January 2003 Market Outlook CONTENTS

HAPPY NEW YEAR! Aviation Strategy Issue No: 63 January 2003 Market outlook CONTENTS imes are tough for the mainstream aviation industry. IATA is now Analysis Testimating a net loss of $13bn for the global industry in 2002. And the painfully slow recovery from September 11 has been overshad- Market outlook 1 owed by the prospect of war in Iraq. We have no particular insight into the potential Iraqi war, just a Continental barriers hope, shared by most people in the West, that it will not happen. to LCC expansion 2 If it does happen, there will be a short-term surge in the spot price of crude oil and kerosine. However, as there is a global excess of supply over demand in the oil industry and a lack of solidarity within United Airlines: the OPEC, the overall outlook is for a softening in fuel prices in 2003. reorganisational challenge 3-7 The bigger concern for the aviation sector is that confidence in air travel will again be undermined and the incipient recovery in the Briefing transatlantic market will be choked off. As well as the Middle Eastern carriers like Gulf Air, Emirates and Saudia, the Euro-majors are Air Malta: exposed to developments in the region. BA and KLM earn about 5-6% Hub or hubris? 8-9 of their revenues on routes to/from the Middle East while for Lufthansa, Air France and Alitalia the proportion is 2-3%. Russian airlines: In terms of the global market balance, the supply side adjustments Aeroflot, Sibir, Pulkovo, Kras, in terms of parking, downsizing, order deferrals and cancellations. The UT Air, Transaero, East Line, number of parked aircraft peaked at about 2,200 at mid-year and has Domodedovo, Volga Dnepr remained at that level while aircraft available for sale or lease has and Aerosvit declined slightly from its early 2002 peak of around 1,400. 10-14 Load factors are at record levels: 75.7% for the AEA carriers in the first nine months of last year, 70.7% for US domestic traffic and 76.7% Freighter values and for US international traffic. Yet yields have resolutely refused to lease rates 15 rebound - for example, the average US domestic fare in November 2002 was 20% lower than that in November 2000 while the average Databases 16-19 international fare was 10% lower. KLM's recent profit warning was announced at the same time as it was reporting the highest load fac- Airline traffic and financials tors for eight years. What this means is that the mainline scheduled industry will not be Regional trends rescued by unit revenue growth. Indeed, it is likely that business fares will continue to be reduced on both sides of the Atlantic as airlines Orders attempt to recapture business travellers disillusioned by their treat- ment during the boom times of the late 90s. Other ideas like airlines within airlines are being tried, on the basis that mistakes from previous failed attempts at this concept will not be PUBLISHER repeated, and some mergers or takeovers are being considered, but without much enthusiasm. This unfortunately leaves most of the mainstream carriers with only one direction - further cost-cutting. (A few air- Aviation Economics lines - Air France and some of the leading Asian carriers, perhaps - James House, LG, may still be able to control their unit costs through capacity expansion). The challenge for airline management will be to communicate the 22/24 Corsham Street reasons for unit labour cost improvements effectively to the unions, London N1 6DR something that failed spectacularly at United (see pages 3-7). Tel: +44 (0) 20 7490 5215 Fax: +44 (0) 20 7490 5218 www.aviationeconomics.com e-mail: [email protected] Aviation Strategy Analysis Continental barriers to LCC expansion here are two basic interpretations of this capac- % CAPACITY SHARES OF LCCs Tity share analysis of intra-European schedules BY COUNTRY (4Q2002) carried out by Gert Zonneveld of WestLB Domestic Intra-Europe Total Panmure. UK 32.0 33.3 33.1 First, low-cost carrier (LCC) penetration in the Ireland 0 32.4 31.4 UK and Ireland (about one third of total capacity) Italy 0 15.7 12.3 Aviation Strategy will inevitably be replicated in continental European Belgium 09.59.5 is published 11 times a year markets as the LCCs develop their continental Switzerland 09.69.4 by Aviation Economics bases. Second, an alternative view is that there are at the beginning of France 2.0 10.7 8.2 the month fundamental differences that mean that the LCCs will not achieve the same success as they have in Netherlands 07.67.6 Spain 08.86.9 Editor: the UK and Ireland. (LCCs are defined as Ryanair, Keith McMullan easyJet, Buzz and bmibaby.) Sweden 07.65.5 [email protected] At London, Luton, Stansted and Gatwick air- Norway 06.03.2 ports are workable alternatives at London for busi- Germany 02.72.8 Subscription enquiries: ness travellers as well as leisure/VFR passengers. Denmark 02.82.7 Julian Longin EasyJet, operating from all three to major domestic [email protected] points like Glasgow, Edinburgh and Belfast has in % CAPACITY SHARES OF LCCs Tel: +44 (0)20 7490 5215 effect forced BA and bmi to downsize or abandon BY COUNTRY PAIR (4Q2002) their domestic trunk routes to/from London Belgium Ireland 69.6 Copyright: Heathrow. Ireland UK 47.2 Aviation Economics This strategy should work in France if easyJet All rights reserved Spain UK 44.9 is allowed to expand at Paris Orly, currently occu- Italy UK 44.6 Aviation Economics pied by Air Lib, which is in administrative bankrupt- France UK 39.1 Registered No: 2967706 cy. Air Lib's future depends on French government (England) and EC acceptance of its restructuring plan (The Austria UK 34.1 French decision is due in mid-January). From Air France Ireland 31.9 Registered Office: James France's perspective, the failure of Air Lib would Sweden UK 28.6 House, LG 22/24 Corsham St London N1 6DR open Orly to easyJet and potentially worrying com- Switzerland UK 27.5 VAT No: 701780947 petition for its shuttle operations to that airport Netherlands UK 24.5 ISSN 1463-9254 (though it would benefit on African routes where Air Portugal UK 23.9 Lib competes). Andrew Lobbenberg of JP Morgan The opinions expressed in this publica- Norway UK 19.7 tion do not necessarily reflect the opin- points out that Air France has recently been argu- Germany Ireland 18.4 ions of the editors, publisher or contribu- tors. Every effort is made to ensure that ing that easyJet might be a less disruptive com- Belgium Italy 18.1 the information contained in this publica- petitor than Air Lib. tion is accurate, but no legal reponsibility Netherlands Switzerland 17.3 is accepted for any errors or omissions. Germany poses a different sort of problems for Belgium UK 16.7 the LCCs There are almost no alternative airports The contents of this publication, either in Germany UK 15.7 whole or in part, may not be copied, close to major population centres. EasyJet will be stored or reproduced in any format, print- Denmark UK 14.8 ed or electronic, without the written con- taking on Lufthansa directly at Munich if or when it Germany Norway 14.3 sent of the publisher. decides to complete its purchase of DBA, and it will France Switzerland 13.9 need a rapid frequency and route build-up to estab- lish a credible alternative to Lufthansa hub opera- Germany Italy 7.6 tion. Belgium France 6.3 Other issues include the competitive train ser- Source: European Airlines - tracking market vice, a residual reluctance about online credit card shares of low fare and network carriers [email protected] bookings and unavoidable social costs. January 2003 2 Aviation Strategy Analysis United Airlines: the extent of the reorganisational challenge nited Airlines operates the world's ronment and its dependence on major sacri- Ustrongest airline network. It is the cor- fice by staff and creditors, who may not nerstone of the largest global alliance, has share a common understanding of the grav- unassailable domestic hubs at Chicago ity (or the causes) of the current crisis. O'Hare and Denver and powerful, protected United has very little time for education, dis- positions at Tokyo-Narita and London- cussion or the development of creative alter- Heathrow. It has a modern, efficient fleet, natives. The US Chapter 11 bankruptcy and extremely experienced, capable staff. process is not designed to facilitate radical However, there is a serious chance that restructuring, and it is not designed to move United could be forced into liquidation during quickly unless all stakeholders are largely in 2003, and there is open debate about the agreement. External shocks including war in type of changes needed if United is to suc- Iraq or a further US economic downturn cessfully reorganise. could quickly render these issues moot. To survive, United must rapidly meet Also, one must question whether United's three challenges. current management could rapidly execute the biggest turnaround in aviation history. • Stabilise DIP financing and cash flow Most of current management were directly United's current debtor-in-possession involved in the many decisions that created financing will terminate unless it limits its the current crisis, and have been reluctant to aggregate cash burn from 7 December to 15 make major changes. Recent business February to $960m. This would require plans did not demonstrate a clear grasp of reducing its current daily burn rate, reported the magnitude of the challenge, and were to be $17-22m in December, to a level openly criticised by Wall Street and the between $6-8m per day in late January and ATSB.

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