Issue no. 208 July/August 2015
North Atlantic: Virtual This issue includes airlines protest too much? Page - of the US carriers’ poli cal a ack on the Gulf super- Atlan c forces 1 connectors has been a new focus on the profitability of the A North Atlan c market, which might just provoke a regulatory re- Davies Commission exposes sponse. pre-funding dilemma 4 At first sight, it is not obvious three JV carriers, with each virtual why the US carriers have chosen airline (Star, SkyTeam and oneworld) Rolls-Royce: Under financial to a ack the Gulf carriers so vehe- having varying but generally very pressure, will it be broken mently. There are, remarkably, only high degree of control in their own up? 10 two routes where the US carriers sub-markets (see table, page 2). An avia on tour of Central compete directly with the Gulf carri- Over the past five years the North Eastern Europe 12 ers: Dubai to Washington (Emirates Atlan c market has been turned into and United) and Milan — New York the major profit generator for both JetBlue: At last, closing the (Emirates, Delta, American), using US and European network carriers. margin gap with peers 17 fi h freedom rights. European airlines’ investor presen- Moreover, according to a study ta ons frequently allude to posi ve by Oxford Economics commissioned trends in Atlan c unit revenues, by Emirates, the true O&D markets though they have all stopped pro- of the two groups of carriers are viding regional profitability analyses. markedly different. For the Gulf car- The US DoT does compile this data for pean partners which in effect act as riers, the passenger profile is domi- US airlines (Form 41 data), and this one airline on the North Atlan c, nated by Asian, Middle Eastern and illustrates how important the Atlan c coordina ng prices and capacity, and African origina ng or des ned pas- has become for the profitability of ul mately sharing profits). sengers — 95% in total. By contrast the US carriers (and for their Euro- For the US Big 3, Atlan c margins these regions only account for about 18% of passengers on US airlines, their traffic being dominated by the North Atlan c Consolida on Americas (60%) and Europe (22%). 100 Nevertheless, the Gulf carriers 90 oneworld ATI have been increasing their presence 80 on the North Atlan c market (de- 70 fined as all flights from West and Star ATI East Europe, the Middle East and 60 Africa across to North America) — 50 SkyTeam ATI their capacity share is now about 8% Seats(m) 40 of seat capacity, up from just 0.6% 30 ten years ago. It is perhaps not the 20 Others rela vely small current share that is 10 important, rather it is the poten al Gulf Carriers 0 threat to the concentrated market 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 est structure on the Atlan c — about 72% of capacity is shared among
Published by Aviation Strategy Ltd Aviation Strategy Oligopolisa on of the North Atlan c. ISSN 2041-4021 (Online) Capacity shares on Alliance JV European hub to North American hub routes This newsle er is published ten mes a year by Avia on Strategy Limited Jan/Feb and STAR ALLIANCE Jul/Aug usually appear as combined issues. Our editorial policy is to analyse and cover EWR IAD ORD YYZ LAX SFO TOTAL ATLANTIC contemporary avia on issues and airline FRA 100% 100% 100% 100% 100% 100% 87% strategies in a clear, original and objec- MUC 100% 100% 100% 100% 100% 100% 89% ve manner. Avia on Strategy does not ZRH 100% 100% 100% 100% 100% 100% 82% shy away from cri cal analysis, and takes a global perspec ve — with balanced cover- SKYTEAM age of the European, American and Asian JFK ATL DTW MSP SLC TOTAL ATLANTIC markets. CDG 75% 100% 100% 100% 100% 67% AMS 100% 100% 100% 100% 100% 88% Publisher: FCO 83% 100% 100% 55% Keith McMullan ONEWORLD James Halstead JFK ORD MIA DFW LAX PHL TOTAL ATLANTIC LHR 59% 61% 73% 100% 53% 84% 56% Editorial Team MAD 63% 100% 81% 100% 100% 100% 78% DUB 79% 100% 100% 71% Keith McMullan kgm@avia onstrategy.aero Source: OAG, May 2015 Notes: North Atlan c includes hub to hub and all other routes to/from the hub airport. James Halstead Dublin analysis assumes Aer Lingus to join oneworld JV jch@avia onstrategy.aero Rome analysis assumes Alitalia remains in Skyteam JV
Tel: +44(0)207-490-4453 in 2014 averaged 15.9%; the consol- and the overall market capacity has Fax: +44(0)207-504-8298 idated US domes c market, 10.2%; increased by 2% pa. the Pacific, where ATI alliances with The risk for the US carriers, and Subscriptions: JAL/AA and ANA/UA are currently be- some of their European partners, info@avia onstrategy.aero ing implemented, 7.4%; the finan- is that by using aeropoli cal ac on cially stressed La n American mar- (in which they are supported by Copyright: ket,-5.9%;andthetotalsystem,9.4%. the labour unions) to combat the Over half the $2bn improvement in Gulf carriers they may provoke a ©2015. All rights reserved the Big 3’s opera ng profit between regulatory backlash. The US DoJ is Avia on Strategy Ltd 2013 and 2014 was generated by the showing signs of unease with the Registered No: 8511732 (England) North Atlan c sector. degree of consolida on within the Registered Office: 137-149 Goswell Rd The US carriers’ economic ra- US, launching an inves ga on into London EC1V 7ET onale then becomes clearer. Their possible price and capacity collusion. VAT No: GB 162 7100 38 aim is to protect their major profit- It seems unlikely at present that ISSN 2041-4021 (Online) generator — the North Atlan c — by they will find any damning evidence maintaining “disciplined” capacity for this, but next the US DoJ could The opinions expressed in this publica on growth which the Gulf carriers are turn to the Atlan c where it has donotnecessarilyreflecttheopinionsofthe beginning to threaten, and to stem always been unhappy about the an- editors, publisher or contributors. Every ef- the traffic loss to the Gulf carriers trust immunity afforded to former fort is made to ensure that the informa on contained in this publica on is accurate, but from their European partners on compe tors. no legal reponsibility is accepted for any er- Asian, Middle East and African routes One issue might be that the aca- rors or omissions. The contents of this pub- to North America, which directly demic economic analysis which was lica on, either in whole or in part, may not impacts their joint services across the used by the US DoT to jus fy the vir- be copied, stored or reproduced in any for- mat, printed or electronic form, without the Atlan c. Over the past five years the tual mergers — “horizontal double- wri en consent of the publisher. three JVs have grown in total by 1% marginalisa on” (don’t ask). Essen- pa, the Gulf carriers have expanded ally though, the assump on was by 20% pa but from a low base, that virtual mergers would result in
2 www.aviationstrategy.aero July/August 2015 lower fares, net of fuel and other centra on in sub markets can only nance on its hub-to-hubs, with the ex- external cost changes. Intui on and be jus fied if there is clear effec ve cep onofthewellcontestedJFKmar- evidence suggest otherwise; to take inter-network compe on. ket. one example, a July 2015 survey by The table on page 2 summarises oneworld cannot achieve the CWL Solu ons (a travel consultancy, the current situa on as regards same degree of dominance simply owned by Carlson Wagon Lit) ob- transatlan c hub to hub traffic flows, because its hubs at London and served that bookings on North At- showing capacity shares on routes New York are also top global des- lan cJVshadjumpedfrom16%ofthe between each alliance’s Euro-hubs na ons, served from numerous total in 2009 to 94% in 2014 and that and those of the partner airline in other alliance hubs, and the volume the average fare recorded for the At- North America. of Atlan c traffic at LHR, Europe’s lan c had risen by 17%, compared to Star has been able to build up to- prime O&D point, is over twice that 11% on average for all intercon nen- tal dominance. All the traffic between at CDG or FRA. There is also of course tal routes. Star’s Euro-hubs and its US hubs be- the presence of a local rival, Virgin Rising fares by themselves do not longs to the JV. Connec ng traffic at Atlan c: allied with Delta, this virtual necessarily point to an -compe ve both ends is guaranteed to be fun- airline commands 39% of the LHR-JFK behaviour; the industry has to ra o- nelled into the JV, ie onto one single market and 23% of the total LHR-US nalise to earn its cost of capital over virtual airline. market against oneworld’s 59% on the long term. But the degree of con- SkyTeamhas achievedneardomi- LHR-JFK and 56% on the total market.
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July/August 2015 www.aviationstrategy.aero 3 Davies Commission exposes pre-funding dilemma
is now several weeks since the full by 2020, London City by 2024, Lu- whelmingly because of the lack of Davies Commission issued its fi- ton by 2030 and Stansted by 2041. poli cal commitment. To say that I nal report on new runway ca- (It may be worth reminding ourselves a er all the hard work the avia on pacity for the South East of England. that the last Labour Government’s industry has been frustrated is Given the enormous amount wri en Airports White Paper outlined pro- something of an understatement. aboutthereport,youmightthinkthat posals for two new runways, one at In his book “Great Planning there is not a great deal more to say. Stansted to be opened by 2012 and Disasters” (1980), Peter Hall com- In fact, the spin generated by the re- one at Heathrow to follow in 2020.) mented that: “A er the biggest ac ons to the report means that it is This underlying problem of ca- inquiry, by the Roskill Commission,… some mes difficult to see the forest pacity shortage has been recognised someone unkindly said that the for the trees. It is me to try to iden- for many years, and studies of what documenta on, suitably pulped and fy the key issues and how they might to do about it have almost become a compressed, could provide all the play out over the coming months and growth industry in the UK. material needed for the runways.” years, and one major issue in par cu- In terms of scale and thorough- Heaven knows how many airports lar. ness, the Roskill Commission, which could have been built with all the The star ng point is the fact that reported in 1970, is usually regarded subsequent reports, submissions and the UK is rapidly running out of air- asthefirstmajoranalysisundertaken, responses. port capacity in the South East of Eng- but it was by no means the first, nor of It might be thought, therefore, land, especially for hub opera ons on course the last. that by 2012 yet another study was which Howard Davies was asked to Not one of the many studies got the last thing needed. But poli cians focus. Davies found that for aircra anywhere in terms of implementa- faced with an awkward policy com- movements Heathrow has been full on of their recommenda ons for mitmentandanapproachingelec on since 2010 and that Gatwick will be increased runway capacity, over- didn’t see it like that.
London’s Runway Op ons Net present value and social benefits assessment (2014£bn)
Gatwick Heathrow Second runway Extended runway Northwest runway High Low High Low High Low Consumer benefits 47.1 27.2 46.5 29.1 54.8 33.6 Producer surplus -41.8 -24.7 -31.6 -21.9 -38.4 -25.8 Government revenue 2.5 1.0 1.5 1.3 1.8 1.9 Delays 2.4 2.6 0.8 2.4 1.0 3.0 Wider economic impacts 8.1 5.5 10.0 6.6 11.5 7.7 Other dis-benefits -1.6 -1.1 -2.8 -2.3 -2.7 -3.0 Total benefits 60.1 36.3 58.7 39.3 69.1 46.2 Total dis-benefits -43.3 -25.8 -34.4 -24.3 -41.1 -28.8 Net social benefit 16.8 10.5 24.4 15.1 28.0 17.4 Scheme and surface access cost -6.0 -5.0 -14.1 -14.0 -16.1 -16.0 NPV 10.8 5.5 10.2 1.0 11.8 1.4
Source: Davies Commission Final Report. Note: High case based on carbon-traded assump ons. Low case based on carbon-capped assump ons.
4 www.aviationstrategy.aero July/August 2015 Hence the Davies Commission, an exercise set up with the resources to Assessed scheme capaci es, air transport movements at least match those of Roskill, but with the added, and poli cally useful, Do minimum Expansion Capacity increase objec ve of delaying any final deci- Gatwick second runway 280,000 560,000 280,000 sion un l a er the 2015 General Elec- Heathrow Extended Runway 480,000 740,000 260,000 on. Heathrow Northwest Runway 480,000 700,000 220,000 Davies’ final report in July this year came to a unanimous (unlike Source: Davies Commission Final Report Roskill) and unequivocal set of de- cisions, in par cular that there is a need for one, and eventually two, ad- It is important to recognise, how- port planning since the Second World di onal runways in the South East ever, that the poli cal environment War. Even the briefest of studies of of England, and that the first one today is very different from what it that history highlights two clear and should be built at Heathrow rather was just five or six years ago when recurring themes, both of which have than Gatwick. David Cameron made his ill-judged emerged again in recent years. Over a sixty-year period, the commitment not to build any new Two recurring themes Commission es mated, the bene- runways in the South East. The first, and perhaps less expected, fits to the UK could be as high as Avia on is no longer widely re- is that despite the seriousness of the £214bn, with GDP expected to be up garded as the toxic industry it once subject ma er and the amounts of to 1% higher by 2050 than it would was. The economic downturn helped money involved, airport expansion be without this addi onal airport to focus a en on on the importance has a racted some crazy ideas. capacity.The consulta on generated of growth and employment and the some 63,000 responses and by any role avia on plays in genera ng pros- There are plenty of examples, measure was thorough and com- perity. Companies in both manufac- but a par cularly “innova ve” one prehensive, which is not to say, of turing and services, once unwilling emerged in 1967, when Sir Donald course, that its conclusions a racted to be seen suppor ng the expansion Gibson, Director General of Research universal support. of air transport, are now openly and and Development at the Ministry Whatever the Commission had willingly campaigning for more run- of Public Buildings and Works, and decided, there would always have ways. The Labour Party (at least un- one might assume a serious senior been some opposi on. Having fought der its current leadership) has com- civil servant not prone to smoking what many regarded as a very neg- mi ed to support Davies’ recommen- certain substances, proposed that a ve campaign against Heathrow, da ons,anditseemsamajorityofthe a new airport made of expanded it would be extremely surprising if Conserva ve Party is similarly leaning polystyrene should be constructed Gatwick were now to concede defeat. in that direc on. to float on mud flats in the Thames Similarly, the Mayor of London, The old debate about expand- Estuary. Passengers could travel Boris Johnson, has spentpoli calcap- ing Heathrow or regional airports has to the new airport, he argued, by ital on suppor ng a new hub airport been laid to rest and shown to be hovercra . to the East of London and is clearly a false choice; growth at Heathrow The more recent sugges ons for unwilling to give up, even in the face not only does not prevent growth at a Thames Estuary airport, while lack- of enormous opposi on from the avi- Manchester, Edinburgh or Newcas- ing Sir Donald’s more visionary inno- a on industry and others, including tle, it posi vely helps it. va on, might nevertheless be placed Howard Davies himself. None of this means that the bat- into the same category of the totally Finally, the environmental lobby tle has been won. Noisy, and per- unworkable. will inevitably con nue to oppose air- haps even violent, opposi on is likely The second recurring theme in port expansion anywhere, irrespec- and the Government will s ll be faced post-war UK airport planning is more ve of the economic benefits and with a difficult poli cal decision. serious and at the end of the day far commitments to reduce the environ- Thisshouldnotcomeasasurprise more damaging. mental impact of addi onal capacity. to anyone given the history of UK air- The absence of poli cal will to
July/August 2015 www.aviationstrategy.aero 5 take what are admi edly difficult de- if a third runway is built could be the investment involved. This was not cisions has been seen me and again. crucial here), have certainly made it only the conclusion of the Airports More specifically, what we have had easier for the Government. Commission, but also of the regula- is a cycle whereby a poli cal party On the other hand, we have been tor, the Civil Avia on Authority. seeselectoralgaininopposingairport here before and history suggests that In his Beesley Lecture in October expansion, is elected and soon re- at the end of the day the poli cians last year, the CAA’s former Group Di- alises the error of its previous judge- will lack the commitment (or bravery) rector for Regulatory Policy noted un- ment, sets up a review of some form to support expansion. For a poli cian, equivocally, for example, that “run- todigitselfoutoftheholeithasfound as former Secretary of State for Trans- way expansion should be achievable itselfin,concludesthatmorecapacity port Lord Adonis has recently noted, with private capital, with or without a is a er all needed, only to be replaced doing nothing is o en the easiest way regulatory under-pinning.” by another party which has iden fied out. Such a conclusion is hardly opposi on to more runways as a vote But let’s assume that on the last surprising. Heathrow is a er all a winner. day of Parliament before the 2015 monopoly where demand for access The pa ern isn’t perfect over the Christmas recess the current Secre- far exceeds supply. A new runway decades, but it is sufficiently clear to tary of State for Transport announces will fill up quickly, to some extent act as a guide. that, subject to a ra of safeguards at Gatwick’s expense, which at least The current Conserva ve Gov- and condi ons, the Government will partly explains the Surrey airport’s ernment and its Coali on predeces- support a third Heathrow runway. In- opposi on to Heathrow’s expansion. sor are, of course, a good example. evitably that would not be the end of Finance will probably be needed from Labour’s commitment to two new thesaga;itwouldbarelybethebegin- the public purse for improved road South East runways was overturned ning of the end. access etc, but most will be raised by David Cameron in the hope of win- The Government should be able privately. The overall picture is clear; ning marginal seats near Heathrow. ensure that the necessary Parliamen- the devil is in the detail. Instead of a long-term strategy for tary legisla on is passed rela vely One of the most interes ng and avia on, we had a poli cal slogan: smoothly, especially if the Labour surprising developments to emerge Be er not Bigger. Party maintains its support, despite in the course of the Davies Commis- The result was inevitable, al- strong opposi on from some of its sion’s consulta ons was the decision though it took some me to emerge. own MPs, not least Boris Johnson. by easyJet to support Heathrow The increased focus on economic There will almost certainly be rather than Gatwick expansion. It growth, employment and trade led noisy and aggressive protests and seems a reasonable conclusion that to growing doubts about the sustain- legal challenges, but it is probably this decision played a significant role ability of a “no more runways” policy, reasonable to assume that one of in the Commission’s eventual choice. resul ng in a lengthy review by the the reasons for the Government’s easyJet is Gatwick’s largest cus- Davies Commission and eventually, delay in announcing its conclusion is tomer by some way, and Gatwick is a er the General Elec on, to a po- that it is determined to make such easyJet’s largest base. The airline cur- ten al poli cal U-turn. As the saying a decision as challenge-proof as rently has no presence at Heathrow goes, it’s déjà-vu all over again. possible, just as Howard Davies did and has declined to bid for free slots available for UK domes c and possi- Where now? with respect to his report. blyIrishservicesasaresultofIAG’sac- So wheredo we gofrom here? On bal- Capital raising not a problem quisi on of bmi and Aer Lingus. ance the signs for a posi ve decision However, the posi on taken by cer- It has stated that the number of on a third runway for Heathrow are tain airlines highlights one major is- slots available is too small for a vi- actually quite posi ve, but you would sue which has to be addressed, but able opera on, but such an argument be foolish to bet your house on it. to which at present there is no obvi- is hardly credible given the scale of The Davies Commission, com- ous solu on acceptable to all stake- its opera ons at many other airports bined with strong business support holders. Raising the capital for a third where it similarly faces a major legacy and reduced environmental opposi- Heathrow runway should not be a compe tor. It is far more likely that on (the proposal to ban night flights major problem, despite the size of easyJet is only too well aware of the
6 www.aviationstrategy.aero July/August 2015 fact that entering the Heathrow mar- such as Heathrow with an opera- di onal airport facili es. ket now would put it at a major disad- on where demand for airline ac- The tradi onal approach, at least vantage later when/if slots for a new cess far exceeds the supply of slots, in the UK, has involved a high degree runway are allocated. and will in all probability con nue of pre-funding. In other words, the Andthishighlightsthecri calreg- to do so even with a third runway, airlines currently using a regulated ulatory problem which the Govern- is unlikely to experience difficul es airport pay higher fees while the new ment, the regulator and the whole in- in persuading investors and banks capacity is being built. By the me dustry will have to face eventually, to provide the finance. A er all, un- it comes online, a significant propor- but which so far has a racted only der the current RAB-based regulatory on of its funding will have been met. limited public a en on. system, generally the more invest- This approach has never been If easyJet’s decision to support ment at the airport, the higher the popular with airlines, who view it Heathrow was a surprise, so surely profits for Heathrow Ltd. as favouring the airport owner, but was the announcement by Willie The only poten al problem is that they have tended to acquiesce as pre- Walsh that IAG was not in favour of a the regulator, the CAA, may not al- funding has not resulted in significant third runway there. low the airport to pass on all the compe ve distor on among carri- Over several years the IAG Chief addi onal costs to its cap ve cus- ers. Execu ve had maintained that a new tomers, and as explained below, at For example, BA gained from runway would never be built because present that seems unlikely. The CAA the construc on of Terminal 5 at the poli cal will to overturn decades itself, like the Airports Commission, Heathrow, which was paid for by all of inac on did not exist. But that certainly sees no problem in raising airlines serving the airport, but the wasn’t the same as ac vely oppos- the finance. other carriers subsequently gained, ing construc on. (Ironically, BA it- Slot Alloca on regula on and or will do so, from the construc on self had con nued to lobby for a of the new Terminals 1 and 2 and the the issue of pre-funding third Heathrow runway un l quite re- refurbishment of Terminal 4, to the cently.) To understand why easyJet and IAG costs of which BA contributed. Walsh now argues that the costs have taken such different posi ons It doesn’t take a genius to see that of expanding Heathrow are “outra- on a third Heathrow runway it is this cosy arrangement breaks down if geous” and can’t be financed. “I think necessary to turn to the European at least half of any new facili es, in the issues that need to be addressed Regula on on Slot Alloca on at con- this case a new runway, is required are so very, very significant, not just gested airports, and perhaps not sur- by law to be offered to new entrant the poli cs…. I think there is a major prisingly, the EU element greatly adds airlines, defined as carriers with no issue to address in terms of the cost to the complexity involved. morethanaverylimitedcurrentpres- of the infrastructure, and I fail to see This Regula on specifies (in gen- ence at Heathrow, who will not have how the airport will be able to finance eralterms—theactualcondi onsare contributed to the pre-funding. The it given the impact that it would have far more complicated) that at least incumbent airlines will be hit twice on the opera ng costs for Heathrow.” 50% of any new slots which become in such a situa on: they will face Not surprisingly, Gatwick Airport available — as dis nct from those increased compe on from carriers seized on IAG’s opposi on to argue which are sold/exchanged between which they have effec vely had to that the Davies Commission report airlines — must be offered to new cross-subsidise. was “unravelling fast”, ignoring the entrant carriers. This is normally not Not surprisingly, such blatant rather obvious point that Willie a significant issue with only a small market distor on has found few sup- Walsh would almost certainly have number of slots (or in the case of porters among Heathrow’s current been even more opposed to a new Heathrow, none) becoming available airline customers. Gatwick runway for exactly the each season. Whether to approve pre-funding same reasons.Talk of the ability or A whole runway’s worth of slots, or not will almost certainly be a de- inability to finance airport expansion however, accompanied by high de- cision for the airport regulator, the really serves only to obfuscate the mand, is a totally different ma er. CAA, which has already consulted on argument. The next and closely associated the subject. It has given every indica- As already noted, a monopoly problemishowairlinespayforthead- on of favouring such an approach,
July/August 2015 www.aviationstrategy.aero 7 Paying for a runway: aeronau cal charges lio combined with the extra flexibility provided by the addi on of Aer Lin- 30 gus’ slots, despite the fact that most Scheme es mate of the la er will have to con nue to 25 Current be used on Irish routes for the fore- 20 seeable future, probably means that it can meet its long-haul expansion 15 plans for some years to come. Why, therefore, would it want 10 more compe on at its main base? BAfoughtforalong metokeepmost 5 of the US carriers out of Heathrow,
Weighted avg aero charge per pax (£2014) to its obvious benefit; all it is doing 0 now, the argument goes, is repeat- Gatwick 2nd runway Heathrow extended runway Heathrow northwest runway ing the exercise to protect Fortress Source: Davies Commission Final Report Heathrow, despite the nega ve im- pact this might have on the extent combinedwithincreasedcommercial impress the current airline customers of its short-haul network out of the agreements between the airport and of Heathrow, but they do help to ex- airport, especially with respect to UK its airline customers. plain the posi ons taken by easyJet domes c feeder services. That is a In his address to the RunwaysUK and IAG to the Davies Commission perfectly logical approach from IAG’s conference in London in July, for ex- recommenda ons. commercial perspec ve. ample, the CAA’s Chief Execu ve, An- easyJet clearly expects to be a However, it is equally possible drew Haines, commented : “We are major beneficiary of a third Heathrow that the stance adopted by Willie certainly open to the idea of allowing runway, gaining a large number of Walsh, who to be fair has not been as- pre-funding.”He quite rightly pointed slots because of its new entrant sociated with regulatory protec on- out that the arguments pro and an status. At Gatwick, on the other ism, is just an opening shot in the ap- pre-funding are complex and by no hand, it is already the largest airline proaching ba le on how new runway means all one-sided. However, “al- and would poten ally have had to capacity should be financed. If this is lowing airports to increase charges to contribute substan ally towards the case, IAG is lucky to have easyJet start paying for expansion before a the cost of building new runway as a co-lobbyist. new runway is open could be benefi- capacity, much of which might have BA/IAG has long since lost its role cial to users and investors: gone to new compe tors and li le of as a cosy partner of the Government which is really needed, at least in the v it reduces the amount of finance in developing UK avia on policy. To- short/medium term, by easyJet itself. required and brings forward the point day easyJet is considerably more in- where investment is paid back, and so It is interes ng, however, that fluen al in the corridors of Whitehall. reduces the risk and hence the cost of the airline has firmly opposed pre- Ofcourse,noneofthiswillbeatallrel- that risk; and funding at Heathrow, despite the fact evantunlesstheGovernmentdecides that it would benefit from it. It claims to approve a third Heathrow runway, v by spreading cost over a longer that such an approach would be “un- and that is far from a done deal. period, it reduces the size of the price fair”, but a cynic might suspect it is upli when the runway opens.” New entrant solu on more concerned about se ng future The CAA’s Iain Osborne went even precedents for other airports where There is one possible solu on to the further in his Beesley Lecture in argu- easyJet is an incumbent. slot alloca on/new entrant conun- ing that “pre-funding is, one way or drum. Reading IAG’s posi on another, a natural aspect of market It is likely that those who dra ed opera on,” a statement with which IAG’sposi onismoredifficulttoread. the 50% new entrant rule were re- far from everyone would agree. It already has over 50% of Heathrow’s ally focused on airports where capac- Such arguments are not likely to slots. The acquisi on of bmi’s por o- ity expanded gradually, in rela vely
8 www.aviationstrategy.aero July/August 2015 small chunks. The rule is not nearly This is not a new idea. Indeed, non-discriminatory. as effec ve where there is a one-off Heathrow Airport itself suggested Thus, it is evident that some form substan al increase in slot availabil- something similar in a submission of reform of the EU Slot Regula on ity and high demand for all the new to the Davies Commission: “There would be a way out of the prob- slots.So the obvious answer is to re- are alterna ves that Heathrow is lems associated with the funding of form the Regula on. keen to explore with our airline new UK airport capacity. Such an Economists might argue that a far customers. It may be possible to approach would have a number of be er approach, for example, might replace a propor on of the exis ng benefits, but unfortunately one ma- be to auc on the new slots and use airport charges with a direct pur- jor drawback: it would require agree- the money thereby raised to pay for chase of landing rights by airlines, ment by the 28 Members of the Euro- at least part of the new runway. New with proceeds going either to the pean Union, and the chances of that entrant airlines would not then have Government (and in turn used as a happening any me soon make get- a free ride. contribu on towards the funding of ng government approval for addi- Most Heathrow slots acquired by the capacity expansion), or directly onal runways in the South East of incumbent carriers in recent years to the airport itself. This would need England seem like child’s play. have been paid for, o en involving to be consistent with European rules substan al sums, including BA’s ac- on alloca on of airport slots.” (May quisi on of bmi’s por olio. Such an 2014). approach, while not a total solu on, The Airports Commission itself would appear to be fairer to all con- noted that if the EU Slot Regula on cerned and remove much of the risk could be modified to recognise an in- By Dr Barry Humphreys of market distor on inherent in pre- cumbent airline’s poten al contribu- funding. on rela ve to a new entrant, this Dr Barry Humphreys is an avia on Admi edly most slots currently might be helpful in raising finance for consultant and formerly a Director of Virgin Atlan c Airways and used by Heathrow’s airlines were not the new capacity. Chairman of the Bri sh Air paid for, but they were obtained at However, if the Commission was Transport Associa on. a me when the airport s ll had thinking here of differen al charging, unused capacity, and therefore are rather than avoiding pre-funding not distor ng of compe on. The altogether, there is an added EU airlines involved simply have what complica on in the form of the economists would call a first mover Airports Charges Regula on, which advantage. requires all airport charges to be
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July/August 2015 www.aviationstrategy.aero 9 Rolls-Royce: Under financial pressure, will it be broken up?
East’s first task as opera ons this autumn. He has es on all fronts, raising the ques- he became chief execu- previously stated that the current on of whether there is just an un- W ve of Rolls-Royce Hold- strategy of being in power systems fortunate combina on of trading dif- ings in July was to give yet another on land and sea as well as aero was ficul es in its markets or whether the profits warning. A month later he was broadly right. But that view might good mes were maybe not as good confron ng an ac vist investor, Val- be challenged by his new investors, as they were painted in previous ac- ueAct from San Francisco, which had known for breaking up or shaking up counts, and now is me for a more bought a 5.4% stake, raising fears that many companies in America, such as sober look at the company’s underly- the company might come under pres- Sara Lee and Microso . ing profitability. The answer is: prob- sure to be broken up, with its marine The fourth profits warning in 12 ably a bit of both. and land power businesses sold off. months, downgrading civil aerospace Rolls-Royce’s complicated ac- Mr East wrote to its 54,000 profits by over 25% for 2016 and counts have ever been a headache employees trying to play down that 2017, has added to confusion about for investors and analysts. Now, a er prospect, but admi ng that nothing what is happening to a company that four profit warnings and a queue of had been ruled in or out, while he un l two years ago seemed to be on business woes, they are a persistent did a quick review of the company’s a roll. Now it is beset with difficul- migraine. Tradi onal concerns per-
Rolls Royce Financial Data
Actual Forecast YE Dec 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Civil Aerospace 4,919 5,572 6,437 6,655 6,837 7,097 7,109 7,407 7,604 7,820 7,937 Defence Aerospace 2,123 2,235 2,417 2,591 2,069 2,028 2,028 2,088 2,151 2,216 2,282 Marine Systems 2,591 2,271 1,829 2,037 1,709 1,333 1,133 1,167 1,237 1,361 1,497 Nuclear 1,233 1,083 1,382 667 684 701 722 744 766 789 813 Power Systems 0 331 287 2,831 2,720 2,530 2,530 2,605 2,697 2,805 2,861
Revenue £m Intra-segment sales 0 -215 -143 -147 -155 -155 -155 -155 -155 -155 -155 Group revenue 10,866 11,277 12,209 14,634 13,864 13,533 13,366 13,857 14,300 14,835 15,235 Civil Aerospace 392 499 743 844 942 843 532 568 675 788 853 Defence Aerospace 309 376 395 438 366 355 345 345 344 355 365 Marine Systems 332 287 235 233 138 13 11 58 87 122 150 Nuclear 27 16 78 10 45 46 47 52 57 63 65 Power Systems 0 80 109 294 253 215 220 242 270 286 300 Intra-segment/central -50 -52 -54 -54 -53 -65 -65 -65 -70 -70 -70
EBITA (adjusted) £m Group EBITA 1,010 1,206 1,495 1,767 1,678 1,407 1,090 1,200 1,362 1,544 1,663 Civil Aerospace 8.0% 9.0% 11.5% 12.7% 13.8% 11.9% 7.5% 7.7% 8.9% 10.1% 10.7% Defence Aerospace 14.6% 16.8% 16.3% 16.9% 17.7% 17.5% 17.0% 16.5% 16.0% 16.0% 16.0% Marine Systems 12.8% 12.6% 12.8% 11.4% 8.1% 1.0% 1.0% 5.0% 7.0% 9.0% 10.0% Nuclear 2.2% 1.5% 5.6% 1.5% 6.6% 6.5% 6.5% 7.0% 7.5% 8.0% 8.0% Power Systems N/A N/A 38.0% 10.4% 9.3% 8.5% 8.7% 9.3% 10.0% 10.2% 10.5% EBITA margin Group margin 9.3% 10.7% 12.2% 12.1% 12.1% 10.4% 8.2% 8.7% 9.5% 10.4% 10.9%
Source: Rolls Royce and Berenberg
10 www.aviationstrategy.aero July/August 2015 Rolls Royce Share Price without a link to long-term service contracts. This means future profits 1,300 cannot be pulled forward to make 1,200 the short-term look be er. In effect 1,100 it means less aggressive accoun ng 1,000 (Rolls hired a new finance director from outside the company in the past 900 twelve months) and reported profits GBp 800 that are closer to actual cash flow. On 700 the brighter side, long-term service 600 business should con nue to grow and be very profitable as the number of 500 the new engines in service grows over 400 the next five years. 2010 2011 2012 2013 2014 2015 Meanwhile the pain will be felt with civil aerospace margins falling sist: treatment of upfront finance est version of the A330. Profit mar- from over 12% in 2014 to below 9% from risk-bearing partners (Rolls gins on both outgoing and incom- next year, before recovering, accord- adds to profit; others would see ing products are squeezed—the lat- ing to Berenberg es mates, to nearly loans); pulling forward profits on long ter while produc on costs fall as the 12% in 2020. (Rival General Electric service contracts to make up for li le learning curve steepens, the former has margins over nearly 20%). Even or no profit on actual engine sales; to lure customers to the outgoing Air- that recovery will require costs to be aggressive capitalisa on of the cost bus A330, rather than its re-engined takenoutofthecoreaeroenginebusi- of developing new engines with slow successor. ness, something that was difficult to deprecia on being applied in order There is more woe. Military achieve on Mr Rishton’s watch. Rolls to fla er yearly profits. Add to that engine sales are being hurt by the is a very tradi onal company domi- the lack of transparency on the pile widespread curbing of defence nated by engineers. It seems that Mr of financial deriva ves the company spending, and a downturn in the Rishton—an outsider and a finance runs to handle currency uncertainty markets for both execu ve jets expert —could not command the au- and other risks. and regional aircra are hur ng. thority to drive through changes. It NowthatRolls-Royceisfacingreal Rolls sold out of Interna onal Aero would seem that a er four bruising business problems on all fronts, its fi- Engines, which makes engines for years, he decided to throw in the nancial prospects and aggressive ac- Airbus A320s, and so is out of the towel, even if he was not nudged out. coun ng are coming under scru ny. narrow-body market (80% by vol- On departure he talked wis ully of “a The share price has collapsed from ume) for the foreseeable future. Pra change in lifestyle”. over £12 at the start of last year & Whitney, its erstwhile partner, has Mr East made his name as an to £7.2 towards the end of August. meanwhile achieved a prime posi on engineer who built up ARM, a UK Net profits have sunk to nearly noth- on the biggest and best new private start-up, to become the world’s ing in the marine division which sells jets at the expense of Rolls, while the leading designer of the sort of mi- mainly to offshore oil customers, hit company’s posi on in the regional jet crochips needed for mobile phones, hard by the halving of the oil price. market has been hurt by reverses to though manufacturing was largely The aeroengine business, which ac- the Brazilian Embraer 145’s progress outsourced to Asia. Perhaps those counts for some two thirds of rev- in the market. The profit impact of skills of wringing value out of con- enues and profits, is going through an the Trent 700 run-down alone is put tractors in the supply chain will prove expensive transi on to new products by the company at £150m this year, just as important as shaving pounds such as the Trent XWB (for Airbus’s £250m next year and £200m in 2017. of costs in Derby. A350) and the Trent 7000 to replace An analysis by Berenberg invest- the Trent 700 (Rolls-Royce’s bread- ment bank suggests that more en- winner for two decades) on the lat- gine sales contracts now being done
July/August 2015 www.aviationstrategy.aero 11 An aviation tour of Central Eastern Europe
the September 2008 edi on of founding principles remains to be and 20 million respec vely. Romania Avia on Strategy we looked at seen as its fleet growth con nues has a dis nct topographical barrier in I the developments in the markets unabated over the coming years and the Carpathian mountain range that in Central and Eastern Europe (CEE). will see it grow from its current fleet makes road and rail access between At the me, most of the countries of 65 by the end of 2015 to 106 in Bucharest and the lower Wallachia in the region, whether ex Warsaw 2018. region of Romania to the northern Pact or former Yugoslavia, had ex- Star Alliance is the dominant net- halfofthecountryinTransylvaniaand perienced rela vely strong economic work in the region, connec ng traf- Banat very difficult and me- con- growth star ng in 2000, but 2008 fic through hub airports at Munich, suming(amotorwaycorridorthrough brought about a long and deep re- Frankfurt, Zurich and par cularly Vi- the mountains could be completed cession. This coupled with the strong enna where Austrian has exploited by 2020). These regions have expe- growth of Wizz Air and more recently its historical connec ons especially rienced strong economic growth and the expansion of the E had Equity Al- to the Balkan states. However, Aus- are home to regional airports like liance into the region has had a pro- trian has come under serious compe- Cluj-Napoca, Sibiu, Târgu Mureş and found impact to the region’s avia on on from THY which has expanded Timişoara. industry. its footprint in the region consider- Romania Wizz Air has even become the ably from its Istanbul Ataturk hub, of- de-facto ‘na onal airline’ in Hungary. fering a frequency-driven schedule to Romania has been a major develop- The January 2012 bankruptcy of Hun- feed into its enormous network in the ment market for Wizz which bases gary’s former flag-carrier Malév le CIS countries of the ex-USSR as well as aircra at five ci es. It has a size- Wizz as the largest airline in the Hun- theMiddleEastandfurtherafieldinto ablepresenceinthecapitalBucharest garian market. It successfully fought Africa and Asia. Istanbul’s own rise as where it is vying with na onal car- off a strong challenge from Ryanair an economic and tourist centre has rier TAROM for the number one po- which moved quickly to base its air- also resulted in a strong increase in si on, with seven based aircra at cra at Budapest. Wizz has now se- point-to-point traffic from the CEE re- Otopeni Airport. The second airport cured designa on on some of the bi- gion. inBucharestwhichhadformerlybeen laterally constrained markets, which Most countries in the CEE are too home to most LCCs, Baneasa, was were once the preserve of Malév, to small for domes c flights and thus closed to commercial flights in 2012 des na ons such as Moscow, Dubai, the vast majority of traffic in the re- with all carriers forced to relocate to Tel Aviv, Kutaisi (Georgia) and Baku gion flows across na onal borders. Otopeni which expanded its terminal (though this point was subsequently Notable excep ons are Poland and to accommodate the addi onal traf- dropped). Romania with popula ons of 38.5 fic. Budapest Airport, once a mini- hub for oneworld member Malév with its modern terminal (SkyCourt) Balkan Airlines’ Traffic 2014 built as a facility to facilitate trans- ferring passengers, now finds itself Airline Pax (million) Change (%) (ex-Yugoslavia) with virtually no transfer traffic as Wizz does not yet offer a connec ng Air Serbia 2.3 +68% Croa a Airlines 1.8 +2% product within its own network, let Adria Airways 1.1 +8% alone with other airlines. Whether Montenegro Airlines 0.56 +5% Wizz will con nue to remain true B&H Airlines 0.04 +17% to its ULCC (Ultra Low Cost Carrier)
12 www.aviationstrategy.aero July/August 2015 several failed a empts to priva se Wizz Air Route Network or restructure Air Serbia’s predeces- sor, Jat Airways (Yugoslav Airlines), Trondheim in 2013 the Serbian government Aalesund Base Airport managed to sell a 49% stake in Jat Destination Bergen Turku to E had Airways in a deal believed
Haugesund Oslo Stavanger Stockholm to include other state owned assets Kristiansand Gothenburg in non-avia on industries. Jat was Riga
Glasgow on the brink of bankruptcy in 2013, Billund Malmo Moscow Belfast Gdansk Vilnius facing increasing compe on from Hamburg Doncaster Szczecin Liverpool Groningen Wizz’s Belgrade opera ons, while London LTN Poznan Warsaw Eindhoven Dortmund Bristol Maastricht Lublin easyJet entered the market with Cologne Wrocław Brussels Katowice Kiev Frankfurt Prague Lviv Paris Nuremberg three new routes in early 2013. Brno Poprad/Tatry Kosice Memmingen Debrecen Basel Friedrichshafen Budapest Iasi Jat operated a fleet of ageing air- Cluj Chisinau Arad Târgu Mures Geneva Bergamo Ljubljana TimisoaraSibiu cra , 10 of which were 737-300s (Jat GrenobleMXP VeronaVenice Belgrade Cuneo Bologna Tuzla CraiovaBucharest Pisa Split was the European launch customer Perugia Nis Varna Sofia Bourgas FCO Pescara Kutaisi Zaragoza Girona CIA Skopje for the type in 1985), and five ATR Barcelona NaplesBari Ohrid Sabiha Gokcen Madrid Alghero Thessaloniki Baku ValenciaPalma Kerkyra 72s. Some of the Boeings were be- Lisbon Alicante Catania Zakinthos ing cannibalised to keep the other Antalya Malaga Rhodes Malta Heraklion 737s airworthy. The average age of Larnaca the aircra was over 20 years. The Tel Aviv deal with E had included a manage- ment contract whereby E had re- Hurghada placed several senior members of the Dubai airline’s management with its own hires, a complete re-branding from TAROM operates a curious mixed following a protracted legal dispute Jat to Air Serbia, and the introduc on fleet of 23 aircra , consis ng of two withWizz.Itsbusinessmodelhadfea- of 10 Airbus narrowbodies (A319s A310s (once used for long haul flights tured connec ons at Timişoara from and A320s). Four of the 733s remain, to New York), eight 737s, four A318s Romania and neighbouring Moldova being principally used for the airlines and nine ATRs (both -72s and -42s). and Ukraine primarily to Italy where charter brand, Aviolet. The ATRs re- It has been the subject of priva sa- there is a diaspora of about one mil- ceived extensive cabin upgrades and on conjecture over the years with lion Romanians. two newer 72-500s entered the fleet. recent reports indica ng the Roma- Blue Air is a locally owned LCC In2007thepercentageofpassen- nian government in talks with THY. It with an all-Boeing fleet of 15 air- gers connec ng at Belgrade Airport is difficult to see a ra onale for Turk- cra (both Classics and NGs) based in was just 3%. Since the transforma- ish taking a minority stake (as it is Bucharest, Bacau, Iasi plus Larnaca in on of Jat Airways into Air Serbia and non-ECAA, it could not take a major- Cyprus (following the bankruptcy of the focus on establishing Belgrade as ity stake in TAROM) unless perhaps Cyprus Airways). Its future has also a mini-hub, transfer passengers are the government were to include the been the subject of much debate as it es mated to have risen to over 30% four airports it owns (Timişoara in the faces s ff compe on from TAROM, of the total. Air Serbia’s schedule is west of the country, both Bucharest Wizz and Ryanair. centred around three banks of flight airports and Constanta on the Black Serbia arrivals/departures during the en re Sea coast). season and four banks (the fourth be- Romania had been the only CEE The past two years has seen a dra- ing in the midnight hours of 00:00- country with a regional network car- ma c and unexpected change to 01:00) in the peak summer. This op- rier, Timişoara-based Carpatair, but the avia on landscape in Serbia, era on has doubled the u lisa on Carpatair filed for bankruptcy and the largest of the former Yugoslav of the fleet. The effect on passenger ceased scheduled opera ons in 2013 republics by popula on. Following numbers for the first full year of Air
July/August 2015 www.aviationstrategy.aero 13 Serbia, calendar year 2014, and the contrast with other ex-Yugoslavian CEE Airports (’000 pax) airlines is shown below. During the first seven months of Airport 2014 2013 2012 2011 Country the year, Belgrade Airport handled Prague 11,150 10,974 10,808 11,789 Czech Republic 2.7m passengers in total, an increase Warsaw 10,590 10,656 9,586 9,338 Poland of 6.9% on 2014, with 2015 expected Budapest 9,156 8,521 8,504 8,921 Hungary to break the previous record set in Bucharest Otopeni 8,317 7,643 7,120 5,049 Romania Belgrade 4,639 3,543 3,364 3,125 Serbia 2014, with around 5m passengers, Krakow 3,820 3,648 3,439 3,014 Poland close to its capacity. As a result, Sofia 3,815 3,504 3,467 3,475 Bulgaria the airport has announced plans to Gdansk 3,288 2,870 2,906 2,464 Poland expand Terminal 2 with four new Katowice 2,696 2,544 2,551 2,544 Poland Bourgas 2,530 2,480 2,381 2,253 Bulgaria air bridge gates capable of handling Zagreb 2,431 2,293 2,342 2,320 Croa a widebody aircra and addi onal Wrocław 2,084 1,920 1,997 1,657 Poland bussing gates. This is expected to Tirana 1,810 1,757 1,665 1,817 Albania grow capacity to about 8m. Construc- Chisinau 1,781 1,321 1,220 1,046 Moldova Split 1,753 1,582 1,425 1,300 Croa a on is expected to commence later Warsaw Modlin 1,703 344 898 Poland this year and take between 14-16 Dubrovnik 1,584 1,523 1,480 1,350 Croa a months. Poznan 1,445 1,355 1,596 1,464 Poland French concession and construc- Pris na 1,427 1,629 1,527 1,424 Kosovo Varna 1,387 1,319 1,221 1,182 Bulgaria on company Vinci signed a MoU Bra slava 1,356 1,373 1,416 1,585 Slovakia with Belgrade Airport back in Novem- Ljubljana 1,307 1,268 1,168 1,287 Slovenia ber ’14 and recently confirmed its Skopje 1,211 984 836 764 Macedonia interest in a concession of Belgrade Cluj Napoca 1,182 1,036 932 1,005 Romania Airport earlier this year. It is s ll Tivat 911 898 725 647 Montenegro Timişoara 735 750 1,036 1,203 Romania unclear which priva sa on model, Sarajevo 710 666 580 600 Bosnia & Herzegovina if any, the Serbian government will Podgorica 702 691 637 612 Montenegro adopt. There has been widespread Rzeszow 600 590 562 488 Poland discussion of establishing a state run Zadar 497 473 371 285 Croa a Brno 486 463 569 558 Czech Republic holding company called “Airports Pula 375 354 367 353 Croa a of Serbia” that would manage up Kosiče 357 237 236 266 Slovakia to 25 of Serbia’s airports, including Târgu Mureş 344 357 300 Romania Belgrade. Apart from Nis airport Bacau 313 307 393 337 Romania Bydgoszcz 289 344 340 280 Poland in the south of the country which Szczecin 287 348 356 262 Poland has recently succeeded in a rac ng Iaşi 273 232 173 184 Romania Wizz Air, none of the other airports Łodz 254 354 441 389 Poland operate commercial flights. Indeed, Sibiu 250 223 206 190 Romania Lublin 188 190 6 Poland many are GA airports with grass runway strips or military airfields. Serbia was updated to US FAA Category 1 status in 2014. Prior to that, Serbia‘s status as an FAA IASA from Tashkent to New York City via ber which would remove the last category 2 country prohibited the es- the Serbian capital in 2004. A bilat- remaining administra ve barrier to tablishment of any new direct com- eral agreement between Serbia and flights. mercial flights between Serbia and the US was signed in May this year. The failure of other airlines in the the US by a Serbian carrier. There According to local media reports, the region to make a success of direct have not been any scheduled direct FAA will perform a final inspec on transatlan c flights doesn’t bode flights between Belgrade and the US checks on Serbia’s readiness to han- well — CSA from Prague, Malév and since Uzbekistan Airways ran services dle transatlan c flights this Septem- American Airlines from Budapest
14 www.aviationstrategy.aero July/August 2015 and TAROM from Bucharest. All easyJet. The new terminal which will for expressions of interest for a 91.6% three ci es are larger markets then boost terminal capacity to 5m-plus stake in the company in July ’15. This Belgrade. The challenge for Air Serbia passengers. By the end of this year, follows a failed a empt in August will be to generate enough feed the steel roof and the exterior of the 2012. Specula on has centred on a into its Belgrade hub from regional terminal building will be completed number of poten ally interested par- airports such as Skopje, Podgorica, with the transi on of opera onsfrom es, including: Air India, China South- Sofia, Bucharest, and even Beirut and the exis ng terminal expected in Q1 ern, Qatar Airways, Royal Jordanian Tel Aviv, which it serves along with 2017. and THY. Interes ngly, Royal Jorda- an interline or code share agreement Croa an Airlines, with a fleet of nian came second in the priva sa- on the US side. The Star Alliance will 12 aircra (2 x A320, 4 x A319 and 6 x on of Bosnia’s B&H Airlines, a pro- not take this incursion into what it Q400), recorded a net loss of €12.8m cess ‘won’ by Turkish back in 2008. sees as its “backyard” lightly; a fierce for the first half of 2015 with passen- China Southern is believed to have price ba le is likely pu ng strong gers totalling 802,559. This compares proposed a joint bid for Ljubljana Air- downwards pressure on yields. It also unfavourably with a €3.9 million loss port and Adria back in 2013. In the remains ques onable whether flights in H1 2014. With exis ng Zagreb traf- mean me, Adria has been busy tak- from Belgrade to either or both of fic accoun ng for about 50% of the ing advantage of its EU/ECAA status New York or Chicago would a ract capacity of the new terminal, it re- to base aircra in niche markets in enough business passengers willing mains to be seen whether the Croat- other parts of Europe where it sees to pay a premium for a direct service iangovernmentcanfindasustainable opportuni es. It now bases aircra that will save them 4-5 hours of total solu on for its flag carrier under pri- in Łódź in Poland — a secondary travel me to current one-stop prod- vate ownership; otherwise the pres- city 130km south west of Warsaw — ucts with Star Alliance or SkyTeam. sure on the concessionaires to a ract along with Tirana in Albania. The other challenge remains the LCCs will be formidable. Bosnia seasonality of the market. At present, Slovenia traffic flows between Belgrade and Bosnia’s flag carrier, B&H Airlines, North America in the June-August The Slovenian government in 2014 had its AOC revoked in mid-July un- period are 2.5 mes greater than dur- sold its holding in the capital city air- l October ’15, marking the final nail ing the seven the 7 months between port, Ljubljana, to Fraport for a re- in the coffin of the troubled flag car- October and April. ported €234.4m. LJU handled 1.34 rier. The Sarajevo-based na onal flag million passengers in 2014. Fraport carrier was established as Air Bosna Croa a has enjoyed a strong start to 2015 in August 1994 by the government Despite its flag carrier Croa a Airlines with pax numbers of 798,297 in the of Bosnia and Herzegovina and re- lurching from crisis to crisis, with nu- first seven months, an 11% increase branded from its original name of “Air merous industrial disputes disrup ng on the same period in 2014. Other Bosna”inOctober2006.Duringitsex- its opera ons, the Croa an govern- bidders included Vinci, but Adria’s istence, B&H Airlines was, for a short ment managed to sell a 30 year con- Star Alliance membership and near period, partly owned and managed cession in Zagreb Airport to an Aéro- totaldomina onoftheairportbyStar by THY which purchased a 49% stake ports de Paris (AdP)/ Bouygues led Alliance carriers may have pped the in2008.THYreturnedthesharetothe consor um in December 2013. The balance in favour of Fraport. For now Bosnian state for free in 2012 follow- concession terms required immedi- there are no plans for any major cap- ing disagreements with the govern- ate construc on of a new terminal to ital expenditure in the airport whose ment. replace the exis ng one which dates exis ng runway and terminal should Icar Air is now the only Bosnian- back to the 1960s and operates at be adequate for the foreseeable fu- registered carrier with a func onal over 100% of its design capacity. Par- ture. AOC. The privately-owned airline, ally as a result, Zagreb is somewhat Slovenia’s flag carrier Adria Air- holds a DHL contract and runs freight unique amongst EU capital city air- ways is itself the subject of a second services between Sarajevo and the ports (Croa a joined the EU as its priva sa on a empt. The Slovenian Italian coast with a Let L-410. The 28th member in July, 2013) in not be- government appointed KPMG as sell Federa on government of Bosnia ing served by either Ryanair, Wizz or side advisors and they issued a call and Herzegovina is now considering
July/August 2015 www.aviationstrategy.aero 15 se ng up yet another successor flag the subsidies and now operates two saw CSA first exit a number of re- carrier, with local media quo ng the based aircra (with a third to arrive gional feeder routes and substan ally Prime Minister as being willing to soon). With Wizz now the dominant de-hub Prague to focus on connect- commit the rather modest sum of airline in Skopje, TAV has been pub- ing bilaterally constrained markets to €2.7m for a new airline that would licly suppor ng the business case for the CIS na ons to the east with those ini ally operate with a single leased a government sponsored flag carrier western European markets that have aircra . The Bosnian government in order to reduce dependence upon strongO&DoftheirownfromPrague. recently ruled out priva sa on of the such a price sensi ve LCC like Wizz Korean leased an A330-300 to CSA main airport in Sarajevo. Air. It remains to be seen if there to operate Prague-Seoul flights previ- would be any appe te for a ra onale ously served its own 777. FYROM (Macedonia) investor to enter a market of some Prague airport remains state Turkish airport operator TAV entered 1 million passengers per year in one owned and rela vely expensive, and the Macedonian market in 2010 hav- of Europe’s poorest countries where has shown an unwillingness to enter ing been selected to operate a 20 year Wizz dominates. The unstable poli - into airline agreements with high concession for the landlocked coun- cal environment will not help either growth LCCs. This has acted as a bar- try’s two airports, Skopje (capital city) following months of violent protests rier to entry for the likes of Ryanair and Ohrid, a tourist des na on in the aimed at the incumbent government and has kept Wizz and easyJet’s west of the country. TAV quickly be- of Nikola Gruevski. growth in Prague to a minimum. gan the process of building a new Czech Republic terminal in Skopje. It also embarked on a process whereby the Macedo- TheCzechRepublicwasthefirstcoun- nian government opened tender pro- try in the region to secure a (minority) ceduresforairlinestoapplyforgener- investment in its state owned airline. By Robert Cullemore ous subsidies to operate new routes A er a series of failed priva sa on robert@avia onstrategy.aero over a three year period from Skopje, a empts. Korean Air acquired a 44% which has not had a based carrier fol- stake in Czech Airlines (CSA) for €2.64 lowing the 2009 bankruptcy of MAT million in 2013, and subsequently as- Airways. Wizz successfully applied for sisted in a restructuring effort. This
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16 www.aviationstrategy.aero July/August 2015 JetBlue: At last, closing the margin gap with peers
lo y second-quarter profit nary profit growth for 2015. Analysts’ a new contract because of cri cism margins reported by US carri- consensus es mates see JetBlue’s from the financial community over T ers have generally failed to im- EPS surging by 163% this year, com- JetBlue’s lagging margins, ROIC and press airline investors, who remain pared to 35%-116% EPS growth for share price performance. concerned about nega ve unit rev- the four largest US carriers. JetBlue had already implemented enue trends. As a result, US airline JetBlue’sPRASMtrendsareallthe a sweeping management reorganisa- stocks remain down in the dumps af- more remarkable given the carrier’s on in the spring of 2014, which had ter falling sharply in the spring. rela vely brisk ASM growth, which included the departure of COO Rob But JetBlue Airways has been an is expected to be at the higher end Maruster. And it had strengthened excep on. New York’s hometown of the 7-9% guidance, following 5.1% cri cal areas by promo ng Marty St. airline (the fi h largest US carrier) has growth in 2014 and 6.9% in 2013. Al- George to SVP Commercial and bring- bucked the nega ve industry trend though Southwest is also stepping up ing an airline analyst from Credit Su- and con nued to report PRASM its growth this year, to 7% from 0.5% isse (Kevin Crissey) to the role of Di- growth: 4.5% in Q1 and 1.4% in Q2. in 2014, the top three carriers will see rector Investor Rela ons. The la er outpaced the industry by 2.5% ASM growth at most. The management changes were as much as seven percentage points. JetBlue has had an even ul 12 interpreted as a shi in culture that As a result, JetBlue was the month or so; the key changes have would focus more on costs and mar- best-performing US airline stock in been the following: gins and be more investor-friendly, January-July. The price surged by v New leadership rather than customer-friendly. 46%, compared to a 10% decline by the NYSE Arca Airline Index (XAL). Robin Hayes (formerly JetBlue’s pres- v New plan to drive shareholder The combina on of enormous ident, ex-BA) took over as CEO from returns fuel cost savings, good cost controls Dave Barger when the la er’s con- and the PRASM improvement will tractexpiredinFebruary2015.Barger At its investor day in November 2014, mean JetBlue repor ng extraordi- had faced some pressure not to seek JetBlue unveiled a “long-term plan to drive shareholder returns”, which in- cluded measures to boost revenues, JetBlue’s Financial Results reduce capital commitments and maintain a compe ve cost posi on. 800 8,000 Revenues JetBlue aimed to strike a compro- 700 7,000 mise between pleasing Wall Street Opera ng result 600 6,000 and remaining true to its core values. 500 5,000 In addi on to boos ng profits, free
400 4,000 $m cash flow and ROIC, the measures Net result
$m would enhance the airline’s “product 300 3,000 advantage and service-oriented cul- 200 2,000 ture”. CEO Robin Hayes stated: “Jet- 100 1,000 Blue’s core mission to inspire human- 0 0 ity and its differen ated model of -100 serving underserved customers re- 200120022003200420052006200720082009201020112012201320142015F2016F mains unchanged”.
Note: Analysts’ consensus forecasts (Aug 5, 2015) The revenue ini a ves outlined in the plan were expected to generate
July/August 2015 www.aviationstrategy.aero 17 exactly which revenue ini a ves or JetBlue Route Network strategies might help explain the sud- den PRASM strength. ANC The answer was a surprise: core demand strength, reflec ng JetBlue’s excep onally strong route network
SEA and revenue management. In addi- PDX BTV ROC DTW BUF SYR ORH PWM on to “strong execu on”, the exec- ORD SWFBDL BOS HPN MVY SLC CLE LGAJFKPVDACK DEN PIT PHL EWR u ves men oned matura on of the SMF IAD SFO DCA BWI OAK RDURIC SJC LAS CLT network and the benefit of having ABQ BUR CHS LAX LGB PHX DFW SAV BDA SAN JAX limited exposure to so er global mar- AUS HOU MSY TPA MCO kets and unfavourable currency de- SRQ PBI RSW FLL NAS velopments. PLS CUN POPAZS The Mint routes represented only GCM PUJBQNSJU MBJ PAP STI STT KIN PSE STXSXM SDQLRM 7% of JetBlue’s ASMs and the pre- UVF BGI AUA CUR miumseatson those routesonly 0.7% CTG LIR SJO POS of ASMs in 2Q, so the overall PRASM MDE BOG impact was marginal. And many of the other revenue ini a ves are too new to show much impact. Core network strength LIM As JetBlue execu ves put it in the second-quarter call: “A big chunk of $400m-plus in addi onal annual op- egy, June 2014). There is “Fly-Fi”, the benefit has come from a lot of the era ng income beginning in 2017. which JetBlue claims is the fastest network investments we have made As part of the plan, JetBlue an- in-flight wifi product in the industry. over the last several years, especially nounced the deferral of 18 Airbus air- There is the older-established “Even in La n America”. All six of the car- cra orders from 2016-2018 to 2022- More” extra legroom product that rier’sfocusci es—NewYork,Boston, 2023 — a move that will reduce cap- offers “industry-leading comfort and Fort Lauderdale/Hollywood, LA/Long ital expenditures by $900m through value”. Beach, Orlando and San Juan — were 2017. In June 2015 JetBlue also re- profitable and had margin expansion JetBlue also announced a com- vamped its fare structure. It now has in 2Q. mitment to maintain ex-fuel CASM three branded fare bundle op ons Whether it is due to luck or smart growth below 2% through 2017. In known as “Fare Families” (Blue, Blue earliernetworkdecisions,JetBluehas the longer term, unit costs would Plus and Blue Flex), each of which benefited this year from having min- benefit from strategies such as up- has different offerings, such as free imal exposure to the worst compet- gauging the fleet with larger A321s checked bags, reduced change fees i ve hotspots, such as Dallas and and increasing the number of seats and addi onal FFP points. It is an al- Chicago. on the A320s by 15 or 10% (to 165). terna ve approach to the sta c fees This year JetBlue has benefited v New revenue ini a ves employed by many other airlines. from compe ve capacity reduc ons JetBlue also talked about a rev- in its key markets. As a result, the In the past year, JetBlue has had enue ini a ve called “A320 cabin re- airline has seen excep onally strong numerous new revenue ini a ves in fresh”. It means ou i ng the A320 PRASM performance especially in the various stages of development. There fleet with a cabin similar to the A321’s Caribbean/La n America region. is “Mint”, the premium transcon- highly acclaimed cabin. Thanks to Mint and compe tors’ nental product launched in June Given all of those changes, Jet- capacity reduc ons, JetBlue is also 2014 that has caused quite a s r Blue faced intense ques oning from doing extremely well in the transcon in the market (see Avia on Strat- analysts on its second-quarter call on market. Even the more marginal
18 www.aviationstrategy.aero July/August 2015 transcon routes, such as those from FLL, are now solidly profitable. JetBlue’s Fleet and Firm Order Book JetBlue is predominantly a point- to-point carrier, with most of its at end June 2015 Aircra in opera on Firm Orders† Delivery Schedule routes touching at least one of the six A321 19 27 2015-2018 focus ci es and 86% of its customers A320 130 flying on nonstop i neraries. Its route E190 60 24 2020-2022 A321neo 45 2018-2023 network now covers 90 ci es. A320neo 25 2020-2022 JetBlue’s greatest strength is its Total 209 121 posi on in New York, the na on’s largest travel market. JetBlue is the Note: † JetBlue has flexibility to subs tute any of the Airbus orders for other variants of the A320 family. second largest operator at JFK in terms of domes c capacity (36% of the seats), and it serves all five New York area airports. work in October (its 35th des na on to Boston. In other words, JetBlue is Having spo ed an opportunity in in the region). The airline will oper- arguing that its growth is adding com- 2009 to grow in Boston, JetBlue is ate daily A320 flights from FLL and Or- pe on not only in the US but also in now Logan’s largest carrier, with 26% lando. its partners’ long-haul interna onal of total seats and almost 60 nonstop JetBlue has been excep onally markets. des na ons. Boston was a major and successful in the US-Colombia market In recent months JetBlue has risky investment but it is paying off since first venturing there in 2009; it been vocal in cri cising the larger handsomely. More growth is in the now operates to Bogota, Cartagena carriers’ immunised JVs, going as far pipeline in Boston as JetBlue works and Medellin. Lima (Peru) followed in as calling for a review of the con- towards a target of 150 daily flights. 2013. A third South American coun- sumer benefits of such deals. “Le The Caribbean/La n America re- try, Ecuador, looks set to follow in unchecked, this US government- gion (including Puerto Rico) has been first-quarter 2016 (FFL-Quito). sanc oned collusion will con nue a huge success story for JetBlue. The JetBlue has long eyed South to s fle innova on and compe on markets have year-round demand, American markets such as Brazil in interna onal avia on and will di- have matured quickly, generally but its A320s or A321s do not have rectly harm JetBlue and consumers”, require minimal up-front capital the range. But the poten al future the carrier wrote in its recent Gulf and are nicely profitable. Almost a availability of the A321LR may have subsidies row related submission. third of JetBlue’s capacity is now in brought such plans, as well as flights Of course, JetBlue can be ex- that region (compared to 26% on to Europe, a li le closer (more on pected to side with the Gulf carriers the transcon). JetBlue is already the that below). because Emirates, E had and Qatar largest US carrier in the Caribbean, On the alliance front, JetBlue’s fo- are among its codeshare part- domina ng markets such as Puerto cus has shi ed from signing up new ners. But JetBlue is also concerned Rico and the Dominican Republic. interline partners (now around 40) to about some of the La n American JetBlue has called the region “a deepeningexis ngrela onships(typ- alliance developments, such as natural out of New York”. However, ically into codesharing). Delta/Aeromexico’s ATI applica on, much of the growth now focuses on Interes ngly, JetBlue execu ves given the slot constraints at Mexico FLL (the lower-cost alterna ve to Mi- noted the posi ve effect Boston is City. JetBlue itself found it hard to ami) or on adding service to a des - having in many of its partnerships. secure slots at MEX for its planned na on from mul ple focus ci es. FLL For example, the combina on of Jet- services. now offers 40-plus JetBlue des na- Blue’s growth in Boston and the per- Fleet considera ons ons and is seeing both domes c and formance of its partnership with El Al interna onal growth, with eight new in New York led the Israeli carrier to JetBlue operates a 209-strong fleet ci es launching in late 2015 or 2016. add Boston to its network in June. El (19 A321s, 130 A320s and 60 E190s) This year’s highlight is the addi- Al was the sixth exis ng or new part- and has another 121 aircra on firm on of Mexico City to JetBlue’s net- ner of JetBlue’s that began opera ng order. In the past two years, the air-
July/August 2015 www.aviationstrategy.aero 19 line has deferred some orders (to re- JetBlue Share Price duce and smooth out near-term de- liveries) and begun a switch to larger 30 JetBlue gauge aircra (A321s). 25 All of the deliveries through 2017 20 Rela ve are A321s. JetBlue operates the 15 type in two sea ng configura ons — regular and lower-density Mint. 10 The planned expansion of Mint will 8 mean JetBlue conver ng some of next year’s A321 deliveries to the 6 5 lower-density version. 4 JetBlue has flexibility to switch any of the Airbus orders for other 3 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 variants of the A320 family. That raises the interes ng prospect that JetBlue could become an early cus- second quarter, meaning that the configura on. tomer for the longer range version of carrier effec vely closed the margin The risks also include poten al the A321neo that Airbus is now pitch- gap with its peers. If the significant nega ve feedback from customers. ing as an alterna ve to the 757. The projected revenue growth from the The fare op ons clandes nely intro- A321LR is s ll under development new ini a ves materialises, JetBlue duced first checked bag fees at Jet- but could be available from 2019. could start outperforming the indus- Blue (for the cheapest “Blue” op on). In recent months, JetBlue execu- try in margins in the next couple of But paying for baggage has largely be- ves have gone on record to say that years. come accepted prac ce for US trav- they are seriously interested in the The signs are promising. Mint, ellers; Southwest is now the lone A321LR, which would offer full com- which is currently available only on holdout in that regard. monality benefits with the exis ng two transcon routes out of JFK, has JetBlue hopes to mi gate a po- Airbus fleet and facilitate expansion wonJetBluemanynewcorporatecus- ten al consumer backlash to the in- into markets further afield. tomers. It has significantly improved creased A320 seat count by maintain- In the first place, JetBlue would transcon margins. So JetBlue is bring- ing a be er than industry average use the aircra for a push deeper into ing Mint to the Boston transcon mar- seat pitch (it will be installing “lighter, South America. JetBlue is currently kets in March 2016, as well selected more comfortable” seats) and by up- not considering flights to Europe, but CaribbeanroutesoutofNewYorkand grading the interiors to include larger many of its customers have asked for Boston this winter. seatback screens, etc. A similar prod- suchroutes,soitmayonlybeama er Early results from the June fare uct on the A321s has generated posi- of me. revamp are also encouraging. JetBlue ve customer feedback. expects the move to generate at least So JetBlue is very bullish about Closing the margin gap $65m in incremental opera ng in- the future payoff of the A320 “seat JetBlue has always been successful in come this year and more than $200m densifica on” project, which is ex- the marketplace, inspiring customer annually by 2017. pectedtobegininmid-2016.Itislikely loyalty much like Southwest and However, the new strategies add to have a highly favourable impact on WestJet have done. Now JetBlue complexity and could be challeng- unitcostsandbea“veryROICposi ve is proving that it is possible for an ing to execute. For example, while way to increase capacity”. up-market, middle-sized, non-niche JetBlue sees many opportuni es for The A320 project will help offset LCC to be also financially successful Mint, in the Caribbean markets it will longer-term cost pressures in areas if it has the right route network and have to balance the incremental rev- such as labour and maintenance. One revenue strategies. enues from Mint against the signifi- risk area is pilot costs, because Jet- JetBlue’s opera ng margin cant economic benefits of opera ng Blue’s pilots unionised in 2014, but surged from 9.4% to 17.5% in the A321s in the regular higher-density talks are s ll in the early stages and
20 www.aviationstrategy.aero July/August 2015 there is no near-term impact. and Fitch have all raised JetBlue’s one is bothered about that, though, For the me being, JetBlue’s unit credit ra ngs this year. because the strong liquidity (25% of cost performance remains exem- Notably, JetBlue entered into annual revenues) and accelera ng plary. In 2Q non-fuel CASM inched an “accelerated share repurchase” profit and free cash flow genera on up by only 0.6%, and the full-year with Goldman Sachs in June, paying mean that it is only a ma er of me predic on is 0-1.5%. $150m for an ini al repurchase of before JetBlue catches up. JetBlue is using the oil windfall, in its shares. But JetBlue execu ves the first place, to strengthen its bal- described it as a “policy, not a com- ance sheet. It is opportunis cally pre- mitment”; the programme is mainly paying debt and buying many aircra aimed at offse ng dilu on from By Heini Nuu nen with cash. Its interest costs have de- stock issuance to management and heini@theavia oneconomist.com clined, leverage ra os have improved employees. and as many as 46 of its aircra are So JetBlue is behind its peers in now unencumbered. S&P, Moody’s returning capital to shareholders. No-
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July/August 2015 www.aviationstrategy.aero 21 The Principals and Associates of Avia on Strategy apply a problem-solving, crea ve and pragma c approach to commercial avia on projects. Our exper se is in strategic and financial consul ng in Europe, the Americas, Asia, Africa and the Middle East, covering:
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