Aviation Strategy issue #191, November 2013 · 2013-11-29 · 0% 2% 4% 6% 8%-0.3% 1.0% 1.5% 0.5% 0.5% 2.8% 2.0% 8.0% 2014 v 2013 Source:IAG creaseditsgearingtargets:debt(in-cludingleases)ofbetween50-60%of

Issue no. 191November 2013

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IAG Opera ng profits by airline brand

BA

IB

VY

IAG

IAG: BA surging ahead,dragging Iberia with it

I Airlines Group’s annual capital markets day in the middleof November presented mostly posi ve comments and, unlike other re-

cent announcements from the other European airlines, contained no overtor veiled profit warnings. The group increased its headline target for operat-ing profits in 2015 by over 10% to €1.8bn although the underlying target ofachieving a 12% return on capital remains unchanged.

This upgrade in the group’s targets come mainly from a strong perfor-mance by the Bri sh Airways opera ng unit in the current year and the im-pact of the acquisi on of Vueling. The group implicitly expects that the im-provement inmargins seen this year at BAwill con nue through the next twoyears: the group increased its es mate for BA’s opera ng profit in 2015 from£1.1bn to £1.3bn (with an expected profit this year of £700m). It has alsoadded a contribu on to arise from growth at and Vueling. In contrast, whilesaying that the Iberia restructuring plan is on track, it has in effect forecasta lower opera ng performance from the Spanish flag-carrier by 2015 than ithad proposed in last year’s capital markets presenta on.

Published by Aviation Strategy Ltd

This issue includes

Page

IAG: financial results, plansand forecasts 1

E had Airways: Carving out adis nct iden ty 8

American-US Airways merger:Can it deliver promisedbenefits? 12

Norwegian Air Shu le: Long-haul a risk worth taking? 15

Jet values and lease rates 20

Aviation StrategyISSN 2041-4021 (Online)

This newsle er is published ten mesa year by Avia on Strategy LimitedJan/Feb and Jul/Aug usually appear ascombined issues.Our editorial policy is to analyse andcover contemporary avia on issuesand airline strategies in a clear, originaland objec ve manner. Avia on Strat-egy does not shy away from cri calanalysis, and takes a global perspec ve– with balanced coverage of the Euro-pean, American and Asian markets.

Publisher:Keith McMullanJames Halstead

Editorial TeamKeith McMullankgm@avia onstrategy.aeroJames Halsteadkgm@avia onstrategy.aeroHeini Nuu nenhn@avia onstrategy.aeroNick Morenonm@avia onstrategy.aero

Tel: +44(0)207-490-4453Fax: +44(0)207-504-8298

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Copyright:2013. All rights reserved

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ions of the editors, publisher or con-tributors. Every effort is made to en-sure that the informa on contained inthis publica on is accurate, but no le-gal reponsibility is accepted for any er-rors or omissions. The contents of thispublica on, either in whole or in part,may not be copied, stored or repro-duced in any format, printed or elec-tronic form, without the wri en con-sent of the publisher.

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2011 2012 2013 2014 2015

EURm

IAG Synergy Targets

Costs

Revenues

Original Targets

Net EBIT Impact

The group’s financial targets havenot really changed. It is aiming tohave a business model that can sus-tain organic growth levels (exclud-ing Vueling) of 2-3% a year, andwhich provide returns to sharehold-ers (with luck and a following wind)in excess of cost of capital. It ap-pears to be expec ng opera ng prof-its of €740m in the current year, so toreach its target will need to improveearnings by €1.1bn in the next twoyears.

There are four main planks to thestrategic financial plan over the nexttwo years:

( “Transform Spain” to bring Iberiaback into profit and a sustainablegrowth path;( “Transform London” to improveperformance at BA through sustain-able increased unit revenue perfor-mance;( Extract further synergies fromthe combined group; and( Allow for growth poten al at BAand Vueling.

Each of the first two planks areexpected to generate improvementsin opera ng profits of around €400m(each postulated with €100-€150mupside poten al). The group onceagain has increased its es mate of

future synergies arising from themerger of BA and IB and suggeststhat now it may achieve addi onalrevenue benefits and cost reduc onsof around €190m over the next twoyears. On top of this it is alloca ngaround €200m from growth at bothBA and Vueling. If that upside poten-al at BA and IBwere realised the tar-

get for 2015 could easily reach a €2bnopera ng profit.

Synergies – new target €600mnet EBIT impact

When the BA/IB merger was firstannounced the companies es matedcombined synergies of €400m by2015. Last year at this me the groupes mated the figure at €560m andnow has upgraded it to €650m witha net opera ng impact of €600m.Roughly half of the synergy contribu-on comes from reduced costs and

the other half from improved rev-enues. Of course the management’sstatement of synergies can never beconfirmed independently from pub-lished accounts, but the group doesstate that in 2013:

( Net addi onal revenues reached€66m and cost reduc ons touched€56m giving an annual benefit of€122m;

2 www.aviationstrategy.aero November 2013

http://www.aviationstrategy.aero/

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-10%

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Jan Feb Mar Apr May Jun Jul Aug Sep Oct

Percen

tage

chan

ge

IAG Traffic & Capacity 2013

BA ASK

BA RPK

IB ASK

IB RPK

VY ASK

VY RPK

IAG Fleet Plans

Post 2015Aircra 2012 2013 2015 Change† Orders Op onsA330 / 340 33 29 30 -1 8A350 18 50A380 3 9 3 7747 52 49 39 -4767 14 12 7777 52 54 58787 4 12 30 18A318 2 2 2Total long haul 153 153 157 -3 51 83

A320 family 187 227 282 +110 52 158Other 40 39 17 -9 12Total short haul 227 266 299 +101 52 170

Total fleet 380 419 456 +98 103 253

Source: IAG. † Change from 2012 plans.

( The group began outsourcingtransac onal func ons;( Sales outlets have nowbeen inte-grated in 19 loca ons, with Portugal,Morocco, Israel and the Nordic coun-es integrated in 2013;

( Seven major European airportground handling contracts have beenrenego ated;( 19 new code share routes (withBuenos Aires, Rio and Sao Paoloprominent performers) have beenimplemented, giving 58 total codeshare routes;( A new long- and short-haulGroup fleet order secured addi onaldiscounts from the manufactur-ers, in effect providing savings of€20m-€30m a year.

Fleet Plans

Last year the group announcedits inten on of reducing its total fleetfrom 380 units to 358 by the endof 2015, mostly through cu ng backshort haul opera ons at Iberia aspart of its planned restructuring. Theacquisi on of Vueling added over 50

A320s to the group fleet and has rad-ically changed the short haul growthprospect.

BA is gradually renewing its longhaul fleet. It now has three A380sand four 787s in service with anothersix and eight respec vely to be deliv-ered in the next two years. These arereplacing the ageing 747s and 767s,crea ng a modest increase in aver-age long haul gauge. At the sameme it is disposing of its 737 Clas-

sics (par cularly at Gatwick) as more

A320s are delivered.Iberia con nues to take on new

A330s on lease (as an interim mea-sure un l the A350 comes on stream)gradually replacing the fuel-hungryA340s. Vueling has plans to expandits current fleet of 59 A320s to 100 inthe next two years.

Overall, the group appears to beplanning an average annual growthof 6.6% in capacity (in ASK terms)over the next two years (4.9% paexcluding Vueling). The 100 aircraon order for delivery between 2016and 2022 are primarily to secure fleetreplacement; the addi onal 170 op-ons over that period could generate

long term growth of 5% a year in anupside case.

The group has adjusted the m-ing of its capital expenditure pro-gramme over the next few years,but has retained its plan of an av-erage spend of €2bn a year. Thisneatly fits in with the group’s finan-cial targets for 2015 of a 12% returnon capital (just above its es mated10% weighted average cost of capi-tal); roughly two thirds of the spend-ing is needed for replacement of ex-is ng equipment and one third tohelp generate long term growth of3% a year. As a result of the acqui-si on of Vueling, it has slightly in-

November 2013 www.aviationstrategy.aero 3


BA Capacity plans 2013-2015

Total growth2015v2013

2015v2014

Core networkgrowth

Shorthaulgrowth

Net AAreplacement flying

Increased gauge withA380s and 787s

New longhauldes na ons

Suspendedlong haulmarkets

0% 2% 4% 6% 8%

-0.3%

1.0%

1.5%

0.5%

0.5%

2.8%

2.0%

8.0%

2014v

2013

Source: IAG

creased its gearing targets: debt (in-cluding leases) of between 50-60% oftotal capital, with ra os of net debtand gross debt to EBITDA of threeand four mes respec vely. It is alsotarge ng investment grade for the in-dividual airlines; this may be easierfor BA to achieve than the other two.

Q3 Results

In the three months to endSeptember 2013 group revenueswere up 7% on the back of a 9%increase in passenger capacity andtraffic. A 1% increase in passengerunit revenues was offset by a 14%drop in cargo and other revenues. Inconstant currency terms passengerunit revenue increased on a like-for-like basis by 7.4%, specificallyreflec ng the bounce back from apoor quarter for BAn the prior yearperiod (the result of the London2012 Summer Olympics, a nega ve€100m effect on revenues).

For the group, opera ng prof-its came in at €690m before excep-onal items, against €270m in the

prior year period. Of this BA provided

€407m, Iberia €74m (up from breakeven in the prior year period) andVueling (included for the first me)€139m. Total group unit costs fell by10% year on year, although this waslargely because of Vueling; unit costsexcluding fuel at both BA and Iberiaincreased by 1%.

For the nine months to endSeptember total group opera ngprofits came in at €657m, hugelyup from €17m in the previous year,and even 50% higher than the levelachieved in the same period in 2011.For the full year IAG expects to beable to produce opera ng profitsof €740m (s ll less than half of thelevel it needs to achieve to generatereturns above the cost of capital).Mildly disturbingly, the group statedthat it expected growth in 2014 tobe driven by “volume” rather thanrevenue as BA launches new longhaul routes and as a result of thecon nued expansion at Vueling.

BA – Transforming London

Heathrow looks as if it is return-ing to be the power house of prof-

its for BA. Management stated thatit is well ahead of its original plansfor 2013 and has raised its targets for2015 by £200m to aim for opera ngprofits of £1.3bn (nearly twice thisyear’s expected result of £700m).

One of the main drivers be-hind this was the “transforma onalchange” arising from the acquisi-on of bmi and its slug of slots at

Heathrow. At a stroke this allowedBA to capture over 50% of the slotbase, recover some short haul point-to-point and feed services which ithad had to forego in previous yearsin favour of long haul, and allow itroom to introduce new (and some-mes reintroduce old) long haul ser-

vices. The company had originallyes mated that the bmi integra onwould have had a mildly nega ve im-pact on the current year’s profitabil-ity with a first half loss of around£50m and a second half break even.It now es mates that it has actuallyhad neutral effect in the first half ofthe year and in the second half willgenerate a contribu on ofmore than£30m. In total, short haul revenuesare some £120m be er than an ci-pated.

The increase in the target for2015 comes partly from the be erthan expected performance in 2013.The airline is expec ng:

( Non fuel unit costs to fall by 1%in 2014 in constant exchange ratesand be flat in 2015 genera ng an ad-di onal £70m net impact (althoughthis depends on the final decisionabout the regulatory charging struc-ture at Heathrow);( Fleet replacement programme togenerate £140m net savings (mostlyfuel) as the new genera on aircraare delivered;( Network and product: the com-pany expects that it will be able to



0

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IAG Group Capital Expenditure

2011 plans

2012 plans Current 2013 plans

retain and con nue to gain addi-onal unit revenue benefits with ex-

pecta ons of a 1-2% increase a yearin terms of revenue per ASK – thiscould produce addi onal profit of£100-150m on short haul opera onsand £150-200m on long haul, £130mhigher in total than the company hadoriginally targeted;( In 2015 it will consolidate all theT1 opera ons into T3 (following thebmi purchase, the airline is operat-ing at three terminals at Heathrow),which will allow it to “unlock” theright aircra on the right route andto improve customer service.

The company states that it has anoverall aim of genera ng returns inexcess of its 10% pre-tax cost of cap-ital at each of the three London air-ports – Heathrow, Gatwick and Lon-don City – and for both long haul andshort haul. It does not normally pro-vide airport-level informa on in de-tail, so for outside observers successwill be difficult to corroborate.

However, perhaps disturbingly, itappears that there will be a some-what higher overall growth in BA’s ca-pacity of 6% in 2014 compared withthe average 2-3% medium term tar-get and near flat growth this year.(This is somewhat similar to thegrowth plans at Lu hansa for next

year – see Avia on Strategy Octo-ber 2013). However, the companyexplained it almost ra onally and thecore network growth is seen at 2.8%– almost en rely long haul (see chartabove).

On short haul opera ons BA didsay that it expects to break even inthe current year compared with aloss of £120m in 2012 and impliedthat it is aiming to generate profitsin this sector of £150m within twoyears. It may be able to do this. Over-all capacity growth in this sector isset to be up by only 0.5% in 2014.It is focusing on point to point ser-vices while maintaining the transferrate at LHR and improving connec-on poten als at LGW (without em-

phasising that airport as a hub). Itwill be removing the last of the 737Classics from the fleet in 2014 leav-ing a short haul fleet almost en relyconsis ng of A320s at LHR and LGW,and Embraers at LCY. At LCY, BA isnow the largest operator, and is ben-efi ng from the weak compe onprovided by financially challengedAirFrance affiliate CityJet.

Joint Ventures

As usual it is difficult ge ngprecise figures on the performanceof the joint ventures. On the At-

lan c “Joint Business” with Ameri-can, Iberia and Finnair, BA stated thatin the three years since launch it hadseen:

( Overall capacity up by 12.5% (oran average 4% pa);( Revenue increase of 31.5% andunit revenue improvement of 17%;( An improvement in premiummarket share of over three percent-age points, and in premium loadfactor of nearly seven points;( A one point increase in non-premium market share.

The company also highlightedthat two of the new routes it willbe opera ng next year (to San Diegoand Aus n, Texas) were only madepossible because of the immunisedjoint venture with American.

There was li le comment on its“Siberian JV” with JAL and Finnairexcept that it was genera ng rev-enue benefits especially in codeshares through Narita and Haneda(although probably not hugely sig-nificant given the weakness of theyen). Management hinted that withLATAM plumping to join oneworld(TAM and LAN Columbia join the GBAin March 2014) there might be anopportunity to develop a JV on theSouth Atlan c. It s ll trying to find apartner in China.

Joint ventures are not necessarilyimmutable. A er Qantas shi ed alle-giance to Emirates and dissolved thelong established JV with BA on theKangaroo route, BA stated that it hadbeen able significantly to improve re-turns on the route: it cut capacity by11% and saw unit revenues jump by29%.

Iberia – Transforming Spain

The new Iberia CEO, Luis Gallego,gave a fairly convincing presenta onon how he will transform the di-



nosaur of the Spanish flag carrier andachieve reasonable levels of prof-itability, even if it might not quite getthere by 2015. At the capital marketsday last year, Iberia had stated thatits priority objec ves were to stopopera ng cash burn by mid 2013,build a compe ve cost base for thelong term and to fund the transfor-ma on en rely from within its ownresources.

Between 2008 and 2012 Iberiahad seen its cash pile of €2.9bnshrink to €808m with losses over theperiod of €800m, fleet spending of€700m and early re rement packagepayments of €600m.With a return toa li le be er than break-even in thesummer it might have been able tohalt the cash ou low, but there is ob-viously a long way to go to turn thebusiness around.

In 2013 the company dras callyrestructured its network opera ons.It cut some 17 short haul and fourlong haul routes from its network(along with 20 short haul and threelong haul aircra from its fleet).Route op misa on targeted unprof-itable short haul routes with lim-ited feed poten al and the long haulroutes that were unprofitable andhad no strategic fit, resul ng in anoverall 15% reduc on in capacity.

That was the easy bit. One of thebig difficul es is dealing with the un-compe ve cost structure, employ-ment levels and bloated legacy edi-fice. It is not necessarily that its unitcosts are too high in comparisonwithpeers – ex-fuel unit costs are in factsome 10% below peers on long hauland 15% below legacy peers on shorthaul – but being based at the bot-tom of an inbound tourist well it iscompe ng on routes where the unitrevenues are significantly lower. It isthis gap betweenRASK and CASK that

causes the damage.A empts to restructure the

staffing levels and short haul op-era ons have been fraught withlegal restric ons. Iberia Express waslaunched two years ago designed tobe a lower cost and more efficientshort haul operator than the mainline. This led to union ac on anda government-imposed arbitra-on procedure which generated a

judicial resolu on (“laudo”) thatsignificantly limited Iberia Express’ac vi es. Iberia appealed againstthe judgement as well as a newlaudo with similar restric ons. A erthe announcement of the newrestructuring plan in 2012 and alack of agreement with unions,Iberia unilaterally ini ated collec vedismissal procedures, which againled to strikes but this me a volun-tary media on agreement signedby the company and a majority ofemployees.

The media on agreement didnot quite go as far as Iberia wantedbut allowed for over 3,000 redundan-cies (or 15% of the workforce); a 14%cut in salaries for pilots and cabincrew and a 7% reduc on for groundstaff; an addi onal 4% wage cut un-l produc vity measures are agreed;

salary and tenure freeze un l 2015.So far the company has shed 2,300out of 20,600 jobs (excluding some130 naturalwastage). It is currently innego a ons with the unions for longterm agreements to obtain signifi-cant produc vity improvements forthe exis ng flight and cabin crew,introduce new salary scales and re-move the imposed restric ons onIberia Express.

Commercial turnaround

Just cu ng costs will not be goodenough and the company outlinedsome of the elements it has in place

to try to transform the Iberia prod-uct, customer experience and rev-enue genera on.

The Iberia long haul productwas recognised to be a bit “ red”with sub-standard business class andeconomy offering on long haul lead-ing to a lowoverall customer sa sfac-on in comparison with major peers.

At the beginning of 2013 the com-pany started rolling out a new gener-a on full-flat business class seat onlong haul and significantly upgradedeconomy product including the nowstandard individual IFE on its newA330s. It has already seen a strongincrease in customer sa sfac on onthe new aircra and this new in-flightproduct will be fi ed on the eightnew A330s to and will be retrofi edon the 17 exis ng A340s.

The company is introducing someprofound changes in revenue man-agement. Iberia had some surprisingprocedures; last year were we toldabout a habit of emphasising loss-making short-haul to short-haul con-nec ons. This year we discover thatthey had had such a rigid approachto high season bookings that over-all there was only a 5% differen albetween high and low season yields,while they also had far too many FFPredemp on seats available on toomany of the routes which normallyhave over 90% load factors. Changingthe approach has resulted in posi veunit revenue performance of 2.5% inQ2 2013 and 6% in the summer sea-son.

One of the biggest changes is theintroduc on of a new brand iden-ty and paint scheme – last changed

in 1977. Naturally the brand launchcomes with the usual marke ng gob-bledegook: “... represents our corevalues Afinidad, Empuju, Talento”and is designed to emphasise the



LCC ex-fuel unit costs

0

1

2

3

4

5

6

7

8

Ryanair

Vueling

easyJet

norwegian

airBerlin

€¢/ASK

2.22

4.14 4.264.56

7.15

Source: Vueling. Note: adjusted to VY stage length

Spanish nature of the brand. Iberiain part is using this as a catalyst (asBA itself has done in the past) to in-vigorate and change the corporateculture. It will be imposing a radicaltransforma on in its managementteam: slimming down with a signifi-cant reduc on in numbers and a newmanagement style, simplifica on ofthe organisa on structurewith fewerrepor ng levels and a drive to recruitaddi onal skills from outside the ex-is ng company.

Vueling – emphasis on costdiscipline

Alex Cruz, CEO of Vueling, gavea presenta on on the group’s newlyacquired LCC. He emphasised the vi-sion:

( Cost discipline: targe ng unitcosts ex fuel below €4c/ASK in theshort run, with a con nuing annualcost savings programme( Profitable growth: with a currentfleet of 70 A320s it has plans to ex-pand to over 100 aircra in 2015.It is increasingly focusing on non-Spanish markets and aims to expandmarket presence at key European air-ports. It helps to be market leader in

Barcelona with a 36% share.( Product and innova on: a hybridLCC with “business-class” sea ng inthe front four rows of the aircra ,preferring main airports (and avoid-ing direct compe on with Ryanair)and providing mul ple sales chan-nels. With a strong O&D networkin Barcelona, it also prides itself onopera ng a “profitable and sustain-able model of transfer passengers”– with over 11% of the total pas-sengers connec ng between Vuelingflights in 2013 (16% of the Barcelonatraffic) – while not shying away from(profitable) interline and code shareagreements.( Efficient opera on: Quickturnaround, high u lisa on, singleaircra type, high punctuality. Itstates it achieves 90% customerrecommenda on levels.

Vueling is growing very strongly.It has doubled the size of its oper-a on in the last five years and nowoperates 70 aircra and carries 17mpassengers (12m through Barcelona)on 222 routes connec ng 107 des -na ons in Europe. It prides itself onhaving achieved an opera ng profitin each of the past five years (al-

though profits fell from €2m per air-cra in 2009 to €0.5m per aircra in2012). This year it is expanding ca-pacity and traffic by 25% year on yearand has 62 A320s on order with 58op ons. Despite its size and its hy-brid business model it has an under-lying ex fuel unit cost not too dissimi-lar from either easyJet or norwegian.

It is of course above Ryanair,which just annouced new bases atBrussels Zaventem and Rome Fiumi-cino directly compe ng with Vueling.

One of the major benefits toVueling from being within the IAGstable should be in cost of aircraownership. All its fleet is leased and,although no doubt arranged on thebest terms it could achieve, the com-pany should be able to use the hold-ing Group’s balance sheet and nego-a on power to reduce the net input

cost.

Outlook

All the three major networkgroups in Europe are essen ally pur-suing the same strategy – to returnto a reasonable level of profitabilityin 2015 that more than covers thecost of capital. Each needs to recoverprofitability on short haul opera onswhich have seen severely nega veresults in the past few years. Each ispursuing similar methods, in par c-ular trying to keep capacity growthlow. There are some concerns thatthis “discipline” may slip a li le fordifferent reasons in 2014. IAG hasone major benefit in comparisonwith either LHAG or Air France-KLM:BA’s base at London Heathrow withits vastly superior O&D point topoint traffic base. The IAG team gavea convincingly encouraging viewthat the group will achieve its 2015targets.



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E had Des na ons

E had route networkT E had Airways onlystarted opera ons in November

2003, just 10 years later the flagcarrier of the Abu Dhabi is one ofthe “Big Three” airlines in the Gulfstates – and it is differen a ng fromits rivals through a series of minorityequity investments in airlines aroundthe globe made over the last twoyears.

For the first three years of its ex-istence E had’s growth was steady,if unspectacular, but the pace pickedup from September 2006 whenJames Hogan was appointed chiefexecu ve and president. His strategyincluded what he calls a “forensicapproach to cost control” alongsidenew aircra orders for long-termgrowth and the crea on of essen-ally a virtual global alliance through

codeshares and minority equitystakes.

The results have been promising.E had recorded its first-ever full yearprofit in 2011, and in 2012 the airlineposted revenue of $4.8bn, 17% upon 2011, with EBIT of $170m (a 24%increase on 2011) and a net profitof $42m (compared with a $14m

net profit in 2011).E had carried 10.2mpassengers in 2012,23% up year-on-year.

In the first ninemonths of 2013 E -had recorded revenueof $3.8bn, 9.3% up onJanuary-September2012, based on a 13%rise in passengerscarried to 8.6m. (Noprofit figures arereleased in its quar-terly reports). Cargoaccounted for morethan 17% of total revenue for E hadin Q1-Q3 2013, with cargo tonnagehandled rising by 30% year-on-yearin the period. E had Cargo nowhandles around 90% of all air cargocoming to and from Abu Dhabi, andthe E had freighter fleet comprisesthree A330-200Fs, three 777-200Fsand three 747Fs.

E had currently employs 16,258,with 12,614 of those in the passen-ger airline, of which 1,531 are pilotsand 3,776 are flight a endants. Theother 3,914 are employed in E had

Airport Ser-vices, comprisingGround, Cargoand Cateringposi ons.

Unsurprisinglyavia on is a “crit-ical clusterindustry” inthe Abu DhabiPlan 2030 – theEmirate’s long-

term plan for growth and economicdiversifica on. E had is already akey contributor to the Abu Dhabieconomy – its analysis shows that itcontributed $10.7bn to Abu Dhabi’sGDP directly and indirectly in 2012,represen ng 10.5% of the non-oilGDP of the Emirate. Interes nglyonly around 20% of the 7,000 E hademployees based in the Emirateare actually UAE na onals, whichshows just how “interna onal” theairline is. This year E had opened anew headquarters for the whole ofEurope in Berlin, which followed theopening of its fourth global contactcentre in 2012, in Manchester, whichserves customers in 19 markets 24/7with a staff of around 200. And aspart of its efforts to target the AITmarket, this year E had Holidayslaunched its first opera on outsideof the Middle East – in the UK,offering holidays in Abu Dhabi city,Saadiyat Island and Yas Island.

Today E had operates to 96 des-na ons directly (see chart le ), in


Etihad Airways:Carving out a distinct identity


0

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2006

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Q32013

2020F

E had Fleet

E had FleetFleet Orders

A320 family 20 51A330 25A330-200F 3 2A340 12A350 62A380 10747F 3777-200F 3777-300ER 17 2777-8/9X 25777F 1787 71Total 83 224

62 countries across all con nents inthe world. In the first three-quartersof 2013 new routes were launchedto Washington DC, Amsterdam, SaoPaolo, Belgrade, Sana’a (Yemen) andHo Chi Minh City, with a route to LosAngeles set to launch in June 2014.

Fleet growth

Underpinning the organic growthin the network has been a huge air-cra order announced in July 2008at Farnborough, when orders and op-ons were made for more than 200

aircra worth $43bn at list prices(100 firm orders, 55 op ons and 50“purchase rights”).

At the end of the third quarter2013 E had’s fleet stood at 83 air-cra – 50 of which are Airbus mod-els and 33 Boeing aircra (see tableabove) – and with an average ageof 5.5 years. At the same date morethan 80 aircra were on firm order,including 41 787s, 15 A320 family air-cra , 12 A350s and 10 A380s. TheA380s and 787s are scheduled for de-livery from the end of 2014, and allthose 80 aircra are to be deliveredby 2020, by when the fleet will haverisen to at least 159 aircra .

In October this year E had alsosigned a deal to buy five 777-200LRsfrom Air India for a price reported tobe between $300m to $350m. Theaircra (of which less than 60 weremanufactured) have an average ageof six years and will be delivered toE had from the start of 2014, and af-ter a refit to E had’s standard threeclass cabin configura on the first air-cra will enter service in April 2014.

They will be used on E had’snew route between Abu Dhabi andLos Angeles, announced this Octo-ber andwhich launches in June 2014.E had currently flies to New York,Chicago, Washington DC and TorontoinNorthAmerica (with load factors ofmore than 80% it is believed), and itis keen to add further services to thecon nent, with Hogan predic ng an-other route to the US will start be-fore the end of 2014. E had’s ambi-ons for the US are being helped by

the US government’s agreement tolaunch “pre-clearance customs facil-ity” in Abu Dhabi from this Decem-ber. Elsewhere new routes to India,Europe and south-east Asia are ex-pected to be launched through 2014,with a ra of new services inevitableonce the new 787s and A380s startarriving.

For the period post 2020 E had(at the Dubai air show in Novem-ber) announced two addi onalorders: one for30 787-10s,17 777-9Xs, eight777-8Xs and asingle 777F, pluspurchase rightsfor another 26Boeing aircra ;and one for 50A350 XWBs, 36A320neos andone A330-200F.

These orders for 143 new aircrabring E had’s total order book to astaggering 224.

E had’s global opera ons arecentred on its hub at Abu Dhabi (thecapital of the UAE), which though ithas to compete with Emirates’ hubat Dubai and Qatar’s at Doha is s ll alarge facility by world standards. AbuDhabi Interna onal Airport opened asecond runway in 2008, followed bya new Terminal 3 in 2009, which isexclusively used by E had. These de-velopments increased the airport’scapacity from five to 12m passen-gers a year, but further expansion isplanned.

A “Midfield Terminal Complex”(so-called because it’s located be-tween the two exis ng runways) willhave around 1.4m squaremetres andis due to be completed in the thirdquarter of 2017 at a cost of $3bn, andwhich will increase the airport’s ca-pacity to more than 30m passengersa year ini ally and up to 40m passen-gers in future years a er further ex-pansion.

Nevertheless, E had is clearlysmaller (and younger) than its keyGulf rivals – Emirates carried 39.4mpassengers in the 12 months toMarch 2013 andQatar carried 18m inthe same period, compared with E -had’s 10.2m passengers in 2012.



Clear blue water

Yet E had is undaunted by itstwo larger Gulf rivals, and underHogan E had is a emp ng to putsome clear blue water between itand Emirates and Qatar strategi-cally. There are already some keydifferences. Unlike Emirates’ en relywidebody fleet, almost a third ofE had’s non-cargo aircra are nar-rowbodies, which creates feed intolong-haul routes out of Abu Dhabi– though the propor on of narrow-bodies is not as high as at Qatar Air-ways (where 37% of its passenger air-cra are narrowbodies).

However there are other differ-ences between E had and Qatar –most notably being that unlike Qatar,which has just joined oneworld, E -had is pursing global reach through awide and expanding series of minor-ity airline investments.

Since late 2011 E had hassteadily built a por olio of invest-ments in others airlines, whichinclude:

( A 29.2% stake in airberlin, boughtin December 2011 for an ini al in-vestment of $105m. At a further costof $200m in equity and debt financ-ing E had also has a 70% share in anew joint venture that controls air-berlin’s FFP scheme, called topbonus,with airberlin owning the other 30%.( A 40% stake in Air Seychelles, ac-quired in January 2012 for $20m andshareholders’ loan of $25m, and ac-companied by a five-year manage-ment contract.( A 3% stake in Aer Lingus, boughtin May 2012, which E had says is“with the inten on of forging a com-mercial partnership with the Irish na-onal carrier”.

( In August 2013 E had starteda five-year management contract ofAir Serbia (the former JAT Airways),

as part of a deal with the Serbian gov-ernment to acquire 49%of the airlinein January 2014.( In October this year E had in-creased its stake in Virgin Australiafrom 10.5% to 19.9%, which is themaximum allowed by Australia’s For-eign Investment Review Board thatconvened in June 2013. E had andVirgin Australia signed a 10-yearstrategic partnership in August whichincludes codesharing, joint sales andmarke ng FFP links. Currently E had(25) and Virgin Australia (3) operate28 flights a week between Abu Dhabiand Australia.( In November this year E had an-nounced the acquisi on of a 33%stake in Swiss regional airline Dar-win Airline based in Lugano, whichit said would be the first carrier tobe re-branded as E had Regional, tobe used to “join the dots” for it andits partners in Europe and to connectter ary ci es.

Combined, these six investmentsgive E had stakes in airlines with 430aircra opera ng to 412 des na onsand carrying more than 45m passen-gers a year.

E had also has 185 interlineand 46 codeshare deals with airlinesround the world (in the third quarterof 2013 codeshareswere agreedwithSouth African Airways, Air Canada,Belavia and Korean Air), which E hadsays provide access to more passen-ger and cargo des na ons than anyother airline in the Middle East.

Indian opportunity

E had has also agreed a deal tobuy 24% of India’s Jet Airways foraround $380m, though this is subjectto regulatory approval from the Com-pe on Commission of India. Thise-up ini ally appears more risky

than anything E had has done be-

fore – Jet has made a loss for thelast six years and reported a recordnet loss of $145m in the third quar-ter of 2013. Addi onally the Indianavia on industry is going through atroubled period at the moment, withall four of its listed airlines report-ing losses or (in the case of KingfisherAirlines) suspending opera ons. E -had is also reportedly inves ng an-other $150m in Jet’s FFP, $70m fora sale and leaseback deal for threepairs of Heathrow slots, and as muchas $150m of loans to shore up the Jetbalance sheet. And in order to turnJet Airways around and make a sig-nificant contribu on to E had’s bot-tom line the UAE carrier will haveto devote considerable managementme to its Indian investment – Indian

sources say that E had has promisedthat four of itsmost senior execu veswill take posi ons at Jet, includingWilly Boulter, VP commercial strat-egy and planning, and Rangesh Em-bar, VP finance.

However, it’s no coincidence thatQatar Airways is also reportedly innego a ons to buy a minority stakein SpiceJet, the Indian LCC, becausean opportunity for Gulf airlines to be-come involved in the Indian markethas appeared thanks to the Indiangovernment’s decision to allow for-eign airlines to acquire up to 49%stakes in its carriers combined with anew air services agreement betweenIndia and the UAE that was finally ap-proved in September – a deal thatincreases seats between the two re-gions nearly four-fold to 50,000 aweek over a period of me.

It’s an opportunity that E hadand others are keen to exploit giventhe huge economic links between theregions. According to the Indian min-istry for commerce and industry, bi-lateral trade between India and the



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We welcome feedback from subscribers on the analyses contained inthe newsle er. If you would like to suggest a company or a subject that

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UAE alone is es mated to be worthmore than $75bn in 2013 – a stagger-ing figure, and undoubtedly the fac-tor behind a ra of new UAE invest-ments in India, including property,port facili es, hospitals and – now –airlines.

Hogan says that E had’s equitypartnership strategy is primarilydriven by that effect it has on thebo om line: “Our equity partnersprovide significant contribu ons toour business and not just in termsof the revenues they deliver. Theagreements provide us with greatereconomies of scale, increased pur-chasing power and the ability toleverage synergies. We have enjoyed

coopera on on fleet orders, deliver-ies and management, as well as jointpurchasing in areas ranging fromfuel to insurance to in-flight cateringand equipment. It’s about workingsmarter to deliver lower unit costs.”

The strategy appears to be work-ing. In the third quarter of 2013 E -had says that revenue from code-share and equity alliance partners to-talled $247m – 36% higher than Julyto September 2012 – and represent-ing a substan al 23% of all passengerrevenue at E had in the quarter.

Hogan adds that “it’s easier,faster, and far more cost effec vefor E had to grow through one-on-one partnerships with established,

respected, carriers than to rely onits own resources and to start fromscratch in every market”, and E hadis clearly on the look-out for otherequity investments, though Hoganinsists the “equity model will con-nue to be about growth, not con-

trol”.

What is the real strategy?

The scep cal view is that the de-velopment of minority equity stakeinvestments looks increasingly likethe Swissair “Hunter” strategy of thelate 1990s. Speaking at the GAD con-ference in Nice at the beginning ofNovember, Hogan denied this, em-phasising that the aim is to build astrategy to drive traffic over the hubin Abu Dhabi to give a network that iscompe ve with and differen atedfrom his neighbouring Gulf compe -tors.

In addi on, E had is not tak-ing management control, even wereit allowed, but adding managementteam exper se and board level rep-resenta on hoping to strengthen theexis ngmanagement’s ability to gen-erate returns. Ul mately perhaps thedecisions on investments reflect E -had’s own shareholder’s interests, in-cluding a diversified long-term use ofits oil revenues.


http://www.aviationstrategy.aero/contact_us


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A a four-month delay causedby the DoJ’s an trust lawsuit,

American and US Airways expectto close their merger on December9th, enabling AMR to emerge fromChapter 11 and crea ng the world’slargest carrier. The new company,to be known as American AirlinesGroup, will trade on the Nasdaq un-der the symbol “AAL”.

The final legal hurdles werecleared on November 27th, whenthe bankruptcy court handlingAMR’s Chapter 11 case approved theNovember 12th agreement betweenAMR, US Airways and the DoJ tose le the DoJ’s August lawsuit thathad sought to block the merger. Thecourt also ruled that the merger maybe consummated despite a pendingprivate an trust lawsuit from agroup of consumers.

The DoJ se lement came abouta er considerable pressure frommany quarters (labour, businessleaders, etc), the Texas A orneyGeneral dropping out of the DoJlawsuit on October 1 and with the

trial date approaching (November25). By all counts, it was a reasonablese lement, and all par es seeminglywalked away happy.

The DoJ secured what can onlybe described as unprecedented slotdives tures. American and US Air-ways agreed to divest 52 daily slotpairs at Washington Reagan Na onal(DCA) and 17 slot pairs at NewYork LaGuardia (LGA), as well as twogates and related facili es at eachof Boston Logan, Chicago O’Hare,Dallas Love Field, Los Angeles andMiami (slots only exist at four USNortheast airports). The dives tureswill be made available to LCCs af-ter the merger closes through a DoJ-approved bidding and sale process.

The slot dives tures will mean a15.2% reduc on in the two airlines’combined daily round trips at DCA(from 290 to 246, excluding eight slotpairs currently leased to JetBlue) anda 7% reduc on at LGA (from 175 to163, excluding five slot pairs alreadyleased to Southwest).

By comparison, United and Con-

nental got away with having to giveup only 18 slot pairs at Newark,where the DoJ had similar concernsabout compe on. United was leholding 75% of the slots at Newark,whereas a er the dives tures thenew American will account for 57%of the slots at DCA – only marginallymore than the 55% share currentlyheld by US Airways.

Therefore the DoJ felt that itachieved its key objec ve of secur-ing LCCs significantly improved ac-cess to capacity-constrained airports– something that has to be good forcompe on and consumers in thelong run.

When the DoJ filed its lawsuit inAugust, many were puzzled by thatdecision because it seemed like therules were being changed in the mid-dle of the game. But the reason is be-coming clear. According to an trustlawyers, before the lawsuit AMR andUS Airways were prepared to give upnothing. So, the DoJ has succeededin “extrac ng changes from an indus-try that had come to expect that itsmergers would never be challenged”(as a Reuters ar cle put it).

But American and US Airwaysnow feel that, in the great schemeof things, the dives tures are a rela-vely small price to pay. Their busi-

ness plan was based on 6,700 dailydepartures in 50-plus countries anddid not rise or fall on a dives tureof 112 daily departures or a 15% re-duc on in service at one airport. Be-sides, the new American is retainingits dominant posi on at DCA.

The airlines have agreed sepa-rately with the DOT to con nue to


American-US Airways merger:Can it deliver promised benefits?


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use all of their current DCA com-muter slots for service to smalland medium-sized communi es. An-alysts do not consider that an oner-ous commitment because most ofthose opera ons are believed to beprofitable.

The other so-called concessionsmade by American and US Airwayswere mostly poli cal gestures (to thestates that had joined the DoJ law-suit) that have li le impact on thebo om line. The airlines have agreedto maintain their primary hubs “con-sistent with historical opera ons” forthree years (something they wantedto do anyway) andmaintain daily ser-vice in a number of markets for fiveyears.

All in all, the se lement is ex-pected to have no material impacton pro forma earnings or the mergersynergies. The new American is s llexpected to generate the originallyes mated $1bn-plus in annual netsynergies beginning in 2015.

Industry implica ons

There is a strong and broad con-sensus that the DoJ se lement andthe AMR-US Airways merger gener-ally will be beneficial for the US air-line industry, the US economy andmany local communi es.

However, long-term consumerbenefits in the US domes c marketare uncertain, and obviously notevery LCC will benefit – the reasonswhy the consumer lobby and carrierssuch as Virgin America are notcelebra ng.

The main benefit of the AMR-USAirways merger is that it will lead tothe US having three powerful globalcarriers of roughly equal size. Ameri-can’s pilot unionAPAput it very aptly:“The merger will remedy American’slongstanding network shor alls andput American on equal foo ng withDelta and United.”

While Delta and United will facea stronger compe tor, that will bemore than outweighed by the bene-fits of having fewer domes c playersand hence more ra onal industry ca-pacity and pricing.

Largely because of the earliermergers and Chapter 11 restructur-ings, the past five years have seenvery healthy trends in the US airlineindustry: ght capacity, ra onal pric-ing, higher yields, vastly improvedprofitability and ROIC goals being in-creasingly achieved. Even though theAMR-US Airways merger is not ex-pected to lead to a significant reduc-on in domes c capacity (because

of the complementary networks), it

should help maintain capacity disci-pline. The financial community seesAMR-US Airways as the final majorcomponent in achieving what Fitchhas described as a “more sustainableindustry structure”.

US LCCs will benefit from both amore ra onal domes c capacity en-vironment and the growth opportu-ni es resul ng from the dives turesand the new American’s likely exitfrom some smaller markets as thenetwork ra onalisa on gets underway.

The biggest beneficiaries of thedives tures are likely to be the twolargest LCCs, JetBlue and Southwest.JetBlue, which has been building ser-vice at both DCA and LGA, issueda press release saying that it ap-plauded the DoJ se lement and was“eager” to increase service especiallyat those two airports. Southwest hasa history of bidding aggressively forslots, and CEO Gary Kelly said re-cently that the carrier was “abso-lutely” interested in more slots atDCA and LGA.

Spirit Airlines can also be ex-pected to bid for slots, especially atLGA. Allegiant has said that it wouldconsider any opportuni es, but thereare no obvious ones here for a car-rier with a niche business model thatfocuses on smaller ci es. And sadly,there may not be anything muchthere for Virgin America, which hasin the past found it tough to secureaccess to busy airports such as JFK,O’Hare and Newark.

Virgin America actually wentpublic with its opposi on to theAMR-US Airways merger just oneday before the DoJ se lement wasannounced. The carrier had just wonpermission to present its case to theNovember 25 court hearing. It hadplanned to argue that the mergerwould solidify already considerable



impediments to new entrants andthat any se lement focusing onDCA and LGA slot dives tures wouldbe inadequate. Virgin America isunlikely to be interested in LGAbecause of the perimeter rulesprohibi ng flights to Los Angeles andSan Francisco. It remains to be seenif it is interested in any of the gatesthat will become available at Logan,O’Hare, Love Field, LAX and Miami.

Uncertain consumer benefits

US consumer organisa ons havenever liked this merger because they(correctly) note that a reduc on inthe number of airlines tends to leadto higher fares. A May 2013 study bythe Boyd Group found that the av-erage true price of a one-way cketin the US has increased by 30% since2008.

From the consumer viewpoint,one problem in the US has beenthat the two largest LCCs, Southwestand JetBlue, have begun to behavetoo ra onally. They have stopped ordrama cally slowed growth, stoppedaggressive discoun ng and beguncour ng higher-yield traffic, with theaim ofmaintaining healthy profitabil-ity and maximising shareholder re-turns.

Then again, having a healthy andprofitable airline industry, including asizable and diverse LCC sector, is alsogood for the consumer in the longerrun. There are plenty of airlines le inthe US to ensure robust compe on.

But the slot and gate dives tures,while impressive compared to previ-ous mergers, are unlikely to “dramat-ically enhance the ability of low-costcarriers to compete systemwide”,as the DoJ’s An trust division sug-gested.

Impact on compe on and fareswill depend on the market. Ana-lysts have made the point that since

LCCs tend to focus on large leisure-oriented markets, the DCA and LGAslot dives tures may end up benefit-ing travellers on routes such as Or-lando but ul mately reduce the levelof service to smaller ci es and evenlarger ones such as Raleigh/Durhamand Minneapolis.

Delta has cleverly put itself for-ward as a remedy for such serviceshi s, arguing that it should be al-lowed to bid for slots especially atDCA, because it could ensure con n-ua on of nonstop flights to small andmid-sized ci es. The argument hassome merit, but the DoJ is expectedto rule that only LCCs are eligible tobid.

AMR’s financial turnaround

A er incurring adjusted netlosses totalling $11.2bn in 2001-2012, including a $1.1bn loss in2011 and a $130m loss in 2012, andhaving been in Chapter 11 sinceNovember 2011, AMR has at laststaged a financial turnaround thisyear.

The latest quarterly results sug-gest that AMR is now in great shape.Its 3Q13 net profit was $289m, con-tras ng with a $238m net loss in3Q12. The $530m adjusted net profitwas a new quarterly record. Operat-ing margin was an excellent 10.4%– not in Delta’s league (15.9%) andlower than US Airways’ (12.1%), buteasily bea ng UAL’s 7%.

The turnaround has been drivenby the restructuring efforts. Labourcosts fell by 13.3% year-on-year.Mainline ex-fuel CASM was down by5.4% – the fi h consecu ve quar-ter of unit cost reduc on. AMR alsoenjoyed “solid revenue momentum”.Its transatlan c RASM rose by 11.4%,which the airline a ributed to thesuccess of its joint business with BA,Iberia and Finnair.

In the past two quarters AMRraised almost $2bn in new term loansand $1.4bn through a private EETCoffering (the la er to refinance debt)– all at very low interest rates. As a re-sult, its cash reserves rose to $7.7bn(31% of last year’s revenues) and itsinterest expenses will be reduced.

AMR an cipates further profitmargin improvements from renego-ated vendor and supplier contracts

and through a be er matching of air-cra size to demandwith the deploy-ment of A319s and two-class RJs, be-ginning in 3Q.

AMR’s Chapter 11 has seencon nued ac ve fleet renewal. Themainline opera on is taking A319s,737-800s and 777-300ERs and re r-ing 757-200s and MD-80s. This yearwill see 59 new aircra added to theyear-end 2012 mainline fleet of 608,but because of re rements the fleetwill grow by only nine units (to 617).

AMR will now be repor nghealthy profits for 2013. BofA MerrillLynch’s mid-October predic on wasopera ng and ex-item net profits of$1.5bn and $919m and an opera ngmargin of 6%. Significantly, AMRwill be making an employee profit-sharing payment for 2013 – its firstin 13 years.

But it remains to be seen if andhow quickly the new American willbe able to close the margin gap withDelta and deliver the promised “sig-nificant value” to shareholders.

On the posi ve side, having se-cured unusually strong support fromlabour bodes well for labour in-tegra on. JP Morgan analysts alsosuggested recently that the deci-sion to migrate IT “upwards” toAMR’s more robust systems (con-tras ng with UAL-Con nental’s strat-egy) could “alleviate some of thetechnology hurdles”. Labour and IT



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integra on have been the toughestnuts to crack in recent mergers.

On the nega ve side, S&P sug-gested on November 12 that themain risk associated with the AMR-US Airways merger is that the in-crease in labour costs under newcontracts will come in higher thanthe management currently foresees.

US Airways has below-market labourcosts and con nues to experiencelabour strife.

Theremay also be a problem thatthe combined AMR-US Airways net-work, although very large, “will notbe quite as strong as those createdby the United-Con nental and Delta-Northwest mergers” (as S&P put it).

Others have noted that Delta andUAL are by now far ahead in termsof having captured corporate mar-ket share, making catching up amoredaun ng task for the new American.

By Heini Nuu nenhnuu [email protected]

A placing Europe’s largest eversingle aircra order in 2012,

Norwegian Air Shu le has firmly es-tablished itself as Europe’s third-largest LCC. But is Norwegian takinga huge risk by launching long-haulroutes this year as it chases ambi-ous long-haul expansion around the

globe?

Norwegian Air Shu le waslaunched in 1993 by former em-ployees of Fornebu-based BusyBee, which operated Fokker F50son domes c Norwegian routes onbehalf of Braathens un l it wentbankrupt in 1992. Norwegian tookover a small number of F50s andcon nued to operate the routes

for Braathens, but a er SAS boughtBraathens in 2001 the contract withNorwegian was terminated, and theairline relaunched itself as a LCC inApril 2002.

Based at Oslo Airport, Norwe-gian steadily developed its fleet awayfrom reliance on F50s, but it wasn’tun l the early 2000s that expansiontruly kicked in, with a lis ng on theOslo stock exchange in 2003, a firstprofit being recorded in 2005 andSwedish LCC FlyNordic being boughtfrom Finnair in 2007.

The airline has benefi ed bythe rela ve strength of Scandinavianeconomies compared with the restof Europe over the recent recession-

ary years. in the first three quar-ters of 2013 Norwegian saw revenuerise by 21% year-on-year to NOK11.8bn (€1.5bn), based on a 16%rise in passengers carried to 15.5m;RPKs rose by 29%, slightly behinda 30% increase in ASKs, with loadfactor falling marginally from 79%to 78.5%. In the 1Q-3Q 2013 pe-riod EBIT reached NOK 1.2bn/€151m(compared with NOK 455m in 1Q-3Q 2012), and the net profit totalledNOK 516m (€67m), 19% up year-on-year.

LCC model

Norwegian runs a classic LCCbusiness model: a single class (inshort-haul at least); internet book-ings accoun ng for 80% of all book-ings in the first three-quarters of2013; and with ancillary revenue(mostly from baggage and allocatedsea ng fees) contribu ng 11% of allrevenue in the third quarter of 2013(equivalent to NOK 90 – €11.8 – perscheduled passenger) – though this iss ll short of a targeted propor on of15%.

Norwegian currently operatesmore than 400 scheduled routes to124 des na ons in 38 countries.Revenue from interna onal traffic


Norwegian Air Shuttle:Long-haul a risk worth taking?


accounted for 78% of all revenue inthe third quarter, and this rose 21%compared with the same quarter in2012 – whereas domes c revenuewas almost flat year-on-year. That’slargely the result of a clear focusin interna onal expansion at theairline, with new bases, des na onsand markets being added over thelast 12 months, and partly becauseNorwegian has already built up adominant posi on in the domes cNorwegian market.

Whereas in 2002 SAS was es-sen ally the only op on for routeswithin Norway, by 2011 (the lastyear for which data is available) Nor-wegian Air Shu le carried 45% ofdomes c passengers to/from Osloin 2011, ahead of SAS. However,there is an interes ng sub-plot to do-mes c compe on in Norway. Nor-wegian Air Shu le only agreed tolaunch domes c Norwegian servicesfrom 2002 if the government pro-hibited frequent flier programmes onthose routes, which Norwegian ar-gued would prevent former SAS cus-tomers from flying with a new rival.The Norwegian government there-fore banned SAS from offering itsFFP on domes c flights – but earlierthis year SAS launched a challenge tothis ruling by offering its EuroBonusfrequent-flier program to domes cNorwegian flyers, arguing that ro-bust compe on between SAS, Nor-wegian Air Shu le and others meantthat the prohibi on of FFPs wasno longer necessary. Norwegian AirShu le responded by saying SAS’smove “looks like a blatant viola onof the law˝, but a er an inves ga-on by the Norwegian Compe on

Authority the ban on domes c FFPswas formally li ed in May.

Norwegian has been steadilystrengthening its market share at

the three major Nordic airports – inthe third quarter of 2013 its marketshare (in terms of all passengerscarried) at Oslo was 39% (comparedwith a 29% in Q3 2008), at Stockholm23% (10% in Q3 2008) and at Copen-hagen 17% (2% in Q3 2008). Addedto this are increasingly significantshares at other airports – outsidethe Nordic countries Norwegianoperates bases at London Gatwick,Malaga, Alicante and Las Palmas and,since October this year, at Tenerife.A fi h Spanish base will open atMadrid Barajas in the summer of2014, with two 737-800s sta onedthere to service six new routes, andwhich will entail the hiring of 100pilots and cabin crew locally.

At the three established Spanishbases – Alicante, Las Palmas and Al-icante – Norwegian had a 6% sharein Q3 2013 (compared with 2% inQ3 2008) while at London Gatwickit had a 6% share in the third quar-ter of 2013 (a er only launching abase there in the spring of 2013). AtGatwick passengers carried by Nor-wegian grew by 243,000 in the thirdquarter of 2013, accoun ng for al-most 90% of total passenger growthat the airport in the July to Septem-ber period. Unsurprisingly, Norwe-gian is a key advocate of the con-struc on of a second runway atGatwick.Fleet growth

Norwegian currently operates afleet of 80 aircra (with an aver-age age of 4.6 months) – 10 737-300s, 68 737-800s and two 787-8s,with an addi onal two A340-300swet leased from Portuguese leasingcompany HiFly.

The airline gave no ce of itsextraordinary ambi ons in January2012 when it placed an order for 222aircra , comprising 22 737-800s, 100

737 MAX8s and 100 A320neos. Cur-rently there are 264 aircra on firmorder – the 100 A320neos (being de-livered from 2016 onwards), the 100737 MAX8s (arriving from 2017), 61737-800s and three 787s.

The current fleet plan sees 84 air-cra by the end of this year, rising to95 at end 2014 and 102 in 2015. Bythe 2015 year end the fleet will com-prise five owned 737-300s; 89 737-800s (of which 51 will be owned, 13sold and leased-back, and 25 leased);and eight 787s (three owned and fiveleased).

Of the 737 fleet, the -800s aremost usually allocated to longerroutes to North Africa, the CanaryIslands and North Africa, and onshorter, high-density routes in Eu-rope. The 737 MAX is an interes ngchoice for Norwegian: it is more fuelefficient than the 737-800 (of which,for example, Ryanair ordered 175 inJune), so Norwegian is in effect bet-ng that the price of fuel will re-

main high so that the airline can fullyexploit the be er economics of theMAX.

Norwegian is well aware that itmay face s ffer compe on in the fu-ture from its fellow LCCs. Earlier thisyear Ryanair stated it was specificallytarge ng northern Europe for net-work expansion and indeed this win-ter launched routes between Stock-holm, Oslo and Karlstad to the Ca-nary Islands.

Long-haul ambi ons

On long-haul, the first two(leased) aircra from a total of eightincoming 787s (five to be leasedfrom ILFC and three owned) havealready arrived at Norwegian (thefirst aircra came in June), with onemore (the first of the owned aircra ,coming direct from Boeing) due



0.35

0.40

0.45

0.50

0.55

0.60

Apr-Ju

n 11

Jul-Se

p 11

Oct-Dec11

Jan-Mar12

Apr-Ju

n 12

Jul-Se

p 12

Oct-Dec12

Jan-Mar13

Apr-Ju

n 13

Jul-Se

p 13

NOK

Norwegian yield, unit revenue and unit cost

RASKCASK

RPK yield

before the end of the year, four in2014 and the last one in 2015.

Those 787s are eagerly an ci-pated by Norwegian as a delay intheir delivery forced the airline tolease A340s-300s for the first long-haul routes, which began in May thisyear from Oslo and Stockholm toNew York City and Bangkok. Routesfrom Oslo, Stockholm and Copen-hagen to Fort Lauderdale will launchin November 2013, and a whole raof services from the Nordics willlaunch through 2014 as the 787s ar-rive, including to the new des na-ons of Oakland, Los Angeles and Or-

lando from the spring of 2014. Long-haul services to North America willalso begin from London Gatwick inthe summer of next year.

However, it’s clear that theleased A340s are making the ini allong-haul routes substan ally loss-making for Norwegian, with BjørnKjos, the CEO of Norwegian (and aformer Norwegian air force pilot)admi ng that “before the 787 wecould not add up the figures to geta low enough cost and sufficientmargin against legacy carriers”.

Indeed, results in the third quar-ter of this year were affected sig-nificantly by the need to wet-leasethose replacement aircra , whichcost NOK 101m (€12.7m) in thosethree months and thus was a majorcause of a 31% fall in Norwegian’s netprofit to NOK 436m (€54.9m)in thethird quarter, despite a 15% rise inrevenue. Incidentally the other fac-tor affec ng the 3rd quarter resultswas warm summerweather in north-ern Europe, which hit holidays to theMediterranean region.

Put another way, according toNorwegian the leased aircra havea 50% higher fuel consump on perseat than the 787, and as the 787s

arrive they will save Norwegian NOK80m (€10.1m) per aircra per year(compared with a leased A340). Iron-ically Norwegian had to ground bothof its first two 787s briefly in Septem-ber and October to sort out sometechnical “glitches”, which have af-flicted 787s, but management con-siders this to be aminor setback only.

The incoming 787s are config-ured with 32 seats in Premium Econ-omy and 259 in Economy and are amajor factor in the significant 40% in-crease in capacity planned for 2014,along with larger 737s and increasedsector lengths on short-haul. Aver-age sector length for Norwegian asa whole is currently 1,260km, whichis a significant rise on the average1,048km length it had for the wholeof 2012.

For long-haul the strategy is athree phase plan – the first is expan-sion of Scandinavia to North Americaservices, to be followed by the addi-on of services from London Gatwick

next summer. Those Gatwick flightswill be very compe vely pricedagainst – for example – BA, says Nor-wegian, with the prime target beingholidaymakers and not business pas-sengers (with the Gatwick –JFK ser-vices being a three mes a week ser-vice only). The third phase will be an

expansion of Europe to Asia routes,once traffic rights are secured, withKjos hin ng that China and India arethe prime target markets for Norwe-gian. To support those long-haul am-bi ons Norwegian is highly likely toorder the higher capacity 787-9 inthe medium-term, it is believed, andthat order may even be placed asearly as next year.

Strategic stretch?

The obvious strategic ques on isjust how an LCC that operates inthe tradi onal Scandinavian environ-ment of high costs, taxes and strongunions can expand successfully into asignificant long-haul presence.

On the Scandinavian cost struc-ture, ini ally Norwegian has beencareful not to ques on “structuralnorms”, but more recently Kjos hasbeen challenging someof these, suchas by threatening to hire more for-eigners and basing aircra out of thecountry unless labour regula ons arechanged. Much of Norwegian’s backoffice infrastructure is already basedin east European countries; for exam-ple its IT department is run out ofUkraine.

As can be seen in the chartabove, unit costs have been fallingslowly but steadily as the scale of



0

50

100

150

200

250

300

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

NOK

Norwegian Air Shu le share price

Norwegian increases, and the targetis for a CASK of NOK 0.42 (€0.05)for the whole of 2013. In the thirdquarter CASK excluding fuel fell 7%year-on-year, and significant effortsare being made to reduce non-fuelcosts even further. These includeself check-ins/bag drops, automatedgroup bookings and streamlined op-era ng systems across the airline.

The overall CASK target for 2014is NOK 0.38 (based on current fueland currency forecasts for the year),and a key driver of that year-on-yearfall will be increased sector lengthsand larger aircra . Aswell as the 787sNorwegian will benefit from changesto its 737 fleet – through thewhole of2013 14 new 737-800s will be deliv-ered, which have 38 more seats thanthe 737-300 model that is graduallybeing phased out of the fleet.

Norwegian currently employsaround 3,000 people in Norway,Sweden, Denmark, Finland, Estonia,

UK, Spain and Thailand, and a newagreement between the airline andthe Norwegian Pilot Union (NPU)was agreed in November this year.The deal was significant as thisOctober Norwegian started to set upa new company structure to allowfaster growth interna onally.

With Norwegian Air Shu le ASAas a parent company two fully ownedsubsidiaries will be established, eachwith their own AOC – one based inNorway and one in the EU. Scandi-navian pilots are being transferred tothe Norwegian company (and keeptheir exis ng salaries and other ben-efits), while the EU companywill con-trol traffic rights as needed, withnon-Scandinavian pilots being em-ployed by that subsidiary.

Interes ngly Norwegian is reg-istering its 787s in Ireland to getaround the Norwegian law that re-quires all Norwegian aircra to op-erate with a solely Norwegian crew,

and it has been reported that Norwe-gian is in nego a ons tomove its op-era onal headquarters for all long-haul services to Ireland.

Financially, the airline is robust.Cash and cash equivalents rose ahe y 33% over the last 12 monthsto reach NOK 2.3bn (€0.3bn) as atthe endof September 2013, althoughlong-term debt rose by 16% in theyear to September 30 2013, to reachNOK 4.5bn (€0.6bn) – the majority ofthat increase coming from increasedaircra financing.

At the end of the 3rd quarter2013 the largest single shareholder inthe airline was HBK Invest (which iscontrolled by CEO Bjørn Kjos), with27%, followed by Folketrygdfondet(which manages the Norwegian gov-ernment’s pension fund), with 9.5%.A er that, no single shareholder hadmore than 4.1% of the airline. Finnairsold a 4.7% stake in Norwegian (ac-quired in 2007 as part of the sale ofFlyNordic to Norwegian) for around€53m in April this year.

Shareholders saw a rollercoasterrise in the share price from the IPOthrough to the end of 2011 (see chartabove le ), but since then the shareshad been on a strong upward pathun l May of this year, a er which(and coinciding with the launch oflong-haul routes) they have been ona steady decline. The share pricethrough 2014 will be a key indicatorof just how successfully the marketjudges Norwegian’s a empts to be-come the first European LCC to buildup a significant long-haul opera onhave been.



RJ VALUES (US$m)

NEW 5 years 10 years 20 years NEW 5 years 10 years 20 yearsold old old old old old

CRJ 900 27.7 20.3 Emb 175 24.7 18.2 11.7CRJ 1000 30 Emb195 31.7 24CRJ300-ER 35

S100-95 21.7

NARROWBODY VALUES (US$m)


A318 24.4 17.8 9.6 717-200 6.5A319 (HGW) 34.5 25.7 737-300 (LGW) 2.3A320-200 (IGW) 27.4 21.4 9.5 737-400 (LGW) 3.5A320NEO 48.5 737-500 (LGW) 2.5A321-200 (LGW,Sharklets) 48.7 737-600 (LGW) 10.7A321NEO 56.4 737-700 (LGW,Winglets) 23.7 18.2

737-700 (HGW,Winglets) 36.7737-800 (LGW,Winglets) 31.1 23.6737-800(HGW,Winglets) 47.2737-900ER 33.7757-300 (LGW) 15.2MD-88 1.1

WIDEBODY VALUES (US$m)


A300B4-600 (IGW) 6.4 747-400 (PW 4000) 30.9 15.2A310-300 (IGW) 3.2 747-800 167.6 4.8A330-300 (IGW) 36.1 767-300ER (LGW) 40 31.8 15.5A340-300 ER 30 777-200ER 98.8 78.6 58.3A350-800 129 777-300ER 164.5 132.1 99.8A350-900 134.5 787-800 111.8A380-800 (LGW) 206.9 164.1 787-900 125.8A380-800 (HGW) 217.5 MD-11P 9.3

Source: AVACNotes: As assessed at end-October 2013, mid-range values for all types

T following tables reflect the cur-rent values (not “fair market”)

and lease rates for narrowbody andwidebody jets. Figures are providedby The Aircra Value Analysis Com-pany (see following page for contactdetails) and are not based exclusively

on recent market transac ons butmore generally reflect AVAC’s opin-ion of the worth of the aircra . Inassessing current values, AVAC basesits calcula ons on many factors suchas number of type in service, num-ber on order and backlog, projected

life span, build standard, specifica-on etc.Lease rates are calculated inde-

pendently of values and are all mar-ket based.


Jet values and lease rates


RJ LEASE RATES (US$000s per month)


CRJ 900 219 177 Emb 175 208 170 131CRJ 1000 248 Emb195 261 219CRJ300-ER 287

S100-95 181

NARROWBODY LEASE RATES (US$000s per month)


A318 180 148 100 717-200 96A319 (HGW) 221 282 737-300 (LGW) 59A320-200 (IGW) 234 209 111 737-400 (LGW) 75A320NEO 382 737-500 (LGW) 47A321-200 (LGW,Sharklets) 385 737-600 (LGW) 101A321NEO 445 737-700 (LGW,Winglets) 207 168

737-700 (HGW,Winglets) 310737-800 (LGW,Winglets) 275 221737-800(HGW,Winglets) 351737-900ER 281757-300 (LGW) 143MD-88 42

WIDEBODY LEASE RATES (US$000s per month)


A300B4-600 (IGW) 94 747-400 (PW 4000) 332 205A310-300 (IGW) 73 747-800 1470A330-300 (IGW) 397 767-300ER (LGW) 371 352 233A340-300 ER 371 777-200ER 870 755 617A350-800 998 777-300ER 1542 1264 985A350-900 1104 787-800 868A380-800 (LGW) 1748 1485 787-900 973A380-800 (HGW) 1863 MD-11P 136

Source: AVACNotes: As at end-October 2013, lease rates assessed separately from values

AIRCRAFT AND ASSET VALUATIONSContact Paul Leighton at AVAC

(Aircra Value Analysis Company)

Website: www.aircra values.netEmail: pleighton@aircra values.net

Tel: +44 (0) 20 7477 6563Fax: +44 (0) 20 7477 6564



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Documents

Aviation Strategy issue #191, November 2013 · 2013-11-29 · 0% 2% 4% 6% 8%-0.3% 1.0% 1.5% 0.5% 0.5% 2.8% 2.0% 8.0% 2014 v 2013 Source:IAG creaseditsgearingtargets:debt(in-cludingleases)ofbetween50-60%of