4_Financing the Civil Airline Business

8/9/2019 4_Financing the Civil Airline Business

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Aerospace Technology & Industry

FINANCING THE CIVIL AIRLINEBUSINESS

Dr Rachel CUNLIFFE

School of Engineering & Technology

[email protected]


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Airlines have been operating on very small

margins since deregulation in the 1980’s.

INTRODUCTION

In spite of this, it remains a dynamic industrywhich continuously attracts new airline

businesses and an array of different business

models.


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Where is there information about Airline Finances?

1. Publicly owned companies are obliged to publish an annual report

giving details of their finances. (Privately owned or Government ownedcompanies tend to be secretive.)

2. The annual report includes data formatted according to convention: -

Profit & Loss Account (Income Statement) – Statement of earnings

– summarises revenues and expenses.

Balance Sheet – Statement of financial position on a particular

date – what the airlines total assets and liabilities are.

Cash Flow Statement – Statement explaining changes in balance

sheet, i.e. how cash is generated for the payment of aircraft or

loans.

3. Difficult to compare companies accounts especially when they are

based in different countries.


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What do you need to know to understand airline financial statements?

1. Negative values are shown in brackets and not with a minus sign in

front.

2. Tangible assets = aircraft, buildings, terminals, etc..

3. Tangible assets are assumed to depreciate. Typical: a straight line

depreciation over 15 years to a 10% residual value.

4. Intangible assets = route/traffic rights, take-off/landing slots, brandvalue, staff experience and training, etc..

5. Intangible assets are written off i.e. “amortised” (e.g. over 40 years to a

zero residual value).

6. Gearing indicates percentage of companies worth used as leverage onloans.

Useful abbreviations: -

• ASK = available seats per kilometre

• RPK / RPS = Revenue per kilometre / Revenue per seat


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Comparison of Financial Statements from IAG and EasyJet

IAG has negotiated and

made initial payments for

future aircraft. Between2012-13, they invested in

• 4 Boeing 787s,• 3 Airbus A380s,• and 2 Boeing 777s.

EasyJet sold12 new Airbus

A320s, and 12 mid-life

A319s and then leased

them back.

IAG EasyJet

Aircraft (owned &

leased)

431 + 282 options 217

Percentage a/c leased N/A 33%

Passengers 54million 60.8million

Load factor 80.8% 89.3%

Routes BA = 194 / Ib = 68 633Total Revenue £14,753million £4,258million

RPS (pence/ASK) 6.27 5.74

Fuel Costs £4,701million £1,182million

EasyJet disclosed details of their hedging transactions which reduce the costof fuel: -

Market price $900 to $1,100 per tonne over the year. EasyJet paid $980 on average. Has forward purchased 1.4 million tonnesat $948 i.e. 72% for 2014, and 56% 2015.


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How Much Revenue Do The Airlines Get?

1. Revenue comes mainly from passenger fares, but some income is

derived from cargo. (British Airways, 2013 - Passenger revenue = 93.6%,

Cargo revenue = 6.4%)

2. Attempts to increase revenue can be erratic if aircraft operating the

route are already full. Significant cost of aircraft, crew, landing/take-off

rights, etc..3. Operating margins tend to cyclic with costs and economic performance

of the countries they operate within. Current data suggests an average

profit of $5.42 for each passenger carried (CNN, June 2014).

Step in fuel prices → Slow-down in economy → Slump in revenues


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£ million 2013 2012 Increment

Fuel, oil and emission costs (3,755) (3,712) (1.2)%

Employee costs (2,387) (2,345) (1.8)%

Handling charges, catering and other operating

costs

(1,340) (1,213) (10.5)%

Landing fees and en-route charges (790) (726) (8.8)%

Depreciation, amortisation and impairment (722) (720) (0.3)%

Engineering & other aircraft costs (643) (625) (2.9)%Accommodation, ground equipment and IT costs (576) (613) 6.0%

Selling costs (439) (466) 5.8%

Aircraft operating lease costs (85) (98) 13.3%

Currency differences (28) (1)

Restructuring (5) 36

TOTAL (10,770)

What are the Costs of Running an Airline?

Operating Costs for British Airways December 2013

• Fuel is by far the largest cost.

• The second largest cost is cost of employees

• Data calculated for the ASK (available seats per kilometre). For British Airways

fuel costs have risen in spite of drop in oil price and advances in aircraft

performance – exchange rate fluctuations.


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ICAO Scheduled Airline Financial Results Source: “Airline Finance” by Peter Morrell

The same ICAO data as

before, but separated by

region: -

• US hardest hit by

recessions : “Chapter

11”, consolidation.

•

European airlinesfaired better – BUT –

help from

governments

• Asian airlines most

successful.

Asia Pacific

Europe

North America

Fuel Costs Vs Financial Performance


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What are the Costs of Running an Airline? – EMPLOYEE COSTS

Airlines are essentially a service industry – require largenumbers of employees.

There are two ways of reducing the wage bill: -

1. Hold down salaries and benefits

2. Reduce the numbers of personnel

Bankruptcy Law in US has been used to hold down wages

and renegotiate contracts.


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AIRLINE BANKRUPTCIES

11

Competition has led to numerous airlines filing for bankruptcy (Sabena, British

Midland, Swiss Air, etc..)

In US bankruptcy laws provide for different types of protection: -

• Chapter 7 – straight bankruptcy, assets sold-off

• Chapter 11 – allows debtor to continue operating (“Debtor in Possession”

(DIP)) – debtor remains in control of assets but has to negotiate with creditors.Time is used to cut costs and submit a viable business plan.

Chapter 11 has allowed many US airlines to continue operating.

Downside is devastating effect on

employees.

Up to 2004 144 airlines had filed for

Chapter 11 bankruptcy, and 14 for

Chapter 7 bankruptcy.


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What are the Costs of Running an Airline? – Landing Fees &

Accommodation

• Great variation of landing fees and building rates for “Legacy Carriers” and “Low

Cost Carriers”

• High congestion / high demand produces higher costs

SLOTS – not tradable commodities - but in fact airlines do. (Airports or governments

tend to claim ownership.)

Slots allocated according to“grandfather rights” – BUT

need a landing slot for

every take-off slot – hence

carefully coordinated by

IATA (International Airline

Trade Association).


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What are the Costs of Running an Airline? – LEASES

Advantages of leasing aircraft: -

1. The airline doesn’t tie up valuable capital purchasing its own aircraft

2. Airlines trying out new routes can reduce their risks

3. Airlines can lease aircraft to accommodate short-term peaks in demand

(summertime)

4. Aircraft are available quickly, even if the manufacturers have full order books

5. Airlines may choose to sell all or part of their fleet to a lessor

6. Airlines that go out of business can hand the aircraft back

7. The lessor stands the risk of a slump in the second hand value of the aircraft

Leasing Companies = “airlines with no passengers”

Agreement can be for just a few months, or up to 15 years.

Of more advantage to smaller airlines. For British Airways = 0.008% of costs.

“Wet Lease” includes crew and engineering team.


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What are the Costs of Running an Airline? – LEGISLATION

Airlines have to ensure that their aircraft are compliant withlegislation for: -

• Noise Abatement

• CO2 Emissions

Non-compliant aircraft are not allowed to fly.

New legislation planned for CO2 emissions for aircraft.

Lower noise standards due to come into force for large aircraft 2017

(2020 for smaller aircraft): -

10dB less than current standard New Airbus A320 family and A350XWB are already

compliant.

Long range A350XWB will be able to achieve 16dB below

current standard.


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LOW COST CARRIERS HAVE TAKEN A SIGNIFICANT

SHARE OF THE MARKET

L C C S h a r e ( % ) o f T o t a l S e a t s ( 2 0 0 1 –

2 0 1 2 )

Growth in UK market share of LCC between 2001 to 2012: -

Current data suggests

LCC have seized 36% of

European market and

56% of UK market.

Source: OAG


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AIR SERVICE LICENCES – “5 Freedoms of the Air”

Air service licences are given by governments within a framework of 5 freedom

traffic rights of the air: -

1. The right to fly over a country without landing

2. The right to land in a country (for refuelling) without picking up any

passengers or cargo

3. The right to carry passengers or cargo FROM your country to another

4. The right to carry passengers or cargo TO another country from your own

5. The right to carry passengers or cargo from your country to another, and then

on to a third country

If two airlines merge, they risk losing their licence to fly passengers and cargo.

Alliances bypass the licencing legislation bysharing infrastructure.

“Code-sharing” and “Interlining” agreements

with other airlines without formally merging.

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ALLIANCES & MERGERS

Since 1992, the US has been pursuing a policy of “Open Skies” i.e.

unlimited exchange of third, fourth and fifth freedom traffic rights.

BUT restrictions remain e.g.

• US refuses to trade domestic flight licences (more to lose than gain)

• airline given a licence to operate from a country must be

“substantially owned and effectively controlled” by nationals fromthat country. (Many countries specify limits on foreign ownership).

International Airlines

Group

Traffic rights and restrictions on

foreign ownership have reduced

the number of mergers. Mergerstend to be between members of

a global alliance.

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RECENT FINANCIAL PROBLEMS FACED BY AIRLINES & AIRCRAFT MANUFACTURERS

Shortage of credit from banks meant that airlines turned to government

agencies to supply credit for expansion / new stock.

Since 2008 60% more aircraft purchased using government loans.

1986 Large Aircraft Sector Understanding – framework regulating the terms by which loans were

given to purchasers of civil aircraft

2007 Aircraft Sector Understanding –

• 3 categories of aircraft, category 2 aircraft given more favourable terms

• Home-Country rule – seen as giving unfair advantage to competitors

2011 Aircraft Sector Understanding –

• Abolition of separate categories of aircraft

• Brings government financial arrangements into line with market conditions

• High risk buyers only given 80% funding

• Maximum repayment of 12 years across the board

• BUT no agreement on Home-Country rule

Bombardier C-Series

Sukhoi SuperJet


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January 2012 – “Airline Business” published by NEXUS UK

Air Transport Association of America has asked to block Exim Bank givingcredit guarantees to Air India.

Example: Delta Airlines operated New York to Mumbai non-stop until

2008, after which time they were forced off the route by Air India.

Exim Bank had given $3.3billion for aircraft purchases to Air India

between 2006 and 2009, who then flooded US-India market with extracapacity. Delta forced to cut 64 pilots.

ARGUMENTS AND COUNTER-ARGUMENTS

Airlines employ more Americans than the aircraft

manufacturers, so US finance should back airlines not

Boeing.BUTIf Boeing didn’t sell to India then Airbus would, and US

routes would be flooded with additional capacity

anyway.

HIGHLIGHTING PROBLEM WITH “HOME-COUNTRY” RULE


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0

5

10

15

20

25

30

A v e r a g e A n

n u a l R e t u r n

Return on invested capital - 2004

Averaged over past 4 decades, net profit margin

of the world’s airlines is 0.1%!

One of the most profitable activities is Computer

Reservation System (CRS).

Airlines hope to restore profitability by charging

for extras. Source: Nexus UK

So How Much Profit do the Airlines Make?


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Aircraft Leasing

• Resulting from the downturn in the Global Banking System

• Currently 32% of global fleet is leased from Investment Companies

• Perversely banks seem happier to lend to lessors than airlines

• Business model provides a 5% yield on investment

Recently, Royal Bank of Scotland forced todispose of its Aircraft Leasing business

Sold for $7.3billion to Japanese consortium

206 aircraft Reflection of nature of the business?

A NEW FACET OF THE AEROSPACE INDUSTRY IS BORN: -


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Virgin Galactic at Farnborough

Airshow, 2012

TIMELINE

1918

THE

FUTURE?


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Questions ?

Documents

4_Financing the Civil Airline Business