Issue no. 214 March 2016

HNA Group: creating a This issue includes mysterious global Page conglomerate Dream 1

are few conglomerates in the world of aviaon born out Raonalising the of the establishment of an airline, and none seemingly with intra-European market 6 T such overwhelming ambion as the HNA Group. Chairman and founder,Chen Feng, has stated that “by 2020 we can become one of the Finnair: East by Northeast 10 world’s top 100 companies and by 2030 we want to become one of the top 50”. And yet it is privately owned; its ownership, financial data and LATAM: Impressive cost structure obscure and opaque. cung and fleet HNA Group grew out of Grand China Airlines was established restructuring 15 Airlines, now China’s fourth largest as a parent company for the listed airline. The airline, based in the his- and the group ac- torically piracal tropical island of quired control of a handful of smaller Hainan, was formed by Chen Feng carriers: Chang’an, Xinhua and in 1993 in an unusual public/private Airlines. partnership with the regional gov- Now HNA Group is mulnaonal, ons (how it jusfies this claim is un- ernment of Hainan Province, later in a sprawling conglomerate with fin- clear); ownership of at least 8 air- 1995helpedbyasmallinial$25min- gers in many pies primarily relang to ports, 330 retail stores, 440 hotels, a vestment from George Soros’ Quan- transport and tourism, boasng rev- fleet of 40 ships of various types, a tum Fund apparently creang the enues of RMB190bn ($30bn) in 2015, shipbuilding yard, the world’s largest first sino-foreign “joint venture” air- assets of over RMB600bn and major container leasing operaon, and the line. The group itself was established or controlling stakes in 11 listed com- world’s fourth largest aircra leasing in 2000 — at the same me as as the panies. business. CNAC’s domesc industry reforms It lays claim to a fleet of over The group structure seems to be that created and promoted the top 820 aircra, carrying over 77m pas- set out under five main “pillars”: three holding companies of , sengers on 700 routes involving 210 v HNA Aviaon China Southern and China Eastern. domesc and internaonal desna- The aviaon segment is the core of the scheduled airline business based around Hainan Airlines and HNA GROUP: FIVE CORE PILLARS its domesc Chinese subsidiaries. As shown in the ownership chart of HNA Group Hainan Airlines on page 5 (extracted from a recent capital issuance filing) HNA Group only has a direct share- holding of less than 5% in the capital HNA Aviaon HNA Tourism HNA Logiscs HNA Holding HNA Capital of Hainan Airlines, and indirect inter-

Commercial Airlines Airports Financial Services Charter Airlines Shipbuilding est of around 8% before eliminang Air Cargo Retail Container Leasing Travel Agents Marine Transport Maintenance Real Estate Aircra Leasing Hotels Commodity Trading cross-shareholdings but maintains Handling management control. It states that it operates and manages Hainan Airlines, Tianjin

Published by Aviation Strategy Ltd Aviation Strategy Airlines, Deer Jet, Lucky Air, missed out to Ontario Teachers). Capital Airlines, West Air, Fuzhou As of the end of 2015 the com- ISSN 2041-4021 (Online) Airlines, Urumqi Air, Beibu Gulf pany states that HNA Real Estate This newsleer is published ten mes a year Airlines, Yangtze River Airlines, Guilin held investments in over 40 cies, by Aviaon Strategy Limited Jan/Feb and Jul/Aug usually appear as combined issues. Airlines, MyCargo (Turkey), Africa with 41 projects covering around Our editorial policy is to analyse and cover World Airlines (based in Ghana), 6 million m2 under construcon. It contemporary aviaon issues and airline and French based Aigle Azur (48% holds 20 property projects including strategies in a clear, original and objec- ve manner. Aviaon Strategy does not owned). It also has a 45% stake each office buildings, businesses, hotels, shy away from crical analysis, and takes a in Hong Kong Airlines and HK Express. and apartments, with an area of global perspecve — with balanced cover- In addion it has recently acquired a 867,000m2 and is currently devel- age of the European, American and Asian 2 markets. small 6% stake in the South African oping 10,000m Hainan’s CBD and regional carrier (and Brish Airways a 49,000m2 Pearl River man-made Publisher: franchise partner) Comair, plus a island. 24% stake in Azul in Brazil, a David HNA Retail claims ownership of Keith McMullan James Halstead Neeleman airline, which in turn is in brands like (quoted) Xi’an Minsheng the process of buying 40% of TAP Air department stores, Hunan Joindoor Editorial Team Portugal. supermarkets, Baoji Retailing, Shang- v HNA Holdings hai Jiadeli supermarkets, Hainan Keith McMullan Seaview Internaonal Plaza, and kgm@aviaonstrategy.aero The “Holdings” pillar appears to in- corporate the group’s investments in nearly 330 outlets with operaonal James Halstead 2 jch@aviaonstrategy.aero airports, retail and real estate. areas of over 1.2 million m . Under HNA Airports it claims v HNA Capital Tel: +44(0)207-490-4453 ownership and operaon of eight HNA Capital is the Group’s financial Fax: +44(0)207-504-8298 airports in China, with maybe five sector arm. There is not a lot of in- others under “cooperaon projects”, formaon. The group states that “its Subscriptions: dealing in total with 35mppa. These main businesses are leasing, insur- info@aviaonstrategy.aero encompass Meilan, Sanya ance and trust etc. It has tradional Phoenix, Qionghai Bo’ao, (all three and innovave financial services such Copyright: on Hainan Island), Yichang Sanxia as securies, banking, futures, fund, (Hubei Province), Weifang Nanyuan investment banking, insurance and ©2016. All rights reserved ( Province), Manzhouli Aviaon Strategy Ltd Xijiao (Inner Mongolia), Anqing Registered No: 8511732 (England) Tianzhushan (dual military/civil in HNA AIRPORTS Registered Office: 137-149 Goswell Rd Anhui Province), Tangshan Sannühe London EC1V 7ET (dual military/civil in Heibei Province) Manzhouli VAT No: GB 162 7100 38 and Songyuan Chaganhu Airport ISSN 2041-4021 (Online)

(new build, Jilin Province, due to Songyuan Chaganhu open 2016). Haikou Meilan and The opinions expressed in this publicaon Sanya Phoenix are the two largest Tanshan Sannuhe donotnecessarilyreflecttheopinionsofthe airports on Hainan with passenger Weifang editors, publisher or contributors. Every ef- throughput of over 16mppa each, fort is made to ensure that the informaon contained in this publicaon is accurate, but while Qionghai Bo’ao is a new build Yichang Anqing Tianzhushan no legal reponsibility is accepted for any er- on Hainan island that opened in rors or omissions. The contents of this pub- March. licaon, either in whole or in part, may not The group is looking for invest- be copied, stored or reproduced in any for- Haikou mat, printed or electronic form, without the ment further afield and had been Qionghai Bo’ao Sanya Phoenix wrien consent of the publisher. short-listed for a bid to acquire London City airport with a £2bn price-tag. (They apparently narrowly

2 www.aviationstrategy.aero March 2016 wealth management etc, and has ob- it claims to be China’s top outbound v HNA Logiscs tained licenses covering all financial tour operator, with more than 200 The “logiscs” pillar includes ship- industries.” retail stores. It also owns TransForex building (through Jinhai Heavy with In this core segment lies its invest- — China’s first non-financial instu- an annual build capacity of 6m dwt), ment in quoted Bohai Leasing in part- on that is qualified to provide indi- marine transport (with 50 ships nership with which, following the ac- vidual domesc and foreign currency “of different kinds”), along with quisions of SEACO and Cronos from exchange service and has 52 service cold-storage soluons and logis- GE, it has become the world’s largest outlets covering 23 cies. cs payment exhanges. Through container leasing company. subsidiary Tianjin Tanhai (formerly Under this pillar it also includes In 2010 the group acquired Aus- Tianjin Marine Shipping) the group “HNA Hospitality Group” which it tralian Allco, transferred its base of acquired in early 2016 Californian- states owns and manages over 450 operaonstoHongKongasanaircra based IT supply chain management hotels “at home and abroad” (in- lessor and changed its name to Hong company Ingram Micro for $6bn. cluding brands such as Tangla Hotels Kong Aviaon Capital (later partly re- v and Resorts and NHA Hotels and HNA Ecological Technology versing it into Bohai). Resorts). In addion, perhaps within HNA appears to have created a sixth Following the acquision of this sector is included the group’s “pillar” to be posioned as the hold- Avolon in 2015 the group has 29% shareholding in Spanish hotel ing group for hi-tech businesses. We emerged as the world’s fourth largest group NH Hoteles. have no idea what this will entail ex- aircra leasing company. It obvi- cept that it may have something to do ously has further ambions and was In 2015 the Tourism group signed with “big data”. reputed at the and of 2015 to have a strategic alliance with Pierre & been in talks to acquire AWAS from Vacance-Center Parcs involving HNA Acquision trail Terra Firma for something over $2bn. Group taking a 10% stake in the HNA Group was proud last year to v HNA Tourism French listed company and a promise be able to announce that it had got Under HNA Tourism the group owns of a $1bn investment in Center-Parcs into the Fortune Global 500 list of the tourist agency Caissa Tourisc, which developments within China. world’s largest companies at num-

HNA GROUP AIRLINES’ FLEETS

Capital Airlines Chang’AnAirlines Grand China Air Hainan Airlines Hong Kong Airlines HK Express Lucky Air Tianjin Airlines Urumqi Airlines West Air Yangtze River Express MyCargo Total

190 41 41 195 2 2 ERJ-145 22 22 737 Classic 19 19 737 NG 4 7 3 116 22 6 2 160 A320 54 9 13 7 22 20 125 767 3 3 787 10 10 A330 2 22 18 42 747 3 4 7 Total 56 4 7 3 151 27 13 29 87 6 20 24 4 431

Source: Ascend

March 2016 www.aviationstrategy.aero 3 ber 464 (with $26bn of revenues but other discussions — among other Hainan does not fly to South Africa), only $206m of profits — a margin of things to acquire a major stake in or a 24% stake in Azul (when it does 0.8%). Among aviaon companies, it Spanish tourist group Globalia, or to not fly to Brazil). We can only assume is not far behind IAG in the rankings, buy aircra lessor AWAS. It may even thatthereissomeverylongtermview and nominally shows revenues only be interested in joining the bidding of strategy that we are missing. 40%belowthoseofAmericanAirlines war for Virgin America, currently sub- Opacity — the highest ranked airline in the ject to approaches separately from Global 500 list at number 257 (see JetBlue and Alaskan. Analysing a privately owned con- chart on the next page). Some of the acquisions seem glomerate is not an easy task — the To live up to the wish to become to have lile commercial logic — al- company is under no obligaon to one of the top 100 by 2020 and in the though to be fair it may just be a dif- make public any informaon it does top 50 by 2030, it will probably need ferent logic. not want to, or jusfy any public to generate average annual growth in The acquision of a 48% stake statements it does make. revenues of over 25% a year in the in Aigle Azur in 2012 was said at In April 2015 the group issued next five years (asssuming the rest of the me to be to allow it to de- $350m 5.5% two-year bonds in Hong the world stands sll). It is very un- velop routes from Europe into China Kong (listed in Singapore) through likely to be able to do this organically. using French traffic rights whereas Grand China Air (HK) — a wholly As a result it has been on an ac- it, through Hainan Airlines, was re- owned subsidiary of Grand China celerang acquision trail in the past stricted by the PRC policy of one Chi- Air — and guaranteed by them five years (see table on this page); nese airline per internaonal route. and quoted Hainan Airlines. In the and in 2015 itself seems to have spent It might have been thought pos- offering circular they showed the something over $12bn buying among sible to lease an A330 to the French ownership relaonships between other things Swissport and Avolon, operator to access eg Paris-Beijing. the group and Hainan Airlines. We and stakes in Comair and Azul. It In April 2015 the two companies an- show a simplified form of the organi- kicked off 2016 by acquiring Ingram nounced a code share on Hainan Air- saonal holdings in the chart on the Micro for HNA Logiscs for yet an- lines’ three mes a week Paris-Xi’an- next page. This representaon of other $6bn and apparently injecng Hangzhou service. the structure perhaps raises more another $1bn into Avalon/Hong Kong Equallyitseemsdifficulttounder- quesons from what is missing than Aviaon Capital. stand how beneficial it can really be it answers from what it shows. It has been rumoured to be in to hold a 6% stake in Comair (when The internal ownership structure

HNA GROUP: SELECTED RECENT ACQUISITIONS

Target Stake* Year Sector Country Est Value (US$m) Australian Allco Rental† 2010 Aircra leasing Australia 150 SEACO 2011 Container leasing US 1,050 Ghanaian AWA 49%‡ 2012 Aviaon Ghana na Aigle Azur 48% 2012 Aviaon France 40 TIP Trailer Leasing 2013 Trailer leasing Netherlands 400 NH Hoteles 29% 2014 Hotels Spain 900 Cronos 2014 Container leasing Caribbean 600 Swissport 2015 Aviaon Switzerland 2,800 Avalon 2015 Aircra leasing Ireland 7,600 PVSA 10% 2015 Tourism France na Reuters HQ Office 2015 Real estate London, Canary Wharf 280 Comair 6% 2015 Aviaon South Africa 13 Azul 24% 2015 Aviaon Brazil 450 Ingram Micro 2016 Logiscs US 6,000

Notes: † seat transferred to Hong Kong, renamed as Hong Kong Aviaon Capital. Later part reversed into Bohai Leasing. ‡ Regional start-up. Es- mated maximum foreign ownership. * stake if less than 100%.

4 www.aviationstrategy.aero March 2016 looks as if it might be designed to con- fuse — and may be reminiscent of the FORTUNE GLOBAL 500 (2015) structure of, for example, the Korean 10 100 200 300 400 Chaebol, in that management control 500 in “subsidiaries” is maintained within 400 a family of investors with minimal 300 direct equity investment and convo- 250 luted indirect shareholdings. We as- 200 sume that many of the other parts of 150 HNA Group by extension will be or- 100 2030 ganised in a similar fashion. 2020 The difficulty with this structure 50

is that the ulmate holding company Revenues ($bn logscale) American Targets has no right to consolidate the fi- DeltaLuhansaUnited Air France-KLM nances of its holdings (parcularly IAG HNA Group the cash and cash flow). This also 20 257 273 285 294 365 443 raises the queson of where the 464 money is coming from to fund the The world’s top 500 corporaons ranked by revenue acquisions. While things are going Source: fortune.com well this may not be a problem. The group states that “HNAers to innovaon, strive for excellence’, of the China Dream”. [its employees] will always bear and make greater contribuon to the HNA Group appears parcularly in mind the vision of ’construcng society and mankind, and establish a well connected polically — in its a world-class conglomerate with world-class conglomerate. It is a due home base of Hainan Island and the China Dream’, carry forward the responsibility of 180,000 HNAers to PRC. It may well achieve its plans. The entrepreneurship of ’brave to ex- fight for the rejuvenaon of Chinese rest of the world (and investors) be- plore, persist in change, connue naon and contribute to realisaon ware.

HAINAN AIRLINES OWNERSHIP STRUCTURE

Hainan Provincial HNA Group Government

100% 72.62% Hainan 23.11% Development HNA Airport Group 25.49% Holdings 22.70% Grand China Air 25.49% Haikou Meilan 100% Internaonal Airport American

50.19% 5.36% 28.18% 7.08% 12.08% Aviaon HNA Chiangjiang 1.77% Infrastructure Leasing 4.25% 4.89% Other shareholders Hainan Airlines 49% and free float 4.89% 100% 67% 23% 87% 60% 70%

27% Xinhua Airlines Chang’an Airlines Shanxi Airlines Lucky Air Fuzhou Airlines Urumqi Airlines

Note: shaded boxes represent listed enes.

March 2016 www.aviationstrategy.aero 5 Rationalising the intra-European market

the low cost car- other two, Luhansa Group and of Abu Dhabi to maintain this parc- rier is established as the Air France/KLM are struggling. The ular aspect of its oil diversificaon A most efficient model for network carriers have retreated investment strategy. short/medium haul travel in Europe, to various degrees from non-hub v The residual charter industry, and the network carriers’ short haul operaons, leaving them with their which connues to display an el- operaons generally connue to lose core hub feeding role. ement of resilience as evidenced money, and the tradional charter v The lower cost subsidiaries of by Monarch’s turnaround from an carrier business is evaporang, the the network carriers — Vueling, apparently hopeless situaon. LCCs sll represent less than one half Eurowings, Transavia. Of these sub- v The niche carriers, notably of intra-European capacity. sidiaries only Vueling is clearly a Aegean (successful hybrid but ex- The industry remains remarkably viable proposion largely because of posed to Greek crisis) and Volotea fragmented, with at least seven seg- its role as the de facto flag carrier of (smulang unlikely traffic flows in ments. Catalonia. Transavia and Eurowings niche markets). v The five main LCCs — Ryanair, are faced with unresolved labour The pie charts on this page sum- easyJet, Wizz Air, norwegian, plus and network problems; their growth marise the total intra-European mar- the rapidly growing Pegasus. Ryanair plans are aspiraons rather than ket in terms of capacity. It is notable remains the market leader, adapt- realies. how restrained total capacity growth ing its ultra low cost strategy to v The remaining independent or has been over this period. higher-yielding business orientated quasi-independent naonal carriers Looking at some key traffic markets with “Always Geng Beer” — SAS, LOT, TAP,SN Brussels, etc. trends, pulled together from various so product improvements, and v A subset: Ehad-invested air- sources: further strengthening its finances. lines — airberlin, Alitalia, Air Serbia, v The total intra-European market Meanwhile, easyJet, having led the Meridiana (potenally), etc. Their has grown at an average annual com- LCC advance into business markets, future depends on the willingness pound rate of 4% in the last ten years is being forced to refocus on its cost base and retreat from major cies like Rome. Wizz has unit costs similar INTRA-EUROPEAN SUPPLY BY CARRIER TYPE to Ryanair’s and a solid central Euro- pean core, but is the most threatened 2005 2015 of the LCCs by Brexit, the UK’s pos- 2.9% CAGR sible withdrawal from the EU, as LHAG 9% AFKL Other & charter about 30% of its traffic is between 11% 20% IAG Other & Charter 7% East Europe and the UK. Norwegian 26% Luhansa 8% connues to pursue an innovave, AFKL 5% but risky, long-haul expansion, and Iberia 6% 46% connues to come up against US 53% THY 22% 33% 4% BA other LCCs proteconism. Pegasus is as yet a 13% other LCCs 6% relavely unknown presence outside 10% SAS Other Main Legacy 6% 11% the rapidly growing Turkish market. easyJet 5% Alitalia v 4% easyJet The short haul networks of the Ryanair Other Legacy 8% 6% 9% Legacy LCCs three global network carriers, of Legacy LCCs Ryanair 6% 2% 11% which only one, IAG, is currently financially successful, while the

6 www.aviationstrategy.aero March 2016 in terms of passengers carried to an dominant LCC model increasing its and Eurowings). Note that all the esmated 650m. market share at the expense of the numbers quoted below refer only to v LCCs have provided substanally network carriers’ short haul opera- the intra-European operaons of this all the growth — a compound an- ons, while two of their low cost sub- core group (esmated to account for nual growth rate of 12% a year over sidiaries appear to be vulnerable. about 80% of total intra-European the past ten years. The LCCs as a The most definite indicaon of traffic). broad group account for 45% of intra- the future comes from the firm order The central forecasts made by European passenger traffic up from book — approximately 1,600 narrow the airlines themselves have been 23% ten years ago. bodies as at the end of 2015. usedwhereveravailable.Variouses- v The former AEA carrier group v The main LCCs account for 55%. mates have had to made, parcular in meanwhile have seen passenger v The three network carriers, 12%. the case of Luhansa and Air France- numbers virtually stac with annual v The LCC Subsidiaries of the net- KLM and their subsidiaries, where average growth of 1%. work carriers, 6%. fleet plans have not been quanfied v The three main network car- v Charters, 6%. beyond a few years. Rerement pro- rier groups (IAG, Air France-KLM v Others, 21% (of which THY ac- files have also been factored in. and LHAG) have seen no growth in counts for nearly 11%). The next stage is to convert the intra-European passenger traffic annual fleet projecons into a seat A forecast aer accounng for acquisions; but capacity forecast by mulplying the their LCC subsidiaries and affiliates We have generated a traffic forecast number of units by the average num- have been increasing capacity at a for the “core” intra-European mar- ber of annual seats generated per air- compound annual rate of over 10% ket based on the explicit fleet ex- cra (based on 2014/15 data), In turn in the past five years, albeit from low pansion plans of the main LCCs, the the capacity esmates are converted bases. threenetworkcarriersandtheirthree into passengers by applying the lat- v Tradional charters have seen LCC subsidiaries. To focus the analy- est annual average load factors. Fi- their business decline by about a sis, we have only used the fleet plans nally, an “efficiency” factor is added third over this period. of the most significant players for the to the equaon reflecng a mod- There is a tendency to overes- period to 2022: the LCCs (Ryanair, est expected improvement in aircra mate how quickly raonalisaon of easyJet, Wizz and norwegian); the ulisaon and/or load factor over the this market will occur. Different air- Network carriers (IAG, Luhansa and forecast period. line models will connue to co-exist, Air France-KLM); and the LCC sub- So we end up with a traffic fore- but there are clear trends as to the sidiaries/affiliates (Vueling, Transavia castforthethreesectorswhichiscon- sistent with the fleet plans as they stand at present. An implicit assump- PROJECTED INTRA EUROPE TRAFFIC on is that economic condions will 700 be benign; a major recession would Baseline (3%pa) Potenal 20%surplus cause easyJet, for example, to radi- 600 cally downsize its growth plans. Overall the market connues to 500 be driven by the LCCs whose com- Legacy Network 400 bined growth rate 2015-2022 is es- LCC Affiliates mated at 9.3% pa, back to close to the Pax(m) 300 rate before retrenchment in 2009-

200 2014. The network carriers’ growth rate is 2.1% pa, while that of the LCC 100 LCC affiliates is put between the other two sectors, at 5.6% pa. 0 2015 2016 2017 2018 2019 2020 2021 2022 The overall intra-European growth rate then works out at 6.4% pa for 2015-2022.

March 2016 www.aviationstrategy.aero 7 It should be remembered that tance. One can also trace the evolu- be at the main hub where yields the LCC fleets plans are firm, or at on of LCC traffic in three phases: are strongest (despite the fact that least are explicit, and two of the lead- v 2002-2009 Rapid Growth: Sm- airport charges are likely to be high ing LCCs also provide base passenger ulaon of new markets and thinner there). This is rarely if ever possible forecasts for the long term (which are routes, converng VFR and Charter because of fears of brand polluon broadly compable with our calcu- passengers to the LCC mode, opening and union agreements. lated future volume). By contrast, the up in Eastern Europe, concentraon Locang at a secondary airport at network carriers, with the excepon on secondary points. theincumbentairline’smaincitybase of IAG, are much vaguer with fleet v 2010-2014 Consolidaon: Slow- thenseemedtobeagoodidea:estab- projecons beyond the very short down in deliveries, inial “land grab” lishing Go at Stansted, it was thought, term. The affiliates’ plans are even completed, emergence of new LCC would not only inhibit the growth of more fluid, again with the excepon models, more focus on primary Ryanair but would also e up slots of IAG’s Vueling, dependent on union points. at London’s third airport. That didn’t negoaon and seng hopeful tar- v 2015-2022? Move into network work for BA — Go helped smulate gets, notably Luhansa’s claim that carrier core markets: Focus on higher the overall low-cost market and can- Eurowings will somehow emerge as yielding routes, LCC rebranding and nibalised BA’s Heathrow traffic. Europe’s third LCC. product improvement, primary air- The French version of Transavia The total market growth rate of ports, new distribuon models, in- is based at Orly, where it can indi- 6.4% pa looks compable with LCC- terlining, new feed agreements; net- rectly impact AF’s CDG traffic. The type expansion but is high for the to- work carriers forced to retrench fur- Dutch version is starng a new base tal intra-European market. The his- ther and concentrate on long-haul. at Munich where it will face a typical toric traffic growth rate was around dilemma — it will be under intense LCC subsidiary — an unviable the 3-4% mark; and our assessed pressure from the incumbent carrier, model? baseline assumpon is 3% going for- Luhansa, and if it does succeed in ward. The Airbus intra-European traf- One of the fundamental problems building a presence, the markets it fic forecast, albeit for a longer period with low cost subsidiaries is that they smulates are likely to be grabbed by to 2034, predicts just 1.5% pa. There are compromises. The parent airline’s efficient LCCs. is significant difference in passenger aim is usually to counteract low–cost Eurowings is based at a variety totals derived from 3% compounding compeon but it has to do this with- of secondary airports — Düsseldorf, and 6.4% compounding growth rate. out either disturbing its own unions Hamburg, Cologne, Vienna — where In fact, as the graph on the previous or undermining its core network busi- it may have a certain brand loyalty page below illustrates the implicaon ness. Consequently, a series of con- but again will be the target of genuine is for a theorecal 20% surplus by flicts arise. LCCs. 2022. Airport base: To leverage the Labour relaons: These have Although there are various ways benefits of a low–cost subsidiary, been fraught; unions tend to be this potenal surplus could be re- the opmal place to locate it would deeply suspicious of such ventures, solved — lower LCC delivery profiles, new LCC markets, total collapse of the Charter industry and/or smaller FORECAST CORE INTRA-EUROPEAN MARKET 2015-2022 flag carriers — market trends point to the major impact being absorbed by LCCs LCC affiliates Network Carriers Total the network carriers (and their sub- Passenger CAGR sidiaries), Luhansa and Air France- 2015-2022 9.30% 5.60% 2.10% 6.40% KLM in the main. Market Shares The fundamental reason is the 2015 49% 14% 37% 100% unit cost advantage the LCCs hold in 2022 59% 14% 27% 100% a market where other factors, like claimed service quality or brand loy- alty, connue to decline in impor-

8 www.aviationstrategy.aero March 2016 regarding them, quite correctly, as haul hub relied on a high proporon v Distribuon used to pose a major a potenal threat. Their response of point-to-point passengers in the barrier but with the leading LCCs ex- is to aempt to ring–fence the sub- total traffic mix. The reason was that perimenng with GDS and IT systems sidiaries’ acvies — which frustrate these passengers were higher yield- becoming cleverer interline bookings the subsidiary’s employees who ing than the connecng passengers, should no longer be an issue, though are denied the opportunies which which was partly the result of inter- there sll may be yield management come from rapid company growth; nal accounng convenons that pro- conflicts. their aspiraons to move to a beer rated through cket revenue on a dis- v Product: the short haul experi- post in the parent company are also tance basis. The LCCs have eroded ence on LCCs and network carriers blocked. those network economics by captur- has converged to such an extent that Fleet growth: Although the par- ing more and more of the point-to- economy passengers would have lit- entairlineshaveambiousfleetplans point traffic either at airports within tle cause for complaint, but the Lega- they appear to be aspiraons rather the city capture zone or, increasingly, cies will always want to protect their than reality. The subsidiaries gener- with services to the major airport brand. ally lack direct access to finance to hub. v Primary vs secondary airports: fund major fleet growth. Eurowings In the future it would be logical to again what used to be a major dis- has 22 units on firm order, Transavia expectLCCstoplayasignificantrolein ncon, but increasingly the LCC are 17 — in contrast to Vueling’s 60 let feeding traffic to the network carriers operang to the major hubs. alone Ryanair’s 260. Without mega- at the interconnental hubs. v Operang to major hubs will in- orders the subsidiaries cannot aain LCC interlining/connecng mod- evitably change an LCC’s cost struc- major discounts, which again leaves els do exist — JetStar Asia interlines ture — not just higher airport charges them at serious cost disadvantage to with several full services carriers col- but also decreased aircra ulisaon the genuine LCCs. lecng feed at its Singapore base. because of longer turn-around mes; In summary, Luhansa’s and Air COPA, the high successful Panama- but with no need to smulate traffic, France-KLM’s raonale for low–cost based LCC, has signed interline agree- the higher yields should more than subsidiaries is quesonable. They ments with Emirates and Star Alliance compensate. probably do not provide a soluon airlines. But the European model, as v For the network carrier the sig- to loss-making short haul networks yet a maer for speculaon only, nificantly lower costs should be com- nor to the incursion of LCCs into core would involve, for instance, easyJet pelling, but outsourcing a vital part of Legacy carrier markets. providing AF with feed at CDG or the network to a LCC remains a fright- Ryanair taking over LH’s short haul ening proposion, fraught with im- New LCC feeder model service to Munich or even Frankfurt. plementaon risks. LCCs have greatly complicated net- These are some of the issues work carriers’ feed strategies. Tradi- which used to be intractable but may onally short haul flights to a long- no longer be so:

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March 2016 www.aviationstrategy.aero 9 Finnair: East by Northeast

’ share price doubled years of recession, GDP grew by 0.4% of its proximity to Asia, where the over 2015 as the airline fo- in 2015. More importantly perhaps, fastest connecons between many F cused on its core business and cost-cunghasbeenakeypriorityfor European cies and what it calls concentrated on profitability rather many years, inially starng aer the “Asian megacies” fly over Finland than growth. Can the momentum post-September 11 traffic downturn, and then Russia. This has been an aim of Finland’s flag carrier connue with — for example — its group work- for Finnair for several decades (its through 2016 as it starts a new force steadily shrinking from just un- first Asian route, to Bangkok, started growth phase and, if so, could it der 10,000 in 2003 to 4,900 as at the in 1976), but in May last year, as part prove a valuable acquision for a end of 2015. However, that has led to of a strategic review, Finnair adopted larger airline? significant disputes with unions over a new target of doubling traffic BasedatHelsinki’sVantaaairport, the years, either directly or as a by- to/from Asia by 2020 compared with Finnair was launched as far back as product of clashes between unions the 2010 level. 1924 — making it one of the oldest and the state over collecve labour Currently the airline operates to airlines in the world — and though it agreements and condions. Never- 15 Asian cies in nine countries (both has had ups and downs, under state theless, the necessity to reduce costs leisure and business desnaons) control it has happily stuck to its mis- remains — as can be seen in the chart and this May it will boost the network sion of serving its ny home market on page 12, there is no permanent through new routes to Fukuoka in domescally and internaonally with clear gap yet between unit revenue Japan and Guangzhou in China. At reasonable success ever since. and costs. the former Finnair will benefit from Its core disadvantage, however, is its close relaonship with Japan Asia routes its locaon at the northern extreme Airlines, which is a fellow member of of Europe, which means that it strug- Just as important as cost measures is oneworld. gles to aract any through passenger the connuing aempt to turn Fin- Finnair’s relave proximity to traffic in Europe other than to/from land’s geographical isolaon within north-east Asia means that it can the Nordic countries and east/south Europe into an advantage in terms operate routes with aircra on a to the Balcs and parts of Russia. That tough geographical posioning is reflected in its financials, where it FINNAIR FINANCIAL RESULTS has lurched between profitability and 150 3,000 loss for a number of years. Revenue In 2015, however, despite report- 100 2,000 ing just a 1.7% increase in revenue to 50 1,000 €2.3bn, Finnair turned an operang loss of €36.5m in 2014 into a €23.7m 0 €m

operang profit in 2015. Similarly, an €m €82.5m net loss in 2014 became a -50 Net profit €89.7m net profit last year. -100 The reasons for that creditable result (and the subsequent improve- -150 Operaonal result ment in share price — see chart on -200 page14)aremulple.Atamacrolevel 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Finnair has benefited from an upturn in the Finnish economy — aer three

10 www.aviationstrategy.aero March 2016 FINNAIR ROUTE NETWORK

Tokyo Chicago Nagoya Osaka

Miami Fukuoka Seoul New York

Shanghai Beijing

Longyearbyen

Xi’an Hong Kong Guangzhou Tromsø Ivalo Kittilä Chongqing Rovaniemi Kemio Kuusamo Luleå UmeaOulu Kajaani Kokkola Kuopio Vaasa Joensuu Bergen Jyvaskyla Ekaterinburg Oslo Tampere MariehamnTurku St Petersburg Edinburgh StockholmTallinn Kazan Norrkoping Tartu Dublin Gothenburg Nizhniy Novgorod Riga Manchester Copenhagen Moscow Samara LondonAmsterdamHamburg Gdansk Vilnius Bangkok Berlin Brussels DüsseldorfWarsaw ParisFrankfurt Prague Krakow Munich Zürich Vienna Krabi Geneva Budapest MilanVerona Ljubljana Phuket Singapore Madrid Nice Pula Delhi Barcelona Split Funchal Palma Rome Dubrovnik Malaga Tenerife N Mytilene Tenerife S Athens Las Palmas Catania Kos Antalya Thira Gazipasa Malta Chania Rhodes HeraklionPaphos Tel Aviv Dubai

Note: Equidistant map projecon centred on Helsinki. Great circle routes appear as straight lines.

24-hour round-trip rotaon, which it the world perpetuates a concept Finnair’s only other long-haul points out “enables very high aircra that to go East you travel towards routes are to North America (to ulisaon and reduces the need for the East, whereas the great circle New York, Chicago and Miami), but addional crews due to flight me and therefore shortest route from although these are doing well in the restricons”. From a passenger point the center of European populaon premium segment, Finnair says that of view, the routes are around two can well be to the North and over in economy it “suffered from intense hours less on average compared with Helsinki anyway. Another challenge compeon and overcapacity” in one-stop flights from European hubs here is the faltering economies of the fourth quarter of 2015. A note (though clearly this varies consider- several countries in Asia, not least released by HSBC Global Research ably depending the specific airport China, though Finnair says it has not in February says that it “harbours the comparison is with), and more seen any signs of weakening Chinese some concerns about the limited than four hours shorter compared demand as yet. feed available for Finnair’s US flights, with flights connecng through the Nevertheless, last year Asian given Helsinki’s geography and the Gulf hubs. routes accounted for half of Finnair’s poor economics of Russia, which is a But while Helsinki airport has total traffic, and the airline says that natural feed market for Finnair’s US three runways and relavely short in total it has an approximate 4.6% flying”. connecon mes, it’s a tough sell market share of traffic between A350 investment to persuade European travellers Europe and Asia — though that not based in northern Europe to was down from 4.8% as of 2014, Altogether the long-haul network is connect to Asia though Finland. The which perhaps indicates the level of served by a fleet of 16 aircra, com- tradional Mercator projecon of compeon that Finnair faces. prising eight A330s, five A340s and

March 2016 www.aviationstrategy.aero 11 Helsinki, Brussels and London, with FINNAIR UNIT REVENUE, COST, AND YIELD all its cargo capacity now in the belly of its passenger fleet aer discon- 7.60 nuing separate cargo freighter op- 7.40 Yield/RPK eraons in 2014 and aer Helsinki- 7.20 basedNordicGlobalAirlines(inwhich 7.00 Unit Costs Finnair owed 40%) ceased business in May last year. An excepon to this is 6.80 a wet-leased freighter that the com-

€ cents 6.60 pany operates as a cargo ˝air-bridge˝ 6.40 to connect its network with that of BA 6.20 in London integrang the Asian flows with IAG Cargo. Finnair meanwhile is 6.00 Unit Revenues invesng €80m into a new cargo ter- 5.80 minal at Helsinki over the next few 2012 2013 2014 2015 years, which will replace its present cargoterminalthatwillbedecommis- three A350s. The fleet is being re- cra; this will increase capacity by be- sioned in 2017. newed through the 297-seat A350 tween six to 13 seats for each aircra. However, cargo is a tricky busi- XWB, 19 of which were on order (with For its domesc network (which ness for Finnair at the moment as 11 placed in 2007 — making Finnair unsurprisingly is loss-making) and there is significant overcapacity in the European launch customer for some European routes Finnair con- the market between Europe and Asia, the model — and eight more in 2007), tracts Vantaa-based Nordic Regional and as a result the airline said it expe- with three delivered in 2015 (the first Airlines (Norra) to operate on its rienced ”further weakened average in October) and four others arriving behalf, and the Norra fleet comprises yields and load factors” in Finnair’s this year, four in 2017 and the re- 12 ATR 72-500ss, two E170s and 12 primary markets for cargo traffic in maining eight coming by the end of E190s. 2015. Finnair’s total cargo tonnes car- 2023. The remaining five A340s will Norra was previously known as ried fell 12.4% last year, cargo unit be phased out by the end of 2017, Flybe Nordic, which was created in revenuewasdownby7.5%,andcargo four of which are being sold back to 2011 when Finnair and Flybe bought revenue fell a substanal 20.6% to Airbus. respecve 40% and 60% stake in €183.7m. On short-haul Finnair operates Finnish Commuter Airlines (at a The airline business (both pas- to around 60 desnaons in Europe total price of €25m), which was then senger and cargo) accounted for with 30 owned and leased A320 fam- renamed Flybe Nordic. However, the 91.1% of all revenue in 2015 — the ily aircra, but although this fleet airline’s losses persuaded Flybe to rest is made up of Travel Services has an average age of more than 12 exit and sell its 60% stake for just €1 unit, which comprises tour operators years it has no firm orders at present. to Finnair in March 2015 (aer which Instead Finnair’s strategy in Europe it was renamed as Norra), although currently revolves around operang this was a temporary arrangement FINNAIR FLEET larger aircra to fewer desnaons, before that same 60% stake was and the first stage of this involves the sold on to two Finnish companies — In service Orders lease of two A321s that arrive in May StaffPoint Holding (with 45%) and A319 9 thisyear(eachononeyearcontracts), Kilco (15%) — in November 2015 A320 10 A321 11 before leasing four A321s (on eight for the same €1 price. StaffPoint is A330 8 year terms) from BOC Aviaon for the a staffing/recruitment agency with A340 5 first-half of 2017. Finnair will also add 15,000 employees, while Kilco is an A350 3 16 extra seats to 22 A320 family fleet in investment company that part-owns Total 46 16 2017 by reducing storage and techni- StaffPoint. cal space at the front and a of air- As for cargo, Finnair runs hubs at

12 www.aviationstrategy.aero March 2016 and travel agencies, and which expe- 19.8% down year-on-year — while than a short-term phenomenon (as rienced a fall at both the revenue and cash and cash equivalents totalled very few people argue that low oil profit level last year. €280.5m, some €197m higher than prices are with us permanently), and 12 months previously. In October last once that compensang factor evap- A bright future? year strengthened its finances by is- orates — and with limited scope for Pekko Vauramo, CEO of Finnair, says suing a €200m bond and selling and further significant non-fuel cost sav- that “we are heading in the right di- leasing-back two A350s with GECAS. ings giving Finnair’s structurally high- recon”. While this is broadly true, FurtherA350swillbesoldandleased- cost locaon — Finnair will inevitably significant risk must be present from back with GECAS in 2016 and 2017. be stuck with the underlying problem increasing compeon. 2016 will be crucial for Finnair, as of compensang for unrelenng yield Within Europe Finnair — like all the modest capacity growth of last pressure. other flag carriers — faces intense year (just 3.1%) will be replaced by To be fair, it’s a risk that Finnair compeon from LCCs, although its significant growth. HSBC forecasts it management must be fully aware of, northern posion means that if faces will be around the 10% mark thanks and that’s why the airline is push- no direct compeon from easyJet, to the delivery of more A350s, new ing ahead in other areas, such as an- and Ryanair operates routes only Asian routes and an expansion of the cillary business; ancillary service rev- from Tampere (in southern Finland) short haul network. HSBC believes enue per passenger grew 23.7% in to Bremen and Budapest. The main that underlying profitability should 2015 compared with 2014, to €10.2 LCC competor is Norwegian (see rise in 2016 because although yield per passenger, bringing in total rev- Aviaon Strategy, December 2015), will fall due to compeon, unit costs enue of €104.6m over the year. which operates from Helsinki to 28 will drop by almost 9% year-on-year, Value to IAG? desnaons directly, of which 24 thanks mainly to falling oil prices. are internaonal and four domesc Those oil costs will compensate for Though quoted on the Helsinki stock (Ivalo, Kilä, Oulu and Rovaniemi), rising expenditures elsewhere; for ex- exchange since 1989, the Finnish and from Oulu to two internaonal ample,thearrivaloftheA350sislead- state sll owns 55.8% of the airline, desnaons. As a result, Norwegian ing to a significant expansion of long- and the government would have has an approximate 12% market haul staff recruitment, with 100 new to change its status as a “naonal share at Helsinki airport, and given pilots and 300 new cabin crew mem- strategic asset” before it could sell its its fares structure is Finnair’s fiercest bers arriving from this year onwards. majority stake. competor, ahead of SAS, which has Yet the macro-economic oil situa- There has been growing specula- just eight routes between five Finnish on should be seen as nothing more on that such a move may be immi- airports and its hubs at Stockholm, Oslo and Copenhagen. Finnair says it has a 57.9% share FINNAIR TRAFFIC AND CAPACITY of the market in European traffic 40,000 LoadFactor 85% to/from Helsinki last year — which ASK rose by 5.5% compared with 2014 35,000 RPK 80% — but share isn’t everything, and 30,000 75% it’s crical that Finnair connues 25,000 to maintain its average yield, as it 70% has done over the last couple of 20,000 years following a worrying period of 15,000 decline through 2012 and 2013 (see chart on the facing page). 10,000 Finnair does have some room for 5,000 manouevre given that it’s strong in 0 terms of the balance sheet. As at the 2011 2012 2013 2014 2015 end of 2015 Finnair’s interest-bearing long-term debt stood at €271m —

March 2016 www.aviationstrategy.aero 13 be driven by buying Finnair that isn’t FINNAIR SHARE PRICE PERFORMANCE or couldn’t be achieved by oneworld and the exisng joint venture it and 6.0 IAG have with JAL on Europe-Japan 5.0 routes? In a sense the logic for IAG ac- 4.0 quiring Finnair is a negave one, in that while buying Finnair might not 3.0 bring huge benefit to IAG, if it fell into the hands of Star or SkyTeamthat € (logscale) would be problemacal to say the 2.0 least. Not only would it create a hole intheNordicregionforoneworld,but if Star acquired Finnair that alliance 1.5 2012 2013 2014 2015 2016 would dominate the Nordic region (thankstothecombinaonofSASand Finnair, not to menon Luhansa just to the south). The situaon wouldn’t nent, and that if it does then fellow Essenally that leaves Finnair’s be much beer if a SkyTeam mem- oneworld member IAG is likely to be share of the European market into ber bought Finnair, as Aeroflot and at the head of the queue to buy the north-east Asia as the main raonale Finnair would have a grip on the state’s shareholding. Yet it’s hard to for a purchase, but that share is rel- fastest routes into north-east Asia. see what value Finnair would really avely small and totally dependent Fear of losing an asset to a com- deliver to IAG. Even if it can establish on Russian over-fly rights that poten- petor is never a great raonale for a sustainable gap between unit costs ally could disappear at some point an acquision, but that logic may and revenue, given its ny home mar- (parcularly given Russia’s frosty re- prove just strong enough for IAG to ket it will never be a generator of sub- laonship with the UK at present). In acquire Finnair if/when the Finnish stanal cash and profits for IAG. any case, what further revenue could state puts it up for sale.

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14 www.aviationstrategy.aero March 2016 LATAM: Impressive cost cutting and fleet restructuring

ATAM Airlines Group, created programme already in place when consecuve years and has made when Chile’s LAN completed the region’s economic problems lile progress in repairing its balance L its cross-border acquision of worsened last year.In 2014 the group sheet. Brazil’s TAM in June 2012, has weath- had announced plans to reduce LAN had been consistently prof- ered the tough economic and airline non-fuel costs by $650m by 2018. itable up to an including 2011 and industry condions in South America The programme, which consists of had earned double-digit operang relavely well. a multude of small iniaves, is marginsand solid netprofitssince the Despite its heavy exposure to the running ahead of schedule. mid-2000s. But the merger changed Brazilian domesc market (30% of Second, LATAM has managed to all that. The combine immediately its ASKs), where demand has fallen reduce its 2016-2018 fleet commit- lost LAN’s long-held investment- sharply due to recession, and the de- ments by $2.9bn or almost 40% since grade credit rangs, essenally preciaonofallofthelocalcurrencies January 2015 — an impressive reduc- because of TAM’s high debt levels. in South America, LATAM managed to on for a global airline that is not in And LATAM went on to incur net improve its operang margin by one bankruptcy, though for LATAM some losses totalling $1.1bn in 2012-2015. percentage point to 5.1% in 2015. of it was sll fleet raonalisaon re- LATAM’s share price performance But the net result was again neg- lated to the merger. has been dismal. Aer a long and ave — a loss of US$219m or 2.2% of LATAM must also be commended steady decline, the NYSE-listed ADRs revenues — as a result of a massive for its robust response to Brazil’s re- were trading at $6-7 in mid-March, $468m foreign exchange loss mainly cession. TAM cut its domesc capac- down from their $26-plus value in related to a 49% depreciaon of the ity in Brazil by 9.4% in the fourth quar- June 2012, though there had been a Brazilian real last year. ter—thesharpestreduconinthein- slight improvement since the shares Revenue trends were dismal. dustry — and by 2.5% in 2015. hit $4.50 in January. Because of the currency devalua- On the negave side, LATAM It seems that LATAM is taking ons and macroeconomic malaise, has now reported net losses for four rather long to integrate key aspects of LATAM saw its operang revenues plummet by 18.8% in 2015. And its unit revenues and yield fell by 20.5% LATAM’S FINANCIAL RESULTS and 18.1%, respecvely, in US dollar 1,200 Revenues 15,000 terms. 1,000 12,500

But LATAM’s famously capable ex- Operang income $m LAN management team, which has 800 10,000 guided LAN through many recessions 600 7,500 in the past, again rose to the chal- 400 10%

lenge, implemenng what may be $m 200 5% thesharpestcostreduconsofrecent mes among global carriers. 0 0% On top of significant fuel cost -200 operang margin savings, LATAM achieved $325m of -400 Net result new non-fuel cost savings in 2015, -600 which far exceeded the target of 2011 2012 2013 2014 2015 $200m and helped reduce non-fuel Note: 2011 and 2012 are pro forma figures (LAN and TAM merged in June 2012). CASK by 11.5%. The airline benefited Source: LATAM Airlines Group from having a solid cost-cung

March 2016 www.aviationstrategy.aero 15 remains healthy, especially in Ar- LATAM’S FLEET PLAN genna and Peru. But RASK has suffered because of the weakening At year-end of local currencies, which has also 2015 2016 2017 2018 dampened demand for internaonal Passenger aircra travel out of those countries. In A319-100 50 48 48 48 Q4, the Colombian, Argenne and A320-200 154 146 136 130 Chilean pesos had declined 41%, 19% A320neo 2 16 24 and 17% against the dollar from the A321-200 36 47 47 47 year-earlier period. A321neo 6 Total narrowbody 240 243 247 255 Argenna is apparently an excep- A330-200 10 on in that outbound demand from 767-300 38 37 36 34 there remains strong. That is because A350-900 1 7 11 13 the government abolished a 35% tax 777-300ER 10 10 10 7 787-8 10 10 10 10 on purchases made on credit cards 787-9 7 12 14 18 internaonally. Argenna’ new Pres- Total widebody 76 76 81 82 ident Mauricio Macri has abolished Cargo aircra capital controls, meaning airlines can 777-200F 3 3 2 2 767-300F 8 7 6 6 now sell there as in any other country. Total cargo 11 10 8 8 In the fourth quarter, LATAM’s to- TOTAL FLEET 327 329 336 345 tal internaonal ASKs rose by 11.6% and SSC Domesc ASKs by 5.5%. In- Note: This table excludes three 767-300Fs and one 777-200F that LATAM currently leases out. Source: LATAM Airlines Group cluding the Brazil contracon, system ASKs were up by 3.4%. But LATAM connues to suffer LAN and TAM. The airlines even con- (RASK) fell by a staggering 37.8% in from a mul-year cargo slump. In the nue to have separate FFPs. Notably, US dollar terms, despite the 9.4% fourth quarter, its cargo revenues fell though, 2016 will see the start of a capacity reducon. In Brazilian real by 26.8%, driven by a 13% decline in three-year process of moving to a sin- terms, RASK declined by 2.3%, re- FTKs and a 15% fall in cargo yields. gle brand. flecng weaker corporate demand. Cargo demand is especially weak But, most importantly, the The Brazilian economy contracted by in the Brazilian domesc and interna- merger is clearly helping LAN and 3.8% in 2015. onalmarkets.Connecngcargotraf- TAM weather the current tough While LATAM’s other passenger fic at São Paulo Guarulhos has been condions. One example: LATAM network segments — “Internaonal” affected by an ongoing strike by Cus- has been able to compensate for and “Domesc Spanish speaking toms personnel. some of the Brazil demand decline by countries” (SSC, which include Chile, To manage the cargo slump, developing internaonal connecng Peru, Argenna, Colombia and LATAM currently leases out three of traffic through Brazil and shiing Ecuador) — also saw RASK declines its 11 767-300Fs and one of its four the point of sale to stronger markets (22.8% and 13.3%, respecvely), 777-200Fs to operators outside the elsewhere in South America. both of those segments offered some region. Tough environment modest growth opportunies. With the worsening economic In other words, LATAM has been outlook for Brazil, LATAM has issued It is ironic that the very reason LAN able to redeploy some of the aircra new 2016 capacity guidance that wanted TAM — the huge Brazilian currently not needed in Brazil (do- sees a bigger contracon in Brazil and market — has, in the short term at mesc or internaonal) in SSC Do- lower overall growth internaonally. least, turned into one of its biggest mesc or in internaonal service to Domesc Brazil ASKs are now pro- problems. and from the Spanish speaking coun- jected to decline by 8-10% this year, In the fourth quarter of 2015, tries. while internaonal ASKs will grow TAM’s domesc Brazil unit revenues Travel demand in SSC markets by 3-5%. The laer will be driven by

16 www.aviationstrategy.aero March 2016 a further 25% reducon in Brazil-US TAM and American began codeshar- began expanding those operaons in capacity in the second half of 2016. ing, and TAM joined oneworld — the earnest in early 2015. LATAM sll expects to growth its global alliance selected by LATAM. It is indicave that while pulling Domesc SSC operaons by 6-8% in In the past couple of years, out of the Belo Horizonte-Miami 2016, which would be higher than the LATAM has made two important market this month, TAM boosted its 4.8% growth rate last year.Cargo ATKs hub-building moves in Brazil. First, Brasilia-Miami services from three to are expected to decline by up to 2%, it has been developing São Paulo’s six per week. However, Brasilia is get- similartolastyear’s1.9%contracon. Guarulhos as TAM’s main hub for re- ng its share of this year’s Brazil-US Overall, LATAM expects its capac- gional and long-haul traffic in South service raonalisaon; TAM is pulling ity to be flash in 2016. The current America. Second, it has been building out of the Brasilia-Orlando market. projecon for system ASKs is some- Brasilia, the country’s capital, into a Connecvityisthenewbuzzword wherebetweena1%declineanda2% secondary hub. at LATAM. The group’s execuves increase. Both of those strategies appear have stressed that while reducing LATAM is currently guiding for a to be paying dividends. Thanks to capacity in Brazil, LATAM has been 4.5-6.5% operang margin in 2016, easy connecons, TAM’s long-haul careful to protect its hub strategy and which would be similar or slightly servicesoutofGuarulhosnowgetsig- connecvity and to maintain a focus higher than last year’s. The forecast nificant feed from countries such as on corporate passengers. assumesthepriceofoilaveraging$52 Argenna and Chile. New long-haul In April 2015 LATAM announced a barrel and the real/dollar exchange routes such as São Paulo-Barcelona that it was exploring developing a rate averaging 4.25. (October 2015) and planned routes new hub for the Northeast region On the posive side, it looks like such as São Paulo-Johannesburg of Brazil and that it would decide the Brazilian domesc market will see (pending approval) would probably between three locaons — Fortaleza, a sizable 7% reducon in industry ca- not be possible without feed from Natal or Recife — by year-end. The pacity in 2016, with the two smaller elsewhere in South America. main objecve would be to expand players (Azul and Avianca Brazil) for Brasilia has the aributes for a operaons between Europe and the first me joining TAM and Gol in successful hub: strong local traffic, South America. cung capacity. high GDP per capita, good geograph- The move makes sense, but it is But there is significant uncer- ical locaon for capturing domesc turning out to be tough to decide on tainty about the demand environ- traffic flows and infrastructure for the locaon. In November LATAM de- ment. GDP projecons for Brazil have further growth. TAM already had a layed the decision unl at least the come down in recent months; the 45% passenger share there when it firsthalfof2016,sayingthatitneeded IMF is currently forecasng a 3.5% contracon in 2016. Brazil strategy LATAM’S REDUCED FLEET COMMITMENTS 3,000 as at March 2016 Before the economic crisis, LATAM as at Jan 2015 was actually doing quite well in Brazil, 2,500 having turned TAM’s domesc oper- aons profitable relavely quickly (in 2,000 2013). 1,500

The turnaround was a result of $m capacity reducons, cost cung and improved yield management and 1,000 market segmentaon. The laer enabled TAM to maintain its corpo- 500 rate market share in Brazil. TAM’s 0 long-haul passenger operaons were 2015A 2016F 2017F 2018F restructured and cut back. Its oldest A330swerereplacedwithLAN’s767s. Source: LATAM Airlines Group

March 2016 www.aviationstrategy.aero 17 which stood at $9bn at year-end. Ad- LATAM SHARE PRICE justed net debt/EBITDAR rao was 5.8. It is not too bad, but LATAM is clearly a long way from returning to 25 investment grade. 20 As to the aircra types, LATAM’s fleet renewal can be summarised as 15 follows: 12 In the short-haul fleet, two types 10 were completely phased out in 2014: $ (logscale) 8 the Dash Q400 and the 737-700. 7 LATAM is also slightly reducing its 6 A319/A320 numbers in favour of 5 taking more of the larger A321s. 2013 2014 2015 2016 The first two A320neos will ar- rive this year and that fleet will build rapidly to 24 by the end of 2018. The first six A321neos will enter the fleet more me to analyse the ming of $391m reducon will also help. in 2018. airport infrastructure, which is one of LATAM is disposing of as many as 20 As to the long-haul fleet, LATAM three key criteria — the other two are older aircra in 2016. As there are hasphasedoutitsA340sandwillhave passenger experience and cost com- currently 22 new deliveries sched- disposed of its 10 remaining A330s by peveness. uled (11 A321-200s, six A350-900s the end of this year.Four of the A330s Fleet renewal and cash and five 787-9s), the fleet will grow have been sold, three have been re- by only two units in 2016. preservaon turned to lessors and three are cur- Although the fleet obligaons rently for sale, with their exit planned LATAM has made good progress will peak this year at about $2bn, in the second half of 2016. with fleet renewal, which aims to fleet capex will be only $900m as the Having received ten 787-8s and reduce the number of types and remainder will be financed through seven 787-9s as of the year-end, replace older models with the sale-leasebacks. And the $900m LATAM plans to build the 787-9 fleet latest-technology, more efficient capex is already financed (with to 18 units by the end of 2018. aircra. $500m of EETCs issued in mid-2015, In December LATAM received its The process has accelerated con- plus $400m of ECA-backed financial first A350-900, becoming the first air- siderably in the past year or so, be- leases and commercial loans). line in the Americas to operate the cause LATAM decided that it needed The 2017 and 2018 fleet obliga- type. The A350 fleet will grow to 18 to “adjust capacity to the prevailing ons are now very manageable, with units by the end of 2018. market condions in Lan America” only 7-9 deliveries and $1.4-1.5bn With cargo, LATAM’s focus has and reduce capital spending to main- of commitments each year. This will shied to filling bellyhold capacity, tain a healthy balance sheet and ade- help LATAM preserve its cash posi- especially with the arrival of the quate liquidity. on, which at year-end amounted A350s and 787s. The company fore- So, through aircra sales, lease to $1.5bn (including available credit sees reducing its current 11-strong returns and order deferrals (aer ex- facilies) or 14.5% of 2015 revenues. freighter fleet (excluding four aircra tensive negoaons), LATAM has re- LATAM described that as “adequate that are leased out) by three units by duced its total fleet obligaons in the under current market condions”, the end of 2017. 2016-2018 period from $7.7bn in Jan- but it is a lile low by internaonal uary 2015 to $4.8bn in March 2016. airline standards. Longer-term prospects 2017 and 2018 will see the With connued significant wide- LATAM clearly has the potenal to biggest reducons in commitments body aircra deliveries, it is hard to return to the double-digit operang ($1.1bn and $1.4bn), but this year’s see LATAM not increasing its debt, margins and solid net profits it was

18 www.aviationstrategy.aero March 2016 earning before the merger, but that because both LAN and TAM have keyoneworldpartners,Americanand will not happen unl Brazil makes an strong brands. IAG. economic recovery. LATAM sll has the toughest LATAMbelieves that securing reg- But even if that takes a while, hurdle in merger integraon ahead ulatory approvals in different coun- the tough mes have not changed of it: a move to a single reservaons tries could take 12-18 months, so it LATAM management’s thinking on system. The combine earlier selected will not be possible to start develop- the merger. It was a unique oppor- the Sabre technology, which LAN ing the JVs unl 2017 at the earli- tunity to create a dominant airline adopted in 2012, for the common est. An immunised JV on the US-Brazil combine for a region that will one day plaorm, and last year there was talk routes is also not possible unl Brazil again see robust economic and air of a possible 2017 switchover. has rafied the open skies agreement travel demand growth. Having a single reservaons sys- between the two countries. In the meanme, there is sll tem will unlock opportunies, espe- much work to be done in terms of cially on the revenue side. So there integraon. Having focused on inter- could be addional revenue tailwinds nal processes, network opmisaon and the original targeted $600-700m and fleet restructuring and mod- annual synergies could be exceeded. By Heini Nuunen ernisaon in the inial three years, Another potenal bright spot on heini@theaviaoneconomist.com last summer LATAM announced a the horizon is the development of single brand for LAN, TAM and their immunised JVs. It is not clear why affiliates. Its implementaon will these moves took so long, but in Jan- be a gradual, three-year process. uary LATAM finally submied appli- LATAM is moving cauously in part caons for deeper JVs with its two

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March 2016 www.aviationstrategy.aero 19 The Principals and Associates of Aviaon Strategy apply a problem-solving, creave and pragmac approach to commercial aviaon projects. Our experse is in strategic and financial consulng in Europe, the Americas, Asia, Africa and the Middle East, covering:

Start-up business plans Turnaround strategies State aid applicaons Due diligence Privasaon projects Asset valuaons Antrust invesgaons Merger/takeover proposals Competor analyses Credit analysis Corporate strategy reviews Market analyses IPO prospectuses Antrust invesgaons Traffic/revenue forecasts

For further informaon please contact: James Halstead or Keith McMullan Aviaon Strategy Ltd e-mail: info@aviaonstrategy.aero

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