Super-Connectors: The real threat June 2014

The Euro-Majors are getting more and more upset by the incursion of the Super-Connectors – Emirates, Qatar, Etihad and THY – complaining loudly about unfair competition and instigating EC investigations. Here, we attempt a quantification of the threat.

In round numbers, the four Super-Connectors have a combined fleet of about 700 aircraft, with 900 jets on order plus a further 300 or so options (and then there also Letters of Intent).

In total the Super-Connectors have about $125bn of aircraft on firm order plus a further $45bn of options; for comparison, the combined commercial backlog for Airbus and Boeing is about $845bn, so a backlog share of at least 15%. (These figures are not

list prices, which are normally quoted in press releases, but estimated from actual delivered or ordered prices, which imply a discount of 40-60%.) Emirates is almost certainly Airbus’ most important customer accounting for 7.5% of the total backlog value, which largely reflects its A380 purchases.

This puts an interesting perspective on protectionist responses to the Super-Connectors. If, for instance, Air France or Lufthansa were to block or restrain further expansion into France or the EU, what would be the repercussions for the French and European aerospace industries and their supply chains?

In the following analysis we have projected seat capacity forward using the carriers’ aircraft annual delivery schedules and adjusting for replacement capacity (we assume conservatively that widebody aircraft will be retired at 12 years and narrowbodies at 15 years). No deliveries from new additional orders are allocated in the forecast period. We have also compared the forecast to the Super-Connectors’ own growth plans where available. We then assume that load factors are constant and passenger volumes will grow at the same rates as seat capacity growth, and come up with these forecasts for 2021: Emirates at 95m passengers by 2021, THY at 60m international (close to 100m if domestic is included); Qatar and Etihad at 48m and 37m, respectively. For comparison, Lufthansa is around 80m today.

Now to address the implications of the Super-Connectors’ super-growth, particularly for the European carriers.

The graph below brings together the historic passenger growth of the four airlines and the combined passenger forecast (based on the methodology described above). From 2008 to 2013, a period which coincides with the longest post-1945 recession in the developed world, the Super-Connectors grew by 15.6% pa, from 50m to 100m passengers; from 2013 to 2021, their combined growth rate will probably be a little lower – 10.5% pa – but this will accumulate 230m passengers by 2021.

The next step is to compare this forecast to the volume of passengers associated with a “normal” growth rate; by “normal” we mean the market growth predicted by Boeing, Airbus and other forecasters, which falls in the range 5% pa (average) to 6.5% pa (high growth regions); this is the traffic that the Super-Connectors would plan for if they were growing at the same rate as the market. As the two curves diverge a gap of 59-77m passengers emerges by the year 2021. This is the, say, 68m enigma – the additional traffic that somehow has to be generated by the Super-Connectors to fill their new aircraft.

Of course, the traffic forecasts could simply be wrong. The growth rates from Asia and Africa could be stronger than anticipated with the Super-Connectors stimulating traffic in a similar way to the LCC effect on short/medium haul markets. Or the Super-Connectors could have, like many airlines before them, over-expanded, in which case Middle Eastern consolidation will probably have to take place.

Impact on the Euro-Majors

The Euro-Majors fear increased market share capture. Currently, the Euro-Majors fly about 36m passengers between Europe and the Middle East/Asia/Africa , and they might expect to grow this total to say 45m by 2021 if they tracked market forecasts, but, given the Super-Connectors’ capacity plans, they face the threat of very low growth, maybe retraction, in the world’s fastest growing markets. This would be consistent with an analysis of historic trends. The following graph compares the European carriers’ traffic performance on Middle East/ Asia and Africa routes against the Super-Connectors over ten years (remember that Etihad only started operations in 2003).

The message is that the Super-Connectors have captured or generated almost all the additional traffic in these fast-growing developmental markets while the European carriers have more or less stagnated.

One implication is that the Euro-Majors become essentially niche players in these markets, focusing on the major point-to-point routes where they may be able to achieve substantial yield premiums over connecting flows.

The Euro-Majors and their US partners have also to be concerned about the Super-Connectors allocating new capacity to the Atlantic, diverting non-European originating traffic and by-passing the Euro-hubs. The Super-Connectors could then emerge as a new competitive force on the Atlantic which the Euro-Majors had oligopolised through their immunised alliances with the US Majors. This is probably a much more worrying development for the Euro-Majors than long-haul start-ups like norwegian.

Finally, the Super-Connectors add to the Euro-Majors’ problems in their short-haul sectors, which are generally very loss-making. Having seen their point-to-point traffic eviscerated by the LCCs, their connecting traffic is now also being eroded by the Super-Connectors.

IAG

IAG appears able to take a relatively sanguine view on the Super-Connectors as the threat is limited.

• Both hubs, Heathrow and Madrid, face west. Heathrow is, and is likely to remain, the prime gateway on the North Atlantic while Madrid is the main gateway on the South Atlantic.
• British Airways is the dominant player at the

  hub in Europe with the best International O&D traffic flows; it is much less reliant on connecting traffic than the other two Euro-Majors

• Capacity restraints at the airport mean that BA will be increasingly unable to provide short haul feed on to long haul services – especially from domestic regional points, reinforced by UK aviation policy and taxation. The regional feed services into LHR have for years been under competition from KLM through Amsterdam, so, for example, Emirates’ operations to Newcastle probably impact KLM more than BA.
• Madrid is the main gateway on the South Atlantic with strong O&D traffic to Latin America and Iberia has no exposure to Asia and limited exposure to the Middle East or Africa.
• Among the Euro-Majors it has a relatively low exposure to the Far East – but where it is present it has a significant level of O&D point to point demand (such as Hong Kong or Singapore).
• How its passenger alliance with Qatar will develop is uncertain but the cargo joint-venture looks like a good strategic innovation.
• Nevertheless, IAG will be subject to possible diversion of traffic through the Super-connectors’ hubs, particularly India-UK traffic and UK-Africa routes, which are highly capacity constrained on direct services. Traffic could be lost on India/Asia to Americas, Japan-Europe and Asia-Europe (particularly Spain connecting traffic). The Kangaroo route is in danger from continued attack (following Virgin Atlantic’s recent withdrawal, BA is now the only European carrier serving Australia).

Air France-KLM

Air France-KLM has a high degree of connecting traffic and is under serious threat from the Super-Connectors. A tendency to retreat into protectionist bilateral-think just postpones rather than obviates this threat.

• Amsterdam is primarily a transfer hub with low levels of pure O&D demand, and KLM relies on successful short haul routes from regional (ie non-hub) European cities to feed its long-haul services.
• KLM is particularly exposed to incursion into European non-hub airports by the super-connectors on routes to the Far East, Middle East and Africa. Air France and KLM have a relatively high level of access into China which leaves them open to traffic diversion on routes to Europe, Africa and North and South America.
• AF-KLM has chosen to ally with Etihad but this alliance is with the smallest of the Super-Connectors and is greatly complicated by Etihad’s investment spree in Europe.

Lufthansa Group

Lufthansa, probably correctly, feels itself to be under various attacks by the Super-Connectors.

• The three main Lufthansa Group airlines each have small local catchment areas at their main hubs and are reliant on transfer traffic. Within Germany the biggest problem is that the country is for historical reasons highly decentralised: Lufthansa may have its main hub in the financial centre in Frankfurt; but each of the federal states has a significant level of originating travel demand which generally will have to transfer somewhere to go long haul.
• Lufthansa has some regulatory protection in that the UAE bilateral currently restricts the number of German cities that can be served by Emirates and Etihad, but Qatar is building up its network to the east and, importantly, THY is saturating Germany, offering intercontinental connections from small cities.
• Having failed with THY, its only other alliance option is with Emirates, but this is out of Lufthansa’s hands, dependent on Emirates changing its non-alliance policy.
• On all its long haul routes Lufthansa appears exposed to the growth of the Super-Connectors. On short haul, Etihad’s support of airberlin is a double-edged sword (which may even be Damoclean): it may help to keep at bay further incursion from the LCCs (Ryanair, easyJet, norwegian, Vueling and Wizz) into Germany, but it is likely to exacerbate the pressure on yields and feeder traffic as airberlin chases cash.
• In addition, the Gulf carriers in particular are pursuing cargo traffic; and with limitations on night flights at Frankfurt, Lufthansa may find itself increasingly under pressure in one of its core operational segments.