuations in fuel prices.

Croatia Airlines: unit costs (cost per available seat kilometre, USc) and average trip length compared with trend lines for other European airlines

With the right cost base, a local airline could succeed in growing Croatia market

Croatia Airlines is 97% owned by the Republic of Croatia, which has been considering a privatisation since 2013. Media reports have suggested that Croatia Airlines is looking to select a strategic partner in 2017 (EX YU Aviation News, 10-Jul-2017).

This may be helped by its record of remaining in profit in each of the past four years, albeit with very thin margins. An investor would hope that the margin improvement of 1Q2017 could lead to a more sustainable widening of profit margins, but would be concerned by Croatia Airlines' falling market share.

A strategic partner would also likely want to see a reduction in Croatia Airlines' unit cost to make it more competitive against LCCs.

A further concern would be the high level of seasonality in the airline's business and the pressure on it to maintain connectivity during the loss-making winter months.

The main attraction would likely be the Zagreb hub, where Croatia Airlines remains the biggest airline and where its Star Alliance and codeshare relationships have helped to defend it from growing competition. With the right cost base, the growing inbound tourism market in Croatia provides an opportunity for a local airline to be successful.

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