Musings of an
Aviation Investor May/Jun 2023

Growth momentum has continued since the start of the year with airline equity prices tracking strong traffic demand ahead of what is predicted to be a boom summer in Europe and the US. So-called “Revenge” travel remains unsated even as consumer pockets come under increasing pressure from high energy costs, rising food price inflation and increasing interest rates.

As mentioned in my last piece (see Aviation Strategy, December 2022), leisure travel in the West is relatively price inelastic with flights to the sun an inviolable item in the annual family shopping list. Various commentary from airline management teams have recently stated that the consumer will give up Netflix and eating out before sacrificing the yearly beach holiday. Along with such sentiment in Europe, most carriers are predicting continuing double-digit percentage growth in fares after the already impressive rises seen last year assisted by moderating capacity growth.

Growth caps

Capacity growth is being hampered by OEM delivery delays, which have pushed some of the previously expected 2023 fleet growth into next year, while problems with new generation engines have increased aircraft unserviceability rates further constraining capacity.

Spirit and Frontier Airlines, the two dominant ULCCs in the US, both announced capacity growth cuts for 2023 on the back of such challenges.

Spirit had originally guided 27% higher capacity for 2023 vs 2022, but is now looking at 18%-20% after two successive reductions blaming this on NEO GTF engine problems as well as Airbus delivery delays. In terms of the Pratt & Whitney GTF engine issues, time-on-wing has been less than expected and it has been hit by a barrage of removals at a time when shop visit times are three times longer than that it would expect for the older generation CEO engines. It said in February that between two and seven of its Airbus A320 family NEOs were parked at any one time due to unavailability of serviceable engines. On OEM delays, it said around seven Airbus single aisle units had been pushed from delivery in 2023 into 2024.

Frontier likewise has confronted delivery postponements. In February it stated that delivery of nine new A321NEOs had been shifted into 2024 from this year and in May this had increased by a further two units moving forward into next year.

Frontier has twice revised downwards its FY2023 capacity growth versus 2022, most recently to between 19% and 22% after originally targeting 23-28% growth. It is not blaming engine reliability as it has operated the GE LEAP engine on its older Airbus NEO fleet only introducing the GTF engine type on deliveries starting in the fourth quarter 2022.

Frontier also laying points to the new pandemic-induced phenomenon of shifting day-of-the-week travel profiles, with peak travel days extending into Thursdays and Mondays. It has reshaped its schedules to increase peak day flying from Thursday to Monday, while reducing off peak days. Overall this will lead to a reduction in total flying for Frontier this year, while also de-risking its total schedule to better accommodate disruptions.

Management has said that this schedule revamp will be accretive to earnings by a couple of margin points by cutting some unprofitable flying on Tuesday and Wednesdays. The markets, however, were unconvinced by the announcement, with the share price tanking on the news of the capacity cuts, which will inevitably increase unit costs, a metric which investors follow closely. In my view, Frontier probably knows what it is doing and was originally pushing too much added capacity into its markets, eroding its pricing power. If fuel prices continue to moderate, we are likely to see the airline gradually re-introduce some withdrawn services as margins allow.

It should be noted that several other carriers have shared Frontier’s observation regarding the changed travel behaviour. EasyJet mentioned an extension of the weekend, with travel across the week becoming more equalised.

Problems facing the P&W GTF engine cannot be as easily ignored as a short-term issue and investors will wisely be looking at the universe of airlines with significant existing or future commitments to GTF powered fleets.

This should now be considered as a serious industry challenge as it is now impacting a growing share of global single-aisle capacity, not only the A320NEO family but also the Embraer E2 variants. GO First India has blamed serviceability of the engine as a reason for its insolvency and we now hear that Wizz Air is having to replace its entire GTF powered NEO fleet in its Middle East operation with older CEOs from Europe due to concerns of poor reliability in the hot conditions of the Arabian Gulf. It is likely that the GTF problems will continue into the medium term at a minimum and will probably start to impact lease rates and residual values of aircraft fitted with the powerplant.

Corporate demand

While leisure travel is flourishing most admit that corporate demand remains subdued compared to pre-pandemic times in both the short-haul and long-haul travel. EasyJet thinks that corporate travel is around 90% of pre-Covid, while IAG which has historically relied on the Business class cabin for the largest chunk of its profitability, particularly out of London Heathrow across the Atlantic, says that demand remains someway off pre-pandemic levels, with BA extracting only about 75% of pre-Covid revenues from the business passenger.

As it is not certain that the ZOOM meeting will become the new normal, there remains significant upside por the full-service long-haul airlines to boost revenues and materially improve profitability should the front cabins begin to fill again. This writer is optimistic that this will be evident, likely starting this autumn..

Before looking too far ahead, one point of caution in relation to the bullish sentiments communicated by most of the incumbents regarding the upcoming summer peak, particularly in Europe — there remains low visibility of how revenues will finally pan out.

While it is true that yields for booked summer flights are high, plenty of seats remain to be filled. This is not a new thing as the leisure sector has historically relied upon what is called the “lates” market to boost margins and add the cream to the summer revenue tally. It is my view that this will be as true this year as any other supported by anecdotal as well as data released by some of the carriers. On-the-Beach, the OTA, said in mid-May that, while airlines were bullish, it saw plenty of late booking availability for the summer.

This was supported by easyJet which also in May said that only 36% of seats for the peak summer quarter (Jul-Sept) had been booked, which was at a similar level to pre-Covid times in 2019. I only caution readers, as most indications are that demand will continue to remain robust, but simply that until the outturn, associated risk lingers.

If economic pressures finally flow through to the consumer or good Northern European weather keeps holidaymakers in home countries, airlines could start to break ranks by selling cheaper inventory. This would start to erode unit pricing and the robust margins currently expected. In this case those that have pre-sold higher volumes will be rewarded. The likes of Jet2, which sells higher capacity from its in-house tour operator via holiday packages, as well as Ryanair, which has also sold more seats ahead (42% in late May) but at lower year-on-year average fare increases (10% to modest), will be the primary beneficiaries by being able to avoid aggressive seat dumping.