Lufthansa Suffers, While Pobeda Shines

Madhu Unnikrishnan

June 7th, 2020

  • Lufthansa, as discussed in this week’s cover story, had an awful first quarter highlighted (or should we say lowlighted) by a negative 19% operating margin. The Lufthansa-branded passenger operation itself suffered a negative 23% operating margin. Swiss was much less bad at negative 9%. Austrian was a disaster (negative 47%). Eurowings was even worse (negative 53%). Brussels wasn’t much better (negative 27%).

    Flattering the groupwide bottom line was a slightly positive result for Lufthansa Technik, a giant provider of maintenance and repair services. Cargo and catering posted Q1 operating margins of negative 4% and negative 8%, respectively. As the feature story below explains, there’s a deeper degree of structural stress at Lufthansa, beyond the big shock administered by the Covid pandemic.
  • In Russia, Aeroflot started the first quarter with positive demand momentum. But it was no less affected by the Covid scourge than the rest of the industry, ending the period with a negative 11% operating margin, or negative 17% if you take out revenue from foreign airline overflight fees. Total Q1 revenues excluding these fees dropped 9% y/y, on 5% less ASK capacity. Operating costs also declined just 5%. Consistent with what other airlines are seeing, cargo was and continues to be a bright spot for Aeroflot.

    But the real shining star is Pobeda, its low-cost carrier. Even last quarter, it earned a positive 6% operating margin, growing its revenues 33% on 23% more ASK capacity. For all of 2019, recall, Pobeda earned a fantastic 19% operating margin, which if independent, would have tied it with Gol and Pegasus as the third-most profitable airline in the world (only Allegiant and Air Arabia were better).

    Pobeda in any case thought it best to suspend operations in April and May. But the LCC began flying domestically again on May 31, filling more than 90% of its 189-seat B737-800s right off the bat. Aeroflot sees Pobeda as “uniquely positioned to bring back capacity to the market thanks to its value proposition, appealing to cost-conscious passengers.” Aeroflot itself faces a tougher road to recovery given its exposure to intercontinental markets, and sixth-freedom markets connecting regions like Europe and northeast Asia, or North America and the Middle East.

    But it does have a large home market ripe for domestic expansion. In fact, Aeroflot plans to add some new domestic destinations this year, namely Chita, Orsk, and Yaroslavl. Markets served by its Aurora unit in Russia’s far east are less affected by Covid-related demand declines. That said, the virus is hitting Russia hard overall. Aeroflot and other Russian airlines did receive $118m in government subsidies, which isn’t much. More could be forthcoming, with Aeroflot eligible for extra help as a systemically important company to the economy.

    Speaking of the economy, lower oil and gas prices always mean trouble for Russia, though Aeroflot recalled how the 2015 oil bust saw Russians merely shift their international travel to domestic, rather than simply foregoing vacations altogether. In the meantime, the airline, which is 51% government owned, is busy cutting costs, securing more capital from Russian banks, suspending all advertising activities, and discussing aircraft deferrals with Airbus. It certainly doesn’t want any more A350s right now. It’s prior goal of taking 30 planes overall this year is no longer valid. Almost all of its planes, by the way, are leased rather than owned.  

IndiGo Bullish on Recovery, and Wizz Sees Opportunity

  • On May 25th, India’s national government allowed its airlines to restart a third of their domestic flights, with a host of new protocols and guidelines to prevent the spread of Covid-19. But some states within the country retained their flight restrictions, meaning carriers like IndiGo — as of last week — had only returned about one-fifth of their domestic flying. In its calendar Q1 earnings call last week, IndiGo said it’s eager to build back schedules. Flights it already restarted are about 70% full, and one route in particular — Delhi-Ranchi — is already making money (Ranchi is a hub for mining coal and other natural resources).

    The carrier’s outspoken CEO Rono Dutta, who once served as president of the U.S. giant United, said Indian family-visit traffic will recover rapidly despite the virus, joking that “Indians have family everywhere, and they’re like, ‘Hey, I don’t care if I die, I’m going to meet my sister or whatever.’”

    Looking back at last quarter, January and February were profitable, but March saw operating losses ex special items of $52m. That led to an $18m operating loss for the whole quarter, which translated to a negative 2% operating margin. Revenues rose 5% y/y on 4% more ASK capacity. Operating costs rose 12%, even with fuel costs up just 3%. IndiGo does not do fuel hedging, a “dumb idea” for airlines, according to Dutta. “Airline after airline has got burnt terribly… What the hell do we know about the commodity market?”

    Along with cheaper fuel, the airline is taking advantage of high cargo yields by converting ten of its A320s into freighters. In fact, it might even keep a dedicated cargo fleet even after the crisis ends. More importantly, IndiGo is experimenting with new network models for its core passenger business, and mindful of longer-term international opportunities as Gulf hubs — which gorged on Indian traffic — downsize significantly. Management does not, however, have any interest in buying another carrier. The immediate focus is cash and liquidity, as opposed to profitability and growth. But with hundreds of A320/21 NEOs still on order, IndiGo remains a long-term growth airline, with every intention of replacing its older-generation A320s.

    While cutting pay across the company and introducing unpaid leave options for workers, it retains enough staff to quickly scale up flying when demand merits and governments allow. About 40% of its costs are fixed, including aircraft rentals with lessors, which are critical business partners — “Our relationship with our lessors is very, very critical to us; it’s one of our core success factors.” But what about all the new costs associated with extra cleaning and other new health protocols? There will be some effect, including a roughly 10% to 15% increase in airport staffing costs to manage the additional tasks.

    But right now anyway, this is far outweighed by the sudden absence of airport and air traffic control congestion, normally a frustrating and expensive reality in India. Not having to circle around for lengthy periods while waiting to land in Mumbai means lower fuel costs, labor costs, and maintenance costs. In addition, some of the new procedures themselves actually lower costs, such as requiring all passenger check-ins to be done online rather than at the airport. The crisis separately led India’s aviation regulator to extend a deadline for replacing NEO engines that contained some early glitches (IndiGo has about 40 planes in which one of the engines still needs to be replaced). Long term, the airline remains bullish, comparing itself to Southwest in the U.S., which “took people out of cars.” IndiGo thinks it can succeed much the same as its planes “take people out of railways.”
  • It’s emerging as one of the brightest stars of the post-pandemic airline industry. Wizz Air, one of the most profitable airlines in the world before the crisis, has the cash, the business model, and the determination to become even stronger now. The carrier’s negative 10% operating margin last quarter shows that it’s not immune to the crisis. Last year, its margin for the offpeak period was slightly above break even.

    Recent months, frustratingly, have seen heavy fuel hedge losses, consistent with what other European airlines have experienced. Wizz was forced to suspend most of its flying in March, such that total ASK capacity for the quarter only increased 4% y/y, compared to a 22% increase in the preceding quarter (Q4, 2019). The ultra-LCC, owned by America’s Indigo Partners, saw revenues last quarter rise just 4%, while operating costs jumped 14%. But Wizz says it has enough cash to last it two years, even if it doesn’t carry a single passenger over that period.

    And that’s without any significant government aid. It’s one of the few airlines worldwide still getting rated as investment grade. It’s one of the few airlines honoring its original commitments with Airbus. And though it’s cutting jobs, it still plans to grow seat counts 10% this year as more A321 NEOs arrive. Wizz is nothing if not bullish.

    As rivals across Europe dramatically downsize (think Lufthansa), Wizz plans to open new bases in Milan Malpensa, Larnaca, Tirana, and Lviv. It sees opportunity to expand from London Gatwick. Other airports are practically “begging for capacity.” It will own 70% of a new airline venture it’s launching this month from Abu Dhabi, targeting eastern European cities at first. Wizz Air Abu Dhabi will grow from three to six planes within six months, a more aggressive expansion than originally planned. In 10 years’ time, it could have as many as 50 planes.

    Back in Europe, Wizz is immaculately positioned to benefit from the price-sensitive, shorthaul, leisure demand revival expected to lead the recovery. In fact, it’s already seeing it. Booking patterns are starting to normalize, with half of reservations now coming in within 10 days of departure, rather than very far out. It’s adjusting revenue management algorithms to learn the new patterns. At the same time, its surveys show that 65% of customers intend to travel in the next six months, and 30% within the next two months.

    Wizz says the average age of its customers is 36, and that its many younger travelers “tend to be more adventurous, more agile, and seeking more adventures.” The airline sees great opportunities to grab traffic from downsizing rivals. It sees great opportunity to lower its costs; “This is the time to bargain,” said CEO Jozsef Varadi. He does however worry about governments not coordinating their reopening policies. “We are opening to 45 countries, and there are no two countries with the same set of measures in place or the same interpretations of those measures.”

    Make no mistake: Ryanair, the king of European low-fare travel, has its wary eyes on Wizz. That’s why it’s expanding with its Polish unit Buzz, for example. Indeed, Wizz Air is trying to out-Ryanair Ryanair. Varadi even has a little of Michael O’Leary’s acid tongue, as he demonstrated with a verbal lashing of Italy’s insufferable flag carrier. “So with regard to Alitalia, I think Alitalia is kind of the joke of the industry for quite long now… personally, I’m a little tired of following it, to be honest, and I don’t really care what’s happening to Alitalia.”
  • Turkey’s largest low-cost carrier Pegasus unsurprisingly lost money last quarter as the Covid pandemic struck the industry. Its operating margin, however, at negative 8%, wasn’t as bad as the negative 12% figure posted by its more global rival Turkish Airlines. The LCC’s revenues fell just 1% y/y despite 7% less ASK capacity — ancillaries (including a jump in ticket cancellation fees) helped with that. Operating costs, meanwhile, increased 1%.

    Pegasus joined Turkish in restarting domestic flights last week, hoping to get a least something out of the typically busy summer tourist season. Turkey happens to be one of the most visited countries in the world, and the pandemic’s impact on tourism has been economically devastating. Eventually, international flying will resume too, important because it typically generates more than 40% of the company’s revenue. Domestic accounted for just 21% last quarter, with the balance mostly ancillaries. Pegasus still has lots of A320 NEOs on order.

    Helpfully, one of its local rivals called Atlas Global collapsed just before the Covid crisis. On the other hand, Turkish intends to follow through on using its LCC Anadolujet to replace all of its flying from Istanbul Gocken airport — that’s the main base for Pegasus.

    Separately, Turkish press reports indicate that the first week of restored domestic flying saw pretty full planes. Pegasus, said one report, filled about 60% if its seats. One final note about the airline: Last year, as mentioned in the Aeroflot item above, Pegasus was one of the world’s five most profitable airlines, trailing only Allegiant, Air Arabia, and Gol. The simple explanation for that was its phenomenally lucrative peak summer season.

Operating Margins

Q1 Operating Margins…So Far

AirlineQ1 Operating Margin
Mesa Air8%
Air Arabia7%
Bangkok Air4%
EVA Air -1%
Singapore Airlines-2%
Korean Air -2%
Cebu Pacific-4%
Japan Airlines -7%
Alaska -9%
China Airlines-9%
Wizz Air-10%
Air Canada-12%
Turkish Airlines-12%
All Nippon-15%
Finnair -16%
Air France/KLM-16%
Spring Airlines-17%
Aeroflot -17%
Juneyao -18%
Lufthansa -19%
Air China-24%
China Southern-24%
Jeju Air -28%
China Eastern-31%
SAS (Feb-Apr) -63%
Hainan Airlines-77%
  • Rankings of airlines that have reported so far (excludes special items)

Madhu Unnikrishnan

June 7th, 2020