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Etihad Airways confirms it will take up pro-rata entitlement in Virgin Australia, retain 21.8% stake
Ryanair's results statement for 1Q2017 (Apr-Jun quarter) came as something of a relief for the European airline sector. The continent's leading LCC and largest airline by passenger numbers reported modest growth in profits and – more importantly – reiterated its FY2017 target of a 12% increase in annual net profit.
This came hard on the heels of a profit warning from Europe's number two LCC easyJet. Added to positive quarterly results from Norwegian and Wizz Air recently, Ryanair's announcement provides a more optimistic tone, at least for the low cost end of the market.
That said, Ryanair is also preparing the ground for a possible further weakening of an already depressed pricing environment in Europe, pointing to geopolitical uncertainties, including terrorist activity and Brexit. With a lower cost per passenger than any competitor and a very strong balance sheet, Ryanair is well placed for any airline market downturn.
Following easyJet's fall back into loss in 1H2016 (six months to Mar-2016), it still expected that the summer months would more than offset this, allowing another year of profit growth. A profit warning after the UK's Brexit vote dashed this hope in late Jun-2016. EasyJet's 3Q2016 (April to June) trading statement casts a bigger shadow over its outlook, as weak unit revenue is not being offset by unit cost reduction. According to CAPA calculations, easyJet's 3Q2016 pre-tax profit fell by 59% year on year.
European LCCs Norwegian and Wizz Air have reported improved profits for the same quarter and are on track to achieve stronger full year results, but easyJet is not alone among European airlines in lowering earnings expectations in recent weeks. IAG and Lufthansa have also issued profit warnings. Growing macroeconomic and geopolitical uncertainties are weighing on unit revenue. For some, there is no longer a sufficient release coming from lower fuel prices, which also contribute to unit revenue weakness by encouraging additional capacity.
The majority of European airlines have yet to report April-June results, most notably Ryanair, Air France-KLM and IAG. Nevertheless, the reporting season seems likely to herald a more cautious phase of the airline cycle.
This six-monthly update of the CAPA world airline operating margin model continues to expect industry margins in 2015 to 2017 above previous cyclical peaks, albeit falling slightly in 2017. This is in spite of unexceptional global GDP growth, which has not regained its long term trend rate since 2010.
The higher level of airline operating margin from a given GDP growth rate has been due to several factors. Lower oil prices have played their part, particularly since mid-2014, as does a higher level of global traffic growth than would previously have been expected from relatively sluggish GDP growth. In addition to these external issues, perhaps the most significant factor is a greater degree of capacity discipline. This is now most deeply rooted in the US, which is now by far the most profitable airline region, helping to drive the global result.
On a more cautionary note, the IMF has recently cut its global GDP forecasts, citing Brexit and other geopolitical risks. In addition, profit warnings in recent weeks from IAG, easyJet and Lufthansa are a reminder that cyclical upswings do not last forever. A test of the airline industry's improved profitability will be its resilience in a downturn.
Norwegian Air continued its trend of improving profitability in 2Q2016, when it marked its sixth successive quarter of year-on-year increases in its operating margin. It achieved a further gain in load factor, in spite of double-digit capacity growth. The biggest sources of its growth were its US widebody routes and its operations in Spain, where it has recently opened a seventh base at Palma de Mallorca.
To a large extent its recent positive trend of growing profits has been the result of lower fuel prices. Ex fuel unit costs have been rising for several quarters, outpacing increases in unit revenue. Norwegian has only managed to achieve margin gains because of lower fuel CASK.
Norwegian's operations should become more efficient if it received US foreign airline permits for its Irish and UK subsidiaries, although there is currently little sign that this is about to happen. A new order for 30 A321LRs (part of the A320neo family) should also help Norwegian's unit cost performance and give it more choice over aircraft deployment on shorter long haul routes.
After a period of unit revenue growth following the global financial crisis, Air Europa came under heavy pricing pressure in 2015. Renewed growth by Iberia has intensified competition to Latin America, while LCCs are putting strain on short haul yields.
Air Europa does not report profits, but it is its parent company Globalia's largest business by revenue. The privately owned Globalia group has been profitable since 2013 but suffered a fall in profits in 2015, when its Air Division's revenue declined by 3% in spite of traffic growth. The group balance sheet has low liquidity and Globalia is reportedly considering an IPO.
Widebodies now represent more than half of Air Europa's seats and 20 out of 27 outstanding orders. This reflects the importance of its Latin American network and its ambitions to continue long haul growth, as detailed in part 1 of this report. Moreover, the widebody orders are for Boeing 787s – to replace A330s, generating cost efficiency gains. CAPA estimates that Air Europa's unit cost is above that of LCCs, but closer to them than to FSCs. It has a good track record of labour productivity growth, which will be useful in its quest for further CASK reduction.
Monarch Airlines restructure 2: lower fuel, labour productivity drive return to profit. Risks remain
Part 1 of CAPA's analysis of Monarch's restructuring examined capacity cuts and the shrinking of the fleet and network. An obvious sign of success is that the Monarch Group and Monarch Airlines returned to profit in FY2015. The restructuring helped to stabilise load factor, reduce the seasonality in the business and improve its on-time performance. However, average daily aircraft utilisation continued to fall and load factor has fallen again in the first part of FY2016.
Part 2 of CAPA's analysis examines how the restructuring improved Monarch's financial performance. The return to profit by the UK LCC was driven both by a rise in unit revenue and a fall in unit cost – that cost itself helped by lower fuel prices and improved labour productivity.
Looking ahead, Monarch's Boeing 737MAX deliveries from 2018 should benefit the bottom line. However, in the meantime leisure-focused markets face considerable volatility from geopolitical and macroeconomic uncertainties, not helped by the UK's recent Brexit vote. Although back in profit, Monarch still needs shareholder support to fund its liquidity needs and there have been some reports – denied by the airline – that its owners may be considering a sale. The restructuring now gives it a base from which to address its challenges.
The privately owned Monarch Group no longer publishes a glossy annual report for all to see, a practice that has been discontinued since its 2014 acquisition by turnaround specialists Greybull Capital. Such reticence is sometimes a sign of having something to hide. Not so here; the group's statutory accounts for the year ended Oct-2015 were recently filed with the UK's Companies House. They show a strong return to profit for the Monarch Group, whose largest business is Monarch Airlines.
In the previous year, FY2014, the airline had grown too rapidly and plunged into a heavy loss, while the Monarch Group had almost run out of cash. A subsequent restructuring programme, devised by the management and backed by the new shareholders, sought to restore profitability. The FY2015 accounts demonstrate the success of the restructuring, which involved capacity cuts (mainly in the summer), fleet reduction, withdrawal from charter and long haul flying, a shrinking of the workforce and new labour contracts. With profits restored, Monarch is now growing once more.
This first part of CAPA's analysis of Monarch's restructuring examines the changes to its capacity, schedule network and fleet. Part 2 will consider its improved financial results and future prospects.
From 2009 to 2015 SWISS accounted for 47% of the operating profits produced by all the airlines in the Lufthansa Passenger Airline Group, and 29% for the Lufthansa Group overall. It has also consistently been the Group's most profitable airline in margin terms. In 2015 it even managed to post a higher margin than Lufthansa's MRO business – traditionally a much more robust and profitable activity than most airlines.
Nevertheless, SWISS seems now to be struggling to maintain these achievements. Its passenger load factor, while still the highest in the group, is on the decline. Revenue is falling and SWISS suffered a drop in margin in 1Q2016. The seasonally weak 1Q may not say too much about prospects for the full year, but Lufthansa expects SWISS to report a slightly lower adjusted EBIT in 2016 relative to 2015.
With four new Boeing 777-300ER aircraft now in SWISS' long haul fleet and the first Bombardier C Series due to join its short haul fleet imminently, SWISS is not standing still.
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.
Flybe returned to profit in FY2016 – according to its latest definition of adjusted pre-tax profit, this was its first positive result since before its stock market flotation in 2010. Quibbles over profit definitions aside, it is apparent that Flybe's restructuring under CEO Saad Hammad since 2013 is continuing to make progress. Nevertheless, with an operating profit margin of just 1.4%, Flybe was one of the least profitable listed European airlines in 2015 (or nearest financial year).
Flybe is now into what Mr Hammad calls the 'Profitable Growth' phase of its turnaround. In FY2016 it returned to capacity and revenue growth after declines in the previous year. In FY2017 it is accelerating its capacity growth at a time when market conditions are producing very soft yields, but Flybe is determined to maintain cost discipline.
Of course, the achievement of profitability is only the first step in profitable growth. FY2016 will benefit from fuel cost tailwinds and this should help it to take the next step – even if it faces unit revenue headwinds.
Finnair's 2016 Capital Markets Day on 25-May-2016 was an opportunity to mark the progress made in CEO Pekka Vauramo's first three years at the airline. Since his arrival on 1-Jun-2013 Finnair has completed its entry into the oneworld trans-Atlantic JV and the JAL-BA JV; implemented cost reduction initiatives, including the renegotiation of labour agreements; and taken delivery of its first Airbus A350 aircraft. After falling into loss in 2014, it returned to profit in 2015 and its 1Q2016 results show further progress, although it remains short of Mr Vauramo's medium-term margin targets.
Finnair is now reinvigorating and accelerating its long haul growth plans, based on its niche in Europe-Asia connecting traffic. A target to double its 2010 Asia ASKs by 2020 has been brought forward to 2018, and this can be achieved with minimal additional investment. Through a refocused commercial strategy, Finnair hopes to stay ahead of market RASK performance in a weak unit revenue environment. Through growth, fleet upgrades and improved labour productivity, Finnair aims to make significant CASK reductions. Finnair management certainly appears to be more confident about the future than at any other time in the past three years and more.
Operating margin to reach new high in 2016, but this may signal a subsequent downturn. CAPA’s global airline operating margin model indicates that the industry was more profitable in 2015 than it has been for almost five decades. Moreover, the model predicts that world airline operating margins will rise further above previous historic peak levels in 2016. These new levels of profitability are mainly thanks to the low oil price environment, coupled with strong demand growth in spite of global economic growth rates that are far from exceptional.
Much of the industry is also benefiting from a period of relative capacity discipline. New revenue sources may also be helping, although their role in airline profitability is still emerging.
The macroeconomic and geopolitical backdrops provide the main risks to this forecast. Beyond that, the biggest challenge for the industry will then be to try to sustain margin levels, rather than to allow a peak to be followed by a rapid downturn, as has always happened in the past. But downturns can play a positive role in industry development, possibly even stimulating consolidation.