Korean Air: Rescued by Cargo,
Rescuing Asiana Sep/Oct 2022

The Covid-19 pandemic has turned out to be an existential crisis for many airlines round the world. But for Korean Air, the flag-carrier of South Korea, it seems to have generated interesting opportunities.

Korean’s revenues dipped by 40% in 2020, the first year of lock-downs and border closures, but it was able to report a small operating profit, and a reduction in net losses compared with the previous year. But in 2021, the second and full year of disruption, revenues grew (by 18%) and it achieved its highest ever level of operating profits of ₩1.4tn (US$1bn) reflecting a margin of nearly 16% on turnover of ₩9tn ($7.9bn).

This financially strong performance has continued into 2022. The company recently published its third quarter estimate of results showing (non-consolidated) revenues up by 65% to ₩3.7tn and, despite a 145% increase in fuel costs, a doubling of operating profits to ₩839bn (a 23% margin).

For the nine month period revenues topped ₩9.8tn, operating profits ₩2.4tn and net income came in at ₩1.4tn — a net margin of 14.5%.

Cargo strength

Korean has always had a strong position in air cargo: excluding the package consolidators, Fedex and UPS, it is the world’s fourth largest cargo airline behind Qatar, Emirates and Cathay in terms of tonne kilometres flown.

Pre-pandemic, freight operations accounted for roughly half of all tonne-kilometres performed, but only 20% of total revenues.

During most of 2020 and 2021, Korean was only able to achieve passenger volumes at 10% of 2019 levels. But it was able to take advantage of the supply chain problems and the shortage of air cargo capacity arising from the lack of long haul bellyhold capacity. And it even supplemented the use of its 23 strong dedicated freighter fleet with passenger 777s and A330s stripped to be able to accommodate cargo.

Cargo loads grew by 2.5% in 2020 and 17% in 2021, while cargo load factors increased from the “normal” 70% to a peak of 86% in the second quarter of 2021. Cargo yields jumped by 44% in 2020 and a further 16% in 2021, while cargo unit revenues surged by 62% and 21% in the same years. In 2021, Korean’s cargo revenues were more than 2.5 times the level achieved in 2019, and accounted for 76% of total revenues.

However, Korean has seen freight demand soften in volume terms since the peak winter 2021 season (see graph) and in the third quarter cargo tonne kilometres were 10% lower than prior year levels. Despite this, yields were strong (helped by a near 25% depreciation of the Korean won against the US dollar) and revenues were up by a further 12%. Yields were particularly strong on European routes — the second most important route area for Korean, accounting for a quarter of freight traffic — and revenues there jumped by 37% year on year thanks to “supply restrictions”.

Pent-up passenger demand

While freight volumes have weakened, Korean’s passenger traffic has started to strengthen. As Asia’s borders started to reopen from the second quarter of 2022, the airline has been able to restore passenger services: by the third quarter it was operating services only 50% below the same period in 2019. Load factors had also recovered to 80% in the six months to end September, compared with a mere 45% load factor in the preceding none months. Yields appear to be 45% higher (and unit revenues 40% higher) than in the corresponding periods in 2019.

The company highlights that it is seeing strong demand in long haul operations — particularly inbound visits from the Americas and Europe because of the weak won — and gradual recovery in mid- and short-haul routes as the Asian border restrictions have been relaxed. SE Asian routes are benefiting from pent-up outbound leisure demand and strong recovery in transit passengers from SE Asia through Seoul to the Americas. Business and leisure traffic on the important routes to Japan, which pre-pandemic accounted for 20% of Korean’s international traffic, is bouncing back following the reintroduction of the visa waiver programme that had been suspended in March 2020.

In the last decade China had dominated air traffic growth within the Asian region. Korean had been a strong beneficiary and by 2019 Chinese traffic accounted for 20% of its international demand. It looks as if that segment will remain closed to all but essential travel for some time to come as long as the PRC maintains its zero-Covid policy.

Asiana take-over

At the beginning of 2021 Korean Air launched South Korea’s largest ever rights issue: a ₩3.3tn ($3bn) offering, doubling the number of shares in issue.

This was not just to shore up liquidity — as had been its ₩1tn issue in July 2022, or other airline equity issuances elsewhere in the world at the time — but to provide the finances for a ₩1.8tn acquisition of a 68% stake in Asiana Airlines, South Korea’s second largest airline.

Formed in 1988 by the Kumho Asiana chaebol specifically to upset Korean Air’s then monopoly, Asiana Airlines (including its low cost subsidiaries Air Busan and Air Seoul) had grown by 2019 to account for 34% of the domestic market and 23% of the international. This compares with Korean Air Group’s market shares (including its LCC subsidiary Jin Air) of 33% and 30% respectively.

With a fleet if 80 aircraft, and revenues (in 2019) of ₩6.9tn Asiana is around half the size of its bigger rival. It has not been particularly profitable: in the five years before the pandemic struck it achieved an average operating margin of 0.5% and registered total net losses of ₩860bn.

There is significant overlap in operations. The two carriers competed directly on 68 routes — out of Korean’s total 148 routes (pre-pandemic) and Asiana’s 97.

There are significant differences. Asiana is a member of the Star Alliance; Korean, with immunised JVs with Delta and Air France, is a founding member of the SkyTeam alliance.

Integration of the two will be a challenging exercise. They both have A380s, A330s and 777s (see table). But for its narrowbody fleet Asiana has gone for the Airbus A320 family while Korean is a Boeing 737 operator (although it does have 30 A321neos on order, the first of which is due for delivery this year). Korean plumped for the 747-8i and 787s (with 20 on order); Asiana the A350 (10 in service with another 17 on order). Korean’s CEO, Walter Cho suggests, perhaps optimistically, that it will take two years to integrate the two full service carriers.

Then there is the question of the three LCC subsidiaries. Korean’s Jin Air (which in June 2022 was transferred back to Korean Air from parent Hanjin KAL) is firmly in the Boeing camp with 22 737s (including one MAX-8) and four 777s; while Asiana’s 42%-owned (and separately quoted) Air Busan and the 100% owned Air Seoul owe allegiance to Toulouse with 22 and six A320 family aircraft respectively. There are suggestions that the three may be subsumed under the single Jin Air brand. Cho accepts the difficulty: “if we merge together we will have four different aircraft with five different engines”.

Asiana Airlines had already been put up for sale in mid 2019 as its parent Kumho Asiana encountered a liquidity crisis (before that became fashionable during the pandemic). An agreed sale to Hyundai was pulled, possibly under pressure from the Korean Development Bank, and in November 2020 Korean Air announced its intention to buy the group (with ₩800bn support from the KDB to its chaebol holding company Hanjin KAL in order to maintain its position as holding company).

At the time Korean Air stated: "the main reason behind the decision to acquire Asiana Airlines... is to stabilise the Korean aviation industry, which is suffering from the COVID-19 pandemic. Considering that Korean Air’s financial status could also be endangered if the COVID-19 situation is prolonged, it is inevitable to restructure the domestic aviation market to enhance its competitiveness and minimize the injection of public funds."

Obtaining approval from the various competition authorities has taken time. Even the home-based Korea Fair Trade Commission (KFTC) took more than a year, but in January 2022 approved the deal. It attached some conditions: to hand over slots and traffic rights for 26 international and 14 domestic routes in the next 10 years if a newly competing airline requests them; and, “until competing airlines seek slots and traffic rights, to limit fare increases, refrain from reducing supply and make sure that service quality does not deteriorate until new market entry”. Strong stuff!

Outside Korea, the merger has been approved by Turkey, Vietnam, Taiwan and Australia, but the group is still waiting for approval from the more important US, UK and EU competition authorities. In the meantime the acquisition and integration is on hold. But the airline group is sitting on a useful $4bn of cash at a time when traffic is recovering, and in the knowledge that when the deal is finally approved it will be in a much stronger position.