Wizz Air: Virus,
what virus? May/Jun 2020

In the pool of despond that is European aviation Wizz Air projects a bright ray of optimism. Is it justified?

Wizz Air has been impacted just as much as other airlines. In May it operated just 7% of the 2019 equivalent capacity. It has furloughed about 1,000 employees, 19% of the total, and cut salaries by an average of 14%. Yet CEO József Váradi is convinced that once lockdowns are eased and restrictions on air travel removed, demand for Wizz seats will rebound. His plan is for Wizz to operate at 80% of the previous year’s capacity in the second quarter of FY 2021 (July-September) and to get close to 100% by the end of the year.

There are particular characteristics of Wizz’s demographics which support this outlook. Most of Wizz’s key markets are in Central and Eastern European countries (CEE) where Covid-19 has been relatively mild but its core business also involves connecting these markets to the UK, the worst affected country in Europe. A high proportion of Wizz’s clientele are young (the average age is 36) with a strong inclination to travel, and two thirds of demand is related to VFR which is probably more resilient than pure leisure. In some markets, notably the UK, potential demand may have been boosted by the savings built up during lockdown by normally high spending youth.

In contrast to just about every other airline Wizz Air has been expanding its planned network in recent months, taking advantage of airports desperate to sell unused capacity. It has reaffirmed its ambitious A321-based fleet plan which is designed to grow traffic at an average of 15% a year from 40m passengers in FY2020 (year to March 31) to around 110m in FY2027.

FY 2020 results issued in June were good, despite the impact of Covid on March numbers. Total revenues rose 11.2% to €2.76bn while EBIT before exceptional cost increased 12.6% to €402m. the exceptional item related a loss of €64m on discontinued fuel hedges. Net profit after tax was €281m, more than twice the 2019 result of €123m. As is the norm for LCCs, management is giving no guidance on the losses expected for the current year.

Underpinning the company’s confidence is a healthy balance sheet, with a debt/equity ratio of 1.6/1, and more importantly, very good liquidity; as at the end of March Wizz Air had €1.5bn of cash, almost all unencumbered, and has since received £300m of low-interest loans from the UK government under CCFF, a scheme available to all solvent UK companies. Even assuming a full grounding, the airline estimates that its monthly cashburn is only €70-90m which would allow it to survive a prolonged crisis of over one year.

Despite the fact that it was generating hardly any income, Wizz Air’s capitalisation on the London Stock Exchange was €3.3bn in early June, the third most valuable airline in Europe, below IAG at €5.5bn and Ryanair at €12.4bn, but remarkably above easyJet at €3.0bn. Investors tend to put Wizz Air in the same category as Ryanair; in 2019, when such measurements were possible, Wizz and Ryanair had p/e ratios of 14 to 15, while the Legacies were rated in the 3-6 range.

High-level market basics

The pie chart opposite is a reminder of the structure of the intra-European market in the pre-Covid era (based on scheduled capacity between countries in west and central Europe, ex-Russia, and in domestic markets). It is remarkable that the three network groups, the Legacies, accounted for nearly 40% of the market, and the three main low cost subsidiaries within these groups — Vueling, Eurowings and Transavia — contributed for just 10% of the market

Add in the smaller flag-carriers — Alitalia, SAS, TAP etc — and over 50% of intra-European capacity market is now facing a traumatic restructuring, partly dictated by the conditions of state aid, finally being forced into addressing the reality of the economics of feed to their global hubs, abandoning unprofitable routes and airport bases.

About 30% of the market is operated generally efficiently by the three well-capitalised and liquid LCCs — Ryanair, easyJet and Wizz Air — though each is differently positioned to deal with the post-Covid world.

The remaining 20% of the intra-Europe market is again mostly populated by endangered carriers — regionals like Flybe which has folded, charters like TUI which are drastically downsizing or LCCs like Norwegian, perpetually on the brink of bankruptcy — though there are some dynamic airlines — for example, Volotea, which has found low cost niches overlooked by larger carriers, or Aegean, combining low cost with strong local branding.

In the post-Covid era there will undoubtedly be a re-setting of the intra-European industry, though there are a lot of opaque questions. How much demand will disappear altogether as a result of changed leisure and business travel patterns? Can demand be re-stimulated through low fares or will anti-viral regulations permanently raise costs? How radical will the Legacies’ restructurings be? Will Air France and Lufthansa in particular use this crisis to cull their loss-making short-haul networks? Or will governmental largesse, to use Michael O’Leary’s terminology, be used to offer below-cost fares?

Overall though, all the opportunities seem to be with the LCCs while most of the threats are with the Legacies.

Wizz Air’s strategy is to seize the opportunities; more precisely, to be opportunistic with its western expansion while being dependent on regulatory change for eastern expansion. In the middle of the Covid crisis Wizz Air has announced a stream of new bases: Milan Malpensa (five aircraft); Larnaca (two); Tirana (three); Lviv in the Ukraine (one); Dortmund (three); Saint Petersburg (one); Bacău in Romania (two); plus expansion at Belgrade (three). a doubling to six aircraft at its new Abu Dhabi venture and plans for a Gatwick base. (However, it should be noted that aircraft have been moved from other Wizz airports to these new bases). József Váradi commented: “We continue take advantage of market opportunities and re-stimulate demand for low-cost travel. This expansion further contributes to the vital recovery of the economy in our markets and we remain focused on best servicing them, while protecting the health of our customers and employees”.

Airports are, to varying extents, desperate for new business as both aeronautical and commercial revenue have evaporated while costs are mostly fixed. Even London Gatwick now faces a pile of spare slots depending on whether BA’s withdrawal is permanent and whether Virgin Atlantic and Norwegian find financial support. It is significant that it is Wizz rather than the other two LCCs that has made the first move here, with plans for a four-aircraft base in the winter, possibly rising to 10 next year. Wizz has been allocated an additional 196 weekly slots, to add to its existing slot total of 56, though it is not clear what proportion of the new slots are historic.

In the post-September 11 crisis, the secondary and tertiary airports looked to the new entrant LCCs for rescue; in the Covid crisis almost all airports need the LCCs to begin to restore traffic volumes. Yet Wizz is the only real player at present.

easyJet is being cautious, reverting to its low fleet growth plan (see Aviation Strategy, December 2019) and planning to return to only about 40% of pre-Covid capacity by September and starting to focus on a major cost reduction effort. If Sir Stelios had managed to persuade other shareholders, easyJet would be retrenching like a Legacy carrier, having cancelled its A320 neo orders.

Ryanair is aiming at restoring 60-70% of capacity by August and in the meantime seems to be concentrating on renegotiating its existing airport contracts, with the threat of intensifying its churn tactic whereby underperforming airports, or those that do not agree to Ryanair’s cost and performance terms, are dropped or aircraft are shifted to more profitable or compliant bases.

Wizz vs Ryanair

Ryanair’s post-Covid expansion prospects are still clouded by the 737 MAX. Its plans require the delivery of 200 units over the next five years, 150 of which are for growth rather than replacement, and It expects recertification to be completed by this summer and delivery of some of the backlog to take place soon after, but nothing is certain. Its fall-back strategy of gaining experience as an A320 operator at Lauda Air, then negotiating a major order with Airbus now seems to have been abandoned, with Lauda Air being downgraded to a wet-lease operator.

Meanwhile, Wizz Air intends to continue to take delivery of nine A321s, six neos and three ceos, through this financial year. The expected operating improvements of the A321 neo compared to the A320 include: 239 against 186 seats, 16% lower fuel burn per block hour and 50% reduction in noise pollution. In total 268 A320 neo family units are on firm order, including 20 XLRs. As the table shows a net increase of 174 to 295 units is planned between now and FY2027.

Both airlines will have to grapple with the repercussions of the Covid crisis on new aircraft prices and lease rates. According to AVAC (see aircraftvalues.com) new market prices for MAXes and neos have collapsed by at least 20% and operating lease rates are down by around 30%.

Ryanair is negotiating fiercely and successfully for compensation and discounts from Boeing. It has massive leverage because, as well as being is a key customer, it is legally entitled to cancel deliveries and recover all its deposits and PDPs as delays in fixing the aircraft design have exceeded one year. On the other hand, there is no alternative supplier in the foreseeable future.

Wizz is a key customer for Airbus but probably cannot negotiate any significant change in the pricing on its A321 contracts. The market price analysis, necessarily tentative at present, implies that Wizz now stands to receive less cash from the sale/leaseback transactions it uses to finance its deliveries. But there will probably still be a cushion between the discounted unit price negotiated by its founding shareholder, Indigo Partners, with Airbus. On the other hand, the lease rate on its new deliveries should fall.

Ryanair and Wizz bases overlap everywhere in the CEE. Wizz’s own analysis puts itself at 40% of the LCC CEE market, Ryanair at 32%, easyJet at 6% and others (Norwegian, Pegasus, Flydubai, Blue Air, etc) at 22%. Significantly, Wizz places itself as the number one LCC operator in nine of the 14 CEE countries it serves. Wizz’s share of the total CEE market is estimated at 18%, with Ryanair number two at 14% and LOT with 6% in third.

In terms of cost and efficiency there is almost nothing between the two LCCs. Wizz has a longer average stage length, 1635 km, than Ryanair, 1250 km, and achieves total revenue of €69 per passenger against €57 white its operating cost per passenger is €61 against €50, a 21% difference in both cases. Net profit margin at Wizz in FY2020 was 10.2%, pretty close to Ryanair’s 11.8%.

The point is that Ryanair has potentially a serious competitor on cost and efficiency in Wizz, and one whose expansion path is more certain because of the A321. It could be added that Wizz is a more attractive brand than Ryanair.

Finally, Wizz Air’s joint venture with the Abu Dhabi Developmental Holding Company (ADDH), is not only going ahead this summer but also the number of based aircraft has been doubled from three to six. Wizz envisages a growth in this fleet to 50 aircraft within ten years. The logic is a market of five billion within an 8-hour radius of Abu Dhabi and counter-seasonality, UAE travel tending to peak in the winter season. The reality is another unknown element added into the maelstrom of Middle Eastern aviation market (see next article).