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Canada’s Airlines Part 2: Air Canada works to bolster its international network in 2014[/h]Analysis
10-Jan-2014 8:27 PM
Air Canada begins 2014 on relatively solid footing after taking painful steps during the past few years to thwart a second formal restructuring. It is paring down debt to improve its financial leverage, achieving its liquidity targets and setting ambitious cost reduction goals in order to narrow cost gaps with its domestic rival
WestJet.
While Air
Canada continues to watch developments in the Canadian domestic market – mainly the introduction of WestJet’s new regional carrier Encore – and craft its competitive responses, international service is a major tenet of the carrier’s strategy to sustain its positive momentum in 2014. The main pillars of Air Canada’s international push are its new low cost carrier
rouge, higher density 777-300ERs and the long-awaited arrival of the first of 37
Boeing 787s set to debut on service to
Tel Aviv and Tokyo.
Air Canada appears poised to execute both offensive and defensive moves during 2014 as it works to fend off WestJet’s encroachment on regional domestic routes and works to optimise and grow its long-haul international network as its rival examines the possibility of increasing competition with Air Canada on long-haul flights. Much like WestJet, Air Canada has a full agenda, but appears now to be in a reasonable position to execute its plans.
[h=3]Air Canada offers a solid financial foundation to support international growth[/h]In late 2013, Air Canada ticked off a list of positive financial metrics, made possible in part through new labour contracts (formalised with the aid of the Canadian government, following confrontations with unions) and pension relief it received in Mar-2013, that set the stage for the carrier to carry out its 2014 agenda.
Air Canada’s CAD2.4 billion in liquidity during 3Q3013 was above its targeted minimum of CAD1.7 billion. Its liquidity levels as measured by 12 months trailing revenue were 20% at the end of Sep-2013, a percentage the carrier had not reached since 2010 and up from a low of 9% during 2008.
Air Canada's liquidity position and % of 12 month trailing revenues: 2007 to 3Q2013
Source: Air Canada
As its liquidity levels have risen and stabilised, Air Canada’s debt has also been decreasing, falling about CAD1.4 billion from YE2009 to Sep-2013. Those improvements have resulted in more favourable leverage ratios for Air Canada. Its adjusted net debt to EBITAR fell from 8x in 2009 to 2.9x at the end of 3Q2013.
Air Canada net debt: YE2009 to 30-Sep-2013
Source: Air Canada
Air Canada leverage ratios: 2007 to 3Q2013
Source: Air Canada
Again, some of the positive momentum is arguably attributed to aid from the Canadian government; but Air Canada during the last couple of years has also worked on its own to improve its balance sheet and lower its costs. On a unit basis, Air Canada’s costs fell 3.4% year-on-year for 3Q2013, which beat previous estimates of a 1.5% to 2.5% decline.
Air Canada during 2013 also declared that rouge, larger capacity 777s and the 787 are major drivers in its ambitious target to reduce unit costs by 15% over the medium term. At the same time Air Canada for the moment is reaching the lower end of stated return on invested capital (ROIC) range of 10% to 13% by 2015 with returns of 10.8% at the end of 3Q2013.
See related report:
Air Canada’s positive momentum continues as it eyes sustainable ROIC targets
[h=3]Air Canada is deploying 787s on routes to test the aircraft’s mission profile[/h]During 2014 many pieces of Air Canada’s international strategy should fall into place as the carrier is expected to add six 251-seat
Boeing787-8 aircraft by YE2014.
Air Canada fleet projections: 30-Sep-2013 to Dec-2015
Source: Air Canada
After operating its 787s on some domestic services, Air Canada plans to deploy the new widebodies on flights from
Toronto to Tel Aviv and
Tokyo Haneda starting in Jul-2014. The service to Tel Aviv appears to fit the 787’s touted mission profile of an aircraft suited for long and thin routes. Tel Aviv is roughly 5,030nm from Toronto, and current schedules in OAG (6-Jan-2014 to 12-Jan-2014) show that Air Canada presently operates three weekly flights from Toronto with Boeing 767-300s, which have a 5,990nm range.
The 767s used on the service to Tel Aviv are pushing their operating envelope, and the 787s presumably should allow Air Canada to operate a more efficient and properly-sized aircraft for the market.
Haneda, which is approximately 4,040nm from
Toronto Pearson, is also a market that fits the 787’s stated mission. The daily service to Haneda allows Air Canada the opportunity to achieve favourable load factors with the 251-seat Boeing 787s (versus the 349-seat 777-300s and 208-seat 767s it operates to
Tokyo Narita). Air Canada also promotes the fact that it is operating the first daytime service from near-downtown Haneda to North America. It will need some magic on Pacific routes, noting in its 3Q2013 report that it had suffered a "4.8% yield decrease which reflected yield declines on all major Pacific services with the exception of
Hong Kong", with negative impacts in
China and
Japan due to "increased industry capacity on (those) services".
The 7,650nm to 8,200nm range of the 787-8 and the 8,000nm to 8,500nm range of the -9 variant (Air Canada has 15 -8 and 22 -9 aircraft on order), clearly open up a range of long-haul routes for Air Canada with a seating capacity that allows it to match demand profiles of some of the new routes it is examining, including Moscow,
Rio de Janeiro and
Lagos.
Potential Air Canada 787 routes
Source: Air Canada, Jun-2013
[h=3]After its 2013 debut, rouge needs to begin proving its mettle in 2014[/h]
Air Canada rouge will also receive much scrutiny during 2014 as it enters it first full year of operations. After a hard-won battle with its unions to create the low-cost carrier, pressure is mounting for Air Canada to deliver on the premise that a lower cost base will allow Air Canada to improve its profits (or in some cases attain profits) in markets featuring a higher percentage of leisure travellers.
During summer 2014 rouge is bolstering service to European leisure destinations after its market debut in summer 2013 with service to
Athens,
Edinburgh and Venice, using 767s previously dedicated to mainline operations. During 2014 rouge is launching year-round Toronto-
Dublin service (as WestJet launches seasonal Toronto-St John’s-Dublin flights and with
Air Transat also in the market), and fights from Toronto to
Barcelona,
Lisbon and
Manchester. Rouge is also introducing flights from
Montreal to
Rome, Barcelona and
Nice.
See related report:
Rouge trans-Atlantic expansion creates new competitive dynamics in long-haul leisure markets
Additionally, Air Canada is either introducing or transitioning service to Caribbean and
US destinations to rouge, including markets in Florida and
Las Vegas during 2014 as well flights to
Mexico. Back in Jun-2013, Air Canada stated it expected rouge to offer service to 40 routes from four Canadian cities by YE2014. So perhaps new flights from
Vancouver and
Calgary could be in the offing.
Air Canada has previously estimated a unit cost reduction of 21% and 29% for rouge’s
Airbus A319s and 767s, respectively, versus operating unit costs at the mainline.
As rouge’s scope broadens during 2014, questions about the carrier’s financial and cost performance will also grow as investors attempt to determine if Air Canada can successfully operate a low-cost subsidiary. By YE2014, Air Canada expects to have transitioned a total of eight 767 and 25 A319s from the mainline to rouge.
[h=3]Higher gauge 777-300ERs allow a widebody diversity for specific market demands[/h]Air Canada’s mainline international expansion during the past couple of years has included service to
Copenhagen,
Brussels, Tokyo
Narita(from Calgary) and new service from Toronto to
Istanbul and
Seoul.
During 2013 Air Canada also added seven flights to
Beijing, and at mid-2013 the carrier stated it offered 11 daily departures to Asia, an important region for Air Canada to be steeped in as WestJet continues to discuss a potential widebody order during the next few years.
Capping off Air Canada’s international strategy is the addition of five high density 777-300ERs, which should be accounted for in the carrier’s fleet in early 2014. The 458-seat, three class aircraft (Executive First, premium economy and standard economy) are aimed at markets with a higher volume of economy travellers, and Air Canada began operating the aircraft on service from
Montreal to Paris in Jul-2013. Five times weekly service from Vancouver to Hong Kong was slated to begin on 1-Jan-2014.
Other possible routes reportedly under consideration include Toronto-
Munich and Vancouver-London (the latter of which is interesting given that
Delta is launching service from
Seattle to London in Mar-2014. Seattle is approximately 225km from Vancouver).
With its widebody evolution, Air Canada appears to have a range of aircraft to deploy long and thin markets, routes that have a high volume of leisure passengers but a steady flow of higher-yielding business customers and markets where the majority of customers are leisure passengers. The carrier also assures that the financing of these widebody aircraft is manageable, noting it forged an EETC transaction for the five higher capacity 777-300ERs with a blended coupon rate of 4.7% for a 12-year maximum term. The carrier has also cited “positive developments” with respect to its 787 financing.
[h=3]Air Canada’s international expansion is driving significant capacity growth in 2014[/h]Air Canada is projecting a capacity increase of 9% to 11% during 2014 versus a 4% to 6% rise anticipated by WestJet. Canada’s largest carrier stresses “higher margin” international flying represents a large portion of the projected capacity increase in 2014, driven by the six 787 deliveries and the transitioning of 767 widebodies to rouge. Still, the rise (which is more than double its 2013
ASM growth) might give investors pause as Air Canada is still in the infancy of regaining its financial footing, and has much to prove in terms of sustaining viable financial returns.
Air Canada capacity growth: 2010 to 2014
Source: Air Canada
But after a few painful years of stressing it needed to transform its legacy business model, Air Canada starts 2014 with some much-needed positive momentum. There are immediate threats from WestJet’s new short-haul operations and the looming possibility its familiar rival could expand its long-haul presence in the mid term.
But it seems Air Canada for the moment can enjoy going on the offensive in its international operations, rounding out its long-haul network before the next competitive round with WestJet commences. (Air Canada does possess the advantage of its antitrust-immunised North Atlantic partnership, noting in its 3Q2013 report that it "continues to benefit from increased traffic through its transatlantic revenue sharing joint venture with
United Airlines and
Lufthansa.")
In short 2014 promises to be an important year in pointing the way for Air Canada's international future.
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Unit cost analysis of Emirates, IAG & Virgin; about learning from a new model, not unpicking it[/h]Analysis
11-Jan-2014 10:39 AM
Last year, 2013, saw significant shifts in the attitudes of the major European legacy carriers towards their competitors from the Gulf, as well as some changes in the strategic stance of the Gulf carriers towards global partnerships.
Qatar Airways joined
oneworld,
Emirates entered into a joint venture agreement with
Qantas, and
Air France-
KLM started to codeshare with
Etihad, which continued to develop its equity alliance strategy with a growing number of European airlines (among others).
Nevertheless, old attitudes linger and there is still a feeling among some in Europe, including airlines and regulators, that the success of the Gulf carriers is based on unfair subsidies.
In this report we analyse Emirates’ unit costs and compare them with IAG and
Virgin Atlantic in order to understand the source of Emirates’ cost advantage. How level is the playing field and what are the conclusions of this unit cost analysis for European legacy carriers and the policy implications for Europe’s regulators and governments?
[h=3]Emirates is cost efficient compared with European legacy airlines, but is not an LCC[/h]One of the key dimensions of competition in the airline industry is unit cost. Quite simply, a low unit cost is a competitive advantage as it allows airlines to be profitable at low fares. One of the difficulties in comparing unit costs is that they vary according to average trip length.
In general, the cost of producing a seat-kilometre falls as average sector length increases since the fixed costs are amortised over more seat-kms and variable costs such as fuel are more efficiently consumed in longer flights.
Plotting Cost per Available Seat Kilometre (CASK) vs sector length allows the relative cost efficiency of different airlines to be compared visually. The chart below should be familiar to many CAPA readers. It shows CASK, denominated in UScents, against average sector length for a number of European airlines and for Emirates.
The chart shows that Emirates’ unit cost is lower than that of every European legacy carrier, but, since it also has a longer average trip length than almost every one of them, its unit cost ‘should’ be lower.
Nevertheless, the chart shows that Emirates’ CASK is below the trend line for European legacy carriers and is also lower than that of the ultra long-haul
Virgin Atlantic (the only European airline with this route profile). This suggests that, compared to European legacy carriers, Emirates is a cost efficient operator, although it could not be described as an LCC. This does not consider unit revenue differences and note also that we do not include Asian and other competitors on this chart.
Cost per ASK, CASK, (
US cent) and average trip length for selected European legacy and low-cost carriers and Emirates: 2012*
*Financial year ends as follows:
Jet2.com,
Ryanair, Emirates Mar-2013; Virgin Atlantic Feb-2013;
Aeroflot,
Pegasus Airlines,
Air Berlin,
Turkish Airlines,
Lufthansa,
Aer Lingus, IAG,
Iberia,
BA, Air
France-KLM,
Finnair,
Norwegian,
Vueling Dec-2012;
Monarch,
SAS Oct-2012;
easyJet Sep-2012;
Wizz Air Mar-2012.
Source: CAPA analysis of airline company traffic and financial statements and press releases
[h=3]Unit cost comparison needs to be based on a similar average trip length[/h]Emirates appears particularly to have a significant CASK advantage compared with the major European legacy groups (which all sit above the trend line on our CASK chart) and these are the carriers that have been hardest hit by Gulf carrier competition.
So, what are the sources of Emirates’ unit cost advantage? A straight comparison of its unit cost with any one European group would run into the problem of different average trip lengths. In order to circumvent this problem, we note that Emirates’ average trip length falls between those of IAG and Virgin Atlantic. If a European airline existed that consisted of equal parts IAG and Virgin Atlantic, its average trip length would be similar to that of Emirates and its unit cost could meaningfully be compared with Emirates.
[h=3]Cost per ATK better takes account of cargo traffic[/h]Before getting into such a comparison, we switch to an alternative measure of unit cost. Emirates has a fairly significant amount of cargo traffic and so looking at costs per available seat kilometre compared with a carrier that has a lower proportion of cargo traffic could result in some distortions. Some of the costs relate to the carriage of freight and so dividing costs only by ASKs will flatter airlines with a small cargo business.
Total available tonne kilometres (ATK) take account of cargo and passenger traffic and unit costs measured as cost per ATK is the measure we will now adopt for this analysis.
[h=3]Emirates’ average trip length is between those of IAG and Virgin Atlantic[/h]Virgin Atlantic has a similar, but slightly higher, unit cost to Emirates, in spite of a longer average trip length. IAG has significantly higher unit cost than Emirates, but this is partly due to its shorter average trip length. A comparison of cost per ATK by cost category for the individual groups is blurred by these sector length differences.
Cost per available tonne kilometre (USc) by cost category for Emirates, IAG and Virgin Atlantic: 2012*
*Year end: Dec-2012 for IAG, Feb-2012 for Virgin Atlantic, Mar-2013 for Emirates
Source: CAPA – Centre for Aviation, company reports, CAA
As noted above, however, we can compare Emirates’ unit costs by cost category with the average unit cost of IAG and Virgin Atlantic, since the average trip length of the latter two approximates to the average trip length of the former.
[h=3]Emirates’ cost per ATK is 26% below the average of IAG and Virgin Atlantic[/h]A glance at the chart below shows that Emirates’ total cost per ATK is below the average cost per ATK of IAG and Virgin by US16 cents, or 26%. Moreover, Emirates has an advantage in almost every cost category. The exceptions are selling costs and aircraft ownership costs (depreciation, amortisation and operating leases), where Emirates’ cost per ATK is higher.
Cost per available tonne kilometre (USc) by cost category for Emirates versus the average of IAG and Virgin Atlantic: 2012*
*Year end: Dec-2012 for IAG, Feb-2012 for Virgin Atlantic, Mar-2013 for Emirates
Source: CAPA – Centre for Aviation, company reports, CAA
[h=3]In which cost categories does Emirates gain its advantage?[/h]Looking in more detail at each cost category, and assessing where Emirates derives the greatest advantage, the chart below shows the difference in cost per ATK between Emirates and our fictional business, whose cost per ATK is the average of IAG and Virgin Atlantic.
Depreciation, amortisation and operating leases. Emirates actually has a significant cost-per-ATK
disadvantage in the cost of aircraft ownership. This is due to its policy of investing heavily in new aircraft and its significant use of operating leases. This tends to fly in the face of arguments that Emirates profits unduly from Exim financing, where US airlines in particular prefer to fly very old aircraft. It is worth noting, however, that what Emirates loses in this category, it more than makes up with lower maintenance cost per ATK (see below).
Commercial and selling costs. This is the only other category in which Emirates has a higher unit cost than the IAG/Virgin average. Although the difference is not very large, it illustrates the crucial importance of reaching as wide a customer base as possible, both by making use of all distribution channels and also by promoting the Emirates brand globally.
In parts of Emirates’ catchment area, such as
India and Africa, direct distribution channels are not as prevalent as in Europe and so this can lead to higher distribution costs.
In addition, it is essential for a carrier based in a small city state, whose strategy involves connecting long-haul destinations across the planet, to ensure that its brand name and product are well known globally. This involves extensive promotional expenditure, such as high profile sponsorship of most sports, including Arsenal, AC Milan, Real
Madrid Football Clubs (some of Europe's leading teams), the US tennis open, the Japanese golf open, the rugby world cup and many others.
Difference in cost per available tonne kilometre (USc) by cost category for Emirates versus the average of IAG and Virgin Atlantic: 2012*
*Year end: Dec-2012 for IAG, Feb-2012 for Virgin Atlantic, Mar-2013 for Emirates
Source: CAPA – Centre for Aviation, company reports, CAA
Landing, parking and overflying. Emirates’ cost per ATK in this category is almost half that of the IAG/Virgin average, mainly because it benefits from relatively low airport charges at its
Dubai hub. These charges are non-discriminatorily available to other airlines operating to
Dubai - but they are only half of the equation and Emirates must also pay airport charges at the destinations to which it flies. Overflying and navigation fees, which are the larger part of this cost category, are charged globally and Emirates does not have any great advantage in this part of its cost structure.
Nevertheless, with roughly half of its aircraft movements taking place at Dubai, where airport charges are significantly lower than at the major European hubs (in particular, compared with the
London Heathrow hub of IAG and Virgin Atlantic), Emirates has an advantage in this area. For the two long-haul aircraft types illustrated in the chart below (747-400 and 767-400), Dubai’s landing and terminal charges with baggage and check-in are around one third below
Heathrow’s and two thirds below the average of Paris DCG,
Frankfurt and
Amsterdam.
Combined Landing/Terminal Charges with Baggage/Check-in (USD) for
Dubai International Airport,
London Heathrow Airport,
Paris Charles De Gaulle Airport,
Frankfurt Airport,
Amsterdam Airport Schiphol
Source: CAPA - Centre for Aviation &
Air Transport Research Society airport database
Handling, catering and other. Emirates’ unit cost in this area is around one third lower than for IAG/Virgin. This is a broad category, involving a number of different items and in which levels of outsourcing and the cost of outsourced labour vary considerably. As a result, pinpointing the precise source of advantage is not simple, but local labour rates probably play an important part.
Fuel. Emirates has a 16% fuel cost per ATK advantage versus the average of IAG and Virgin. Contrary to what some observers still claim, this does not reflect any clandestine price discount provided to Emirates arising from its domicile in an oil-rich region (a claim that conveniently ignores the fact that the emirate of Dubai is actually not an oil producer).
In fact, a simple calculation involving the division of annual fuel costs by volume of jet fuel consumed (taking figures from the respective annual reports) shows that Emirates paid USD1,064 per tonne for fuel and IAG paid USD1,060 per tonne in FY2012-2013. Emirates’ advantage in fuel cost per ATK comes from the greater fuel efficiency of its fleet, which have a larger number of seats and modern engines.
Maintenance. As noted above, Emirates’ modern fleet provides a cost advantage in terms of maintenance cost per ATK and this is enhanced by the use of large aircraft with high seat density. Not only does Emirates have a lower average fleet age than IAG and Virgin, but it also has a greater focus on newer aircraft types. Taking aircraft ownership and maintenance costs together, Emirates has a 17% lower cost per ATK than the IAG/Virgin average in this area.
British Airways average fleet age
Source: CAPA Fleet Database
Iberia average fleet age
Source: CAPA Fleet Database
Virgin Atlantic Airways average fleet age
Source: CAPA Fleet Database
Emirates average fleet age
Source: CAPA Fleet Database
Labour. The biggest source of unit cost advantage for Emirates is in labour costs, which account for almost US6 cents out of the total US16 cents cost per ATK advantage enjoyed by Emirates over the average cost per ATK of IAG/Virgin. Emirates’ labour cost per ATK is half that of the IAG/Virgin average.
Most of this advantage comes from having a lower labour cost per employee. IAG’s average labour cost per employee, almost USD94,000, is more than 80% higher than the figure of USD51,500 for Emirates, while Virgin Atlantic pays 9% more than Emirates. The average of the IAG and Virgin figures is USD75,000, which is 45% higher than the Emirates figure. Of course, Emirates benefits enormously in this area from the absence of income tax in Dubai. The IAG/Virgin average would be well below USD60,000 after
UK tax and social security deductions.
In addition to the tax benefits, Emirates operates in a union-free environment and does not have significant legacy pension costs. All this suggests that IAG may need to consider more ways to contain wage rates if it is to remain competitive. Furthermore, Emirates has a higher level of labour productivity, in terms of ATK per employee, than the IAG/Virgin average (probably due to larger aircraft), although not compared with Virgin alone (whose longer flights increase the km element of ATKs). In the important area of pilot costs, a CAPA analysis in 2012 showed that Emirates' pilots on average were up to 40% more productive in ASK terms than
Qantas' long haul pilots.
Labour productivity measures for Emirates, IAG and Virgin Atlantic: 2012*
| Emirates
| IAG
| Virgin
| Ave of
IAG & Virgin
|
|---|
Labour cost per employee USD
| | | | |
ATK per employee
| | | | |
Employee cost per ATK US c
| | | | |
[TD="align: right"]51,548
[/TD]
[TD="align: right"]93,699
[/TD]
[TD="align: right"]56,250
[/TD]
[TD="align: right"]74,974
[/TD]
[TD="align: right"]859
[/TD]
[TD="align: right"]520
[/TD]
[TD="align: right"]966
[/TD]
[TD="align: right"]743
[/TD]
[TD="align: right"]6.00
[/TD]
[TD="align: right"]18.03
[/TD]
[TD="align: right"]5.82
[/TD]
[TD="align: right"]11.93
[/TD]
*Year end: Dec-2012 for IAG, Feb-2012 for Virgin Atlantic, Mar-2013 for Emirates
Source: CAPA – Centre for Aviation, company reports, CAA
[h=3]The operating efficiency of the long-haul to long-haul model[/h]An over-arching feature of Emirates' unit cost advantage against European legacy carriers is its operating efficiency. While some argue that Dubai-specific advantages such as low airport charges and the absence of income tax are unfair and represent a form of subsidy, this misses the point that Emirates’ long-haul to long-haul business model is inherently efficient. Each of its aircraft flies a similar total distance annually to those of IAG and Virgin Atlantic.
However, the average Emirates aircraft makes more flights per day than the average Virgin aircraft and has more seats than the average IAG aircraft. Compared with the average of IAG and Virgin, Emirates’ aircraft make a similar number of daily flights, but they have 27% more seats per departure. As a result, Emirates’ aircraft, on average, carry nearly 40% more passengers per day than both IAG and Virgin Atlantic.
Aircraft operating efficiency measures for Emirates, IAG and Virgin Atlantic: 2012*
| Emirates
| IAG
| Virgin
Atlantic
| Ave of
IAG & Virgin
|
|---|
Ave trip length km
| | | | |
Ave. daily departures per aircraft
| | | | |
Utilisation hours per day
| | | | |
Ave. seats per departure
| | | | |
Passengers carried per aircraft per day
| | | | |
[TD="align: center"]4,788
[/TD]
[TD="align: center"]3,223
[/TD]
[TD="align: center"]7,194
[/TD]
[TD="align: center"]5,209
[/TD]
[TD="align: center"]2.2
[/TD]
[TD="align: center"]3.2
[/TD]
[TD="align: center"]1.5
[/TD]
[TD="align: center"]2.4
[/TD]
[TD="align: center"]13.55
[/TD]
[TD="align: center"]12.20
[/TD]
[TD="align: center"]13.73
[/TD]
[TD="align: center"]12.97
[/TD]
[TD="align: center"]309
[/TD]
[TD="align: center"]155
[/TD]
[TD="align: center"]333
[/TD]
[TD="align: center"]244
[/TD]
[TD="align: center"]548
[/TD]
[TD="align: center"]397
[/TD]
[TD="align: center"]392
[/TD]
[TD="align: center"]395
[/TD]
*Year end: Dec-2012 for IAG, Feb-2012 for Virgin Atlantic, Mar-2013 for Emirates
Source: CAPA – Centre for Aviation analysis, Airline Monitor
[h=3]Normalising the two areas of ‘subsidy’ would still leave Emirates with a significant unit cost advantage versus IAG/Virgin[/h]The higher number of seats per departure, reflecting Emirates' widebody-only fleet strategy, is a significant factor in its unit cost advantage against the average of IAG and Virgin. This has an impact on every cost category mentioned above and is far more important than the so-called ‘unfair subsidies’.
If the two ‘subsidies’ were normalised, so that Emirates’ labour costs were higher by, say, one third and its landing and parking fees were doubled, its cost per ATK would increase by 6%.
Emirates' cost per ATK would still be 21% below the average of IAG and Virgin.
[h=3]European airlines and regulators can do more to improve Europe’s competitivity[/h]Rather than complaining of unfair subsidies, European legacy airlines - and regulators - should look to their own failings.
Sticking for now to a discussion of costs (we have not considered revenues in this analysis), this implies European carriers must push their current restructuring programmes as hard as possible and then take them yet further, with a particular focus on labour productivity. They must also seek to acquire modern, fuel efficient aircraft as soon as possible, although this is not always straightforward when balance sheets are stretched and cash flow is tight.
For European governments and regulators, the conclusions are also clear:
Much to the regret of some, an abolition of employee income tax and dramatic cuts in airport charges cannot be expected. Nevertheless, governments should be reducing or removing all additional taxes and levies on air transport and easing any legislative restrictions on labour productivity.
They should also help to minimise infrastructure-related costs and inefficiencies, both on the ground (for example by simplifying the planning process for new airport capacity) and in the air (for example by speeding up the European Single Sky, a massively costly albatross around airlines' necks).
Until these government/regulatory related issues are resolved, talk of creating a "level playing field" means no more than aiming to removing the efficiencies of a new model that has clearly shown itself to be successful. Analysing each aspect of this new model should be the starting point for every government's travel strategy.
Yearning for the inefficiencies of the past may offer a level of nostalgia, but provides a poor roadmap to the future. "It is the nature of a man as he grows older, a small bridge in time, to protest against change, particularly change for the better." (John Steinbeck)
[h=3]
What makes the ideal airline CEO? Do CAPA’s World Aviation Summit delegates agree with the experts?[/h]Analysis
11-Jan-2014 10:08 AM
At CAPA’s World Aviation Summit in
Amsterdam in Nov-2013, delegates were asked what they considered to be the key characteristics that an airline CEO should possess. Included in the responses were words such as vision, decision-maker, innovative, charismatic, leadership, communications, focus, passion, adaptability, discipline, entrepreneur. Delegates were also asked to nominate who they considered to be the best airline CEO ever.
In the fiercely competitive airline market place, the airline CEO needs an almost impossibly broad range of skills. Is it reasonable to expect to find all these qualities in one person? How important are the other executives and the board of directors to a CEO? A panel session at the Summit, led by CAPA Executive Chairman Peter Harbison, discussed these and a range of other issues that touch on what makes the ideal airline CEO. Who were the panellists’ nominations for best airline CEO and did Summit delegates share their views?
See related report:
Airline CEOs: the increasingly important quest to find the ideal characteristics
Extracts from the 90-minute discussion at CAPA's World Air Transport Summit in Amsterdam, 28-Nov-2013
[h=3]A wide spectrum of skills is essential[/h]Nicolas Boutin, partner and managing director at The
Boston Consulting Group, highlights the challenge faced by CEOs in needing to combine skills from the two different ends of the spectrum. “They need to be tough and also inclusive and a communicator”, he says. For Mr Boutin, legacy airline CEOs must be determined and single minded, while simultaneously being inspirational and motivational.
Con Korfiatis, aviation partner at search firm Heidrick & Struggles, stresses the need for a fully rounded executive with all the functional competencies. A good CEO must have more than this, however. When seeking a CEO appointment, Mr Korfiatis also focuses “on the person themselves, what they are like as an individual”. There must be a cultural fit, a CEO must be a “change agent” and have team skills. In his view, an airline CEO does not necessarily need to come from the airline industry.
Willie Walsh, CEO of IAG and the only panellist actually running an airline company, agrees that it is not necessary to come from the industry itself. He adds a further point, drawn from his own experience. “The qualities needed to become a CEO and the qualities that make a good CEO are not necessarily the same,” he says.
According to Mr Walsh, his first CEO appointment, at
Aer Lingus, came about because “no one else would do it. I was in the right place at the right time.” He recalls a director of the company asking him if he was sure he really wanted the job. “He said ‘if you get this wrong, you’ll go down in history as the guy who bankrupted Aer Lingus,” says Mr Walsh, “‘Get it right and everyone will take the credit’”.
Andrew Herdman, director general of the
Association of Asia Pacific Airlines, highlights that start-up businesses often need different qualities from those required by larger airlines, a point also developed by Mr Walsh. “The people you need to start an organisation are not always the same as [you need] to take it to the next level,” he says.
[h=3]The importance of a good team…[/h]Mr Herdman contrasts the different traditions of business in the West with those in Asia. “The Western approach [sees] the CEO as everything,” he says, “and the media seize on that more than different strategies. No one person has it all and the rest of the management team fills it out. [For example], a visionary marketing leader may have a quiet colleague that’s good at day to day operations”. In Asia, he says that there is less pressure for the CEO to be in the public eye.
He also sees a need for a CEO to be able to manage the political dimension of the airline business. “Government policy is everywhere,” he says, “… [CEOs receive] weekly phone calls from the cabinet about what to do.” The life expectancy of airline CEOs in the Asia Pacific region is only two to three years, according to Mr Herdman and a CEO needs a “deep team”. He adds: “The best organisations can survive the absence of their leader”.
The panellists all agree on the need for a CEO to have a strong team, with executives from a range of backgrounds. “Individuals going off on their own without support often fail. A team is vital,” says Mr Walsh.
[h=3]…but someone needs to make the big calls[/h]Although he stresses the importance of a good team, Mr Walsh believes that it is then down to the CEO to “get the most out of what is there”. This is not always straightforward. “Determination is key,” he says, “Determination to get things done in the face of challenges, both internal and external.” He suggests that his training as a pilot helped. “You need to make decisions quickly and move on.”
This brings into focus the importance of making good appointments, a theme developed by the IAG CEO. “You don’t recruit people exactly like you,” he says, “but you recruit people you can work with. You need to put time and effort into selecting people.”
Nevertheless, even with a good team in place, “analysis [only] gets you so far”, says Mr Herdman, “Someone needs to decide and co-ordinate. You need someone to make the big calls.” This falls to the CEO. “It’s all about making it work,” agrees Mr Walsh, “No one goes back and says ‘can I see all the options you didn’t choose?’”.
Left to right: Andrew Herdman (
AAPA), Willie Walsh (IAG), Con Korfiatis (Heidrick & Struggles), Nicolas Boutin (Boston Consulting Group)
Source: CAPA – Centre for Aviation
[h=3]How to develop the potential of female managers[/h]In response to a question from the floor, the discussion widens to address the issue of how to make the most of the potential of female managers. Mr Walsh is clear in his view. “Having good people is what is important,” he says, “… focus on the person regardless of age, race, or gender.”
Mr Walsh believes that
easyJet CEO Carolyn McCall is “one of the best in the business” and that the existence of female CEOs is a positive in pointing the way for other women executives, although they remain relatively rare in the airline industry.
CityJet’s Christine Ourmières is another example.
“The idea that there are things women can’t do is a nonsense”, says Mr Walsh. He also argues that is important to have “a diversity policy we act on”, including a campaign in
British Airways to encourage more women to become pilots and the appointment of more female directors to the IAG board.
[h=3]The role of the board of directors[/h]The part played by board of directors more widely in setting the tone and in shaping an airline’s business is another topic tackled by the panel. “Boards need a more diversified set of skills and backgrounds,” says Mr Boutin, “the short term results focus is an enormous pressure.”
Mr Walsh sees the relationships between the chairman and the CEO and between the chairman and the board as particularly important. He also argues that good non-executive directors are essential in enhancing the quality of the business and that board experience is an asset for company executives. “We encourage executives to take non-executive roles [elsewhere]”, he says.
Mr Herdman sums up the crucial role played by boards. “They get [the airline] through transitions, manage the political dimension and sign off on the big decisions,” he says.
[h=3]A retailer as an airline CEO?[/h]Airlines are increasingly complex organisations, embracing many different business activities under one roof. It has already been suggested that an airline CEO does not necessarily need to come from an airline industry background, a point that is not really disputed among the panellists. But, as airlines increasingly attempt to develop a more retail-like approach to selling, should they recruit retailers as CEOs?
Again, Mr Walsh is clear in his view. “There are great retailers out there, for example Burberry”, he says, “but it doesn’t sell bread or milk, it sells its core product. Airlines need to work out what is core and be very good at it. Recruiting a CEO who is a retailer is the wrong way to go. You can’t sell everything to everyone.”
[h=3]Who are the panellists’ favourite airline CEOs?[/h]The AAPA’s Mr Herdman says that he worked for “a lot of CEOs, some good ones” at
Cathay Pacific. He nominates Peter Sutch as a “key leader” and also mentions former
Singapore Airlines CEO Dr Cheong Choong Kong for his vision.
IAG’s Mr Walsh mentions fellow Irishman Michael O’Leary, CEO of
Ryanair, for “what he’s achieved”. Although Mr O’Leary has what Mr Walsh describes as a “strong personality”, Ryanair has a “strong team” and is “a well managed company”. Mr Walsh also mentions easyJet's Carolyn McCall, who is “doing a great job”. However, his favourite airline CEO is Akbar Al Baker of
Qatar Airways “for building from nothing in 1997 to a five star airline today”.
Mr Korfiatis identifies a common theme among the CEOs mentioned as being “people who stood the test of time” and, in that vein, he nominates Herb Kelleher, co-founder and former CEO of
Southwest Airlines. He also cites
Lion Air’s Rusdi Kirani.
Mr Boutin mentions
Emirates’ Tim
Clark and IAG’s Willie Walsh, before naming has choice of favourite as Alexandre de Juniac of
Air France-
KLM. “He’s not an airline guy, but he’s doing restructuring in a difficult context and also trying to keep motivation and a focus on the customer”, he says.
The last word goes to the survey of Summit delegates, who were asked to give the name of their own favourite airline CEO. The name with the highest number of nominations was that of Ryanair’s Michael O’Leary.
Whether he ticks all the boxes for the "ideal" airline CEO is a question for another day. There certainly aren't many like him. But perhaps in view of these responses he should delay his plans to become fuzzy and cuddly....
[h=3]
Azul’s IPO prospects during 2014 will be challenged by tenuous market conditions[/h]Analysis
10-Jan-2014 8:30 PM
Brazil’s third largest airline
Azul begins 2014 armed with the final regulatory approval of its merger integration with Brazilian regional carrier
TRIP and the possibility of undertaking a public offering after shelving plans for an IPO during 2013.
Even as Azul continues to chart a steady course of growth, it does face some headwinds in 2014 as its recent declaration to cap fares for the upcoming Jun-2014 World Cup will result in a revenue hit of BRL20 million (USD8.4 million). The projected loss occurs as Brazil’s economy remains weak, which has resulted in depressed demand in the country’s domestic market during the past year.
Similar to
Mexico, hopes are high that Brazil’s economy will undergo a rebound during 2014. But that does not necessarily translate into a rebound in demand as some cost conscious travellers may choose to hold onto their discretionary income until they conclude an economic recovery is well underway. Those dynamics will certainly play a role in Azul’s evaluation of whether to access public markets for a capital injection.
[h=3]Despite depressed demand, Azul and
Avianca Brazil show steady traffic growth[/h]Traffic in Brazil’s domestic market remained essentially flat for the first 11 months of 2013, notching up 0.75% as capacity dropped nearly 4% compared to the first 11 months of 2012. Brazil’s largest carriers
TAM and
Gol have been reining in capacity during the past year in order to better match supply with demand.
Although Gol increased its domestic supply by nearly 5% year-on-year between Jan-2013 and Nov-2013, it started slashing capacity ahead of TAM during 2012 as a means to improve its negative financial performance. During the first 11 months of 2013 TAM’s domestic capacity fell 8% year-on-year while traffic remained essentially flat.
See related report:
Brazil domestic airline market remains challenging after flat growth in 1H2013
Growth at Azul and
Avianca Brazil has continued unabated in the weak demand environment in the Brazilian domestic market – evidenced by Azul’s 28% capacity growth in the 11 months ending Nov-2013 and Avianca Brazil’s 32% capacity expansion. Traffic levels held up for both carriers as Azul recorded 29% RPK growth and Avianca Brazil’s traffic increased by 37%. Given the economic conditions in Brazil and the efforts by Azul and Avianca Brazil to grow their domestic market presence, it is possible each carrier for the time being is trading yields for loads in order to continue their march to gain market share.
Azul’s market share increased from 10% to 13% year-on-year for the first 11 months of 2013 while Avianca Brazil’s share rose 2ppt to 7%. Factoring in TRIP’s 4% share, Azul’s total share of the Brazilian domestic market was 17%. Purely looking at the numbers, Azul has achieved its goal in acquiring TRIP – to quickly build up its share in a fast moving Brazilian market.
Brazil's domestic market share breakdown (% of RPKs) by carrier: 11M2012 vs 11M2013
Jan-Nov-2012
| Jan-Nov-2013
|
Source: Brazil's
Anac
*Note: Webjet was fully absorbed into Gol during 2013
At the same time TRIP has been shrinking, reflected in its 17% capacity decline year-on-year from Jan-2013 to Nov-2013 and its 7% drop in traffic. TRIP’s decreasing supply is likely the result of network optimisation undertaken as Azul and TRIP combined their respective route offerings.
See related report:
Azul’s pursuit of TRIP signals shift of strategy in fast-changing Brazilian market
[h=3]Azul faces labour discontent over compensation levels at TRIP[/h]Brazilian regulator
ANAC gave its final approval to the integration of Azul and TRIP in Oct-2013, although it appears there is some labour unrest about compensation rates between the two carriers. Reports in the Brazilian press indicate that Azul’s cabin crew union is unhappy about differences in compensation and benefits, and claimed TRIP had higher remuneration packages. Those reports stated the union was planning to voice its opposition of the integration in a Brazilian labour court.
Azul chairman David Neeleman has indicated the salary issues could result in pilots at Azul and TRIP continuing to operate their respective aircraft in the same fashion as prior to the merger. Without the benefits of cross-fleeting some synergies could be lost, which is not an ideal scenario in successfully executing a merger.
Despite the pressing need to iron out labour issues, Azul is continuing to add new markets. It recently introduced new service from Salvador to Paulo Afonso and Porte Alegre to
Passo Fundo. Both routes are operated with 68-seat
ATR 72 turboprops. Azul has also upped competition with Gol on new service from
Sao Paulo Guarulhos to Navegantes, also operated with
ATR turboprops.
Azul competes with small operator Brava Lihas Aéreas on
Porto Alegre to Passo Fundo and has no competition on service between Salvador and Paulo Afonso, according to OAG data. Those routes demonstrate that untapped markets within Brazil’s domestic space remain; however Azul needs to get its internal house in order to ensure it can expand profitability. It cannot rely on a market share grab as a viable business strategy for the long term.
Presently, Azul has roughly a 17% share of system-wide seat deployment in Brazil and a nearly 21% share of domestic seats (includes TRIP), according to CAPA and OAG data. Its growth has been impressive, but now that Azul is close to reaching its six year anniversary, it needs to display some financial traction. Based on public documents, the carrier lost USD82 million during 2012.
Brazil capacity by carrier (% of seats): 6-Jan-2014 to 12-Jan-2014
Source: CAPA - Centre for Aviation and OAG
Brazil domestic capacity share by carrier (% of seats): 6-Jan-2014 to 12-Jan-2014
Source: CAPA - Centre for Aviation and OAG
[h=3]Azul expects a revenue hit from capping World Cup fares[/h]In early Jan-2014
Wall Street Journal reported that Azul would cap ticket prices at USD420 per segment for the World Cup soccer tournament held in Brazil beginning in Jun-2014. Along with outlining the BRL20 million (USD8.4 million) revenue loss Azul will endure as a result of capping fares, Mr Neelemen also remarked that Azul expects corporate demand to fall during the tournament.
The Journal reported that as a result of weak business sales Azul would cancel roughly 20% of its 900 daily flights between 12-Jun-2014 and 13-Jul-2014. It has asked regulators for permission to bolster service between the 12 World Cup host cities (see map). But even if it gains approval, its revenue hit from the World Cup will likely be higher than the estimates provided given the decline in higher-yielding corporate traffic.
2014 World Cup host cities
Source: FIFA
[h=3]Conditions remain murky as Azul contemplates an IPO in 2014[/h]Azul management has talked about reviving its quest for an initial public offering in 2014 after announcing an IPO in May-2013. It shelved plans shortly after, citing unfavourable market conditions. Given the financial hit it outlined from the World Cup, and the continuing uncertainty in the Brazilian economy, it may be just as tough for Azul to attract investors in 2014.
Azul has filed an application with Brazilian authorities to register as a public company in the country. Regulators rejected a previous application by the carrier after raising concerns that its capital structure would value preferred shares at 75 times higher than ordinary shares. Azul does not necessarily have to list on Brazilian exchanges, but it seems its preference is to conduct offerings in Brazil and the
United States.
Brazil’s GDP growth is projected at 4% during 2014 after growing around 2% in 2013. The improvement is encouraging, but a cloud of uncertainty hovers over the ability of Brazil’s economy to rebound, not to mention the mounting questions over its readiness for the World Cup.
When it declared its intention to issue public shares in May-2013, Azul noted part of the proceeds would be dedicated to paying off a USD58 million loan carrying a 10% interest rate due in Jun-2014. The loan represented nearly 42% of the USD139 million in cash and equivalents Azul had on hand as of 31-Mar-2013. If Azul opts not to access the public markets for financing, it will need to find other means to fund its expansion and meet its financial obligations.
See related report:
Azul’s IPO is at a challenging time for economic and traffic growth in Brazil – but offers potential
[h=3]Azul’s business model remains sound even as short-term challenges remain[/h]Despite the immediate challenges that Brazil’s economy has created for the country’s domestic airlines, eventually demand will slowly start to rebound. With its fleet of
Embraer 175s/190s/195s and ATR turboprops Azul seems poised to capitalise on migration of middle class travellers from bus to air transport, particularly in underserved markets.
But in the near term the carrier needs to remedy any lingering problems from its merger with TRIP, and ensure it generates the necessary revenue to gain a solid financial footing in order to attract investors willing to stick with the carrier over the long term.
CAPA
[/TD]
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