Outlook as uncertain as ever June 2012

Dublin-based stockbroker Davy Securities this month held their transport investor conference in London in June. Hardly surprisingly, the airline speakers were relatively downbeat for the short term.

All expressed concerns of underlying demand weakness and the strength of the fuel price. Although oil has dipped in recent weeks to $90/bbl, dollar strength against the euro has mitigated this decline, and the outlook is as uncertain as ever. Although yields have been improving strongly in the first part of the year, this has not been enough to recover the increased cost of fuel.

Lufthansa Group

Lufthansa highlighted that it has been cutting capacity plans and was now looking at a 1% growth in overall capacity for 2012, with a 4% ceiling on capacity expansion in 2013. It concentrated on some details of its latest restructuring plans — which go under the soubriquet of SCORE.

Primarily Lufthansa is looking to improve earnings by €1.5bn over the next three years, partly through savings from better coordination within the Group itself, implementing common purchasing and a 25% cut in administrative costs. Most of the benefits are expected to come from Lufthansa Passenger Airlines, with a target of reduction on costs of some €600m and an improvement in revenues of €300m. In part this comes from plans for much reduced capacity growth and no increase in the size of the fleet before 2014. The aim is to reduce long-haul unit costs by 10% over three years and by 20% in the longer run. Overall one third of the cost savings are expected to come from staff cost reductions — with over 3,500 administrative posts to be cut worldwide.

In short-haul operations it is attacking intra-group competition, using its “low cost” subsidiary, Germanwings, as a complement to its own Lufthansa operations, particularly for non-hub flying.

It has managed to offload British Midland, expensively, to BA, but retains a problem with loss-making Austrian. Its attempts to negotiate with the unions there for a sustainable working package failed and it took the unusually aggressive stance of transferring all flight operations to the Tyrolean AOC (Austrian’s regional subsidiary), which had the most favourable working practices agreements.

International Airlines Group

IAG re-emphasised the severe pressure from the weak Spanish economy and its industrial dispute with the Iberia pilots. BA operations at Heathrow were performing well — particularly on the Atlantic and particularly for premium traffic. IAG’s presentation concentrated on the long term potential and emphasised the opportunities for further developing long-haul to long-haul connections through its double hub system of Heathrow and Barajas.

Intriguingly, it mentioned that the acquisition of British Midland from Lufthansa was providing multiple benefits. It has not just enabled it to recover an extra 10% of slots at the constrained Heathrow in order to reinstate some of the short- and long-haul routes it had been forced to give up over the years because of capacity limitations, but also has seemingly brought it a closer relationship with airport operator BAA. The two will be trying to promote Heathrow as the European hub of choice.

IAG is still in the early stages of integrating the merger of BA and Iberia. With potential synergistic benefits the target is to achieve a trebling of underlying operating profits by 2015 — a €1.1bn improvement to come roughly equally from revenue improvements and cost savings.

Ryanair

Ryanair also reflected the relatively weak sentiment, pointing to a weak first quarter figure for profitability (to end June 2012) and confirming current guidance for a dip in profitability for the full year to March 2013 to between €400 and €440m, down from €503m in FY 2012. With capital spending declining, as its order backlog with Boeing reaches its end (the last 11 737-800s are due to be delivered next winter), it is still on course to provide shareholders with a return of €1.5bn over a five year period through a mixture of share buy-backs and special dividends while maintaining strong cash balances (it ended its financial year in March with €3.5bn in cash and net debt of only €109m).

Perhaps significantly it suggested the possibility of a “blood-bath” arising out of competition against Wizz; both carriers moved in to fill the gap in Budapest created by the demise of Malev and have been pursuing aggressive fare wars in that market. Ryanair’s opening of a base in Wroclaw in Poland is further attacking Wizz’s natural strengths.

This no doubt leads to its conservative guidance of a mere 3% increase in average fares in the current year (after a 16% growth in the year to March 2012). It maintains its aim is to increase total traffic by 5% in the current financial year to 79 million passengers — while once again weighting the increase more to the summer season.

Under stockmarket rules, Ryanair is forbidden from saying too much about its recently renewed bid for Aer Lingus. However, it did give some pointers as to its decision to renew the bid. The Irish government is required to sell various state assets under the terms of the bailout agreement with the EC, and its holding in Aer Lingus is one such asset that should be sold in 2013. In order for Ryanair to be in the running to be considered to acquire the government stake, it states it would have to ensure pre-clearance from the competition authorities. It appears to believe that the recent approval of the BA/bmi deal suggests a change of opinion in Brussels, and a structural increase in Aer Lingus’s free float (and reduction in the union shareholding) gives it the greater potential for general shareholder acceptance.

Vueling

The presentation from Vueling was somewhat a contrast. This is an airline that is becoming the national airline for Catalonia, and is an unusual hybrid of low cost and business oriented carrier — it has introduced assigned seating, provides a business club/lounge product, a guaranteed middle-seat-free premium class and free newspapers. Taking advantage of the demise of Spanair, it has increased its leadership in Barcelona: with a one-third increase in passenger traffic in the first five months of this year it now has a near 30% share of the market at the airport.

While it had been used as a low cost feed for Iberia in Barajas, this experiment has stopped following Iberia’s establishment of Iberia Express (all due to the Iberia scope clauses with its pilot unions limiting use of other carriers but not mentioning limitations from Iberia’s own subsidiaries). Vueling highlighted the plans by the Spanish Government to increase airport passenger charges from July this year — a near doubling of the per passenger fee at both Madrid and Barcelona and a 25% increase at other AENA airports. Although this will undoubtedly affect passenger demand, it may ironically improve Vueling’s relative competitive position: easyJet has already announced its plan to withdraw from Madrid as a base, and Ryanair may well follow suit at both Madrid and Barcelona.

The establishment of Iberia Express has effectively given Iberia a one off chance to change the operating economics of its short-haul feed into Barajas — with crew pay rates closer to market reality than its legacy operations — despite the resulting destruction of relations with its main pilots’ union. Lufthansa also is eager to get its non-hub direct flying into positive contribution — uniquely among the European network carriers, because of the nature of the decentralised German market, it has to offer short-haul services for its major corporate clients that do not provide feed to its long-haul operations. For both IAG and Lufthansa there is the dilemma of attempting to square the circle between providing effective feed to long-haul services and making short-haul operations profitable.

One point absent from the presentations by the two major network players was any mention of the benefits of consolidation on the North Atlantic; the common theme, if any, was the wish to return short-haul operations to some semblance of profitable contribution.