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SAS: 2Q losses widen after six quarters of improving results. LCCs & SAS growth depress unit revenue

After improving its underlying profit in FY2015 and narrowing its losses in the seasonally weak 1Q2016, SAS suffered a widening of losses in 2Q2016. This was the first year-on-year deterioration in its underlying result for six quarters. It benefited from lower fuel prices and from its own cost savings programme, but experienced plummeting unit revenue.

This reflects the ongoing growth of LCC competition in short haul markets, but is also the result of its own capacity increase. SAS' growth is led by rapid expansion on long haul, where Norwegian is also providing LCC competition. SAS is investing in its network and product and growing its revenue from higher-yielding loyalty scheme members, but these measures do not appear to be giving sufficient support to unit revenue.

These trends are unlikely to dissipate any time soon, and there is now the real prospect that its FY2015 result represented a cyclical peak for SAS. The company recognises the need for further change in order to improve its competitiveness. Strategies to seek labour cost reform can be expected, in spite of a strike call by Swedish pilots.

2Q operating loss widens, reversing positive trend of 1Q

In 2Q2016 (Feb-2016 to Apr-2016) SAS reported a pre-tax profit of SEK127 million (EUR14 million) – 64% reduced from SEK355 million in the same period a year earlier. The results for both periods included significant positive non-recurring items; in particular, in 2Q2016, a SEK655 reimbursement of cargo cartel fines that were paid to the European Commission in 2010 and, in 2Q2016, SEK678 million of gains on the sale of Heathrow slots. Adjusted for non-recurring items, the pre-tax result was a loss of SEK601 million (EUR65 million) – 82% wider than the loss of SEK331 million a year earlier.

The operating result – before non-recurring items, finance costs and results from affiliated companies – was a loss of SEK486 million (EUR52 million) in 2Q2016, more than double the SEK226 million loss in 2Q2015. Revenue fell by 5.2% to SEK8,916 million (EUR958 million) and the operating margin declined by 3.0ppts to -5.5%.

The widening of underlying losses reversed the trend of 1Q2016, when the operating loss narrowed by 58% year-on-year to SEK269 million. Indeed, 2Q2016 was the first quarter since 3Q2014 in which SAS suffered a fall in underlying profitability.

Nevertheless, in spite of the deterioration in the 2Q result, the 1H2016 operating loss narrowed a little – by 13%, to SEK755 million (EUR81 million). 1H2016 revenue fell by 3.3% to SEK17,191 million (EUR1,848 million) and the operating margin gained 0.5ppts to -4.4%.

SAS results summary 2Q and 1H2016 versus 2Q and 1H2015

SEK million

2QFY2015

2QFY2016

Change

1HFY2015

1HFY2016

Change

Revenue

9403

8916

-5.2%

17774

17191

-3.3%

Operating costs*

9629

9402

-2.4%

18640

17946

-3.7%

Operating result*

-226

-486

115.0%

-866

-755

-12.8%

EBIT margin %

-2.4

-5.5

-3.0ppts

-4.9

-4.4

+0.5ppts

Adjusted profit before tax**

-331

-601

81.6%

-1160

-1005

-13.4%

Reported profit before tax

355

127

-64.2%

-481

-182

-62.2%

2Q ASK growth of 10.2%, load factor falls 1.8ppts

In 2Q2016 SAS increased its total ASKs by 10.2% (10.7% for 1H) but RPK growth of 7.3% (7.9% for 1H) did not match, and load factor fell by 1.8ppts to 69.2% (down 1.8ppts to 68.8% for 1H). A falling load factor trend is a concern (it fell in 2015), especially since SAS is below the industry average, and given that yield also fell in 2Q2016 (see below).

SAS total passenger traffic, 2Q and 1H FY2016

Growth driven by long haul scheduled traffic; charter traffic only 4% of ASKs

For scheduled traffic – which accounted for 96% of ASKs and 98% of passengers in 2Q2016 – the trends were similar to those for total traffic. Scheduled ASKs grew by 10.8% (11.5% for 1H), with RPKs up 7.9% (8.7% for 1H) and load factor down by 1.8ppts to 68.3% (down 1.8ppts to 67.7% for 1H).

SAS' shrinking charter operations continue to improve their levels of utilisation. It can be calculated that charter ASKs fell by 2.7%, but RPKs fell by only 2.0% (and charter passenger numbers grew by 2.9%), so the load factor gained 0.7ppts to 92.7%.

SAS scheduled passenger traffic, yield, unit revenue and unit cost, 2Q and 1H FY2016

Capacity growth was mainly driven by SAS' long haul network, where ASKs increased by 30.9% in 2Q (26.2% in 1H), but RPKs grew by only 22.2% (19.7% in 1H). On routes between Scandinavia and Europe and on domestic routes, SAS increased its capacity at single-digit rates, but RPK growth did not match ASK growth in any route region (see table below).

SAS scheduled passenger traffic by route sector

2Q revenue falls by 5.2%; currency-adjusted PASK down 11.5%

SAS' revenue fell by 5.2% in 2Q2016, in spite of the capacity increase. Scheduled passenger revenue, which accounted for 78% of the total, also fell by 5.2%. Charter revenue was only 2% of the total, but outperformed with a decline of only 0.5%. Freight revenue fell by 6.4%. Total revenue per ASK fell by 13.9%.

Currency movements had a negative impact on total revenue, although it still would have fallen by 2.2% at constant exchange rates in 2Q2016. Currency-adjusted passenger revenue per ASK (PASK) fell by 11.5%, reflected both weak pricing (currency-adjusted yield per RPK fell by 9.2%) and the 1.8ppt load factor decline noted above.

SAS Group revenue, 2Q FY2016 versus 2Q FY2015

(SEK million)

2Q FY2015

2Q FY2016

Change

% of 2Q FY2016 revenues

Passenger revenue

7,339

6,956

-5.2%

78%

Charter revenue

217

216

-0.5%

2%

Cargo and mail revenue

326

305

-6.4%

3%

Other traffic revenue

489

564

15.3%

6%

Other operating revenue

1,032

875

-15.2%

10%

Operating revenue

9,403

8,916

-5.2%

100%

2Q operating costs fall by 2.4%

SAS' total operating costs fell by 2.4% in 2Q2016, which was less than the fall in revenue and in spite of the increase in capacity. Fuel costs fell by 34.9%, thanks to lower market prices for jet fuel (partly offset by SAS' hedging programme and exchange rate movements).

Ex fuel costs increased by 7.8%, but this was still less than the growth in ASKs. Maintenance costs grew by 52.1%, mainly due to more extensive maintenance and changed assessments for future engine maintenance, as well as return requirements on leased aircraft.

Operating cost per ASK (CASK) fell by 11.4% and ex fuel CASK fell by 2.1%.

SAS said that its cost restructuring programme led to savings of SEK180 million in 2Q2016 and SEK335 million in 1H2016. It is aiming for SEK700 million of savings in FY2016, followed by SEK600 million in FY2017 and SEK200 million in FY2018.

SAS Group operating costs* 2Q2016 versus 2Q2015

(SEK million)

2Q FY2015

2Q FY2016

Change

% of 2Q2016 costs

Payroll expenses

-2,427

-2,308

-4.9%

24.5%

Selling costs

-632

-618

-2.2%

6.6%

Jet fuel

-2,299

-1,497

-34.9%

15.9%

Government user fees

-993

-977

-1.6%

10.4%

Catering costs

-189

-204

7.9%

2.2%

Handling costs

-507

-641

26.4%

6.8%

Technical aircraft maintenance

-609

-926

52.1%

9.8%

Data and telecommunications costs

-313

-332

6.1%

3.5%

Other expenses

-593

-881

48.6%

9.4%

Leasing costs for aircraft

-662

-706

6.6%

7.5%

Depreciation, amortisation and impairment

-405

-312

-23.0%

3.3%

Total operating expenses

-9,629

-9,402

-2.4%

100.0%

Total ex fuel

-7,330

-7,905

7.8%

84.1%

Labour productivity improves, but Scandinavian labour terms are a disadvantage

The airline's 2Q2016 labour costs fell by 4.9% and average headcount fell by 7.5%, in spite of capacity growth, and this was a welcome indication of improving productivity. Nevertheless, labour costs are SAS' largest cost category; the company is based in a region that gives it a disadvantage in terms of labour costs.

This was recognised by the CEO, Rickard Gustafson, in the 2Q results announcement: "At present, SAS is the only airline that operates between Scandinavia and Europe where the flight crews are exclusively subject to Scandinavian employment terms".

This highlights the need for change with regard to labour costs. Either SAS will need to negotiate new terms for its employees or it will need to consider a more flexible employment strategy, incorporating crews based in other countries. As the LCC Norwegian continues to provide growing competition to SAS – now also on long haul – the need for further structural reform of SAS' labour costs will become more urgent.

Recent talks with pilots over their collective labour agreements have led to agreement with SAS' pilots in Norway, but have led to strike calls by SAS' Swedish pilot union. Labour negotiations are not always guaranteed to run smoothly, but improved cost efficiency is a strategic imperative for SAS.

Unit revenue weakness an enduring trend, due to LCC competition…

The weakness of passenger unit revenue has been an enduring trend in SAS' markets throughout much of this decade. This partly reflects the impact of price-based LCC competition, particularly in the short/medium haul markets that account for the majority of SAS' capacity.

See related report: SAS, Norwegian and Finnair. The Nordic three continue to carve out separate niches

Number of seats between Scandinavia and Europe by airline type, FY2010 to FY2016*

…and SAS capacity growth

This unit revenue softness is also a function of SAS' own capacity growth. In each of FY2011 to FY2014 SAS increased ASKs and its unit revenue fell. In the first three quarters of 2015 SAS cut its ASKs and achieved growth in currency-adjusted PASK. Since the return to ASK growth in each quarter from 4Q2015, its PASK has resumed its downward trend.

SAS short haul scheduled passenger revenue per ASK, SEK, rolling 12 months

Loyalty scheme grows as SAS attempts to differentiate itself

One of SAS' priorities in order to increase its differentiation from LCC competitors is to focus on Scandinavian frequent travellers and to grow its loyalty scheme membership. SAS is also investing in digitalisation in order to provide a more customised approach to its frequent flyers. This is part of its strategy to attempt to give more solidity to unit revenue.

The number of Eurobonus members increased by 0.5 million year-on-year to 4.4 million in Apr-2016, one million more than two years previously. Eurobonus members now account for more than 50% of SAS passenger revenue. Revenue from Silver/Gold/Diamond members grew by 4.5% year-on-year in 2Q2016, while revenue from non-members fell by 3.8%.

SAS Eurobonus members (million), 2QFY2015 and 2QFY2016

Long haul growth is also a response to its frequent flyers

SAS' long haul growth is also a response to demand from its frequent flyers for more direct connections to other world regions. It has grown its widebody fleet from 12 in 2Q2015 to 16 aircraft (four A330-300E, four A330-300X, and eight A340-300X), and has eight A350-900s on order for delivery from 2019 (source: CAPA Fleet Database).

It has also invested in widebody cabin upgrades and added more destinations (Hong Kong, Miami, Los Angeles and Boston all added over the past year). In 2Q2016 it carried a record number of long haul passengers and achieved a load factor close to 75% in business class.

See related report: SAS & Norwegian Air set to take market share in Scandinavia-US market as United and Delta pull out

FY2016 outlook unchanged

SAS has maintained its outlook for FY2016. It will grow ASKs by 10%, compared with expected market seat capacity growth of 5% to 6%, but it will increase its number of flights by only 1%. Capacity growth will be driven by a 25% increase in long haul ASKs. SAS expects lower unit revenue and lower unit cost and to report a positive pre-tax result before non-recurring items.

In spite of SAS' investment in its network and product, a combination of market conditions and its own capacity growth mean that unit revenue looks set to remain on a downward path. Lower fuel prices and SAS' cost efficiency programme should ensure that it can keep unit cost below its unit revenue for FY2016.

Further structural reform is still needed

However, although SAS' underlying 1H2016 result was better than that of the same period a year earlier, the deterioration from 1Q to 2Q highlights the unpredictable nature of SAS' profits. Given its highly seasonal profit pattern (losses in 1H and profits in 2H), there is still plenty to play for in FY2016.

SAS' reconfirmation that it aims for a positive underlying pre-tax profit is entirely credible. However, it also leaves scope for the result to be lower than last year's SEK1,174 million. Its operating margin was 4.1% in 2015, when the global airline industry's collective operating margin reached a new high of 8.3% (according to IATA).

See related report: SAS: capacity discipline helps it to best margin for many years; plans double digit growth in 2016

The global industry is forecast (by both CAPA and IATA) to achieve an even higher margin in 2016. SAS has done much in recent years to become more competitive. Nevertheless, the possibility that its 2015 margin could turn out to be its cyclical peak demonstrates the ongoing need for further structural reform.

Mr Gustafson, the CEO, understands this: "Given this background", he has said, "we have to continue to change to thereby ensure long-term competitiveness and a sustainable return for our shareholders.”

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