20-Jun-2017 5:12 PM

Flybe plans post peak fleet profit progress; new CEO introduces a business improvement plan

Analysis

After strong growth since the end of the financial year to Mar-2015, Flybe's fleet numbers reached a peak in May-2017 and are now set to fall by 18% over the next three years. The airline's new CEO, Christine Ourmieres-Widener should reap the benefits of actions taken by her predecessor to limit the impact of surplus capacity ordered by his predecessor.

Flybe's fleet growth over the past two years has accelerated its growth in seat capacity and this has had a negative impact on its load factor and unit revenue. Together with struggling to control unit cost, this caused Flybe to fall back into loss in FY2017. Ms Ourmieres-Widener has introduced a plan to improve the airline's performance.

Flybe was the fastest growing top 20 European airline group last winter, but its capacity growth is slowing this summer and it plans to cut capacity next winter. Freed from the excess fleet growth that burdened its FY2017 result, Flybe now has an opportunity to control its capacity growth, adapt it more closely to demand, and thereby - to restore profits.

Flybe reached peak fleet in May-2017

Flybe's fleet has grown substantially since the end of FY2015, reaching a peak of 85 aircraft in total in May-2017. This growth was the result of a number of legacy fleet issues dating back to a previous management team (two CEOs back).

The Embraer E195s that had been regarded as surplus (by the last CEO) had either left the fleet or were reallocated to productive use on Flybe routes by the end of FY2016. However, the growth has been driven by the delivery of all 24 Bombardier Q400 turboprops from Republic Airline.

These turboprop deliveries were part of a deal reached with Embraer whereby Flybe extricated itself from a commitment to buy 20 new Embraer E175 jets, taking instead the smaller turboprops from Republic. Flybe subsequently agreed with lessor Nordic Aviation Capital to cancel leases for nine of the 24 Q400s and to acquire 10 Q400s that it had contracted to lease.

Excluding its ATR 72 aircraft, of which it has five that are used in its contract flying for SAS, the fleet in use by Flybe for its own network reached a peak of 80 aircraft in May-2017. This compares with 67 at the end of FY2015.

Flybe fleet numbers*: Apr-2014 to May-2017

Fleet growth drove accelerated seat growth in FY2016 and FY2017, weighing on load factor…

Although Flybe's fleet expansion has been less than it would have been had it not taken action to limit the legacy commitments, the airline has experienced rapid seat growth in the past two financial years after a period of contraction before that.

For Flybe UK, its own brand airline (as distinct from its third party contract business for other airlines), seat numbers grew by 9.7% in FY2016 and growth accelerated further to 12.3% in FY2017.

The rapid capacity growth of the past two years had a negative impact on Flybe's load factor, which fell by 3ppts to 69.6% in FY2017 after falling by 0.6ppts in FY2016. Flybe's passenger numbers grew by 7.6% in FY2017 and by 6.4% in FY2016 - in both cases slower than capacity growth.

Although the FY2017 load factor was still significantly higher than its FY2013 level of 62.6%, this demonstrates Flybe's difficulty in filling the splurge of new capacity in the past two years.

Flybe UK passenger numbers (million) and load factor (%): FY2009 to FY2017

… and on revenue per seat

Flybe UK managed to hold its yield, or passenger revenue per passenger, fairly steady from FY2015 to FY2017. It actually increased by 1.7% in FY2016, before staying flat at GBP70.20 in FY2017.

However, the fall in load factor noted above meant that its passenger revenue per seat, or unit revenue, fell by 1.4% in FY2016 and by a further 3.6% in FY2017.

Flybe UK passenger revenue per seat (GBP), passenger revenue per passenger (GBP) and load factor (%): FY2013 to FY2017

The adverse impact of seat growth on revenue per seat growth is clearly visibly in the chart below. In FY2014 and FY2015 Flybe UK's seat growth was negative and unit revenue growth was positive, but the two curves flipped over in FY2016 and FY2017.

Flybe UK growth in seat numbers and in passenger revenue per seat (%): FY2013 to FY2017

Flybe's unit revenue fell below unit cost in FY2017

Flybe UK accounts for 96% of Flybe Group revenue, the remaining 4% being Flybe Aviation Services (MRO), and passenger revenue accounts for 92% of Flybe UK revenue.

The key challenge for Flybe's profitability is the very thin margin between its unit revenue and its unit cost. It typically makes a small profit or a small loss each year, depending on the gap between the two. Over the past two financial years, with unit revenue falling, the volatility in its unit cost has determined whether it has made a profit or a loss.

Flybe UK's total revenue per seat was flat at GBP53.30 in FY2017, but its total cost per seat grew by 2.0% and was higher than unit revenue, at GBP53.70. This unit cost increase occurred in spite of a fall in fuel prices, as a result of a 5% increase in ex fuel cost per seat.

Although ex fuel unit cost had fallen in FY2016, Flybe has not been able to keep a lid on this important metric, which was 6% higher in FY2017 than in FY2014.

This meant that Flybe UK's operating result fell from a profit of GBP6.3 million in FY2016 to a loss of GBP5.8 million in FY2017.

Flybe UK total revenue per seat (GBP) and cost per seat (GBP): FY2013 to FY2017

As a result, Flybe Group fell back into loss in FY2017

Flybe UK's loss was partly offset by a small profit at Flybe Aviation Services in FY2017, but the Flybe Group fell from a pre-tax profit of GBP2.7 million in FY2016 to a pre-tax loss of GBP19.9 million in FY2017.

Adjusted for revaluation gains/losses on USD loans, the pre-tax results were a profit of GBP5.5 million in FY2016 and a loss of GBP6.7 million in FY2017. This adjusted profit measure was in loss for the sixth time in the past seven years.

Flybe revenue, profit before tax and adjusted profit before tax* FY2009 to FY2017 (GBP million)

Flybe is among Europe's weakest airlines by operating margin

Flybe Group's operating profit margin dropped from 1.4% in FY2016 to -0.3% in FY2017.

Among 27 listed European airline groups and their principal subsidiaries, this margin ranks Flybe in 23rd place for the nearest financial year to calendar 2016. It is one of only five that made an operating loss last year.

Operating margins for listed European airline companies and subsidiaries (% of revenue): 2015 and 2016

Flybe's fleet numbers are now falling

According to the CAPA Fleet Database, Flybe has a fleet of 84 aircraft as at 8-Jun-2017. This consists of 79 deployed in the Flybe UK operation, one fewer than at the peak in May-2017. These 79 comprise 59 Q400s (of which five are NG), 11 E175s, and nine E195s.

The Flybe Group also has five ATR 72s deployed in its White Label operation for SAS in Sweden.

It has four E175s on order, for delivery in 2019, according to the CAPA Fleet Database.

Flybe fleet as at 8-Jun-2017

Aircraft	In service
ATR 72-600	5
Bombardier DHC-8Q-402	54
Bombardier DHC-8Q-402(NG)	5
British Aerospace BAE146-200	0
Embraer E175STD	11
Embraer E195LR	9
Total	84

Following action over recent years to contain the fleet expansion resulting from legacy aircraft orders under previous management teams, Flybe's fleet is now set to decline to 65 aircraft at the end of FY2020. More than offsetting the E175 deliveries, numbers will fall due to lease expiries on Q400s and E195s.

With the inclusion of Flybe's 5 ATR aircraft, total fleet numbers will decline from the May-2017 peak of 85 to 70 in Mar-2020 - a fall of 18%.

Flybe fleet plan* and percentage of owned aircraft: FY2016 to FY2020

Seat growth is slowing in 1H of FY2018 and will reverse in 2H

As Flybe moves past its peak fleet capacity, the growth in the airline's numbers of seats flown will slow down and then reverse in FY2018 (year to Mar-2018). It has not given a target growth rate for the full financial year, but plans an increase of 2.7% year-on-year in 1H2018 (six months to Sep-2017).

The slower capacity growth rate is having beneficial effect on yield and load factor. With its 1Q2018 trading period more than two thirds complete, Flybe expects 1H yield to rise by 2.6% and 1H passenger revenue per seat to rise by 4.6%.

These metrics are boosted by the timing of Easter (which fell in 1H for FY2018, but not for FY2017), but CEO Christine Ourmieres-Widener told analysts at a presentation on the FY2017 results that underlying trading was also improving.

Flybe expects to cut seat capacity by around 4% year-on-year in the winter 2017/2018 season. This will be in stark contrast to last winter, when Flybe was Europe's fastest growing airline group among the top 20 by seat numbers, with an increase of 19%.

Flybe weekly seat capacity: 2014 to 2017*

Flybe to increase UK focus, in contrast with international growth of past two years

As part of the network optimisation planned by Ms Ourmieres-Widener, Flybe is to increase its focus on the UK. It will withdraw from routes flown entirely within the mainland continent of Europe next winter, although this is only a very small part of its business (accounting for less than 1% of its ASKs in calendar 2016, according to data from OAG).

According to OAG data for the week of 5-Jun-2017, 51% of Flybe's seats are in the domestic UK market. This includes capacity operated for Flybe by franchise partners.

Flybe is changing its Scottish franchise partner from Loganair to Eastern Airways under a five year agreement commencing in Sep-2017. The two airlines plan a new partnership covering existing Flybe branded routes from Aberdeen, Edinburgh, Glasgow and Manchester to be operated by Eastern under a revenue and risk sharing agreement covering four aircraft. Loganair now plans to resume operations under its own brand.

Flybe's other franchise partners are Stobart Air, which operates 12 services for it from London Southend, and Blue Islands, which operates services to/from Jersey and Guernsey.

While the UK domestic market has always been Flybe's main focus, network changes made over the past two years have focused more on adding international capacity. The return to a greater UK focus essentially reverses recent trends.

Flybe: international vs domestic seats, week of 5-Jun-2017

In calendar 2015 60% of Flybe's annual seats were domestic UK, but strong international expansion since then reduced this proportion to 53% in 2016. OAG data for the first 48 weeks of 2017 indicate that the domestic share has fallen further to 51%.

Note that these data, illustrated in the chart below, differ from the seat capacity statistics published by the company as they include all Flybe-coded capacity, including flights operated for it by franchise partners. However, the point that international capacity drove Flybe's expansion in the period 2015 to 2017 remains valid.

In the past winter Flybe launched 40 new routes, of which three were in the domestic UK market and 37 were on international routes. Its total of 147 routes comprised 63 domestic routes and 84 international routes.

The rebalancing back towards UK operations will reduce its Brexit risk. Although its intra-ECAA activities are very small, its UK-ECAA network is significant, and has some exposure to regulatory risk until the post Brexit UK/EU traffic rights regime is negotiated.

One area of UK domestic expansion already under way is Flybe's new London Heathrow routes to Aberdeen and Edinburgh, commenced at the start of the summer 2017 schedule. Ms Ourmieres-Widener told analysts that these routes were performing in line with expectations. She expected that the new alliance with Eastern Airways would help as it would strengthen Flybe's position in Aberdeen.

Flybe: annual seats flown split between domestic and international

New CEO should be helped by reduced fleet outlook

In spite of operating a network that faces no competition from other airlines on the majority of its routes, and in spite of being comfortably Europe's largest regional airline - Flybe has regularly struggled to make a profit.

Its thin/negative margins are evidence that, in fact, it faces significant competition, but from surface transport. They are also evidence that its unit cost is too high relative to the unit revenue that it is able to generate. This has been exacerbated by excess capacity growth, but also partly reflects the high unit cost that is inherent in the regional airline model.

Flybe's new CEO Christine Ourmieres-Widener joined in Jan-2017 to replace Saad Hammad after his surprise departure in Oct-2016. She now has the opportunity to restore Flybe on the path to sustainable profitability.

Ms Ourmieres-Widener has introduced a business improvement plan focusing on the optimisation of revenue, fleet and network; operational and organisational excellence, sales and marketing; technology (including an improved digital strategy), and cost improvements.

She has correctly identified the areas of focus for Flybe and is blessed with the good timing to have arrived at the airline as it becomes free of the enforced capacity growth that burdened her predecessor.