World Aviation Yearbook: North America by CAPA

WORLD AVIATIONYearbook 2013north america

2 2 airLine LeaDer | MAR-APR 2012

PROFILES

north america toP 10 airLineSSOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | WEEk STARTINg 31-MAR-2013

north america toP 10 airPortSSOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | WEEk STARTINg 31-MAR-2013

North AmericaOutlookNorth AmericA is oN the briNk

of reAchiNg full mAturity as the planned merger between American and US Airways and the previous tie-

ups among the country’s airlines will result in three large full-service network airlines, one major low-fare carrier, roughly three hybrid airlines and a couple of fringe airlines operating under the ultra low-cost carrier model. Canada is also moving into a new level of maturity as its two major airlines are in the midst of creating new businesses to enlarge their revenue, and one strong niche player adds some rationalisation to their duopoly.

north america caPacity SeatS Per weekSOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | WEEk STARTINg 31-MAR-2013

ranking carrier name SeatS

1 Delta air Lines 3,734,822

2 United airlines 3,349,883

3 Southwest airlines 3,170,990

4 american airlines 2,789,021

5 US airways 2,199,479

6 air canada 913,027

7 JetBlue airways 725,700

8 alaska airlines 670,537

9 airtran 509,707

10 westJet 443,294

ranking carrier name SeatS

1atlanta hartsfield-Jackson international airport

2,183,726

2 chicago o'hare international airport 1,534,449

3 Los angeles international airport 1,491,895

4 Dallas/Fort worth international airport 1,445,441

5 Denver international airport 1,176,220

6new york John F kennedy international airport

1,172,450

7 Phoenix Sky harbor international airport 1,045,480

8 charlotte Douglas airport 1,022,360

9 miami international airport 977,104

10 San Francisco international airport 961,942

Delta Air Lines

United AirlinesSouthwest

AirlinesAmerican Airlines

US Airways

Air Canada

JetBlue Airways

Alaska Airlines

AirTran

Other

0M 1M 2M 3M 4M

3,734,822

3,349,883

3,170,990

2,789,021

2,199,479

913,027

725,700

670,537

509,707

3,761,245

3

north america FLeetSOURCE: CAPA - CENTRE FOR AVIATION | WEEk STARTINg 31-MAR-2013

north america ProJecteD DeLivery DateS For aircraFt on orDerSOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | WEEk STARTINg 31-MAR-2013

north america FLeet BreakDown For aircraFt in ServiceSOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | WEEk STARTINg 31-MAR-2013

north america moSt PoPULar aircraFt tyPeS in ServiceSOURCE: CAPA - CENTRE FOR AVIATION

north america caPacity SeatS Share By aLLianceSOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | WEEk STARTINg 31-MAR-2013

iata north america PremiUm traFFic: 2009-2013SOURCE: CAPA - CENTRE FOR AVIATION AND IATA

Narrowbody Jet

Regional Jet

Turboprop

Business Jet

Widebody Jet

Small CommercialTurboprop

Piston EngineAircraft

Military Transport

43.5%

22.2%

13.6%

12.4%

6.7% 1.2%0.4%

0.1%737

CRJ

EMB145

A320

757

Others

DC9

CARAVAN

18.2%

11.8%

10.5%

6.8%6.4%5.7%

4.8%

35.7%

Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12

-40

-30

-20

-10

0

10

20

30

Prem

ium

Tra

ffic

Gro

wth

%

Unaligned

Star

oneworld (affiliate)

SkyTeam

oneworld

34.6%

32.1%

18.7%

14.6%0.1%

10k

7.5k

5k

2.5k

0

8,488

409

1,964

In service In storage On order

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

0

100

200

300

767 777 787 737 747 A320

A330 A350 DHC8 ERJ170 MRJ

4

Lcc caPacity Share (%) oF totaL SeatS: 2001-2013SOURCE: CAPA - CENTRE FOR AVIATION WITh DATA PROVIDED By OAg

north america traFFic: 2008-2013SOURCE: CAPA - CENTRE FOR AVIATION AND IATA

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Jan-Mar

2013

0

5

10

15

20

25

30

35

17.6%

19.8%

21.9%24.0%

24.9%26.0%

27.1%28.5% 28.0% 28.7%

29.7% 30.1% 30.1%

Reve

nue

Pass

enge

r Ki

lom

etre

s %

20092008 2010 2011 2012 2013-15

-10

-5

0

5

10

15

... But the full maturation of those markets does not mean challenges in achieving viable business models have been wiped out. While a high level of maturity deters some start-ups from introducing junk capacity into the market place, established airlines need to ensure they have a solid foundation to weather the wild cyclicality that remains the only predictable pattern in the airline business.

Once American and US Airways reach full integration about 18 months after closing on their merger during 3Q2013, three carriers will account for approximately 58% of the US domestic market based on current O&D data from trade group Airlines For America (A4A). Adding Southwest’s roughly 25% share, four carriers (including regional feed for the majors) will represent roughly 83% of the US domestic market. The speedy pace of US consolidation during the last few years is a rapid change from 2005, when seven carriers accounted for about 90% of the market.

The stage is essentially set in the US to support traditional network, hybrid low fare airlines offering medium frills, and ultra low-cost carriers to serve the market place. Most of the airlines that fall into those three categories have focused during the last few years on creating seemingly viable growth models while ensuring fragile profitability is sustainable. Collectively the 10 largest US carriers have recorded three straight years of profitability, a commendable feat given the wild volatility in oil prices. But the margins are razor thin falling from 2.2% in 2010 to 0.1% in 2012 as fuel continued to be a permanent blight on airline performance in 2012 amidst capacity rationalisation and some pricing traction. During 2012 fuel accounted for 36% of the collective operating expenses recorded by the largest US carriers, according to A4A, nearly a 6% rise from the year prior.

Observers from inside and outside the industry in 2013 will closely monitor Delta’s attempt to partially mitigate fuel price volatility through its acquisition of the Trainer refinery outside of Philadelphia, Pennsylvania, which closed during 2012. US ‘superstorm Sandy’ that struck the US east coast late in 2012 derailed Trainer from making a positive contribution to Delta’s financial results in 4Q2012, but the 58% percentage of US market held by american, delta, United,

once american’S merger iS complete

5

36%

airline remains bullish that its estimates of a USD300 million reduction in annual fuel costs resulting from the Trainer purchase remain sound.

Delta’s agility in quickly moving to purchase a refinery stems from the competitive gap it enjoys from its still-merging US competitors. United in 2013 is attempting to finish picking up the pieces of a fragmented 2012 that began with a painful IT system cutover and hit a crescendo mid-year when an aircraft redeployment snafus triggered significant operational disruptions that sent some high-yielding customers elsewhere. Overall integration headaches resulted in United recording lacklustre financial results for most of 2012, so the carrier will spend much of 2013 working to deliver the full USD1.2 billion in merger synergies it predicted were achievable when it announced its tie-up with Continental in 2010. But the carrier has already given itself some leeway indicating that it might be 2014 before it can completely harvest the targeted synergies. American and US Airways will just be starting the arduous process of integration during late 2013.

Southwest Airlines will also spend 2013 fleshing out its position in the US market place as it continues its integration with AirTran

after acquiring its smaller rival in 2011. Southwest has pledged to deliver USD400 million in merger synergies in 2013, ahead of completing its AirTran integration in 2014.

As airline business models in the US become more defined, Southwest finds itself caught in between the hybrid carriers and the full-service airlines. Based on US Department of Transportation data from Dec-2011 to Nov-2012, Southwest held a 15% share of the US domestic market, third behind Delta’s 16.3% share and United’s 15.6% share. With Spirit’s transition to an ultra low-cost carrier and Allegiant Air recording lower unit costs than Spirit, Southwest can no longer declare itself a low-cost leader and has acknowledged it is battling cost creep similar to its legacy colleagues. While Southwest has made a marked push to expand its corporate traveller base, it does not quite fit into the hybrid category that neatly defines Alaska Air Group and JetBlue Airways. With the elimination of AirTran’s business class and assigned seating, Southwest appears to prefer remaining in the nebulous area between full-service and hybrid carriers.

The emergent hybrids Alaska and JetBlue plan significantly higher capacity expansion than their legacy peers and Southwest during 2013, following a similar pattern from 2012. Despite higher than industry average supply growth both carriers sustained profits during 2012, and appear to be targeting their growth in 2013 in certain pockets where they either hold a position of strength or are shielded from competition. JetBlue plans to continue building out its Boston focus city and its points in Latin America and the Caribbean, while Alaska is turning its attention away from the US west coast-Hawaii market to flesh out its transcontinental network from its Seattle hub and from San Diego, which

proportion of 2012 operating coStS dUe to fUel

As airline business models in the US become more defined, Southwest finds itself caught in between the hybrid carriers and the full-service airlines.

... integration headaches resulted in United recording lacklustre financial results for most of 2012

6

became a long-haul destination for the carrier in 2012. Both Alaska and JetBlue have somewhat unique positions in their

respective bases and headquarters in Seattle and New York JFK. Those markets are major gateways from Asia and Europe, which make both carriers attractive to a range of partners. Alaska has long-standing relationships with American and Delta, and is leveraging its relationship with Delta as it grows its presence from Seattle into Asia, providing feed to Delta’s long-haul flights. JetBlue has long touted its prime position at JFK to partners looking for feed in the continental US, building up to more than 20 interline and one-way codeshare relationships. During 2013 the carrier plans to foster some two-way codeshares, further distinguishing itself as more of a hybrid value carrier than a pure low-cost airline.

The other well-known hybrid carrier in the US, Virgin America, is putting the brakes on growth during 2013 as it works to record its first annual profit since launching operations in 2007. The carrier has deferred and cancelled some Airbus deliveries to ease its financial commitments and cut its supply after growing capacity roughly 72% during the 2010-2012 time period. But unlike Alaska and JetBlue, Virgin America does not hold a relative position of strength at its San Francisco base, accounting for just approximately 9% of the seat share in the market. Virgin America’s network is built around major metropolitan areas where legacy carriers are dominant and have no intention of ceding their corporate share to Virgin America even if the younger carrier has a slick onboard product. Pressure will be intense on Virgin America during 2013 to right its financial course and give investors some hope of a promise of profitability.

US ultra low-cost carrier Spirit Airlines has made a major push from legacy strongholds during the last couple of years, turning its attention away from a focus on growing service from its Fort Lauderdale base into the Caribbean and Latin America. Spirit will continue to press forward with that strategy in 2013, fleshing out some markets from Baltimore, Denver, Detroit, Houston, Minneapolis and Philadelphia. So far the carrier has largely proven its theory that it can stimulate low-yielding traffic in those already-crowded markets that are undesirable to the legacy carriers, evidenced by its steady financial performance in 2012 despite suffering significant disruptions from superstorm Sandy.

The other well-know ultra low-cost carrier Allegiant Air will spend a large portion of 2013 trying to prove it can replicate its strategy of linking small markets to major tourist destinations, such as Las Vegas and Orlando, in Hawaii. Allegiant had a limited time in the Hawaiian market during 2012, so 2013 is the year when the carrier’s growth plan will be put to the test.

As American and US Airways start the arduous process of merger integration, the US domestic space is reaching a relative level of maturity and rationality. The next area for shifting sands could be on the alliance level as carriers participating in trans-Atlantic joint business ventures appear to be realising those tie-ups may not quite meet their needs in building truly global networks. Delta’s decision to take an equity stake in Virgin Atlantic reflects the reality that alliance JVs are not a completely foolproof tactic to flesh out a true global network.

As WestJet attempts to ratchet up its corporate traveller base, Air Canada is focusing on the opposite end of the spectrum by launching its low-cost leisure carrier Rouge...

7

Air Canada has admitted the added supply has pressured its performance in the eastern triangle and in transborder markets. WestJet during the last year has also introduced flights to New York LaGuardia, further intensifying competition in the busy Toronto-New York market.

Even as the North American market reaches a level of maturity not enjoyed in other regions, intense competition among the region’s airlines that now have a pronounced focus on generating profits, delivering decent returns and building and preserving balance sheet strength, is driving a new set of dynamics in the region in 2013.

...Intense competition among the region’s airlines that now have a pronounced focus on generating profits, delivering decent returns and building and preserving balance sheet strength, is driving a new set of dynamics in the region in 2013.

Canada’s domestic space is also undergoing a shift in 2013 as its second largest carrier WestJet launches its new regional subsidiary Encore, further pressuring Air Canada in smaller domestic markets where it was once shielded from competition from its main domestic rival. WestJet is also attempting to expand its 10% share of managed corporate travel during 2013 with the introduction of a premium economy cabin and three tiers of product bundling, the top of which is designed for high-value customers who need maximum flexibility in their travel schedules.

As WestJet attempts to ratchet up its corporate traveller base, Air Canada is focusing on the opposite end of the spectrum by launching its low-cost leisure carrier Rouge during 2013 to ensure it retains a healthy portion of leisure travellers. A contract imposed on the carrier’s pilots by the Canadian Government allows for the establishment of the new carrier with a lower cost base, which Air Canada argues will allow it to compete more effectively in the leisure space. Rouge is launching during 2H2013 with Boeing 767s on long-haul flights to Edinburgh and Venice, and Airbus A320 narrowbodies to sun destinations. Rouge is expected to garner close scrutiny after Air Canada’s previous attempt to operate a lower cost subsidiary ended in 2003 with the shuttering of Tango.

While Air Canada and WestJet dominated 2012 with the hype leading up to the announcements of their planned subsidiaries, smaller carrier Porter Airlines continues to exert its own competitive pressure in the Canadian market. Porter carried roughly 2.5 million passengers in 2012 a 15% increase year-over-year; but despite its smaller scope relative to its two larger rivals, the carrier creates just enough pressure in busy corporate markets to potentially dilute revenue of its two competitors.

All three carriers maintain a significant presence in the contested eastern triangle of Montreal, Ottawa and Toronto, and in many trans-border business markets. WestJet during 2011 made a concerted push in the eastern triangle bolstering frequencies that resulted in a significant amount of capacity being introduced in the markets. Since that time

The next area for shifting sands could be on the alliance level as carriers participating in trans-Atlantic joint business ventures appear to be realising those tie-ups may not quite meet their needs in building truly global networks.

1 AIRLINE LEADER | FEB-MAR 2013

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9

UniteD airLineS ...........................................................pp.11“United airlines pledges it is on the road to revenue recovery as yields improve”First published on www.centreforaviation on 22nd march, 2013

DeLta air LineS ............................................................pp.21“Delta presses forward to build a competitive network in a consolidated and mature US market”First published on www.centreforaviation on 21st march, 2013

american airLineS / US airwayS ..............................pp.33“american and US airways likely to see little competitive change in their overlap markets”First published on www.centreforaviation on 2nd march, 2013

SoUthweSt airLineS ...................................................pp.41“Southwest airlines, the US’ fourth force, does not neatly fit the emerging US business models”First published on www.centreforaviation on 14th march, 2013

NORTH AMERICA:Selected airlines

10

JetBLUe airwayS .........................................................pp.48“JetBlue enjoys a cost “sweet spot” in the consolidating US market”First published on www.centreforaviation on 10th march, 2013

hawaiian airLineS .......................................................pp.56“hawaiian airlines endures short-term pain to secure, it hopes, successful longevity”First published on www.centreforaviation on 19th march, 2013

SPirit airLineS .............................................................pp.64“Spirit exploits the new low-fare market niche in the US to achieve consistent profitability”First published on www.centreforaviation on 15th march, 2013

aLaSka air groUP .......................................................pp.72“alaska continues to face challenges getting investors to acknowledge its solid financial performance”First published on www.centreforaviation on 5th march, 2013

Frontier airLineS .......................................................pp.80“Frontier airlines straddles ultra low-cost and hybrid profiles (or falls between them)”First published on www.centreforaviation on 29th march, 2013

air canaDa ...................................................................pp.87“air transat and westJet face heightened pressure as air canada applies rouge”First published on www.centreforaviation on 15th February, 2013

Porter airLineS ..........................................................pp.95“Porter attempts to determine its place in canadian aviation as rivals move into new endeavours”First published on www.centreforaviation on 4th april, 2013

11

United Airlines Key Data Fleet and Orders United Airlines Fleet Summary: as at 10-Apr-2013

Source: CAPA Fleet Database

12

United Airlines projected delivery dates for aircraft on order: as at 8-Apr-2013 Source: CAPA Fleet Database

Route area pie chart United Airlines international capacity seats by region: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

Top routes table United Airlines top ten international routes by seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

13

Premium/Economy profile United Airlines schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Share price 2012/2013

Source: CAPA - Centre for Aviation and Yahoo! Financial

14

United Airlines pledges it is on the road to revenue recovery as yields improve United Airlines is recording positive unit revenue trends at the start of 2013 after merger integration headaches resulted in significant revenue degradation for the carrier in 2012. With the airline's management assuring that the bulk of the integration challenges have been overcome, and the work to bring legacy United up to par with Continental’s service standards is well underway, expectations are high for United to begin to deliver on the promised benefits from the merger with Continental. Signs of a turnaround for United do appear to be emerging as its passenger unit revenue increase of 6.5% to 7.5% for Feb-2013 was the highest among the traditional US network carriers. It is a significant improvement from the unit revenue weakness United suffered throughout much of 2012 relative to the US industry at large. For the full year 2012 United’s passenger unit revenue growth was flat compared with 7% growth at Delta, a 5.6% rise at America and a year-over-year increase of 4.3% at US Airways. The airline’s on-time performance (OTP) is also on a marked upswing after United suffered a partial operational meltdown during the 2012 summer season when its OTP in Jul-2012 sank to 64%, a 10.2ppt drop year-over-year. US major carrier passenger unit revenue growth: Jan-2012 vs Jan-2013 and Feb-2012 vs Feb-2013 Carrier Jan-2013 PRASM change yr/yr Feb-2013 PRASM change yr/yr American 3.1% 4.7% Delta 5.5% 5% United 3%-4% 6.5%-7.5% US Airways 3% 1% Source: company reports US major carrier passenger unit revenue growth, 2013 vs 2012: Carrier PRASM change yr/yr 2012 American 5.6% Delta 7.1% United 0.8% US Airways 4.3% Source: company reports United's PRASM increase of 6.5% to 7.5% for Feb-2013 was the highest among the traditional US network carriers – but it still leaves a negative gap.

15

United PRASM improvement: 1Q2012 to Jan-2013 Source: United Airlines

The upswing in both revenue and on-time performance is encouraging as United works to regain corporate share it admittedly lost in 2012 as cross-fleeting between the legacy United and Continental fleets created spares shortages, which contributed to its operational weakness. A massive IT cutover also hurt the carrier’s performance in the corporate space, which coupled with the operational snafus sent high-yielding business travellers elsewhere.

United now stands ready to reap the rewards of a combined network Recently outlining United’s rebound to investors, company CEO Jeff Smisek stressed that the carrier beat its operational goals in Jan-2013 and Feb-2013 in both its international and domestic networks – the first time United had achieved those types of results in a decade. With the bulk of the integration challenges seemingly overcome, Mr Smisek noted that United is now equipped to make more favourable revenue management decisions now that the carrier can study the demand patterns of the combined networks. Not surprisingly, United management has repeatedly emphasised that once the teething pains of integration have subsided the combined carrier's network would be its biggest selling point. Based on current schedules in Innovata (17-Mar-2013 to 23-Mar-2013), United has commanding seat share between the US and Western Europe among the US legacy carriers at 16%, followed by Delta at 14%, American with a 9% share and US Airways accounting for 4% of the seat share.

16

United States to Europe: Western Europe (seats per week, one way): 19-Sep-2011 to 08-Sep-2013

Source: CAPA – Centre for Aviation & Innovata United also holds a 17% share from the US to Northeast Asia, compared with 16% at Delta and 5% at American.

17

United States to Asia: Northeast Asia (seats per week, one way): 19-Sep-2011 to 08-Sep-2013

Source: CAPA – Centre for Aviation & Innovata United’s position in Latin America is somewhat weaker as it holds a 12% seat share among US legacy carriers operating to upper South America. American commands a powerful 33% share in the region and Delta has a 10% share. American is also the leading US carrier to lower South America, accounting for a 48% share compared with 18% for Delta and 9% for United.

18

United States to Latin America: Upper South America (seats per week, one way): 19-Sep-2011 to 08-Sep-2013

Source: CAPA – Centre for Aviation & Innovata United States to Latin America: Lower South America (seats per week, one way): 19-Sep-2011 to 08-Sep-2013

Source: CAPA – Centre for Aviation & Innovata

19

Much of the market share in those regions among the US majors will remain unchanged once American and US Airways merge, given US Airways’ smaller international footprint. The carrier has no service to Asia and by the time the merger is complete will only serve Rio de Janeiro and Sao Paulo in Brazil. So United should be able maintain its strong international position from the US to Europe and Asia. Alliance changes will create challenges for United and Star Alliance United and its fellow Star partners face a major challenge in Latin America, where the major alliance shift that will occur once LATAM Airlines Group joins oneworld is set to create a major gap in the region for Star, which currently accounts for roughly 28% of the seating capacity in the region. Once TAM, which is now part of the mammoth carrier created by its merger with LAN, migrates to oneworld, Star’s share will fall to 17%. Star has a major hole to fill in Latin America’s largest market, Brazil, given TAM is the country’s largest carrier. The alliance can recoup some of the loss with the expected entry of Avianca-TACA affiliate Avianca Brazil, which was prohibited from joining Star when Avianca-TACA joined in 2012 by TAM. But now the carrier’s ascension into Star is likely, giving the alliance some traction in Brazil’s domestic market. The addition of Copa and Avianca-TACA to Star results in the alliance maintaining a significant presence in Latin America, and more importantly, continuing to have a share lead over SkyTeam whose seat share in the region will essentially remain unchanged at 12%. Getting the legacy United product on par with Continental’s standards A topic much less discussed by United is the outlay that has been necessary to bring the legacy United up to Continental’s standards. Prior to the merger, Continental’s inflight product was measurably better than United’s as a result of United spending nearly half of the last decade in Chapter 11 bankruptcy protection. Mr Smisek noted that since the merger United has had “some unusual levels of expenditures” that spanned not only merger integration but some front-end loaded capex costs to ensure product parity between the two carriers. “We’ve had to play a lot of catch-up,” said Mr Smisek. “Particularly...on the old United side of the house.” United is in the midst of equipping its international fleet with lie-flat business class seats and is introducing the lie-flat product on its premium service from New York to Los Angeles and San Francisco, joining its rivals American and Delta in offering similar products on those high-yield domestic routes. In addition to operating lie-flat seats from New York to Los Angeles and San Francisco, Delta is introducing the upgraded business class offering on service from New York to Seattle. American will be offering a similar product on its new Airbus A321 narrowbodies scheduled for delivery beginning in Nov-2013. United is also in the midst of equipping its fleet with satellite Wi-Fi connectivity, and has installed larger bins on some of United’s older narrowbody aircraft.

20

Offering a long-term view of United capital expenditure philosophy, United CFO John Rainey explained the carrier expects depreciation and amortisation expense of about USD1.6 billion to USD1.7 billion during 2013, and from a gross capital expenditure perspective the ideal target would be to match depreciation and amortisation. Mr Rainey also made another important point, noting that if United hits return targets (the carrier has a stated goal of return on capital investment of 10%), “then you have a scenario where you’re spending off pretty good cash flow and you can have a very good discussion about the right cash flow allocation and including what goes to shareholders”. His remarks about shareholder returns are becoming prevalent in the airline financial discourse as the US industry is reaching a level of fiscal and supply discipline that is driving the need for discussions about use of cash allocation and how to reward the patient shareholders that have endured the historical boom and bust cycle that has produced zero returns in the airline business. Delta recently stated it has reached a point where it can reasonably look at some sort of return to shareholders. It is time for United to start delivering on promises United intends to keep its capacity discipline in place, and has not deviated from its plans to decrease capacity by 1% during 2013 and keep its fleet count flat during the next few years. With a fleet count of roughly 700, United management estimates that roughly 30 replacement aircraft for less fuel-efficient jets will be required annually. Confidence by United’s management that the most painful aspects of the merger integration are now settled will need to be converted to reality for investors awaiting the promised USD1.2 billion in merger synergies. The carrier has not committed to reaching that target in 2013, warning that the full realisation of those benefits could spill over into 2014. With the immediate pressure of merger-related integration headaches waning, United now needs to sustain its revenue momentum and give shareholders assurance that their patience in waiting for some return on their investment will pay off. The carrier’s improved grasp on its operations should allow United to deliver on its promises, but the competition will not be standing still either. United's mainline and regional fleet as of Jan-2013

Source: United Airlines

21

Delta Air Lines Key Data Fleet and Orders Delta Air Lines Fleet Summary: as at 10-Apr-2013


22

Delta Air Lines projected delivery dates for aircraft on order: as at 8-Apr-2013 Source: CAPA Fleet Database

Route area pie chart Delta Air Lines international capacity seats by region: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

Top routes table Delta Air Lines top ten international routes by seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

23

Premium/Economy profile Delta Air Lines schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013




24

Delta presses forward to build a competitive network in a consolidated and mature US market Delta Air Lines continues to leverage the competitive strength it holds over its US legacy peers to flesh out its network and build pockets of strength as United and Continental remain in the throes of their merger integration and American and US Airways lay the groundwork to begin the complex process of combining their respective organisations. During the last couple of years Delta has used the nimbleness it enjoys versus its legacy domestic competitors to broker equity investments in foreign carriers to build a robust network ahead of the completion of US consolidation. Those investments have moved in tandem with Delta’s bolstering its presence in New York through its slot swap deal with US Airways and its investment in facilities at JFK and LaGuardia airports. During 2013 Delta is attempting to strengthen its position in the fragmented but strategic Los Angeles market through a 12% boost in daily seats year-over-year from Jul-2012 to Jul-2013. But, despite a solid strategy to fortify its network and out perform its peers in many financial metrics, Delta’s stock price continues to trade weaker than its competitors, despite recent declarations by management that the carrier would record its best first quarter performance during 1Q2013 in a decade. It may be that Delta's increasing costs are cause for discomfort. Recording a profit during 1Q2013 after 13 years of 1Q losses Delta estimates it will turn a profit during 1Q2013, its first profitable first quarter in 13 years. Recently company President Ed Bastian remarked that when Delta recorded its last profitable first quarter in 2000, fuel prices per gallon were USD0.62 cents compared with current prices of roughly USD3.25 per gallon. He estimated that represents a USD2 billion increase in costs. Fuel costs during the last five years have consistently remained at levels of USD100 per barrel or higher, but Delta has recorded annual profits since 2010, and expects to remain profitable during 2013. By its own estimates, Delta’s 2012 pre-tax income of nearly USD1.6 billion was more than double the USD679 million recorded by Southwest. Estimates from Morningstar show that Delta also in 2012 recorded the highest operating cash flow among its peers.

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Delta pre-tax income versus its US airline peers: 2012

Source: Delta Air Lines US legacy carrier (and Southwest) operating cash flow: 2012 Carrier Operating cash flow Delta USD2.5 billion Southwest USD2.1 billion United USD935 million US Airways USD1 billion Source: Morningstar Yet Delta’s closing share price on 20-Mar-2013 of USD17.07 was trading USD15.43 below United’s USD32.50 share price, and below US Airways’ shares priced at USD17.23. Southwest has a closing share price of USD12.79. Mr Bastian says patience has been required of Delta’s shareholders as the carrier during the last few years has used its free cash flow to pay down more than USD5 billion in net debt, which will help the carrier reach its goal of USD10 billion in net debt during 2013. While the carrier plans to continue to pay down debt, Mr Bastian noted that Delta will now look at evaluating optimal uses of its free cash flow during the next three years. He did not get into specifics, but indicated that Delta is considering “some element of return to our shareholders”, and would reveal its plans ahead of its annual shareholder meeting in Jun-2013. Using the cash flow to pay out dividends or a stock repurchase should help lift Delta’s stock price as it turns its focus to some return to investors after working to get its balance sheet in order. Plans to use Virgin Atlantic to turn a corner in New York Delta during the last few years has been working to improve its position in the large New York market, gaining 132 slot pairs at New York LaGuardia from US Airways and strengthening flights from JFK. Mr Bastian estimated Delta has gained seven points of corporate market share

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in New York during the last three years and believes that will continue to grow during 2013. Driving Delta’s efforts to capture market share in New York going forward is the carrier’s equity stake in Virgin Atlantic. The two airlines are also forging a trans-Atlantic joint venture to leverage Virgin Atlantic’s position in the critical New York-London market, where Delta had admittedly had a weaker position against oneworld joint venture partners American and British Airways. Delta's increase in New York corporate share: 2009 to 2012 Source: Delta Air Lines

Based on Delta’s estimates of seat share during 1Q2013 from JFK to London Heathrow, combined Virgin Atlantic and Delta would comprise a 36% share compared with AA-BA’s 62% share. While the oneworld partners still hold an advantage, the combined share of Delta and Virgin Atlantic does help each carrier gain some leverage in the competition for corporate share in the largest trans-Atlantic market. But Delta through its 49% stake in Virgin Atlantic is investing in the carrier during a time of transition as new CEO Craig Keeger takes the helm, and new domestic flights within the UK are debuting from

London Heathrow. All of the change is underpinned by Virgin Atlantic’s weak financial performance. The carrier during FY2011-12 recorded a loss of GBP92 million, and it has been reported its losses for FY2012-13 will grow to GBP135 million. With positions on Virgin Atlantic’s board, Delta will exert some influence over Virgin Atlantic’s future, but given the mounting losses and overall uncertain economic state in Europe, it could take a fair amount of time for Delta to recoup its USD360 million investment in Virgin Atlantic. Obviously Delta believes that is a small price to pay to secure an improved position between London and New York, which is “a must-have market”, said Mr Bastian. But Delta CEO Richard Anderson has previously laid out a time frame for Virgin Atlantic to improve its fortunes, noting that Delta expects its new partner to be profitable within the next three years. Delta’s moves during the last few years to strengthen its position in New York have resulted in the carrier capturing 33% of the one-way seats on offer (18-Mar-2013 to 24-Mar-2013) from LaGuardia and a 22% share at JFK. The new partnership with Virgin Atlantic provides the missing piece Delta needs to have an effectively stocked war chest in the New York market.

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New York LaGuardia Airport capacity by carrier (% of seats): 18-Mar-2013 to 24-Mar-2013

Source: CAPA – Centre for Aviation & Innovata New York John F Kennedy International Airport capacity by carrier (% of seats): 18-Mar-2013 to 24-Mar-2013

Source: CAPA – Centre for Aviation & Innovata Working to even the playing field in Los Angeles During 2013 Delta is moving to fortify another large corporate market as it adds new service from Los Angeles and expands frequencies in other markets. The expansion should help lift Delta’s seat share in Los Angeles, which presently stands at 13%. Los Angeles is highly fragmented, with no one carrier claiming a significant share of the seats on offer.

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But it remains a strategic US west coast gateway, and all the major network airlines need to ensure they maintain equal footing with one another in the market. Los Angeles International Airport capacity by carrier (% of seats): 18-Mar-2013 to 24-Mar-2013

Source: CAPA – Centre for Aviation & Innovata Between Apr-2013 and Jul-2013 Delta is introducing new year-round flights to Seattle and Spokane, Washington; Nashville, Tennessee; and San Jose, Costa Rica. The carrier’s flights to Costa Rica mark the first from the US west coast to the country’s capital city by a US carrier. Schedules in Innovata show that Avianca-TACA subsidiary LACSA operates service from Los Angeles to San Jose. Delta joins Southwest and American in operating service from Los Angeles to Nashville, and enters the crowded Los Angeles-Seattle market presently served by its partner Alaska Airlines, Virgin America and United. Schedules in Innovata show that when Delta launches flights between Seattle and Los Angeles it will account for roughly 8% of the seats on offer. Alaska will hold a commanding 68% share followed by Virgin America’s 19% share and nearly 5% held by United.

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Los Angeles International to Seattle/Tacoma International (seats per week, one-way): 19-Sep-2011 to 08-Sep-2013

Source: CAPA – Centre for Aviation & Innovata The reasons behind Delta’s decision to enter the amply served Los Angeles-Seattle market are not clear, given its partner Alaska is the largest carrier on the pairing. Asked about Delta’s launch of service Alaska CEO Brad Tilden recently stressed the strong relationship Alaska has with Delta, noting Alaska provides significant feed to Delta’s widebody operation from Seattle. Delta has been expanding long-haul flights from Seattle to Asia, reflected in its planned service to Shanghai and Tokyo Haneda in Jun-2013 joining existing service to Tokyo Narita, Beijing, Osaka, Amsterdam and Paris. Mr Tilden did not address Delta’s flights from Los Angeles and Seattle specifically, but it is obviously not part of a joint strategy. He observed only that there are “little things that happen along the edges”.... “I don’t think we should let them [those little things] distract us from what is overall an exceptionally good relationship.” Delta faces no competition on its service from Los Angeles to Spokane. Alaska is the largest carrier operating from Spokane, holding a nearly 41% seat share. The carrier operates numerous flights from Spokane to its Portland and Seattle hubs. Delta also serves Spokane from its Minneapolis and Salt Lake City hubs, but also flies direct from those markets to Los Angeles. Spokane might be a test case for some uncompetitive point-to-point flying from Los Angeles.

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The passengers on the pairing could drive some very slight incremental traffic on long-haul service operated by Delta partners in Los Angeles – SkyTeam members Aeromexico, Air France-KLM, China Airlines, China Eastern, China Southern and Korean and non-alliance carrier Virgin Australia and WestJet. Presumably all of the capacity Delta is adding in Los Angeles will benefit its partnerships by driving more passengers onto long-haul flights from the airport, which serves a US gateway to Asia. Delta and Virgin Atlantic also plan to begin codesharing during 2013 on Virgin’s flights from Los Angeles to Heathrow. Rounding out new year-round service is Delta’s planned operation from Los Angeles to San Jose, California, another crowded market served by American, Alaska, Southwest, Virgin America and United. Delta is also competing with Alaska on its seasonal flights to Anchorage from Los Angeles. Anchorage during the last few years has gained some increases in seasonal traffic from US carriers. JetBlue during May-2013 is introducing seasonal service from Seattle to Anchorage, joining seasonal Long Beach-Anchorage service the carrier has been operating since 2011. United plans to begin seasonal service from its Newark hub to Anchorage in Jul-2013, offering one weekly flight on Saturdays. On its planned seasonal service to Bozeman Delta is competing with United. Delta already serves Bozeman primarily from its Salt Lake City and Minneapolis hubs, but also offers less frequent service from its Atlanta hub. Boston is another crowded market Delta is entering from Los Angeles. Once the carrier begins seasonal service in Jul-2013 it will become the fifth carrier serving the market. Aside from stamp-collector syndrome as Delta flexes its muscles, it is hard to find the logic in the decision to operate service to Boston since it does not hold a leading position in either market. In Boston, Delta has a 12% seat share, compared with 15% for US Airways and about 30% for market leader JetBlue. Boston Logan International Airport capacity by carrier (% of seats): 18-Mar-2013 to 24-Mar-2013


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Using foreign equity investments to fill international network gaps Delta is also building out its network in other strategic geographical regions through equity stakes in its SkyTeam partner Aeromexico and Brazil’s second largest carrier Gol, which has been struggling financially during the last year as demand in the Brazilian domestic market place cooled. Since Delta and Gol announced Delta’s USD100 million investment in the Brazilian carrier in late 2011 along with the US carrier assuming a seat on Gol’s board, speculation has been growing that Gol would eventually join the Delta-anchored SkyTeam alliance. But since that time Gol has repeatedly stated its intent to remain independent even as the alliance winds shift in Latin America with LATAM’s joining of oneworld, leaving Star without a strong partner in Brazil. After LATAM announced its alliance decision, Gol CEO Paulo Kakinoff remarked in local press reports the carrier’s intent to remain independent, which would leave it able to service both Star and SkyTeam connections. Even if Gol does remain on its own, Delta’s partnership with the carrier gives it some traction in Latin America’s largest market. Delta’s position in Latin America is weak compared to its legacy counterparts United and American and during the last year American in particular has been building up service in Brazil, leveraging its stature as the largest airline between the US and Latin America. Easing concerns about costs and its performance of its new oil refinery, hit by Sandy Delta during the last year has been recording unit cost creep as it invested in certain product improvements including fleet-wide Wi-Fi, lie-flat business class seats and a significant terminal upgrade at JFK set for debut in May-2013. Those projects and wage increases from a pilot contract negotiated during 2012 have pressured the carrier’s unit costs, but Mr Bastian assured that the bulk of the 3% to 5% rise in unit costs during 2013 would occur during the first half of the year. The carrier has undertaken a USD1 billion cost improvement programme that entails a fleet restructuring, maintenance costs improvements, lowering distribution expense and increasing staffing efficiency. After the scheme is completed, Delta believes that it can drive unit costs expansion of flat to 2% growth in the long term. Delta’s highly watched execution of the resumption of production at an oil refinery it purchased during 2012 outside of Philadelphia, Pennsylvania hit a snag when superstorm Sandy struck the US west coast in Oct-2012. The storm disrupted production at the refinery and resulted in Delta recording a USD63 million loss from Trainer’s operations during 4Q2012. Mr Bastian admitted Delta has experienced some teething pains with the restart of operations at the refinery. He stated that operational delays resulted in the refinery operating at about 75% capacity in Jan-2013 and Feb-2013, but assured the facility would breakeven for 1Q2013. As production reaches

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full scale, Delta expects the refinery to produce a USD75 million to USD100 million profit in 2Q2013. Delta continues its attempts to widen competitive advantages it holds over network peers Delta handily recognises the advantage it holds over its large US network legacy peers in completing its merger with Northwest roughly two years ago. With the integration complete it can quickly make the necessary moves to strengthen its network and drive down its most volatile expense – fuel. Only time will tell if its foreign investments and the acquisition of an oil refinery will preserve the carrier’s edge, but Delta seems ready and willing to adapt to both competitive pressure and cost constraints by taking its future into its own hands. Meanwhile, the market appears to be cautious about the carrier's ability to keep a lid on costs as it moves along.

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American Airlines / US Airways Key Data Fleet and Orders American Airlines Fleet Summary: as at 10-Apr-2013

Source: CAPA Fleet Database US Airways Fleet Summary: as at 10-Apr-2013


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American Airlines projected delivery dates for aircraft on order: as at 8-Apr-2013 Source: CAPA Fleet Database

US Airways projected delivery dates for aircraft on order: as at 8-Apr-2013 Source: CAPA Fleet Database

Route area pie chart American Airlines international capacity seats by region: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

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US Airways international capacity seats by region: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

Top routes table American Airlines top ten international routes by seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

US Airways top ten international routes by seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile American Airlines schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

US Airways schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

American and US Airways likely to see little competitive change in their overlap markets American and US Airways are pressing full steam ahead to close their merger by 3Q2012, including stressing to US legislators that the combination will improve the overall health of the country’s airline industry and make the merged airline a more viable competitor with legacy and low-cost carriers alike. With just a dozen routes that overlap, the carriers should not encounter any resistance from anti-trust authorities, and given that most the markets are hub to hub pairings, few changes are likely to be made to service patterns once the 18 month integration process is complete. Some of the arguments made by American and US Airways over increasing competition from low-cost carriers and their potential service expansion into overlap markets might be overblown as those airlines in previous mergers have been selective in grabbing the low hanging fruit created by the tie-ups between Delta-Northwest, United-Continental and Southwest-AirTran. Overlap on a dozen routes Executives at American and US Airways have declared that presently the two carriers compete on 12 non-stop airport-to-airport routes compared with 11 at Delta and Northwest at the time of their merger in 2008, 13 between United and Continental when those carriers unveiled their tie-up in 2010 and 23 at Southwest and AirTran at the close of their merger in 2011. Those 12

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routes are largely services operated between US Airways’ hubs in Charlotte, Phoenix and Philadelphia and American’s hubs in Dallas/Fort Worth, Miami, Chicago and Los Angeles. Number of overlapping markets by US carriers merging within the last five years

Source: US Airways The largest route among the 12 is Phoenix to Los Angeles, where current schedules in Innovata (24-Feb-2013 to 02-Mar-2013) show roughly 20,603 one-way seats in the market operated by American, Delta, Southwest, United and US Airways. Seat share on American and US Airways overlapping markets: 24-Feb-2013 to 02-Mar-2013

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Source: CAPA – Centre for Aviation & Innovata Of the 12 non-stop airport-to-airport routes, US Airways and American hold a duopoly on six – Charlotte to Dallas and Miami, Philadelphia to Miami and Dallas and Washington National to Nashville and Raleigh-Durham. It is possible the US Department of Justice, after its review of the proposed merger, could require the carriers to divest some slots at Washington National since the carriers presently have a combined seat share of 62% at the airport. US Airways during 2011 gained 42 slots pairs at Washington National in a swap with Delta, which gained 132 pairs from US Airways at New York LaGuardia. Washington Ronald Reagan National Airport capacity by carrier (% of seats): 25-Feb-2013 to 03-Mar-2013

Source: CAPA – Centre for Aviation & Innovata Spirit Airlines is scheduled to launch new service from Philadelphia to Dallas in Apr-2013, but with just a single daily flight the carrier’s entry will not dramatically alter the competitive landscape as its approximately 1,015 seats will only account for a roughly 9% share for the week of 14-Apr-2013 to 20-Apr-2013.

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Wright Amendment expiration could drive new airlines to overlapping markets US Airways in testimony during a hearing in the US Congress on 26-Feb-2013 stated that the 2014 expiration of the Wright Amendment, (which limits flights with more than 56 seats from Dallas Love Field to within Texas and the four adjoining states of Arkansas, Louisiana, New Mexico and Oklahoma), will mean non-stop competition from other airlines “is already present or will soon be added on all airport pair overlaps”. Love Field is Southwest’s headquarters and the carrier holds a roughly 98% seat share at the airport. While Southwest would likely consider launching service to some of the overlap cities from Dallas, it is not likely to make a large push into those markets. Phoenix is a likely possibility as is Chicago since those two markets are in the carrier’s top 10 airports based on daily departures. Service to Philadelphia might be plausible since Southwest serves the city from its top destinations of Midway, Denver, St Louis, Las Vegas, Houston and Phoenix. Southwest also operates flights from Philadelphia to Fort Lauderdale, Tampa, Orlando and Fort Myers and West Palm Beach, Florida, and Nashville, Tennessee. But once the Wright restrictions are lifted, Southwest’s top priority will likely be linking Dallas with its top cities of Chicago, Denver, Baltimore and Los Angeles. Southwest Airlines top airports by departures: Jan-2013

Source: Southwest Airlines Charlotte could also be a candidate for service from Dallas once the Wright Amendment is lifted. Southwest during Apr-2013 is transitioning AirTran’s flights from Charlotte to its own branded service. AirTran’s service from Charlotte to its Atlanta hub is being eliminated while Southwest is assuming AirTran’s Baltimore flights and introducing service to Chicago Midway, Houston Hobby and Orlando. Southwest’s intentions in Charlotte are somewhat of an unknown, given the airport is 394km from AirTran’s Atlanta hub, which Southwest has stated it would de-hub as the integration moves forward. Service from Dallas to both Atlanta and Charlotte could be a distinct possibility once the restrictions from Love Field are lifted. But the notion that Southwest will come into a market with much lower fares is outdated as the carrier is suffering from cost creep woes that are also a challenge for its legacy competitor Delta. The new reality is Southwest must set price points that cover its increasing costs of operations, which is reflected in data from the US Department of Transportation that show fares at

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Houston Hobby – where Southwest has long been the dominant carrier and currently accounts for 74% of the seats on offer – increased nearly 48% from 3Q2000 to 3Q2012. Hobby is just 38km from Houston Intercontinental, which is a large hub for United Airlines. The rise in fares at Hobby shows that low-cost carriers cannot always be relied upon to ensure that a low fare option will always be available as the US market moves forward to complete its final phase of major airline consolidation. Competitive threat from LCCs remains slim US Airways and American in Congressional testimony also stated that in addition to the “new” American competing against Delta and United, it would also face competition from a host of smaller low-cost carriers including JetBlue, Spirit, Alaska, Frontier, Allegiant and Virgin America. While the larger carriers in that grouping, JetBlue and Alaska, along with Southwest, do exert some competitive pressure in the US marketplace, the likelihood those airlines will make a push into the overlap markets of American and US Airways is small. The greater likelihood is that some of the smaller low-cost carriers will fill in the gaps that will inevitably be created when American and US Airways rationalise their combined network and cut unviable smaller routes. Both Allegiant and Frontier have done that in Orlando by opting to enter markets that AirTran was exiting. Aside from Spirit Airlines, which has unleashed competition with American during the last couple of years from Dallas/Fort Worth, it is unlikely the larger low fare carriers will enter the overlapping markets of American and US Airways. The smaller carriers – Frontier, Virgin America and Allegiant have their own strategies in the US marketplace going forward. Frontier is dodging direct competition with Southwest out of its Denver hub while trialling secondary airports such as Trenton, New Jersey. Virgin America is continuing its quest to achieve profitability while Allegiant in the continental US has no plans to deviate from its strategy of serving large leisure markets including Las Vegas and Orlando from smaller cities. While US Airways and American argue that the continued growth of LCCs will ensure that air travel in the US will remain competitive, the reality is there will be little change in the overlapping markets of American and US Airways. United will likely keep its seat share stable in the three of 12 overlapping markets featured in the combined American-US Airways network, and low-cost carriers will find little compelling reason to challenge the combined carrier on its hub-to-hub pairings as the combined carrier will have the scale to lower fares temporarily to drive competition from its fortresses. Spirit may see some opportunity as it chases low-yielding travellers that the legacy carriers are opting to ignore, but essentially the 12 overlapping markets should remain status quo, with the possibility of increased fares once the combined American and US Airways leverage their new pricing strength on hub-to-hub routes.

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Southwest Airlines Key Data Fleet and Orders Southwest Airlines Fleet Summary: as at 10-Apr-2013 Source: CAPA Fleet Database

Southwest Airlines projected delivery dates for aircraft on order: as at 8-Apr-2013 Source: CAPA Fleet Database

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Route area pie chart Southwest Airlines international capacity seats by region: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

Top routes table Southwest Airlines top ten international routes by seats: as at 8-Apr-2013


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Premium/Economy profile Southwest Airlines schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013




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Southwest Airlines, the US' fourth force, does not neatly fit the emerging US business models Southwest Airlines sits at an interesting crossroads as the US market reaches a high level of maturity ushered in by legacy carrier consolidation and its own merger with AirTran Airways that is targeted for completion in 2014. With the changes, three distinct business models are emerging in the US – full service, hybrid and ultra low-cost. But Southwest does not fit neatly into any of those categories, which the carrier might view as a positive attribute as it examines how to evolve its business model. Southwest's history of a skittish approach to change leaves many questions unanswered as to how the airline can retain the attributes that make it a recognisable brand while making key decisions to ensure a large pipe of steady revenue generation. The low-cost pioneer during the last couple of years has seen its edge in that regard soften as Chapter 11 reorganisations and consolidation among the US majors has resulted in those airlines lowering their unit costs. During 2012 Southwest’s unit costs increased 4.2% year-over-year, and on a stage length adjusted basis there was roughly a 30% difference in its nearly USD7 cent unit costs compared with Allegiant Air, who along with Spirit is considered the new breed of ultra low-cost carrier. At the same time, Southwest’s 2012 passenger unit revenue growth was just 2.6% compared to 3.6% at JetBlue. Southwest operates a fleet of nearly 700 aircraft, making it more than three times the size of JetBlue, yet JetBlue (which is notably a much younger carrier and has the accompanying younger workforce) managed to attain a unit revenue premium to Southwest, with just a 4% difference in unit costs. JetBlue has explained that its strategy is not to have the lowest costs or the larger costs associated with legacy business models. It believes it has just the right cost levels to execute its business model that is medium-frills including product bundling that includes product upsells such as expedited security and seats onboard with more room. US Airline unit costs excluding fuel on a stage-length adjusted basis: 2012

Source: Alaska Air Group

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Southwest’s product model needs to evolve to protect its relevancy in the US market While JetBlue has carved out a definitive business model to attract business and leisure customers to balance out peaks and troughs in leisure travel seasonality, Southwest is typically a slow adapter to shifting its business focus. In some ways the carrier’s cautious approach is understandable given its worldwide acclaim as the airline that ushered in the low-cost carrier era. But with inevitable shrinking of the US domestic market place that will occur once American and US Airways complete their merger, Southwest will need to have a fresh look at holes in its business model to ensure it can compete effectively in the new US domestic reality. Even prior to American and US Airways announcing their intentions to merge, US domestic seats and available seat miles fell sharply from 2Q2007 through 2Q2013, according to statistics from Airlines For America (A4A), even factoring a slight increase from 2Q2012 to 2Q2013. US carrier domestic flight, seat and ASM growth: 2007 to 2Q2013

Source: Airlines For America Based on current schedules in Innovata (10-Mar-2013 to 17-Mar-2013), American and US Airways combined hold nearly a 25% seat share of the US domestic market. Using those statistics as a baseline Southwest slips into fourth place in the market place based on seat share; so the carrier needs a clear focus going forward in order to compete effectively. United States capacity by carrier (% of seats): 11-Mar-2013 to 17-Mar-2013


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Working to increase revenue by USD1 billion in 2013 Southwest has put forward a plan to increase its top-line revenue by USD1.1 billion in 2013, USD800 million of which will be driven by its AirTran acquisition, the introduction of higher-density 175-seat Boeing 737-800s, adding six seats to its 737-700s and a reservations system replacement. The remaining USD300 million will be driven by gains from a new network management system, network optimisation to maximise turn times and new ancillary revenue streams from selling select boarding positions at the gate and tightening flexibility around restricted fares. Additionally, Southwest is in the midst of implementing a codeshare with AirTran, and as of 23-Feb-2013 the carriers were selling codeshare itineraries from 39 airports, and carrier CFO Tammy Romo told investors that the codeshare will be fully implemented for the combined 97 destinations in Apr-2013. Southwest is also replacing its reservations system, and expects to complete the first phase, which will support international itineraries, in 2014. The carrier will engage the first Southwest-branded international flight in Sep-2013 when it assumes AirTran’s service between Orlando, Florida and San Juan, Puerto Rico. Southwest will compete with JetBlue, which has a focus city in San Juan, and Spirit Airlines on the pairing. The route offers an interesting set of competitive dynamics reflected in JetBlue’s medium frills that include free satellite television and gourmet snacks and Spirit’s bare bones low-fare service that entails added charges for essentially any item beyond the ticket price. Southwest’s cost structure does not support offering the same prices as Spirit, yet it cannot charge more than JetBlue given Southwest does not offer assigned seating or free inflight entertainment. The competitive set illustrates Southwest’s challenge as it works to create a product that remains relative in the US market place. Southwest’s pledges of no bag and change fees close off potential revenue sources As Southwest works to deliver its promised USD1.1 billion rise in revenues during 2013, the carrier faces questions over other potential revenue streams as all US carriers capitalise on ancillary revenues from baggage fees, priority boarding, seat selection and extra legroom and expedited security screening. Southwest is experimenting somewhat with priority boarding by selling early boarding slots at the gate, but seating remains unassigned. Its broad marketing campaign from a few years ago dubbed “Bags Fly Free” has a deep resonance among customers, so it would be nearly impossible for the airline to consider baggage fees. However, it will continue collecting luggage fees on AirTran branded flights until the integration is complete. Ms Romo assured Southwest was looking at other avenues to grow ancillary revenues, and indicates more charges could be harvested from tightening restrictions around some of its lower fares, but stressed those options were not necessarily a change fee, which is something the carrier has touted as part of its customer friendly image. Aside from devising the low-cost, low-fare point-to-point business model, Southwest is typically gun-shy in adopting any new business tactic that would shatter its 40-plus year-old image. That

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is one of the reasons behind the questions arising over how the carrier will expand its revenue in the long term. In some ways the carrier has pigeonholed itself, and could be limited in introducing elements into its business model that could make a significant contribution to revenue. Southwest takes a conservative approach in building out international markets and de-hubbing Atlanta. But that conservative mindset may hold it back A driving force behind Southwest’s pursuit and ultimate acquisition of AirTran was to accelerate Southwest’s foray into near international service. After the 2011 closure of the acquisition Southwest expanded AirTran’s existing service to Mexico through new flights from Orange County, California to Cabo San Lucas and service from San Antonio, Texas to Cancun and Mexico City. The expansion of AirTran’s international service allowed Southwest to understand those markets using AirTran’s existing infrastructure, which in classic Southwest style was a low-risk foray into international markets. But most of the near international markets are well served by both legacy and other US carriers. While Southwest is well known globally as a low-cost pioneer, the carrier could face a tough time in international markets as other airlines have established their brands among the passenger base, especially the reliable visiting, friends and relatives (VFR) customers. Another key impetus for Southwest’s pursuit of AirTran was gaining access to Atlanta, AirTran’s hub. More than a year after the transaction’s close Southwest is de-hubbing Atlanta after eliminating some under-performing smaller markets from the airport and bolstering service to its stronger markets. It is not clear if Atlanta is delivering the benefits originally calculated by Southwest, but it would seem Atlanta is a big driver in the planned USD400 million in merger synergies Southwest estimates achieving this year. Southwest made a strategic move in acquiring AirTran, building up its scale ahead of the last US major tie-up between American and US Airways. But Southwest has opted to abandon AirTran product attributes including a business class, which could have provided a significant amount of incremental revenue and helped the combined carrier retain higher-yielding passengers in Atlanta. Southwest worked quickly to fashion its own response to US major consolidation, but remains stuck in a conservative mindset that will hamper its efforts to meaningfully expand revenue during the next few years. BACKGROUND INFORMATION Southwest Airlines fleet as of 31-Dec-2012

Source: Southwest Airlines

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JetBlue Airways Key Data Fleet and Orders JetBlue Airways Fleet Summary: as at 10-Apr-2013 Source: CAPA Fleet Database

JetBlue Airways projected delivery dates for aircraft on order: as at 8-Apr-2013 Source: CAPA Fleet Database

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Route area pie chart JetBlue Airways international capacity seats by region: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

Top routes table JetBlue Airways top ten international routes by seats: as at 8-Apr-2013


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Premium/Economy profile JetBlue Airways schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013




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JetBlue enjoys a cost "sweet spot" in the consolidating US market JetBlue Airways is building on a unique position it holds between bare-bones discounters and US network carriers to sustain its profitability. Its hybrid product remains attractive to customers with a distaste for the ultra low-cost business model adopted by Spirit Airlines and the higher fares charged by US legacy airlines. The US market is moving into seemingly its final stages of maturity with three network airlines – American (once it merges with US Airways), Delta and United – and one large low-cost carrier – Southwest – dominating the landscape. JetBlue meanwhile believes its growth plan built on expansion from Boston and the build-up of its Caribbean network will allow the carrier to forge an independent and profitable operation somewhat buffered from the waves of consolidation sweeping the country. The airline may still have to convince some sceptics that it can turn a profit on its planned 2013 capacity growth of 5.5% to 7.5%, but JetBlue grew its 2012 net profit nearly 49% year-over-year to USD128 million on a 7.6% rise in available seat miles. Between 2009 and 2012 the carrier’s profits jumped 120%, which is a solid performance from a comparatively young carrier versus its US industry peers. Growth in Boston and the Caribbean is largely shielded from competitive threats JetBlue’s network growth platform is squarely rooted in primarily business market growth from Boston and expansion into leisure and visiting friends and relatives (VFR) markets into upper Latin America and the Caribbean. Those two regions have served as the backbone of JetBlue’s growth during the last few years, at a time when it has been consistently profitable. Boston and the Caribbean join JetBlue’s well-established markets from the US northeast to Florida and its transcontinental flights to the western US (see background information). Those markets are largely shielded from legacy and low-cost competition as legacy carriers have given up attempting to establish hub operations at Boston, and American has drastically reduced its presence at JetBlue’s largest international focus city in San Juan. Presently, JetBlue accounts for roughly 30% of the seats on offer in Boston and 31% in San Juan. The carrier marks a milestone in Nov-2013 when it launches new flights from Chicago O’Hare to San Juan, which is the first destination it will offer from San Juan outside the US northeast. Overall, JetBlue’s capacity during 2013 from Boston is expected to grow 15% and increase 10% into Latin America and the Caribbean.

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Boston Logan International Airport capacity by carrier (% of seats): 04-Mar-2013 to 10-Mar-2013

Source: CAPA – Centre for Aviation & Innovata San Juan Luis Munoz Marin International Airport capacity by carrier (% of seats): 04-Mar-2013 to 10-Mar-2013

Source: CAPA – Centre for Aviation & Innovata JetBlue balances short and long term expansion Airline executives estimate that it takes on average about two years for business markets to mature, while a VFR market in the Caribbean could take as little as six months to reach maturity. JetBlue offers a mix of business and leisure markets from Boston, but recently has been bolstering business markets from its focus city. In addition to numerous leisure markets JetBlue also serves major business destinations including JFK and Newark, Baltimore and Washington National, Chicago O’Hare, Charlotte, Denver, Seattle, Dallas, Richmond and Raleigh-Durham. Its new service from Boston to Philadelphia begins in May-2013.

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JetBlue aims to leverage the differing timespans of market maturity as carrier CEO Dave Barger recently explained the carrier is “using some of the markets down south [in the Caribbean] to help fund some of the new markets that we’re opening up North”. Mr Barger explained JetBlue’s targeted growth in two primary regions results in the majority of its capacity allocation resting in mature markets. The carrier estimates during 1Q2013 that markets three years of age or older will account for 86% of its capacity while new markets will represent just 5% of its available seat miles. Even as Boston and the Caribbean and Latin America will drive JetBlue’s growth during 1Q2013, many of its now mature markets lie within those regions, and the carrier so far seems to have validated its theory that the markets which take less time to mature can support the routes that take longer to ramp up. JetBlue capacity allocation in new and mature markets: 2007 to 1Q2013

Source: JetBlue Airways The hybrid is enjoying a cost structure sweet spot, one third below United's Since its inception JetBlue has stressed its differentiated product that includes complimentary snacks and drinks and free live satellite television (along with some premium content for sale). While those elements remain intact, JetBlue has steadily built itself into a hybrid carrier by offering extended legroom for sale, and later bundling that product with priority boarding and expedited security screening for an upsell as part of its strategy to appeal to higher-yielding corporate travellers while preserving its leisure customer base. “It’s fair to say that we’re not the lowest cost model that’s out in the industry when you think about the super discounters,” Mr Barger says. “And we’re certainly not the network carrier cost model either.” He explained JetBlue has hit somewhat of a “sweet spot” in terms of its cost structure. During 4Q2012 JetBlue calculates that based on stage lengths of roughly 1,000 miles its unit costs were just above Southwest and Spirit Airlines and about USD4.72 cents below United’s stage length-adjusted cost per available seat mile of USD12.30 cents.

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JetBlue's comparative unit costs excluding fuel versus its US peers: 4Q2012

Source: JetBlue Airways *Note - adjusted for 1,000 mile stage length JetBlue’s middle-of-the-road product offering not only appeals to some corporate travellers that may not be able to justify paying full business fares on other carriers, but also to customers that are willing to pay a notch above bare-bones fares offered by Spirit Airlines for a few amenities. JetBlue has made a marked push into markets Spirit serves in upper Latin America from Fort Lauderdale, betting it can net some customers that prefer medium frills for ticket prices that fall in the mid-point of legacy and ultra low-cost carrier fares. JetBlue faces competition from Spirit on nearly all of its international markets from Fort Lauderdale including Bogota, Colombia; Cancun, Mexico; Santo Domingo, Dominican Republic; Bahamas; Kingston, Jamaica; and its focus city of San Juan, Puerto Rico. Spirit opted to recently to discontinue flights from Fort Lauderdale to Nassau, Bahamas, a market still served by JetBlue, Bahamasair and Sky Bahamas. The competition intensifies when JetBlue introduces service in Jun-2013 between Fort Lauderdale and Medellin, Colombia. JetBlue also serves Cartenga from its New York JFK base. It appears JetBlue will continue to put competitive pressure on Spirit from Fort Lauderdale, which still remains Spirit’s headquarters and largest base of operations even though the carrier has focussed on US domestic markets from other bases during the last couple of years. JetBlue chief commercial officer Robin Hayes recently stated that the South Florida-Latin America/Caribbean market offers rich opportunity given the quick ramp of those markets. Improved financial strength enhanced by sound strategic network growth JetBlue’s consistent profitability from 2009 to 2012 coincided with the paring down of its net debt by USD450 million between 2008 and 2012. Mr Barger notes the carrier achieved its debt reduction while growing its fleet by 35%. The carrier recently started embracing the return on invested capital metric (ROIC), and generated a 4.8% return during 2012, which was lower than Spirit’s 26% ROIC, the 13%

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recorded by Alaska Airlines (a leader in the metric) and Delta’s leading 11% return among the legacy carriers. At 13 years of age, JetBlue is the youngest carrier among the US airlines, and still accounts for only roughly 5% of the country’s domestic market. While Alaska and JetBlue are somewhat similar in size with respect to the number of aircraft each carrier operates (Alaska at roughly 172 and JetBlue with approximately 181), Alaska traces its history back to the 1930s and has had time to harvest its leading position in Seattle to forge domestic and international partnerships that allow the carrier to expand its passenger base while keeping its costs in check. Its younger counterpart JetBlue is using the same tactics from its largest headquarters and base JFK, which offers ample partnership opportunities for JetBlue. Between 2007 and the beginning of 2013 the carrier increased its airline partners (one way codeshares and interlines) from one to 23. JetBlue arguably has all the pieces in place to close the ROIC gap with its peers, who are decades ahead in being traded as public companies. It is growing in markets with few competitive threats, realising the importance of keeping a tidy balance sheet and funding new market growth from reliable mature markets. While the strategy is not headline grabbing, it does appear solid as the carrier’s sound, but not stellar, financial results show. As the rest of the US industry attempts to secure its place amidst the final round of consolidation, JetBlue remains on solid footing to forge an independent and profitable existence. BACKGROUND INFO JetBlue route map as of Mar-2013

Source: JetBlue Airways

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Hawaiian Airlines Key Data Fleet and Orders Hawaiian Airlines Fleet Summary: as at 10-Apr-2013 Source: CAPA Fleet Database

Hawaiian Airlines projected delivery dates for aircraft on order: as at 8-Apr-2013 Source: CAPA Fleet Database

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Route area pie chart Hawaiian Airlines international capacity seats by region: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

Top routes table Hawaiian Airlines top ten international routes by seats: as at 8-Apr-2013


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Premium/Economy profile Hawaiian Airlines schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013




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Hawaiian Airlines endures short-term pain to secure, it hopes, successful longevity Hawaiian Airlines faces a challenging time during 1H2013 as its efforts to diversify outside of the Hawaii-US west coast market during the last few years need more time to bear fruit. Its ambitious long-haul expansion is accompanied by the introduction of a new inter-island subsidiary and the reworking of other portions of its inter-island network. All of the changes Hawaiian is undertaking or planning to introduce are intended to bolster efforts to preserve its profitability, which has been fairly consistent during the last few years. But in the near future the carrier is facing pressure as its new long-haul Asian markets spool up and increases in competitive capacity create pressure in its trans-Pacific service to the continental US. While the strategy Hawaiian is adopting to persevere in the long-term is solid, the airline might be attempting to accomplish too much too fast, which in the shorter-term is creating pressure on yields and unit revenues. Asia represents the bulk of Hawaiian’s market diversification During the last five years Hawaiian has either introduced or announced service to 10 new destinations, the bulk of which are long-haul Asian services. Sendai will become Hawaiian’s fifth destination in Japan in Jun-2013 when it introduces new service as part of an add-on to its flights from Honolulu to Sapporo. It also operates service to Sapporo, Tokyo Haneda, Osaka and Fukuoka. Other Asian destinations the carrier has added during that time include Seoul and Manila. During 2012 Hawaiian launched service to Brisbane, joining existing service to Sydney. New flights to Auckland debut in Mar-2013 followed by new flights to Taipei, Taiwan in Jul-2013. The push into Asia with a particular focus on Japan is in line with Hawaiian’s goal of diversifying its network outside of North America. From the 12 months ending in 3Q2009 to the same period in 2012 the percentage of Hawaiian’s revenue stemming from its North American markets fell 15ppt to 47% while the carrier’s international markets recorded a 20ppt rise to 28%. Hawaiian Airlines' % of revenue allocation by geographical region: 12M ending 3Q2009 to 12M ending 3Q2012

Source: Hawaiian Airlines

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Hawaiian’s push into Japan was to capitalise on the strong tourism links between the two island regions. But during 2012 the weakening of the Yen and competitive capacity in some of its markets to Japan pressured the carrier’s results. Hawaiian cited Fukuoka in particular, explaining the market ramped up slower than other routes to Japan. Delta Air Lines during 2012 expanded its service between Honolulu and Fukuoka, which added some competitive pressure in the market. During 4Q2012 the depreciation of the yen helped lower Hawaiian’s unit revenues by nearly 12% year-over-year as over half of the company’s foreign receipts are recorded in Japan’s currency. Hawaiian also faced some competitive retaliation on service from Honolulu to Seoul as Asiana Airlines matched Hawaiian’s daily service in the market. During mid-2012 one-way seat capacity in the market increased by approximately 38%, and Hawaiian management concluded excess supply existed on the pairing. The carrier remains hopeful that the new service to Auckland and Taipei along with increased flights to Sydney will offset some the currency-related pressures in its Japanese markets. It seems that consumer sentiment in Japan is rising, and the yen has gained some value as worry mounts about the euro zone’s bailout of Cyprus, but it is not clear that any of the slight improvement will translate into improved results for US carriers serving Japan. Hawaiian continues to feel competitive heat in its mature US trans-Pacific markets Hawaiian during 2012 also faced competitive capacity in its trans-Pacific markets to the US mainland, as supply expanded 13% year-over-year between Hawaii and the US mainland during 4Q2012 and 12% from the Hawaiian islands to the country’s west coast. Hawaiian accounted for 3ppt and 2ppt increases, respectively, in each of those segments. The capacity increases pressured the carrier’s North American unit revenues during 4Q2012, which fell 10% year-over-year as Hawaiian discounted its fares to sustain passenger volumes. The carrier’s management recently concluded that seat capacity from Hawaii to the US mainland would grow 11% year-over-year during 1Q2013 and 4% during 2Q2013 before falling by roughly 4% during 3Q2013. The lower growth during 1H2013 has created some pricing traction, but Hawaiian warned that as bookings for the first quarter are recorded well in advance, the pricing gains will make few positive contributions to the carrier’s 1Q2013 outlook. Alaska Airlines, which has also ramped up service to Hawaii from the US west coast during the last few years, has also cited pressure in its Hawaiian markets. During 2013 its capacity deployment to Hawaii is expected to remain flat after pronounced growth to the Hawaiian islands since 2008. Miscalculation in its inter-island push Hawaiian also somewhat misfired during 2012 when it established a hub at Maui’s Kahului Airport to leverage more inter-island service. In early 2012 the airline unveiled plans to expand capacity from Maui to the neighbouring islands by 25%, which the carrier later admitted was a bit too ambitious. As Hawaiian worked to rationalise its supply the carrier’s performance in

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inter-island markets improved during 2Q2012, but weakened in the following quarters as the number of passengers feeding into its inter-island services from partner airlines tapered off, and it is not entirely clear when the sagging numbers will recover as oversupply from the mainland results in dilution of connecting passengers to the islands. In addition to the establishment of a hub in Maui, Hawaiian in 2012 also unveiled plans to establish a new inter-island subsidiary to operate turboprops to smaller inter-island markets, and late in the year contracted Empire Airlines to operate two used 48-seat ATR-42 turboprops it acquired from ASL Aviation Group. The new carrier, dubbed Ohana by Hawaiian, is introducing flights in 2H2013 from Honolulu to the smaller islands of Lanai and Molokai. At the time it outlined its intent to launch the new carrier, Hawaiian stated that the new carrier would not tax its resources, noting the operation would be small in scale ranging from three to six aircraft. Small operator Island Air also operates in the Honolulu-Molokai and Lanai markets, and will operate approximately 2,100 one-way seats from Honolulu to Molokai and roughly 1,150 between Honolulu and Lanai when Ohana is scheduled to make its debut, according to schedules from Innovata. Hawaiian plans to operate daily flights in each market, but it is not clear those smaller routes will support additional capacity. Inter-island operator go! also offers flights from Honolulu to Molokai through partner Mokulele that operates Cessna Caravans on the pairing. Additionally, small Cessna operator Pacific Wings also operates service in the market. go! and Island Air also operate flights from Honolulu to Lanai. Given Hawaiian’s slight miscalculations in making a push from its Maui hub, it is not clear if there is enough demand on the routes. A search on the various websites from carriers serving the market shows that presently some flights for travel within a month are sold out, indicating some pent-up demand. Both Mokulele and Pacific Wings operate eight and nine-seat Cessna Caravans while Island Air has introduced a higher-gauge ATR-72 turboprop, joining its fleet of five 37-seat Dash 8 turboprops. Island Air in Feb-2012 also announced the wet lease of a 33-seat Saab 340 turboprop to serve as a bridge aircraft as it planned to introduce three 70-seat ATR-72 aircraft by the end of 2012. Presently, the carrier only operates a single larger turboprop. But Oracle CEO Larry Ellison recently purchased Island Air, which will give the carrier significant financial support and the resources to potentially add the two remaining larger turboprops. It is not clear if Island Air will overhaul its strategy as a result of Mr Ellison’s purchase. He owns a substantial portion of real estate on Lanai, according to the Honolulu Star Advertiser. The purchase of Island Air could be a way to ensure a steady flow of business to his holdings on Lanai. Hawaiian has much to prove after facing near-term headwinds Hawaiian’s whirlwind expansion during the last few years has resulted in its top-line revenues growing from USD1.2 billion in 2008 to nearly USD2 billion in 2012, according to Morningstar research. During that time the carrier’s operating income also grew from USD431 million to USD1.1 billion. But the route expansion coupled with the introduction of nine Airbus A330-200 widebodies during that time has also resulted in its overall expenses jumping from USD431 million to USD1.1 billion.

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The carrier has warned of tough times during 1H2013, especially for 1Q as yields are expected to fall 2% and unit revenues are forecast to decrease 6% to 9%. All the recent moves by Hawaiian to strengthen its long-haul network (which also includes new service from Honolulu to New York that debuted in 2012) and its strategy to build a strong position in larger and short-haul inter-island markets, are seemingly logical moves to ensure it remains on solid footing for the future. But with its fleet of Airbus A330s projected to grow from nine to 22 from year-end 2012 to the same period in 2015, the carrier will face increasing pressure to secure long-term profitable markets for those aircraft. Market potential for Hawaiian remains robust, particularly if the carrier’s flights to New York are successful. That market is likely a test case for potential additional US east coast markets including Miami, Houston and Dallas as well as markets in eastern Canada. Hawaiian Airlines' fleet plan: 2009 to 2015

Source: Hawaiian Airlines

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Hawaiian existing and potential routes: year-end 2012

Source: Hawaiian Airlines While Hawaiian has a broad market wish list, the reality is the carrier needs to withstand the immediate revenue pressure it faces in 1H2013. If it can navigate through that immediate tough period, the airline arguably has a sound enough business plan that entails reasonable revenue diversification. For Hawaiian, the real test of its adaptability seems to be emerging in the short-term.

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Spirit Airlines Key Data Fleet and Orders Spirit Airlines Fleet Summary: as at 10-Apr-2013 Source: CAPA Fleet Database

Spirit Airlines projected delivery dates for aircraft on order: as at 8-Apr-2013 Source: CAPA Fleet Database

Route area pie chart

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Spirit Airlines international capacity seats by region: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

Top routes table Spirit Airlines top ten international routes by seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile Spirit Airlines schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

Share price 2012/2013 Source: CAPA - Centre for Aviation and Yahoo! Financial

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Spirit exploits the new low-fare market niche in the US to achieve consistent profitability Despite some backlash from consumers of its no-frills business model that entails selling all add-on items in the travel experience, Spirit Airlines has recorded a strong financial performance since its transition to an ultra low-cost carrier in 2007. The cost base it maintains by skewing customer behaviour in the purchasing cycle allows it to exploit a passenger base the legacy carriers and Southwest Airlines have abandoned, allowing Spirit to operate under the radar of the larger carriers who are squarely focused on expanding their share of high-yielding corporate customers. The airline concludes that the shifting dynamics of the US market place and its relative low 2% penetration of that space support capacity growth of nearly 22% during 2013. Recently, analysts at Raymond James recorded that US legacy carriers and Southwest Airlines have exhibited capacity constraint for roughly three years, concluding they would not sell seats which did not cover the cost of fuel, the largest expense for any airline. The company estimates that Southwest’s fares have risen approximately 25% during that time. Spirit aims to influence customer behaviour to reduce costs Spirit’s average base fare during 2012 was USD75, a 20% drop from the USD94 recorded in 2008. At the same time its non-ticket revenue has jumped 168% from USD19 to USD51. Spirit makes no apologies for its business model that essentially offers a base price for travelling between two destinations with all other aspects of travel for sale including checked and carry-on luggage, water, food and even printed boarding passes. Spirit Airlines' ticket and non-ticket fares: 2008 to 2012

Source: Spirit Airlines

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Carrier CFO Ted Christie recently outlined the rationale behind Spirit’s business model to investors, noting that the airline prices its products to influence customer behaviour as a means to lower costs. At times the sole purpose for the introduction of an unbundled product is to lower costs, Mr Christie explained. He cited the example of feed for checked and carry on bags that result in passengers checking fewer bags, which pulls weight off the aircraft and lowers fuel burn. By charging for printed boarding passes, Spirit cuts down on the resources needed at the airport to process passengers. Spirit’s strategy is reflected in the carrier’s 2012 unit costs excluding fuel of USD6 cents, which is far below US legacy carriers. Based on Spirit’s calculations, United’s unit costs excluding fuel are nearly double those of Spirit. Spirit Airlines 2012 CASM vs US legacy carriers

Source: Spirit Airlines *Note - stage length adjusted for 909 miles Spirit's business model translates into consistent profitability Even as stories in the consumer press frequently surface about passengers frustrated by what they perceive as nickel and diming by Spirit, the carrier’s traffic has jumped 45% since 2010, and Mr Christie touted the fact that Spirit has been consistently profitable since the ultra low-cost transition in 2007. From 2008 to 2012 Spirit’s net income rose more than 200% to USD108 million. During the last couple of years Spirit shifted its network strategy from serving populated

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markets in the US north east through Florida and into the Caribbean and Latin America to a push into the central and western regions of the US. Mr Christie noted that Spirit believes there are numerous markets in the US that could be exploited at Spirit’s price points. The carrier has entered legacy stronghold markets with the largest push occurring from Dallas/Fort Worth, which is now Spirit’s second largest base in terms of seats on offer. Other legacy fortresses where Spirit has made a push include Denver, Detroit, Houston, Minneapolis and Philadelphia. Spirit Airlines' traffic: 2010 to 2012

Source: CAPA – Centre for Aviation and airline reports Spirit enters those markets with one to two flights per day, which the carrier reasons is just enough to stimulate the low-yielding passengers now abandoned by legacy carriers. Spirit’s ultra low-cost structure gives the carrier an ability to target those passengers through lower fares and still attain profitability. Aside from some pricing action from Delta in targeted markets, the legacy carriers have left Spirit alone as it works to capture more budget conscious travellers in large metropolitan markets. Spirit’s capacity growth in 2013 stems from larger gauge aircraft and fleshing out its network Putting Spirit’s planned 21.5% capacity growth for 2013 into context, Mr Christie stated that overall the carrier only accounts for about 1.5% to 2% of the US domestic market. Moreover, some of the capacity growth is stemming from larger-gauge Airbus A320 narrowbodies, which are configured with 174 seats compared with 145 seats on its Airbus A319s. Of the nine aircraft Spirit is taking delivery of in 2013, seven are the larger-configuration A320s and the remaining two jets are A319s.

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Spirit Airlines' fleet plan as of Feb-2013

Source: Spirit Airlines The network growth driving the capacity increase is from adding new connections from existing markets Spirit has added during the last few years. Mr Christie stated that will allow Spirit to fully utilise its airport assets. Mr Christie also noted that there are more than 400 markets Spirit does not serve today that meet its market criteria – more than 200 passengers per day each way, high average fares and a price level Spirit can achieve that allows it to stimulate enough demand to record a 14% margin or higher. He stated it would take more than 140 aircraft to serve those untapped markets, which is more than Spirit has on order for delivery through the current decade. Spirit believes there are enough markets where it can execute its strategy to support annual capacity growth of 18% to 22% through 2015. Spirit is obviously presenting a positive scenario about its growth prospects to assure investors its business plan is viable for the long term. While its ultra low-cost focus appears to be robust enough to withstand macroeconomic uncertainty, its calculus has not always proven to be accurate. Some new markets that have been cut include Dallas-Fort Worth-Boston, Chicago-Los Angeles and Phoenix-Mesa-Los Angeles. As the performance in some markets fails to meet internal targets, Spirit assures that it has no emotional attachment to markets and attaches no value to attaining a certain level of market share. With one or two flights a day representing a low service footprint in those markets, Spirit reasons its can cut its losses quickly in underperforming markets and easily redeploy assets elsewhere. Using a new revenue management approach for ancillaries Product unbundling is a huge pillar in Spirit’s ability to offer the lowest fares amongst US carriers. But as the ancillary wave in the airline industry potentially reaches its crest, questions are arising as to how ancillary revenue can evolve. Mr Christie remarked that the airline business has done a good job at managing ticket price revenue with respect to charging the appropriate fare based on desired travel date or other customer desires. But carriers generally don’t apply the same reasoning to managing ancillary revenue streams.

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He cites the example of charging the same bag fee for travel on 23-Sep versus 23-Dec, “which doesn’t make a heck of a lot of sense”, said Mr Christie. In September there could be as little as two bags in an aircraft belly while on 23-Dec an airline leaves bags on the ground. “We have a supply-demand problem,” Mr Christie declared. “So we believe there are opportunities...to price that product that will drive incremental revenue.” His comments seem to indicate the next iteration of maximising ancillary revenue lies in broadening revenue management of existing ancillary revenue rather than exploiting new revenue streams. As ancillaries have proven to be a steady source of revenue that is more inelastic than pure ticket revenues, the number of elements that are eligible for unbundling is becoming limited. Spirit's profitability supports the new low-fare airline niche Spirit Airlines has crafted and exploited a new and somewhat unique low-fare, low-cost base in the US that has emerged in the country due to legacy carrier consolidations. Its cost base so far has allowed the airline to profitably benefit from carrying passengers that network carriers no longer find lucrative. Spirit’s calculations show that its growth opportunities are somewhat boundless. Even if the carrier’s prospects might not be as robust as it estimates, Spirit’s financial performance for the moment appears to support its ambitious capacity growth. As an ultra low-cost operator it is apparently in a niche which is currently nicely vacant. BACKGROUND INFORMATION Spirit Airlines' route map: Mar-2013

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Alaska Air Group Key Data Fleet and Orders Alaska Air Group Fleet Summary: as at 10-Apr-2013 Source: CAPA Fleet Database

Alaska Air Group projected delivery dates for aircraft on order: as at 8-Apr-2013 Source: CAPA Fleet Database

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Route area pie chart Alaska Air Group international capacity seats by region: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

Top routes table Alaska Air Group top ten international routes by seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile Alaska Airlines schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata


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Alaska continues to face challenges getting investors to acknowledge its solid financial performance Alaska Air Group during the last few years has consistently outperformed its US carrier peers in a financial metric – return on invested capital (ROIC) – that is prevalent in discourse in other industries but has only surfaced in discussion among airline executives during the last few years. Since 2010 the carrier has exceeded its ROIC targets on an after tax basis and has posted annual profits for the last nine years. Despite its consistent profitability, Alaska’s robust financial performance is often overlooked by the investment community, leaving executives scratching their heads as to why the company’s consistent financial results are not more recognisable. Even as Alaska delivers consistent profitability, questions often arise over the company’s growth prospects at its two subsidiaries – Alaska Airlines and Horizon Air (which now operates under the Alaska banner). The carrier holds an advantageous position as the leading airline in Seattle, where it can feed into long-haul flights operated by its partner Delta Air Lines. It also has a strong relationship with American Airlines, but it is not certain how that partnership will evolve once American and US Airways close on their merger and complete a roughly 18 month-long integration process. Alaska does have the opportunity to flesh out its domestic network, and remains bullish that it will still deliver sound financial results with planned annual capacity growth of 4% to 8% during the next few years. Exceeding return targets for three years running Since 2008 Alaska’s after-tax return on invested capital has grown 7ppt to a 13% return in 2012, which marked the third consecutive year the company exceeded its 10% ROIC target. Since measuring ROIC is still a young concept in the US airline industry, different airlines use various methodologies to calculate ROIC. But taking the different methods into account, Alaska believes it trails only behind Delta Air Lines, which is arguably the strongest US legacy airline as United continues merger integration with Continental and American and US Airways aim to begin their integration in 3Q2013. Alaska Air Group ROIC performance: 2005-2012


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Alaska Air Group's 2012 ROIC compared with its US airline peers

Source: Alaska Air Group At the same time, during the last few years Alaska has had a marked focus on paying down debt, and has improved its debt-to-capital ratio considerably since 2008 from 81% to 54% in 2012. Alaska Air Group adjusted debt-to-capitalisation: 2008 vs 2012

Source: Alaska Air Group Recognising its debt levels were unacceptable, Alaska CFO Brandon Pedersen recently told investors that during the last four years the company has generated USD2.3 billion in operating cash flow, which has allowed the carrier to invest in modernising its aircraft and pairing down to a single fleet of Boeing 737 narrowbodies at the mainline level and Bombardier Q400s operated by Horizon. Alaska during that time has also reduced its debt and capital leases by more than USD1.1 billion and repurchased roughly USD200 million in stock.

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Alaska’s favourable performance is not reflected in its valuations; a low profile doesn't help Alaska’s consistent profitability, paying down of debt and favourable share price valuation relative to US major carriers and the larger low-cost carriers, curiously has not drawn a high level of attention among the investment community. The lack of recognition for its performance also perplexes Alaska as Mr Pedersen stated the company’s multiple lags other carriers as its enterprise value divided by pre-tax interest and amortisation is below the major US carriers and low-cost competitors. Alaska Air Group's valuation versus its competitors: 12M2012

Source: Alaska Air Group Some of the lack of recognition of its performance could be attributed to Alaska’s low profile outside of its core markets of the US west coast and service to Hawaii. Mr Pedersen remarked that as Alaska was looking to grow outside of the state of Alaska and the US Pacific northwest, “we are taking a look at our brand and how it resonates with potential new customers”. After making a major push into Hawaii during the last few years after ATA and Aloha collapsed in 2008, Alaska in 2012 expanded its long-haul US transcontinental network with new service from San Diego to Orlando and regional California markets of Fresno, Monterrey and Santa Rosa. The company during 2012 also launched mainline service from its Seattle hub to Kansas City and Philadelphia as well as new service from its Portland hub to Washington National airport. In Mar-2013 Alaska is introducing flights from San Diego and Boston followed by new service in Apr-2013 from Seattle to Salt Lake City. The transcontinental push comes as Alaska levels off its growth to Hawaii, which will just increase roughly 5% year-over-year in 2013 compared to 615% from 2007 to 2008 as Alaska entered the Hawaii-US west coast market. Between 2007 and Mar-2013 Alaska went from no service to Hawaii to 26 daily nonstop flights from the US west coast to the Hawaiian islands.

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Alaska Air Group mainline growth in Hawaiian markets: 2007 to 2013

Source: Alaska Air Group While the expansion in Hawaii has obviously made a contribution to Alaska’s bottom line, Mr Pedersen does acknowledge that unit revenue performance in some of Alaska’s Hawaii markets has not met the carrier’s targets, and as a result the carrier is moving to make seasonal capacity adjustments to improve its performance on those underperforming routes. Higher capacity growth relative to the US industry average; to grow 8% in 2013 Another aspect of Alaska’s operations that potentially spooks investors is the company’s high available seat mile growth relative to the US industry average, which based on data from Airlines For America was about 1.4% in the US domestic market from 2Q2012 to 2Q2013. During 2013 the carrier plans to grow capacity by about 8%, fuelled in part by the net delivery of three aircraft (nine deliveries of higher-gauge 181-seat Boeing 737-900ERs and six returns – three 144-seat 737-400s and three 124-seat 737-700s). Explaining the rationale behind Alaska’s planned 4% to 8% annual growth during the next few years, Mr Pedersen stated the company’s internal estimate is 1% growth equals one aircraft operating on transcontinental service or on flights to Hawaii. “Do we think there are profitable opportunities for us to deploy five or six airplanes per year? Yes we do,” Mr Pedersen remarked. “And that doesn’t feel like a big number to us.” He also stressed that Alaska owns about 75% of its fleet, which at year-end 2012 stood at approximately 173 aircraft, giving the carrier low-risk flexibility to dial back growth if necessary. Alaska Air Group actual and expected fleet growth: YE2011 to YE2014


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As Alaska looks to flesh out its network through the addition of new transcontinental markets it also needs to ensure the rest of its more mature markets are running profitably to absorb the spool-up of new routes. Mr Pedersen believes there are growth opportunities for Alaska in new transcontinental markets from its Portland and Seattle hubs as well as California. The carrier has a well-established reputation in those origin markets so the strategy is to build brand loyalty as the carrier works to expand its transcontinental network. Mr Pedersen likened new markets to research and development, explaining that naturally the younger markets would have lower margins. The goal is to develop those markets while stronger routes reach maturity to balance out the new market growth. Alaska hopes to maintain relationship with American post-merger Alaska’s two major partners in the US are American and Delta, and the carrier recently outlined plans to expand its partnership with American to include 22 of Alaska’s routes to Hawaii and some transcontinental flights. The carriers were able to expand their relationship after American negotiated a new contract with its pilots that lifted previous restrictions on the scope of American’s domestic codeshares. Mr Pedersen stated it was too early to speculate how the American-US Airways merger would affect Alaska’s relationship with American. The role of US Airways’ Phoenix hub in the combined network will likely be a factor in shaping the future relationship between the merged carrier and Alaska given Phoenix’s location in the US southwest. The relationship between Alaska and Delta is likely to grow as Delta works to increase its long-haul flying from Seattle, particularly to Asia. Alaska is helping to drive Delta’s expansion by feeding passengers from its extensive west coast network to Delta’s long-haul service. Alaska Air deserves more recognition for delivering consistent profitability Alaska’s outlook for 2013 is relatively positive as Mr Pedersen stated the business environment is stable and corporate demand was remaining steady. Overall the carrier retains a solid financial foundation and fleet flexibility that should allow it to weather any downturn in demand triggered by automatic spending cuts in the US government that took effect on 01-Mar-2013. While its growth prospects might lead some investors to take a timid approach to the carrier, Alaska’s consistent returns during the last few years show the company is adept at turning profits even as its capacity growth is higher than the industry average. The risks in its business model – expansion into new markets that are not certain to produce profits – are inherent for all airlines, and Alaska likely deserves more attention than it receives for sustaining profits while managing the typical uncertainties that accompany running an airline. This would be a pity if it were because of its low profile. Then again, that might be a place for management to look.

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Frontier Airlines Key Data Fleet and Orders Frontier Airlines Fleet Summary: as at 10-Apr-2013 Source: CAPA Fleet Database

Frontier Airlines projected delivery dates for aircraft on order: as at 8-Apr-2013 Source: CAPA Fleet Database

Route area pie chart Frontier Airlines international capacity seats by region: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

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Top routes table Frontier Airlines top ten international routes by seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

Premium/Economy profile Frontier Airlines schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

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Frontier Airlines straddles ultra low-cost and hybrid profiles (or falls between them) Denver-based Frontier Airlines has experienced a vast upheaval during the last few years. Acquired by US regional operator Republic Airways Holdings in 2009, Republic decided more than a year ago to spin-off or sell Frontier. Meanwhile, during its time as a subsidiary of Republic, Frontier has successfully executed a cost cutting scheme and network overhaul that has largely produced favourable results. As it worked to achieve cost efficiency Republic management declared its intent to transform Frontier into an ultra low-cost carrier to mimic the cost structure of other US carriers in that genre, namely Allegiant and Spirit. But as Frontier has worked to improve its fortunes it has not developed a business model that falls strictly into a no-frills offering in the same vein as Spirit Airlines. Its network is a mix of flying from a hub in Denver and point-to-point operations largely from Orlando and its new focus city of Trenton, New Jersey. Frontier lacks the scale to develop into a full-blown hybrid carrier like JetBlue, yet does not strictly adhere to a pure leisure focus. Unlike the two major hybrid carriers in the US, Alaska and JetBlue, who leverage their respective leading positions in Seattle and JFK to forge favourable partnerships with other carriers, Frontier is saddled with heavy competition from United and Southwest in Denver. Combined, those two carriers account for roughly 67% of Denver’s seating capacity, compared with approximately 17% for Frontier. Denver International Airport capacity by carrier (% of seats): 25-Mar-2013 to 31-Mar-2013

Source: CAPA – Centre for Aviation & Innovata By contrast Alaska holds a 54% seat share in Seattle and JetBlue on a system-wide basis has a 24% share at JFK. But JetBlue’s domestic share at its largest base is 36%, supplying the carrier

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with an attractive scale to forge partnerships primarily with international carriers. JetBlue has more than 20 interline partners, and recently announced one-way codesharing with Aer Lingus and Qatar Airways. The carrier has also recently indicated it might introduce two-way codeshares in the near future. Frontier is a small airline searching for an identity Frontier is a relatively small carrier compared to its ultra low-cost and hybrid peers, operating roughly 53 Airbus narrowbody aircraft. Republic also operates five smaller 100-seat Embraer E190s in a pro-rate operation for Frontier. Frontier's current and projected fleet: YE2012 vs YE2013 Source: Frontier Airlines

With the network overhaul Frontier completed during 2012, which entailed the elimination of Midwest hubs in Milwaukee and Kansas City (Republic also purchased Midwest in 2009 and later folded its operations into the Frontier banner), Frontier has positioned the majority of its operations in Denver, which is the carrier’s top base and headquarters.

Frontier Airlines top 10 hubs/bases/stations by seats: (25-Mar-2013 to 31-Mar-2013)

Source: CAPA – Centre for Aviation & Innovata Frontier during 2012 also opted to develop a point-to-point operation at Orlando International Airport, taking a cue from Allegiant (which has a major base at Orlando Sanford) and operating

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mainly low-frequency service to several destinations including Allentown, Pennsylvania; Bloomington-Normal, Illinois; Trenton, New Jersey; Columbia, Missouri; Greensboro, North Carolina; Harrisburg, Pennsylvania; Madison, Wisconsin; Milwaukee, Wisconsin; and Omaha, Nebraska. Frontier also serves its Denver hub from Orlando. The carrier offers a similar service pattern from its new focus city of Trenton, New Jersey, where it offers low-frequency weekly service to New Orleans, Fort Lauderdale, Orlando, Fort Myers and Tampa. Recently Frontier management explained how the carrier approaches its low-frequency operation noting that it combines multiple routes with a single aircraft for frequencies that range on its offerings from two to six per week. The carrier stated that it has seen some success with the approach in Denver; but took care to stress the approach was not driving Frontier’s utilisation lower. The airline is “simply lacing together the aircraft in a different way”. Frontier records unit costs that move it away from an ultra low-cost model – a hybrid? Frontier’s efforts in using a low-frequency approach in certain markets requires a certain cost structure. The ultra low-cost leader in the US and pure leisure operator Allegiant Air recorded unit cost of USD5.32 cents for FY2012, the best among any type of US airline. Allegiant’s fellow ultra low-cost carrier Spirit had unit costs of USD6 cents. Frontier’s 2012 unit costs of USD7.19 cents were higher than the USD6.99 cents recorded by JetBlue, which has proclaimed itself to have found a cost structure sweet spot centred between the ultra low-cost carriers and the legacy airlines. JetBlue’s product design is a medium frills model, where it offers some perks free and charges a fee for more premium offerings. Frontier’s 2012 unit costs increased about 3.4% year-over-year, with the carrier gaining some unit cost benefit in 2011 from restructuring and some lease concessions on its Airbus aircraft. While it has worked to transform itself into an ultra low-cost carrier, in reality Frontier appears to have adopted the hybrid business model of Alaska and JetBlue. Both JetBlue and Frontier offer satellite television. Frontier charges for the service while JetBlue offers certain satellite television content to passengers free of charge and also sells more premium television and movies. Frontier also has a higher level of complexity than Allegiant or Spirit as the carrier was an early adopter of fare bundles that are now popular in the US aviation industry. Since 2008 the carrier has been offering three fare bundles that include varying degrees of products – preferred seating, same-day standby, premium beverages, miles accumulation and change fee waivers – at tiered pricing levels. The fare bundles have survived the change in ownership, so the tactic must be assumed a positive contributor to Frontier’s revenue. Frontier also offers a stretch seating option with 36in of pitch and the opportunity to buy seats in advance that are closer to the front of the aircraft. All of these product offerings are more reflective of a hybrid business model than an ultra low-cost offering. While Spirit essentially charges for all aspects of travel beyond the ticket and Allegiant has deep partnerships with hotel and rental car companies to offer packaged travel, Frontier’s approach is more reflective of

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carriers looking to boost ancillary sales primarily through the unbundling facets of the air travel experience, and then rebundling them in packages for upsell. Straddling two models that seem to produce adequate returns During the last year it seems Frontier has consequently been straddling the ultra low-cost and hybrid business models, and during a recent discussion investors queried Frontier over its business strategy, drawing attention to the strength of Spirit’s returns. Data from Alaska Airlines show that based on carrier-reported return on invested capital (ROIC), Spirit soars above all carriers at 26.5%, including Alaska, which has been a pioneer in using the ROIC metric and has consistently beat its internal targets in that measure. ROIC has only began surfacing in airline financial discourse, and given its relative youth in that regard there are many methods carriers use to calculate the metric. Based on Alaska’s calculation – (EBIT + lease interest) – taxed at 40%/(average long-term debt + book equity + capital operating leases. Reported ROIC by US carriers and adjusted for Alaska Air's calculation: 2012

Source: Alaska Air Group Frontier’s management noted that in terms of density per aircraft, the seat-count on its Airbus aircraft is closer to Spirit’s Airbus narrowbody configuration. Frontier operates its A320s with 168 seats, and is considering adding six more seats to the jets for a total of 174 – versus a 178-seat configuration on Spirit’s A320s. But at the same time Frontier executives noted that premium seats and products, which do reduce seating capacity by a small amount, do create differentiation and importantly, meaningful additional ancillary revenue flow.

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Frontier’s fate lies with a potential new owner As Frontier continues to work through establishing a business model while it remains on the selling block, the carrier has produced solid revenue performance as top-line revenues during 2012, excluding special items, grew 7% year-over-year to USD1.4 billion and unit revenues factoring out special items increased 5.8%. The airline also has the benefit of competitive capacity in Denver mostly being rational during the last few years even though it competes with two of the largest US carriers at its headquarters, hub and largest base. Its unit costs during 2012 did not reach the level of ultra low-cost carriers, but Frontier could be inching closer to becoming a smaller hybrid carrier in the US market place, which puts the carrier in untested waters as potential buyers evaluate the carrier’s business plan. Republic executives throughout the majority of 2012 and continuing into 2013 have said that 2013 would be the year that Frontier’s fate would be solidified. The latest target is to announce a plan going forward by the end of 1Q2013. As the evaluations of how to monetise Frontier continue, the carrier appears to be gravitating towards a hybrid model. The US industry overall continues to redefine itself in the aftermath of legacy carriers reaching maturation, by consolidating into three major network carriers, Southwest (moving more into legacy territory) and the emergent hybrids and low-cost carriers vying for passengers abandoned by network airlines. For the time being it is not clear where Frontier will ultimately fall within the new framework; but a number of prospective new owners could have distinct ideas of the carrier’s path forward. At least its current seemingly ambiguous starting point may offer some options for a new owner.

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Air Canada Key Data Fleet and Orders Air Canada Fleet Summary: as at 10-Apr-2013 Source: CAPA Fleet Database

Air Canada projected delivery dates for aircraft on order: as at 8-Apr-2013 Source: CAPA Fleet Database

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Route area pie chart Air Canada international capacity seats by region: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

Top routes table Air Canada top ten international routes by seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile Air Canada schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata


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Air Transat and WestJet face heightened pressure as Air Canada applies Rouge Air Canada is sticking to its strategy for its new low-cost carrier Rouge by introducing service in Jul-2013 to untapped long-haul leisure markets and operating flights to sun destinations - with a presumably lower cost structure. The carrier is taking aim at both domestic rival WestJet and its vacations package business and large Canadian tour operator Transat. Now that Air Canada has unveiled the initial routes for Rouge, its competitors appear to be making schedule adjustments in response to the decision by Canada’s largest carrier to compete more aggressively in the leisure market. Air Canada finally gained the green light to move forward with the establishment of Rouge after the government in 2012 stepped into contentious negotiations between pilots and management and ultimately allowed the carrier to impose a contract on pilots that included elements for the establishment of a low-cost carrier. Rouge will launch with 767s and A319s Now Air Canada is preparing to launch Rouge in Jul-2013 with two Boeing 767 widebodies and two Airbus A319 narrowbodies. The widebodies will be operated on new service from Toronto to Edinburgh, Scotland and Venice, Italy. Rouge will also take over Air Canada’s mainline service from Toronto and Montreal to Athens. Rouge will assume Air Canada’s service to 10 Caribbean destinations – Punta Cana, Liberia, San Jose, Puerto Plata, Varadero, Kingston, Santa Clara, Cayo Coco, Holguin, and Samana. Rouge planned service to Europe: Jul-2013

Source: Air Canada Rouge planned service to the Caribbean: Jul-2013

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Source: Air Canada Air Transat faces new Rouge competition as it works to reverse its fortunes As expected Air Canada is intensifying competition with larger tour operator Transat (of which Air Transat is a subsidiary) on Rouge’s planned flights to Europe. While Air Canada faces no direct competition on the Toronto-Edinburgh route, Air Transat operates service from Toronto to Glasgow, which is 67km from Edinburgh. Factoring in Air Transat’s service to Glasgow, Air Canada and Air Transat will compete on all of Rouge’s European markets. Schedules in Innovata show that during Jul-2013 at Rouge’s debut it will operate 639 weekly one-way seats to Edinburgh compared with 1,245 on Air Transat’s Toronto-Glasgow route. On service between Toronto and Venice, where the two carriers compete directly, Air Canada will offer 639 seats in the market compared with 342 from Air Transat. Innovata schedules also show that Air Canada is projected to offer roughly 852 one-way seats between Toronto and Athens during Jul-2013, compared with 684 offered by Air Transat. On flights between Montreal and Athens, Air Transat is projected to operate 684 seats compared with 426 on offer by Air Canada. It appears Air Transat is pulling back slightly in some of the markets where it will face direct competition with Rouge, as online route tracker Airline Route has reported that during Jul-2013 to Aug-2013 Air Transat will reduce its Toronto-Athens frequencies from twice weekly to once weekly compared with the same period the year prior. Weekly frequencies between Toronto and Glasgow are falling from five to six year-over-year. Air Transat also serves Venice from Montreal (508km from Toronto), and during the Jul-2013 to Aug-2013 period Air Transat is increasing frequencies on the route from once weekly to twice weekly year-over-year but operating the service with 249-seat Airbus A310 aircraft instead of the 342/343-seat Airbus A330-200/300 aircraft used on the route during the year prior. Air Canada has only disclosed the configuration of its Rouge 767s for the 2013 winter time period that will feature 282 seats in a three class configuration – 230 Rouge standard (economy) seats at 30in pitch, 28 Rouge Plus seats with extra legroom featuring 35in pitch and 24 Premium Rouge seats that offer a pitch of 37in. Air Canada is intensifying competition with Air Transat at a time when parent company Transat is trying to improve its profitability. During its fiscal year of 2012, which ended in Oct-2012, Air Transat recorded a net loss of CAD16.7 million (USD16.7 million) compared with a CAD14.7 million (USD14.7 million) loss for fiscal year 2011. The company is in the midst of a three-year programme to improve pre-tax earnings by CAD50 million (USD50 million) in fiscal 2014 through revenue improvements and cost-cutting schemes. Air Transat did improve its revenues year-over-year in fiscal year 2012 by 1.6% to CAD3.7 billion (USD3.7 billion).

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During FY2012 Air Transat’s revenues from its European operations fell roughly CAD13 million (USD13 million) to CAD313 million (USD314 million) during the winter months as traveller volumes fell roughly 10%. The company explained that during that time revenues from its European subsidiaries held steady, but the value of the euro against the Canadian dollar weakened their performance. Transat’s European revenues during the summer season fell CAD15 million (USD15 million) to CAD549 million (USD549 million). Transat performance in European markets: FY2012 versus FY2011

Source: Transat Note - also includes performance for Transat's UK and French subsidiaries During the summer high season for transatlantic travel, Air Transat opted to reduce its capacity by 4% year-over-year between May-2012 and Oct-2012, and at the end of fiscal 3Q2012 cited a slight uptick in pricing and improved load factors year-over-year. But Transat faces a different operating environment during 2013 when pricing traction will be more difficult to attain as Rouge enters three of Air Transat’s transatlantic leisure markets with promotional fares that will likely include deals on miles accumulation. Air Canada seems relatively conservative with respect to the capacity it is introducing in the Rouge transatlantic markets, but with Europe’s economy still on shaky ground the bulk of the demand in those markets will need to originate in Canada, which could create pricing pressure for all the carriers serving those markets. Air Transat seems to be responding to Rouge by shaving some of its capacity, but it remains uncertain if those adjustments will be enough to dull Rouge’s effect on the market. Air Canada is revamping its vacation packages business to include the flight operations of Rouge with the goal of improving its fortunes on leisure routes and improving its fortunes on the ground packages it offers within its vacations business. Air Canada and WestJet deploy revamped cabins in the Caribbean The A319 narrowbodies being deployed by Rouge into Air Canada’s existing Caribbean markets from Toronto will be configured with 142 seats – 118 in economy with a 29in pitch and 24 in Rouge Plus featuring a 35in pitch. By the time Rogue debuts its narrowbodies in those markets that feature extra legroom WestJet will be operating its reconfigured 737s on those routes with four rows featuring a larger 36in pitch marketed as a premium economy offering. Schedules in Innovata for the beginning of Jul-2013 show that Rouge will compete with WestJet in seven of the 10 markets it is taking over from Air Canada. That number will likely rise to

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eight after WestJet on 11-Feb-2013 transitions its seasonal Toronto-Liberia service to year-round. Both Air Canada and WestJet have their own vacation divisions in an attempt to contain customers attracted to packages offered by Transat and Canada’s other large tour operator Sunwing. Air Transat and Sunwing will have largely backed away from most of the Latin American and Caribbean markets where Rouge plans to operate at the time of its debut in Jul-2013. Those two carriers typically serve the sun destinations during the northern hemisphere winter and deploy the capacity elsewhere once the high demand for warm destinations wanes. Service offered by Sunwing and Air Transat to Punta Cana, San Jose (only Air Transat), Puerto Plata and Santa Clara ends around the Apr-2013 to May-2013 time period. Innovata schedules show that Cubana also ends seasonal service from Toronto to Cayo Coco in the Apr/May time period. While schedules are subject to change, it appears that neither Air Canada nor WestJet are pumping huge amounts of capacity into the Caribbean during the summer season. The highest volume routes in terms of seats on offer appears to be Kingston where Air Canada, Caribbean and WestJet will offer approximately 1,624 seats in the Jul-2013 timeframe. Punta Cana is the second largest market with 934 seats on offer. But WestJet has also stated its intent to add a single flight each week from Toronto to Kingston, Varadero and Puerto Plata. The push is likely a means to fortify some of those markets as Rouge attempts to introduce a fresh product into the market place. Competitive capacity on Rouge's Caribbean routes: Jul-2012

Source: CAPA - Centre for Aviation and Innovata Note –Seats per week, one way Note – Air Canada faces no competition on service to San Jose. WestJet's transition to year-round flights between Toronto and Liberia is not yet reflected in the system

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Rouge has had a painful birth, but its proof will be in how it can change Air Canada's culture Born out of a need to put an entity into the air which has fundamentally lower costs than its legacy parent, Rouge is also sure to become a litmus test for the carrier's staff's view of how management is handling Air Canada's future. Intransigence at the union level - albeit with some limited gestures towards recognising the effects of a changed world - has generally prevented Air Canada from making the sort of radical cost reductions that the airline needs. So Rouge, as a break-out from this stalemate, occupies a most important role. The saving grace for Air Canada up until now has been its ability to generate higher yields in the domestic market as compared with its major competitor, WestJet. But as WestJet takes aim at regional markets with its new fleet and leverages its opportunities towards competing across the board for the premium markets, Air Canada cannot afford to rest on its laurels. Its yield advantage is under attack, making it exposed with a much higher cost base than its smaller competitor. Air Canada’s theory that Rouge’s lower cost base will improve its performance in leisure markets will now be put to the test in just a few short months. While its strategy appears to be taking aim at travel package tour operators, the Air Canada planes painted in a Rouge livery will meet a familiar foe in the Caribbean as WestJet appears to be readying for the intensified competition. Rouge could have a better chance of performing favourably in its transatlantic markets as its main competitor works to secure financial footing, but it is rare that these types of experiments produce positive results. Rouge has much to prove to live up to the vibrancy of its name.

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Porter Airlines Key Data Fleet and Orders Porter Airlines Fleet Summary: as at 10-Apr-2013 Source: CAPA Fleet Database

Route area pie chart Porter Airlines international capacity seats by region: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

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Top routes table Porter Airlines top ten international routes by seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

Premium/Economy profile Porter Airlines schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013 Source: CAPA - Centre for Aviation and Innovata

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Porter sets its sights on becoming Canadian aviation’s third force After quietly allowing its rivals to grab headlines in 2012 with the unveiling of new subsidiaries, Canada’s Porter Airlines has followed through on plans to declare its long-term strategy, boldly proclaiming its ambitions to become a strong third force in Canada’s aviation market. Underpinning Porter’s efforts are the carrier’s plans to introduce Bombardier CSeries CS100 narrowbodies in a drive to broaden its reach to markets beyond the eastern half of Canada and the US. Porter’s evolution follows hints dropped by the carrier in recent weeks that it would table its long-term vision going forward after Air Canada and WestJet dominated Canadian aviation discourse in 2012 by unveiling plans to create their respective subsidiaries Rouge and Encore. Porter now envisions the 107-seat narrowbody aircraft joining its existing fleet of Bombardier Q400 turboprops to allow for expansion into western Canada, and new transborder markets on the US west coast and Florida. While Porter believes now is the time to forge a new era in its business, the reality is its growth could disrupt a market place that is just showing signs of stability. Air Canada and WestJet have displayed prudent capacity restraint that has allowed WestJet to maintain its consistent profitability and Air Canada to record positive results in 2012 after recording losses in 2011, 2009 and 2008. During 2012 Air Canada grew capacity by just 1.2% while WestJet recorded 4% capacity growth versus nearly 9% for the year prior. The capacity introduced by Porter with larger aircraft into already well-served markets could prove disruptive, pressuring yields for all airlines serving those routes. Porter’s bold expansion also hinges on gaining approval for jet operations at its Toronto City Centre base, which will likely stir up an unruly political debate that could completely derail the carrier’s planned business evolution. Porter faces challenges in replicating its niche model on a large scale Since its launch in 2006 Porter has introduced service to 19 markets and built up a fleet of 26 70-seat Q400 turboprops. Despite the controversy it stirred by securing a commanding status at Toronto’s Billy Bishop Airport (Toronto City Centre), Porter still only accounts for about 4% of the Canadian aviation industry based on seat share.

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Canada system-wide capacity share by carrier (% of seats): 15-Apr-2013 to 21-Apr-2013

Source: CAPA – Centre for Aviation & Innovata But replicating its niche on a larger scale to markets not currently within the range of its Q400s (1,014nm for the Q400 vs 2,950nm for the CS100) could prove to be challenging for Porter. The carrier has identified nine transborder markets and four routes in western Canada as targets for the new 12 CS100 aircraft which are scheduled for delivery beginning in 2016. Porter's prospective CS100 routes

Source: Porter Airlines Of those markets only two – West Palm Beach and San Francisco – have a single carrier offering flights from Toronto Pearson Airport, Air Canada. The remaining 11 markets are amply served

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by Air Canada, WestJet and in some cases tour operator Sunwing and US major carrier American, pitting Porter against full-service airlines and tourist operators alike. Existing operators on Porter's prospective CS100 routes from Toronto Pearson: 14-Apr-2013 to 20-Apr-2013

Source: CAPA – Centre for Aviation & Innovata While Porter will not introduce a huge amount of capacity on those routes as it will take time to ramp up the CS100 jet operations, its foray into those markets could be disruptive enough to pressure profitability of other airlines. Its introduction of flights into western Canada could produce a similar result for carriers operating in Canada’s eastern triangle (Toronto-Montreal-Ottawa). After WestJet bolstered its frequencies in those markets last year, Air Canada cited pressure on its yields in those markets, and in some transborder markets where its competitors had expanded. WestJet also launched flights from Toronto to New York LaGuardia, competing with Air Canada and American Airlines on the pairing. Porter also serves the New York area from Toronto City Centre with service to Newark.

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Assessing the competitive pressure in the transborder markets, Air Canada CEO Calin Rovinescu recently remarked that while it is a natural tendency for new entrants in markets to introduce discounted fares, he did not predict any immediate change in competitive behaviour in those markets. If Porter succeeds in executing its planned expansion, the same competitive dynamics could be introduced in the carrier’s targeted markets in western Canada, Florida and the US west coast. Both Air Canada and WestJet serve the four western Canadian markets Porter is targeting and a majority of the transborder markets earmarked for the carrier’s expansion. Porter will disrupt pricing in those markets with introductory fares and dilute continued pricing power by existing carriers by potentially introducing unnecessary supply on those routes. Intensifying competition for high-yielding passengers Porter’s planned expansion will no doubt pressure both of Canada’s largest carriers as it attempts to improve its stature in the Canadian market place. But WestJet could feel the most pressure as Porter and WestJet could be chasing the same passenger base – corporate travellers not currently wedded to Air Canada. WestJet in particular has been making a push into the corporate space during the last few years through improvements in its loyalty programme and expanding codeshare and interline partnerships. It is making a further push into the corporate sector through the upcoming launch of a premium economy offering and fare bundles that are in part targeted towards corporate travellers. Previously WestJet CEO Gregg Saretsky has remarked the carrier only has about 10% of the managed corporate share in Canada, which represents a significant opportunity for the carrier to chase more business travellers that produce higher yields. But with Porter potentially looking to expand its corporate base through the acquisition of larger, longer-range jets, WestJet’s opportunities to expand its reach into the business travel market could shrink as Porter will compete aggressively for passengers who are not deeply entrenched in Air Canada’s loyalty programme. The added capacity could also force Air Canada, Porter and WestJet into lowering their fares to stay competitive in the space. The result could be a reversal of a trend recently cited by the Conference Board of Canada during the last couple of years when Canadian airlines enjoyed an ability to raise fares above inflation following a decade of little or no growth in ticket prices. Reigniting controversy at Toronto City Centre All of Porter’s much-hyped expansion plans hinge on gaining approval from the requisite authorities to operate jets from Toronto City Centre and the endorsement for adding 168m at each end of the airport’s main runway. Porter needs the green light to modify the so-called tripartite agreement amongst the city, the federal government and the Toronto Port Authority that bans jet operations at the airport, which sits on a small island close to Toronto’s city centre. Porter’s declarations to operate jets from the airport will no doubt fuel heated discussions as some residents will strongly oppose the introduction of larger aircraft from the site even as Porter

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touts the CS100 as a whisper jet. Porter is obviously hoping the facts that the CS100 is quieter than the Q400 and that its order would boost Bombardier’s new flagship programme will it help it secure the necessary political backing and overcome the looming controversy. To underscore the seriousness it places on gaining approval to operate large jets from Toronto City Centre Porter, during its media blitz to announce its expansion plans, put its board chairman Don Carty – a native Canadian, former head of American and also chairman of Virgin America’s board of directors – front and centre to discuss the modifications necessary at the airport (including additional takeoff and landing slots) to accommodate the new routes and aircraft. Mr Carty told Canadian newspaper The National Post that he was encouraged by preliminary discussions with the tripartite members about Porter’s desire to extend the runway and operate jets from the airport, and indicated that the parties might issue their approval within six months. But the decision might not be made that easily as both Air Canada and WestJet have both made rumblings about operating larger aircraft from the airport if Porter gets the green light for additional service. Air Canada was entrenched in a legal battle for years before it finally returned to the airport in May-2011 with its own Q400 flights operated by partner SkyService Airlines. The carrier will no doubt set its sights on operating larger aircraft from the airport, and potentially use legal means to block Porter’s expansion if it fails to gain the same access as Porter. Behind the hype surrounding Porter’s unveiling of its declaration to build up its business to challenge Air Canada and WestJet, is the reality that various elements need to fall into place before its ambitions become a reality – namely convincing regulators and local and federal governments that its expansion is necessary to ensure adequate competition is present in the Canadian market place. If that occurs Porter also needs the commercial wherewithal to face fierce competitors that will fight intently to keep their customer bases intact. The result could be favourable for travellers as fares will fall, but the fragile financial health of Canada’s airlines could be jeopardised if demand fails to keep pace with Porter’s planned expansion.

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