TUI looks to long-haul
to help stem AIT decline June 2016

Following the merger of TUI AG and TUI Travel in December 2014, the “new” TUI Group is attempting to become a globally-scaled, integrated vertical business in the all-inclusive tour (AIT) market. But can that business model — and the company’s ambition to expand long-haul flights — compensate for the underlying structural decline of the AIT market?

Aviation Strategy has been following the UK AIT market for many years, and the gradual decline that began in the early 2000s shows no sign of reversal. As can be seen in the chart, total charter passengers out of the UK yet fell again last year — for the 14^th year in a row — and the 2015 total of 16.4m is less than half the 2001 figure of 34.5m charter passengers.

In terms of the split of scheduled versus non-scheduled capacity offered by UK airlines (see chart), non-scheduled ASKs also dropped again last year, to 13.6% — its lowest ever proportion — and is substantially down on the 32% that non-scheduled ASKs represented in 2001, or the 37% of 1989.

As is well recognised now (though that wasn’t the case as recently as three or four years ago), the decline in the AIT market is structural and permanent, with the power of the internet allowing leisure travellers to research, construct and book their own holiday packages of accommodation and flights from multiple suppliers online very easily. The concept of prospective holidaymakers being trapped on the other side of a desk while travel agents tell them what is and isn’t available has been rendered anachronistic, and the number of high street travel agencies has declined relentlessly year after year.

The last remaining giants of the European AIT industry — TUI and the Thomas Cook Group — belatedly reacted to these changing fundamentals by overhauling their business models and managing the decline of the lower margin, mass holiday package while building up revenue from (more profitable) differentiated holiday experiences and services.

The TUI merger

For the first of these giants, though, part of its reaction to the changing market was a plan by TUI AG (the Hannover-based travel and shipping conglomerate) and UK-based TUI Travel to merge and become the world’s largest integrated tour operator/tourism business. However, this ambition had met with a mixed response from analysts, with scepticism based partly on the seemingly never-ending history and rumours of the on-off merger, which started not long after TUI Travel came into existence in 2007 following the merger of TUI AG's travel assets with UK-based tour operator First Choice (see Aviation Strategy, July/August 2014).

The more legitimate concern was based on the potential financial benefits of the merger, and whether it made sense strategically. From TUI’s point of view, the strategic rationale was that the UK business was a good fit in terms of vertical integration, while the merger of TUI AG and TUI Travel is expected to deliver annual cost savings of €50m by the end of 2016/17 — although TUI is incurring €35m of one-off integration costs in order to achieve those savings.

In fact in financial year 2014/15 (which included nine months post-merger) TUI posted its best-ever 12-month period of underlying EBITA (€1bn, based on €19bn of revenue), and the second year (FY15/16) has started reasonably well. In the first half of its 2015/16 financial year — the six month period ending 31^st March 2016 — the TUI Group saw revenue rise 2.7% year-on-year to €6.8bn, and at the EBITA level it reported a loss of €288.3m, compared with a €368.5m loss a year earlier (tour operators typically rack up losses in the first six months of their financial year, where they have more costs than revenue). Its “underlying” results (which exclude one-offs and other items, and which adjust for timings of key travel dates such as Easter) for H1 2015/16 showed an EBITA loss of €236.9m, compared with a €283.1m loss a year earlier. At the underlying level the net loss was €293m in H1 2015/16, compared with a net loss of €323m in April to September 2014.

Looking at the critical summer holiday season for 2016 (as can be seen in the table), as of early May TUI Group had achieved a 1% increase in the average selling price (ASP) of all its mainstream holidays, and with a 1% increase in bookings the two factors combined to produce a 2% rise in revenue. The situation, however, varies significantly between source markets. In the large UK market TUI has not pushed through price increases, and customer numbers have risen by an impressive 7%. However, in the Nordics, an average 6% increase in the selling price has seen customers fall by a hefty 9%, leading to an overall fall in revenue of 4% out of the Nordics.

TUI — like all tour operators — is vulnerable to external shocks that can effectively switch off demand for popular destinations almost instantaneously, and at the moment the company is coping with reduced demand for Belgium, North Africa and Turkey. If Turkey’s figures were excluded, for example, TUI’s 2016 summer bookings would be 8% up year-on-year, rather than 1%.

TUI’s strategy

The TUI Group’s goal is to become a “content centric, vertically integrated tourism business” — and in financial terms it aims to deliver at least a 10% CAGR in underlying EBITA in the current financial year (2015/16, ending 30^th September 2016) and the following two years, to 2017/18.

To achieve the latter, TUI is being ruthless in its drive to become vertically integrated and achieve economies of scale globally. For example, in April this year TUI announced a deal to sell its Hotelbeds subsidiary (a marketplace selling rooms to travel agencies and airlines) by September for €1.2bn to Cinven and the Canada Pension Plan Investment Board, the proceeds of which will be used to strengthen its balance sheet and “invest in future growth opportunities”. That first purpose is crucial, as TUI Group still has long-term debt of €2.3bn, as at the end of March 2016.

And, interestingly, the TUI Group now says that after carrying out a strategic review it will break up and dispose of its so-called Specialist Group. A move into specialist holidays had been part of TUI’s core strategy previously and was seen as a big growth engine as it attempted to diversify away from lower margin product, but clearly management now believes that not all specialist products offer those high margins. Perhaps more importantly, according to Fritz Joussen — TUI Group chief executive — the 50 individual businesses that make up the Specialist unit “don't use our brand; they don't use our IT; they are not in our hotels; they are not in our cruise ships; they don't use our aviation. There is no synergy and we therefore have decided we want to be disciplined — we want to be vertically integrated and content-centric”.

Therefore some specialist businesses (such as Crystal Ski and Thomson Lakes & Mountains) are being transferred into the UK source market core product, but all the other more esoteric specialist businesses (such as educational trips for schools and high-end tailor-made holiday products) will be sold in one transaction. The emphasis is now firmly on making the “core” holiday product — from where the majority of revenues are generated — more differentiated and value-added for customers.

The key to achieving this goal is the assembly of “exclusive content” — whether holiday packages, hotels or cruises — and a vital way to deliver that is a concerted push into more long-haul product, which typically is higher margin and makes revenues more resilient by diversifying risk of market downturns (such as has been occurring in Mediterranean destinations this summer through fear of ISIS attacks).

Indeed TUI’s long-haul bookings rose by 9% in the winter 2015/16 season, and as at May long-haul bookings for the summer 2016 season were up 10% year-on-year, with destinations in the Caribbean and the Asia-Pacific region proving to be particularly popular with European source markets (and specifically from the UK source market, for long-haul holidays to Mexico and the Dominican Republic).

Long-haul expansion

That strategy is flowing into TUI’s group’s fleet plans. Currently the company operates 145 aircraft in five airlines (see table), and they fly approximately 13m passengers a year to more than 180 destinations around the world.

The TUI Group currently has 63 aircraft on firm order, comprising three 787-9s (one each arriving in FYs 15/16, 16/17 and 17/18) and 60 737MAXs (with 40 MAX-8s and 20 MAX-9 models), which are being delivered through to 2021. TUI Group ordered one 787-9 in May 2015, and then swapped two undelivered orders for 787-8s for two 787-9s. The Group also has options for a further 21 737MAxs and a single 787-9.

Currently the TUI Group carries 1m long-haul passengers a year on its packages, and the group wants to increase this to more than 1.5m within the next five years. The 787s are core to this long-haul ambition, and among key destinations for new charter routes as the fleet builds from the current 13 to 17 (including one option, which the Group is likely to exercise) will be the Caribbean, the Indian Ocean and Thailand.

In terms of the individual airlines, Luton-based Thomson Airways operates a fleet of 60 to almost 100 destinations, and is the group owner of the firm orders for three 787-9s and 60 737s MAXs. Its current fleet of nine 787s will be the core of TUI’s long-haul business going forward, and it currently operates to multiple destinations in Africa, the Americas and Asia. Its 14 757s will be phased out by 2021

Based at Hannover airport is TUIfly, which operates 40 737s to around 40 destinations, while Jetairfly (based in Brussels) has 28 aircraft; TUI Airlines Netherlands (Schiphol) has 11; and TUIfly Nordic (Stockholm) has six.

One further airline is Corsair International, which is based at Orly airport and which operates two A330-200s, two A330-300s and three 747-400s. It operates both scheduled and charter services to a handful of destinations in the Africa and the Americas, but is loss-making and as the TUI Group has been trying (unsuccessfully) to sell the carrier for a while, it is no longer regarded as being part of the core TUI airline fleet.

But even after discounting Corsair, the five constituent airlines still contain 10 different aircraft models. Although the dominant model is the 737-800, which accounts for almost two-thirds the total fleet, this variety has long been the norm for TUI (whatever its corporate structure), and it’s a valid criticism to say that over the years management has been far too slow in rationalising and standardising the fleet.

Rebranding and rationalisation

When the merger was completed TUI stated that the different airlines would be rebranded under one single and global TUI airline brand, although Fritz Joussen — TUI Group joint chief executive at the time, alongside Peter Long (Joussen becoming sole chief executive in February 2016) — said that it would be a careful process as they did not want to “destroy local brand equity”.

That process will therefore take many years to complete (some reports say up to 10 years!), and is starting with continental European airlines first, before the Thomson brand gives way to the TUI brand in a second phase. So far only Schiphol-based ArkeFly has been rebranded (in October 2015), and it is now known as TUI Airlines Netherlands. According to Joussen the rebranded Dutch airline has since “won seven percentage points in market share”. Jetairfly is scheduled to be the next airline to be rebranded.

TUI also has a “One Aviation” programme in which its airlines align and combine their engineering and maintenance, ground operations, supplier management and procurement; this effort is targeting €50m of annual savings by 2018/19.

There has been speculation that these rebranding and savings programmes are the first step towards a much greater rationalisation of TUI’s aviation assets in face of fierce competition from LCCs (which make self-assembly for prospective holidaymakers easy and cheap), with some unconfirmed reports that TUI’s long-term plan is to use Thomson Airways as the base for the combined airline. Potentially this could lead to significant reduction in jobs at the Tuifly operation in Hanover (where 2,000 people are based) — though this will inevitably face fierce opposition from German unions if it does occur.

The anglo-german strategy will come under review following the Brexit vote.