ISSUE 15 April 2013

3D Insight A Publication by AACO and Seabury Aviation & Aerospace 3D Insight - Issue 15 Page 2

The Major Outside of MENA Part Two of a Four part series

Background This is the second article in a 4-part series on the There is a particular focus on the big four full- Arab Air Carriers Organization’s (AACO) major service North – American competitors. It examines the North American Airlines (AA), (UA), US Airways carriers, who, whilst not presenting much direct (US) and (DL). competition to AACO airlines, offer useful lessons.

Fig 1 - Seat capacity breakdown from MENA excluding AACO carriers

Jun’12 seats (K)

Source: Innovata, Seabury analysis. 3D Insight - Issue 15 Page 3

In the last decade, the US industry experienced several shocks having a dramatic America’s Big 4 impact on air travel demand and supply (September 11, volatile fuel prices, the global Introduction economic recession, debt restructuring in Europe). All these factors forced airlines to adjust their business models and undergo significant capacity reductions. Many airlines decided to push for acquisitions and mergers as the only way to remain competitive in the difficult economic environment. American Airlines merged with Trans World Airlines (TWA) in 2001, US Airways with America West Airlines (HP) in 2005 and Delta Air Lines with Northwest Airlines (NW) in 2008. In 2010, United Airlines integrated with Continental Airlines (CO).

As a result of these consolidations, nearly 70% of the current operating revenue reported by US carriers is produced by the six largest carriers: the “Big 4” accounting for ~ 57%, and LCCs and JetBlue Airways, with a further 10% 1 . 2011 was the third straight year that the North American commercial airline industry reported sustained profitability and according to the FAA, that trend is expected to continue on 2012’s income statements. 3D Insight - Issue 15 Page 4

Capacity Deployment Overview

The US carriers follow very strict capacity As shown in Figure 2, the market out of North discipline to match seat supply with demand. In America remains essentially flat, with a total 2008, the US carriers made the most substantial growth of only 6% over 8 years. The entire market capacity cuts among all air carriers globally. was deeply impacted by the 2008-2009 economic Except for “Essential Air Services,” where crisis with a total capacity reduction of 8%, which airlines are subsidised by the has however been recovered over the last 3 Department of Transportation (DoT) to maintain years. a minimal level of scheduled air service to small communities, airlines may terminate or reduce services without any restriction.

Fig 2 - North America total capacity development

Seats departed per annum (B)

+5% 2,000 +7%

1,800 17% 14% -8% 1,600 2% 2% 1% 1,400 9% 11% 10% 1,200 9% 13% 1,000 19% Ex-NAM - Non-NAM carrier 800 Ex-NAM - NAM carrier Ex-NAM - LCC 600 Ex-NAM - Big 4 51% 400 40% NAM - Other carriers 200 NAM - LCC NAM - Big 4 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 Note: Big 4 includes AA, CO+UA, DL+NW, US+HP; NAM carriers include all carriers domiciled in North America; Non-NAM carriers include all carriers domiciled outside of North America; Other carriers include all carriers excl. LCCs and the Big 4, with Intra-North America capacity. Source: Innovata, Seabury analysis.

The Big 4 US carriers have lost more than 10 As in the previous article, capacity has been percentage points of intra-NAM capacity share to separated into 14 different flows: Intra-EU-27, the profitable US LCCs (mainly Southwest Airlines Norway, Switzerland and Iceland; Russia and the and JetBlue Airways). While on the ex-North CIS; Turkey; AACO North ; AACO Levant; America market, capacity distribution remained AACO Arabian Gulf; Indian Sub-Continent and flat. Non-NAM carriers increased their capacity Iran; Rest of Africa; South Asia; South East. share by 3 net percentage points; Emirates, Etihad and Qatar Airways contributing 1.1 points Figure 3 shows that from North America, the main each. Noticeable changes in the European and capacity reduction took place in the domestic America LCC markets were caused by entrance market where since 2006, non-NAM carriers of airberlin in 2008 and the more than doubled pulled out 19% and NAM carriers 1% of their capacity deployed by Condor since 2004. capacity. 3D Insight - Issue 15 Page 5

Fig 3 - 2006-2011 seat capacity growth from North America to the world

Growth (%)

10% North American carriers 7% Non-N. American carriers 0% 27% 0% 13%

2% -1% 1% -19% 1% 1% 0% 7% 1% 4% 76% 3% European Common Aviation Area -1% 1% Russia & CIS 49% Turkey 8% AACO North Africa 1% AACO Levant 4% 2% AACO Arabian Gulf 6% 108% Indian Sub-Continent and Iran Africa 41% South Asia South East Asia North East Asia North America Central America & Caribbean South America

Note: Annual seat capacity. Source: Innovata, Seabury analysis.

Intra North America Capacity Fig 4 - Capacity development on North American routes

Seats departed per annum (M)

2,000 CAGR (%) -13% 7% -11% 1,500 -1% 7% LCC

53% 1,000 Other charter -1% 56% + FSCs

10% -5% 500 5% 8% US+HP 7% AA +2% 15% 12% UA+CO -4%

11% 10% DL+NW -2% 0 2004 2005 2006 2007 2008 2009 2010 2011 2012

Note: Big 4 includes AA, CO+UA, DL+NW, US+HP; Other FSC & Charter include Medium, small and other FSC, regional and charter airlines. Source: Innovata, Seabury analysis.

Intra North America capacity has dropped by 13% been the most impacted with a ca. 3% share loss, over the last 8 years. The Big 4 carriers have while LCCs have maintained their presence. 3D Insight - Issue 15 Page 6

While the previous article explained that LCCs the US is perceived as a commodity. Air fares increasingly entered the European market up until oscillate on the low-end which forces scheduled 2008-2009, US LCCs established themselves carriers to operate domestic routes on a low cost earlier. Southwest was created in 1971 and basis directly competing with their no frills rivals. gradually expanded its network with relative freedom. Conversely, Ryanair, created in 1985, Under these oppressive market circumstances, had to wait until 1992 for the first deregulation domestic operations are very sensitive to any of the European market to be able to open economic fluctuation or instability. These are routes without any restrictions. In summary, the tough times for regionals on both sides of the North American domestic market, unlike the Atlantic. In the USA, ExpressJet sold itself to intra-European market, has long-since reached SkyWest Airlines for $50 million less in 2010 maturity. Today, limited growth opportunity than it was offered in 2008. Delta shut down between third-tier cities remains to be explored. Comair. Pinnacle, as part of its own bankruptcy Long-term excess supply has also had a reorganisation, closed Colgan Air. American Eagle significant impact on consumer behavior, which expects to be spun off from American Airlines 2 . has become extremely price elastic. Air travel in Regional carriers face uncertain futures.

Ex North America Capacity Fig 5 - Big 4 ex-North America capacity growth

2006 and 2011 US Big 4 seat capacity from North America, CAGR (%)

Russia & CIS +0% Turkey Europe +5% North East Asia +2% 0% Levant Central America North +13% & Caribbean Africa* -3% 100% Arabian Indian South Asia Africa Gulf subcontinent -1% +112% +108% +7%

South America South East Asia +3% +4%

Note: *100% as a proxy, as the Big4 were not flying to North Africa in 2006. Source: Innovata, Seabury analysis.

From North America, the fastest growing market is Non-NAM carriers deployed more than 300,000 seats The Arabian Gulf-North America market which has in 2006 and over 1.7 million in 2011. The significant recorded a breathtaking constant growth of 108% growth of Gulf-North America capacity is expected to and 41% p.a. for North American and Gulf carriers continue as the Americas are the least served regions respectively. About 8,000 annual seats were offered by in the “Big three” Gulf carriers’ networks, and they are NAM carriers in 2006, vs. more than 300,000 in 2011. shifting their focus mainly to the US development. 3D Insight - Issue 15 Page 7

The Indian subcontinent occupies the second is reflected in growing aviation partnership position in terms of capacity growth with still a lot between India and North America. A single sky of untapped demand from both ends of the route agreement was signed in August 2005, boosting for both business and VFR 3 travel. As per the capacity offered on US-India routes by 60% per 2011 American Community Survey, the Indian annum on average 5 . However, North American American community in the United States is over airlines are still facing numerous challenges 5 million strong which represent 1.6% of total including access to good quality and cost US population. The Indian American diaspora effective infrastructure and service providers, is characterised by a high level of education which explains the average 76% growth for and is represented in many high-income fields Indian carriers compared to 7% growth for North including academics and entrepreneurs, doctors American carriers. This might change in the and lawyers, engineers (mainly high-tech and IT future if Indian Civil Authorities are able to enforce sectors) and financiers. The states with the highest strong pricing regulation policies to ensure fair Indian population are California (about 300,000 competition for foreign carriers. Indian Americans in California’s Silicon Valley), New York, New Jersey, Texas and Illinois 4 . The third fastest growing market from North America is Africa, with 49% annual growth for There has been steady progress in relations NAM carriers. between India and the US in recent years, which

Fig 6 - North America-Africa capacity development

Annual seats (K) 800

700

600 SA SA ET 500 ET VR 400 VR DL DL 300 UA+CO UA+CO Other 200 Other

100

0 2004 2005 2006 2007 2008 2009 2010 2011 2012

On the African side, South African Airways has United entered the market in 2009 and is maintained a regular service to North America now expanding on certain key routes such as 6 over the last 8 years; while on the US side, Delta Houston-Lagos, connecting two main oil capitals . has been a pioneer since 2006 with routes to US carriers are opening routes carefully to ensure Accra, Johannesburg, Lagos and Dakar from access to all infrastructure (including safe access Atlanta and New York. to oil), and security for passenger and personnel. 3D Insight - Issue 15 Page 8

While Delta has started code-sharing with Air In the past, connections via Europe were Nigeria on Addis-Ababa-Washington Dulles preferred; due to difficulties with inter-Africa routes, United may be also interested in creating transfer. Today US carriers have reached a ca. partnerships. However, the advantage of alliances 50% capacity share, which has been a long way will be limited, as member carriers are all in from their total absence from the market in the eastern or southern African countries (Nigeria, 1990s. Kenya, South Africa), while some connections with Western Africa would be sensible commercially.

Fig 7 - LCC ex-North American capacity growth

2006 and 2011 LCC seat capacity from North America, CAGR (%)

North East Asia* Europe +100% +1%

Central America & Caribbean +28%

South America +87% South East Asia +128%

Note: *100% as a proxy, as the Big4 were not flying to North East Asia in 2006. Source: Innovata, Seabury analysis.

Focus on MENA

As mentioned above, the Arabian Gulf is the fastest by the three major Gulf carriers, Emirates, Qatar growing market from the US. This is mainly driven Airways and Etihad Airways. 3D Insight - Issue 15 Page 9

Fig 8 - Capacity distribution from North America to MENA

To the North Africa To the Arabian Gulf To the Levant Seats departed per annum (M) Seats departed per annum (M) Seats departed per annum (M)

1.0 2.5 2.5 2.3

2.1 13% 0.8 2.0 2.0 +38% 1.8 15%

1.6 17% 0.6 1.5 1.5 21% +4% +6% 1.2 1.1 111.1 1.1 1.1 1.1 0.4 1.0 0.4 0.9 0.4 0.3 0.3 1.0 19% 87% 1.0 17% 0.8 46% 44% 8% 14% 2% 0.3 85% 36% 43% 41% 0.3 0.8 30% 31% 0.3 0.6 82% 22% 23% 5% 5% 13% 79% 8% 6% 4% 5% 5% 0.2 0.2 4% 0.2 0.5 0.5 8% 030.3 81% 71% 64% 64% 59% 50% 52% 54% 0.2 0.2 87% 69% 54% 98% 78% 100% 0.0 0.0 0.0 20042006 2008 2010 2012 2004 2006 2008 2010 2012 2004 2006 2008 2010 2012

Other carriers Big 4 AACO % 2011 capacity 10% 58% 32% share

Note: Big 4 includes AA,US+HP, UA+CO and DL+NW; Other carriers include Medium, small and other FSC carriers. Source: Innovata, Seabury analysis.

Fig 9 - North America to MENA capacity development by fleet type

To the North Africa To the Arabian Gulf To the Levant Departed flights (K) Departed flights (K) Departed flights (K)

8 8 8

7 7 7

6 6 6

5 5 5

4 4 84% 4 7% 3 3 3 11% 53% 2 2 2 66% 1 1 1 100% 21% 40% 16% 100% 79% 24% 0 20% 0 0 2004 2006 2008 2010 2012 2004 2006 2008 2010 2012 2004 2006 2008 2010 2012

Other carrier - NB AACO-NB Big 4 - NB Other carrier - WB AACO-WB Big 4 - WB

Note: NB: Narrow body; WB: Wide body; Narrow body includes R-jets and Turboprops. Source: Innovata, Seabury analysis. 3D Insight - Issue 15 Page 10

In 2012, Emirates, the largest carrier between the Etihad Airways currently operates only flights US and Middle East, launched flights to three new from Abu Dhabi to New York JFK and Chicago, it US destinations – Dallas/Fort Worth, Seattle and has revealed plans to launch services from Abu Washington Dulles, in addition to the currently Dhabi to Washington Dulles in March 2013 and operated cities of Houston, Los Angeles, New to add more US markets once it starts to receive York-JFK and San Francisco. The expansion is deliveries of the 41 Boeing 787s it has on order in somewhat rapid for the carrier whose last additions 2014 7 . in the US market were San Francisco and Los Angeles in 2008. Emirates also increased its Qatar Airways offers services to New York-JFK, weekly offering in the Dubai-JFK market by roughly Houston and Washington Dulles. In August 1,000 seats each way from 1 January 2013, when 2012, Qatar Airways announced it was launching the carrier began operating an Airbus A380 on Chicago effective April 2013 as the fourth US its second daily flight in the market, replacing a gateway in its network. As its CEO, Akbar Al Boeing 777-300ER. Emirates also uses the A380 Baker, said in October 2012, Qatar Airways on one of its twice-daily New York frequencies 7 . intends to nearly double its footprint in the United Forging a partnership with American Airlines will States with three new destinations listed as also help Emirates raise its presence in the USA. Detroit, Boston and Atlanta 9 . The Gulf carrier also has existing partnerships with and JetBlue 8. Qatar Airways should be fully integrated into oneworld by mid-2014. Given the structure of its Emirates dominates the North America-GCC network, Qatar Airways seeks additional feed for (Gulf Cooperation Council) market. However, in its European routes and aims to connect with the the future, its primacy might be shaken as Qatar US partners. and Etihad Airways aim to quickly expand their NAM market presence. Although within the US

Revenue Improvement Initiatives Revenue performance of the US airlines is At the end of 2011, the average RASK achieved strongly dependent on economic conditions. by the Big 4 exceeded 2009 level by more than Since 2009, US airlines have reported sharp 20% (see Figure 10), and the positive trend unit revenue improvement. Short-haul services continues. The main drivers are most likely the have recovered the ground lost in the 2008 Great modest economic recovery reflected by the rise in Recession. Long-haul routes were hit harder premium class together with the radical capacity during 2009 because of the larger proportion of reductions described in the previous chapters, their revenues made up by premium passengers which enable revenue management departments and cargo, and it will still take them some time to to push yields up. reach the 2008 level 10 . 3D Insight - Issue 15 Page 11

Fig 10 - RASK development of the Big 4 US carriers from 2005 to 2011

Total RASK ($ cents) 10.0

9.0

8.0 CAGR (%)

7.0 AA +5% UA +5% DL +6% 6.0 US +4%

5.0 2005 2006 2007 2008 2009 2010 2011 2012

Note: United Airlines includes Continental from 2010; Delta includes Northwest from 2008; US Airways Group numbers from proxy consolidated income statements. Source: Financial public data, Seabury analysis.

Ancillary revenue became a new priority for US extra legroom seating and on-board catering. airlines, as typically ancillary services have higher For the first time, Southwest appeared on the top margins than core transportation activities and 10 list occupying the fifth position behind fourth significantly contribute to the company’s bottom- Qantas Airways. While Southwest has chosen line. Since 2008, carriers have invested a lot of not to generate revenue from checked baggage effort in finding additional revenue sources. They fees, it has embraced the sale of convenience- have unbundled and enhanced former products adding services such as Southwest’s EarlyBird and started charging for certain ancillary services. service and the Business Select product. The Today, the Big 4 achieved 10% ancillary revenue most effective means by which Southwest share. At the same time, ancillary revenue gain is has generated ancillary revenue has been its slowing down as airlines have already explored revamped Rapid Rewards frequent flier program. the obvious opportunities and only more refined Co-branded credit cards also contributed to and complex ones remain. As per 2011 financial Southwest’s success11 . figures, ancillary revenue represented 11% of American Airlines’ total revenue and its value was Due to the highly competitive environment in the almost double compared to 2002. US Airways American cargo market, US airlines provide cargo reached 10%, Delta 11% and United Continental services primarily through the belly-cargo capacity 9% ancillary revenue share. on their scheduled passenger aircraft. Because of limited capacity dedicated to cargo operations, According to Amadeus Review of Ancillary the importance of cargo revenue is minimal Revenue Results 2011, United Continental, Delta compared to Europe. In 2011, the Big 4 reported and American Airlines are the top 3, respectively, cargo contribution not higher than 3% of overall for total ancillary revenue. The biggest global revenue. ancillary revenue swings are in baggage fees, 3D Insight - Issue 15 Page 12

Fig 11 - Expected GDP growth forecast vs. historical seat capacity growth

Constant price GDP growth for 2012-2017 vs. seat growth for 2006-2011 from home to the world (one direction)

2012-2017 avg. Regions GDP growth (%)

Asia 6.0% 10% 19%

South Asia 5.9% 2% 15%

Africa 55%5.5% 112% 16%

Russia & CIS 4.2% 0% 24%

MENA 4.1% 23% 10%

South America 4.0% -1% n/a

Europe 2.5% 4% 13%

Note: MENA includes North Africa, Levant and Arabian Gulf; South America includes Caribbean, Latin and South America; Asia includes North East Asia, Indian Subcontinent and South-East Asia; straight average growth between 2012 and 2017; CAGR seat growth. Source: Innovata, Seabury analysis, International Monetary Fund.

Load Factor Increase Figure 12 shows that despite the vast plunge in air capacity reductions and at the expense of a decline travel demand, all US carriers managed to hold in yields. load factors at 80%. This was mainly due to strict

Fig 12 - Capacity load factor

RPK/ASK (%) 85%

80%

75% CAGR (%)

70% AA +0.7% UA +0.2% DL +1. 2% 65% US +1.1%

60% 2005 2006 2007 2008 2009 2010 2011

Note: United Airlines includes Continental from 2010; Delta includes Northwest from 2008. Source: Financial public data, Seabury analysis. 3D Insight - Issue 15 Page 13

Focus on product

After US market deregulation, American carriers class, the Big 4 charge for the first checked plunged into oppressive price wars uncontrollably bag and offer free snacks and non-alcoholic pushing their fares down. In order to match their beverages on flights longer than 2 hours. product with decreasing prices, they started Conversely, Southwest and JetBlue offer the first charging for extra services which were originally checked bag for free and meals on every flight. provided within the basic fares. Today, ancillary Unlike the legacy carriers, Southwest and JetBlue revenue plays an indispensable role, and US are all-economy-class airlines; however, they are airlines are focusing on driving this through both targeting more business traffic and tailor modernising their brand, product and services. their product and services to the needs of the US All Big 4 airlines are equipping their fleets with corporate clients. JetBlue has even transitioned in-flight Wi-Fi, and JetBlue offers industry-leading to SABRE, the global distribution system, in an onboard entertainment. Additionally, Southwest effort to capture a better mix of corporate traffic. Airlines is implementing a wireless network On long-haul, the Big 4 operate a 3-class product throughout its fleet. with economy class closer to the traditional full-service airline. However, their product is still On domestic routes, the Big 4 American airlines limited compared to the European and Asian directly compete with their no-frill rivals who take carriers. advantage of their lower cost base enabling them to offer wider and cheaper services. In economy

Cost management Aircraft fuel is the largest, most volatile and The drop in airline travel after 2001 forced airlines unpredictable expense impacting an airline’s to shrink their operations and park their least financial results. In 2011, fuel represented around efficient aircraft. As shown in Figure 13, deserts in 33% of American Airline’s operating expenses, the U.S. Southwest have become one of the top 35% for United Continental and 36% for Delta destinations for US airliner storage because of the and US Airways. Southwest reported that fuel perfect combination of plentiful cheap land and a accounted for almost 38% of operating expenses, dry climate that preserves the planes13 . and JetBlue was almost at 40% mark. Hedging and fuel-efficiency activities protect the industry against growing fuel prices which are not fully offset by an increase in passenger surcharges.

New aircraft technologies have a positive impact on fuel efficiency. Due to poor fuel efficiency and high maintenance cost, Delta shut down its 35-year-old regional carrier, Comair, in September 2012. On April 2012, Delta purchased a refinery in Pennsylvania to mitigate risks coming from the crack spread 12 . 3D Insight - Issue 15 Page 14

Fig 13 - Aircraft parked in the US desert from 1960

Number of aircraft

Source: Airclaims, UBS.

Major cost savings and higher cost control are underserved markets. It operates an all-economy also the main reasons behind airline mergers and fleet predominantly composed of 23-year-old capacity purchase agreements. MD-80s. Low ownership costs enable Allegiant to park aircraft any time its operation is not justified Also, the unique and, more importantly, profitable by demand. For example, in November 2012, on low cost business model of is worth Tuesdays, Wednesdays and Saturdays, Allegiant mentioning. Allegiant focuses on the niche operated only 11% of its flights14 .

Fleet

Figure 14 demonstrates that in 5 years’ time, less efficient aircraft with more modern planes. It LCCs are planning the largest narrowbody fleet has ordered 150 cost-efficient Boeing 737 MAX growth. JetBlue with its 6-year old fleet of A320s aircraft, with the first delivery expected in 2017 16 . and Embraer 190 aircraft has one of the youngest Southwest recently completed the acquisition fleets amongst major US airlines. In 2011, JetBlue of Atlanta-based AirTran, which broadens the ordered new A321 aircraft, with first delivery carrier’s reach in the southeastern US and into taking place in 2013, and 40 additional A320 nearby international markets. The company has neo aircraft. Southwest operates an 11-year-old also announced plans to keep its fleet flat until it fleet 15 . In December 2011, Southwest arranged can reach its 15% pre-tax ROIC target. with Boeing the flexibility to replace its older, 3D Insight - Issue 15 Page 15

Fig 14 - Growth in seat capacity through 2017

% growth versus 2011 NbdiNarrow bodies Wide b odi es 180% 180% LCCs Gulf 164% 158% 160% Big 4 160% Big 4

140% 140% 132%

120% 120%

100% 100%

80% 80%

60% 60%

40% 40% 29% 19% 23% 20% 20% 8%1% 9% 1% 3% 0% 0% -8% -7%

Note: Excludes potential impact of utilisation changes or parked aircraft returning to service; Assumes US carriers currently 20+ years old or Middle East aircraft currently 13+ years old will by retired by YE2017; Delta Airlines includes: Delta Airlines, Northwest; US Airways includes: US Airways, America West Airlines; American Airlines includes: American Airlines, Eagle Airlines; United Airlines includes: Continental Airlines, United Airlines. Source: AdAscend.

The Big 4 American airlines operate a fleet of is supposed to increase its wide body fleet the aircraft that is about 13-years-old. Delta has most, by 23%, followed by United’s 9% increase the oldest fleet with an average age exceeding (see Figure 14). In its 2011 annual report, US 15 years, followed by the 13-year-old fleet of Airways acknowledged the option to negotiate American Airlines17 . In July 2011, American the deferrals of aircraft deliveries commencing in Airlines announced the largest order of narrow 2013 in case financing is unavailable. body aircraft with Boeing and Airbus in aviation history. Under the new agreements, American In September 2012, United Airlines took delivery plans to acquire 460 narrowbody, single-aisle of its first 787 Dreamliner. After an initial domestic aircraft from the Boeing 737 and Airbus A320 use on routes from its Houston hub, the new- families beginning in 2013 and running through generation aircraft has been deployed to 2022 18 . Delta is also in talks to buy fuel-efficient Amsterdam, Lagos, London Heathrow, Shanghai narrow body planes to renew its aging fleet 19 . and Tokyo Narita effective December 2012. It is the first 787 carrier in the US, with a total Widebody aircraft have dominated aircraft orders order of 50 787-800s 20 . Recently, as revealed amongst the Middle Eastern carriers. As GCC by Bloomberg, the world’s biggest airline was carriers openly acknowledge, a large portion supposed to talk with Airbus SAS about buying of this aircraft type is intended to be deployed A350-1000 jets to replace older Boeing Co. (BA) on US routes. Amongst the Big 4, US Airways 747s. 3D Insight - Issue 15 Page 16

Labour

The US airline industry is the sector with the As mentioned previously, US airlines maintain highest number of unionised employees. Labour a low cost base through a very strict capacity unions, together with FAA regulations, have deployment policy which closely matches industry a very strong bargaining power because of demand. To achieve cost savings effectively, US the strike threat. Unions play a critical role in legislation enables the US carriers to temporarily determining labour costs. reduce their workforce without any legal sanctions through “furlough” procedure. According to IATA, in 2007 about half of all workers in the air transportation industry The recently biggest labour dispute in the US belonged to a union. Apart from Delta, all major market took place between American Airlines US carriers are highly unionised, while national and its pilots. The mutual disagreement started and regional carriers include a mix of union and in November 2011 following the bankruptcy filing non-union workplaces. Southwest Airlines chose of American Airlines and lasted until December an interesting tactic on how to combat the unions’ 2012 when the pilots ratified labor deal. It had a power. Although 90% of Southwest’s workforce negative impact on the carrier’s operational and joined unions, employees own 11% of the financial performance. For instance, in September company which makes them fully involved in the 2012 the conflict resulted in the worst on-time company’s operational and financial results 21 . performance of any major US airline.

During the era of regulation, labour unions The bargaining power of pilots might even acquired a lot of power, and employees were increase in the future as many regions in the mostly overpaid. Deregulation completely world have already warned against a potential changed the attitude of the established airlines to pilot shortage. Boeing forecasted that in 2025, their cost structures, as they had to compete with the pilot requirement will be doubled compared to the efficient low cost carriers entering the market. 2006 (see Figure 15). Many airlines went into bankruptcy or filed under Chapter 11 bankruptcy code giving them the opportunity to re-negotiate labour contracts.

Fig 15 - Pilot requirements in 2025

% growth versus 2011 150,000 Number of pilots in 2005 120,000 Pilots needed by 2025 90,000

60,000

30,000

0

Source: Boeing Co. 3D Insight - Issue 15 Page 17

Partnership and consolidations

In order to boost revenues and control their Recently, American Airlines officially announced cost base, US legacy carriers negotiate multiple it is seeking international partnerships, and the air service agreements with regional airlines to airline is in code share discussions with Dubai- feed their network from small and medium-sized based Emirates, despite having an existing cities. These agreements are mostly long-term agreement with its Abu Dhabi-based competitor capacity purchase contracts which are unique to Etihad Airways and new alliance partner Qatar the North American market. Typically, capacity Airways22 . purchasers are responsible for the commercial side of operations. Capacity providers are fully As mentioned in the previous article, unlike accountable for the operations, and their fees Europe, North American airline mergers are are calculated to cover fully allocated costs plus executed as a full integration of branding, a margin. The capacity providers are protected ticketing, airport service, frequent-flier programs against the volatile fuel rises; however, ex- and air services, including labour cuts. Once a fuel cost items must be maintained within the merger is completed, the merging airlines function contractual limits. as one company.

Partnerships and consolidations have become a After the recent mergers of Northwest-Delta and powerful tool to improve revenues through more United-Continental Airlines, US Airways and robust route networks and to realise greater American Airlines are currently holding intensive operational efficiencies. American Airlines was one merger talks and the final decision should be of the founding members of oneworld, Delta Airlines made “within a matter of weeks.” co-founded SkyTeam, and United Continental and US Airways are Star Alliance members.

Regulatory Environment The commercial US aviation domestic market The US airline market seems to be in a was deregulated by the re-regulation phase. Under the current Act in 1978 which removed government control administration, consumers have faced a gauntlet over fares, routes and market entry. As a result, of new regulations designed to protect them. the airline industry became market-driven. These rules are often challenged by IATA, AACO Deregulation forced US airlines to adjust their and other airline associations, as they impose network towards a more financially sustainable additional burdens on airlines’ operations. Since “hub and spoke” model. Since 1990, the US have 2009, consumer regulations have increased been liberalising its international aviation markets airline costs by $1.7 billion annually, or $5.39 per and has concluded numerous “Open Skies” round-trip ticket 23 . agreements. Apart from the FAA regulations, US airlines are Today, the U.S. DoT and the Federal Aviation subject to federal law, e.g., federal antitrust Administration (FAA) serve as a national civil or bankruptcy law. Federal Bankruptcy Law, aviation regulating authorities and control Chapter 11 became a strong tool in reorganisation Operations, Safety, Certification and Commercial and prevents enterprises which are “too big” areas. The FAA also performs slot management from failing. American Airlines filed voluntary at slot-coordinated US airports. FAA regulations petitions for Chapter 11 reorganisation in the have been adopted by other countries, e.g. in the U.S. Bankruptcy Court. The aim is to “achieve Middle East. competitive cost and debt structure and assure long-term viability and the ability to continue delivering a world-class travel experience for customers” 24 . 3D Insight - Issue 15 Page 18

Closing Thoughts Although 2012 was supposed to be a breakthrough More and profound changes are needed, but year in US airline industry, we can definitely expect by the end of this decade, we are likely to see a more changes to come. US airlines will continue consolidation of the industry with fewer players, focusing on revenue share instead of market share. which should be far healthier and bigger than today. The number of airlines operating in the US market is diminishing and there are most probably more mergers to come. The importance of alliances is growing, and this trend will continue in the future.

1 Source: U.S. DOT Form41; Financial data 2011 2 Source: http://www.flightglobal.com/news/articles/analysis-regional-airlines-must-choose-whether-to-align-with-a-major-carrier-or-go-it-alone-376800/ - David Knibb, 21st September 2012 3 Definition: VFR ~ Visiting friends and family 4 Source: http://moia.gov.in/pdf/usa.pdf 5 Source: http://span.state.gov/wwwfspjulaug053.pdf - A. Venkata Narayana, July/August 2005 6 Source: http://centreforaviation.com/analysis/united-airlines-eager-to-tap-expected-growth-in-us-africa-market-65431 - 30th December 2011 7 Source: http://centreforaviation.com/analysis/gulf-carriers-turn-their-attention-to-the-us-to-fuel-their-continued-rapid-growth-80562 - 16th August 2012 8 Source: http://www.flightglobal.com/news/articles/emirates-and-amr-in-partnership-talks-376417/ - Ghim-Lay Yeo; 12th September 2012 9 Source: http://www.usatoday.com/story/todayinthesky/2012/10/24/qatar-airways-ceo/1655711/lines-eager-to-tap-expected-growth-in-us-africa-market-65431 - Ben Mutzabaugh October 25th 2012 10 Source: IATA; Annual Report 2011 - Giovanni Bisignani 11 Source: Amadeus; The Amadeus Yearbook of Ancillary Revenue; Ancillary Revenue Report Series for 2012 by Ideal Works Company – Jay Sorensen, Eric Lucas 12 Definition: Crack spread is a difference between petroleum products and crude oil prices 13 Source: http://www.cbsnews.com/2100-500395_162-4919415.htmlp - CBSNews, April 4th 2009 14 Source: Diio Mi; Capacity data – weekly average November 2012 15 Source: Southwest Airlines CO.; 2011 Annual Report to Shareholders; JetBlue Airways; JetBlue’s 2011 Annual Report on Form 10-K 16 Source: http://www.flightglobal.com/news/articles/southwest-becomes-737-max-launch-customer-with-150-strong-firm-order-365932/ - Kerry Reals, 13th December 2011 17 Source: Ascend; Fleet data 2011 18 Source: American Airlines newsroom; American Announces Largest Aircraft Order in Aviation History, Will Establish Youngest and Most Fuel-Efficient Among U.S. Airline Industry Peers; July 2011 19 Source: http://www.reuters.com/article/2011/06/30/us-airlines-orders-idUSTRE75T5VF20110630 - Kyle Peterson, 30th June 2011 20 Source: http://www.flightglobal.com/news/articles/united-takes-first-787-376864/ - Edward Russell, 24th December 2012 21 Source: http://www.iata.org/whatwedo/Documents/economics/Hirsch_Unions_Wages.pdf - Barry Hirsch, July 2007 22 Source: http://www.flightglobal.com/news/articles/in-focus-american-seeks-more-codeshares-despite-opposition-377452/ - Edward Russell, 9th October 2012 23 Source: AAI Report November 2011; Consumer Regulation and Taxation of the U.S. Airline Industry, Estimating the Burden for Airlines and the Local Impact 24 Source: http://www.aa.com/i18n/information/restructuring.jsp?anchorLocation=DirectURL&title=restructuring NOTE: All sources viewed and downloaded in Q4 2012 3D Insight - Issue 15 Page 19 Statistics

Executive Summary Statistics (Q1-Q3 2012) Source: AACO Note: Includes scheduled operations for EK, EY, G9, GF, KU, ME, MS, QR, RJ, SV, TU, WY, XY

Total Change International Change Domestic Change

No. of Pax 95,053,353 16.5% 81,857,159 16.2% 13,196,194 18.9%

Tonnes Cgo 3,037,358 17.2% 2,991,760 17.6% 45,598 -5.6%

RPKs (000) 314,878,958 17.8% 304,074,829 17.7% 10,804,129 20.1%

ASKs (000) 403,817,722 13.6% 390,520,641 13.6% 13,297,082 16.2%

Pax Load 77.98% 2.7 pp 77.86% 2.7 pp 81.3% 2.7 pp Factor

RTKs (000) 39,246,474 15.2% 38,295,104 15.1% 951,370 15.5%

ATKs (000) 63,686,054 12.7% 62,095,459 12.7% 1,590,595 13.2%

Weight Load 61.62% 1.3 pp 61.67% 1.3 pp 59.81% 1.2 pp Factor

AACO members passenger size and growth Fig 1 - Year-on-year revenue passenger kilometers (RPKs) growth versus passenger load factor (PLF). Bubble size indicates carrier size measured as available seat kilometers ( ASKs) Source: AACO

RPK Growth Q1-Q3’12 (% YOY) 40 1 billion ASKs

30 EY TU WY MS 20 QR EK

G9 10 SV XY RJ ME 0 PLF (%) 40 45 50 55 60 65 70KU 75GF 80 85 90 -10 3D Insight - Issue 15 Page 20

AACO members cargo size and growth Fig 2 - Year-on-year revenue tonne kilometers (RTKs) growth versus weight load factor (WLF). Bubble size indicates carrier size measured as available tonnes kilometers (ATKs) Source: AACO

RTK Growth Q1-Q3’12 (% YOY) 40 500 million ATKs

30 TU MS WY 20 QR SV EK

10

RJ ME 0 40 45 50 55 60KU 65 70 75 80 85 90 GF -10 WLF (%)

Arab passenger growth Fig 3 - Historical trend of Q1-Q3 passenger numbers at most Arab airports Source: AACO, ACI

Pax (million) +14.8% 200 181.6

159.5 158.2 150 142.7

100

50 Passengers

0 Q1/Q3 - 2009 Q1/Q3 - 2010 Q1/Q3 - 2011 Q1/Q3 - 2012

Arab cargo growth Fig 4 - Historical trend of Q1-Q3 cargo transported at most Arab airports Source: AACO, ACI

Tonnes (million) 5 +4.0% 4.34 4.15 4.18 4 3.58

3

2 Cargo

1

0 Q1/Q3 - 2009 Q1/Q3 - 2010 Q1/Q3 - 2011 Q1/Q3 - 2012 3D Insight - Issue 15 Page 21

Arab departure growth Fig 5 - Historical trend of Q1-Q3 quarter traffic volume in most Arab airports Source: AACO, ACI

Departures (million) 2.0 +7.6% 1.55 1.44 1.5 1.37 1.28

1.0

0.5 Departures

0.0 Q1/Q3 - 2009 Q1/Q3 - 2010 Q1/Q3 - 2011 Q1/Q3 - 2012

Intra-regional Arab market Fig 6 – Q1-Q3 international Arab market passenger numbers within the Arab World Source: AACO, IATA

Pax (million) -1% 10 +20% Q1-Q3 2010 9 Q1-Q3 2011 8 Q1-Q3 2012 7 6 5 4 3 +17% +11% +32% 2 +48% 1 0 Within Arabian Within Near Within Near East Near East - North Africa Peninsula East North Africa -Arabian North Africa - Arabian Peninsula Peninsula

Inter-regional Arab market Fig 7 - Q1-Q3 Arab market passenger numbers to/from the Arab world Source: AACO, IATA

Pax (thousand)

35 +6% Q1-Q3 2010 30 Q1-Q3 2011 +4% Q1-Q3 2012 25

20

15 +5% 10 +8% +9% 5

0 With the Americas With Europe With Mid Asia With Australasia With Sub- Saharan Africa 3D Insight - Issue 15 Page 22

Airport passenger volume Fig 8 – 2012 Q1-Q3 passenger volume in most Arab airports by port Source: AACO, ACI

Pax (million) 20 4 6 8 10 12 14 16 18 20 42 44

DXB JED* DOH RUH CAI AUH KWI BAH MCT SHJ CMN HRG DMM AMM SSH BEY ALG TUN RAK MIR AGA LXR RKT RBA ASW FJR

Note: *Estimated.

Airport cargo volume Fig 9 – 2012 Q1-Q3 cargo volume in most Arab airports by port Source: AACO, ACI

Tonnes (thousand) 0 50 100 150200 250 300 350 400450 500 550 600 650 1,650 1,700

DXB DOH AUH SHJ BAH RUH JED* CAI KWI* MCT AMM DMM BEY CMN ALG TUN FJR RKT RAK RBA LXR MIR AGA

Note: *Estimated. 3D Insight - Issue 15 Page 23

Domestic and international Fig 10 - Q1-Q3 AACO members’ domestic and international passenger volume historical trend Note: Includes scheduled operations for EK, EY, G9, GF, KU, ME, MS, QR, RJ, SV, TU, WY Source: AACO

Pax (million) 100 92.8 90 79.7 12.3 Dom. Passengers 80 75.0 10.5 70 66.6 10.1 60 9.9 50 40 80.5 Int’l Passengers 64.9 69.2 30 56.7 20 10 0 Q1-Q3 2009 Q1-Q3 2010 Q1-Q3 2011 Q1-Q3 2012

Fleet growth Fig 11 - AACO members combined fleet growth by aircraft type Source: AACO, ACAS

Aircraft 1,000 908 902 862 5% 3% Freighter 767 4% 9% 10% Regional 800 9% 4% 8% 600 41% 42% Narrowbody 41% 42% 400

46% Widebody 200 46% 45% 45%

0 2009 2010 2011 Q3-2012

Avg Seats 214.8 213.2 215.0 217.7 Avg Age (Yr) 7.70 7.31 7.37 7.38

Fleet changes this quarter Fig 12 – Third quarter changes to the AACO fleet by carrier Source: AACO, ACAS

Aircraft 950 920 53 35 902 900

850 8U (1) EY 1 AH (1) G9 1 RG (1) ME 1 MS (1) TU 1 WY 1 LN (2) 800 AT 2 SD (2) IA 2 IA (2) KU 2 R5 (2) MS 2 GF (2) QR 2 750 EY (3) R5 2 EK (8) BJ 3 SV (28) SV 3 GF 4 EK 8 700 Q2-2012 Parked/Retired Additions Q3-2012 Seabury Aviation & Aerospace is the largest global advisory firm dedicated to commercial aviation and its related businesses. The experience of our 180+ professionals in strategy, operational cost reduction and restructuring is unparalleled.

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