Europe’s LCCs Starting to Feel More Confident

Madhu Unnikrishnan

November 22nd, 2020


  • Like its fellow all-star LCCs Ryanair and Wizz Air, Britain’s easyJet feels good about its current position. Yes, it’s losing money and bleeding cash currently of course. But it could be thriving again in months, with bookings strong for next summer. Last week, it reported a negative 96% operating margin for the six months since April, essentially the six months since the Covid crisis began. Its fleet was grounded for all but two weeks in calendar Q2. And it operated just 38% of its usual capacity in calendar Q3, which includes the normally super-peak months of July and August. Those months did see a modest pop in activity this year — passenger volumes in August, for example, were down only 55% y/y, with seats more than three quarters full. Demand dropped significantly in September though, not only because of normal seasonal patterns but also a reimposition of travel restrictions across Europe.

    Like others, easyJet is unequivocally convinced that such restrictions are the number one impediment to leisure demand. It too saw a surge in bookings immediately after the Canary Islands were removed from the U.K.’s quarantine list. Just as importantly, it was able to capitalize on the sudden surge with quick reactions by its operations and marketing teams. Bookings also jumped after news of successful vaccine trials. What’s more, people are booking not just seats but travel packages, a top strategic focus before the crisis. Indeed, easyJet Holiday bookings doubled immediately after Pfizer and BioNTech announced successful results from their late-stage vaccine trials. In addition, the majority of passengers whose easyJet packages were cancelled this summer plan to use their credits to travel next summer instead (as opposed to asking for a refund).

    More opportunities beckon for easyJet Holidays, with fewer exclusivity contracts between hotels and traditional tour operators like TUI. Hotels, naturally, are eager to attract more guests, and easyJet has the low costs, the network, and the fleet flexibility to help. It has more labor flexibility now too, thanks to new contract concessions. That means, for example, the ability to open seasonal bases in places like Malaga and Faro, employing people there only during summers. A tenth of its U.K. workers are now on seasonal contracts as well.

    EasyJet separately cut 30% of its full-time employees and enacted two-year pay freeze agreements with unions in six of its country markets. Overall, it’s targeting a 20% overall improvement in productivity, not just off the backs of labor but also simpler ground handling contracts, maintenance insourcing, better operational reliability, and new airport deals with incentives for growth and traffic volume.

    Interestingly, this will be the first fiscal year ever that easyJet won’t take delivery of a single aircraft. It deferred some of its Airbus NEO deliveries and remains in discussion about how many it will buy in future years. It doesn’t rule out making “opportunistic” aircraft purchases if demand recovers faster than expected. Cash won’t be an issue following multiple rounds of fundraising. Aircraft sales have been one source of new funds, though easyJet stresses that it still owns 55% of its fleet. Cash burn from operations, meanwhile, is better than it was forecasting this spring. Did it realize the crisis would last so long? Of course not. Nobody did. But management claims it was more cautious early on than some of its rivals (wink, wink Ryanair) who insisted in March that everything would be back to normal by Easter.

    EasyJet’s many pre-crisis strengths, meanwhile, remain relevant in a post-Covid world. True, Ryanair and Wizz Air have lower unit costs. But easyJet has higher unit revenues thanks to its leading positions in major population and economic centers across Europe. London is the prime example. Geneva, Paris, and Milan are some others. Though 80% of its passengers are flying for leisure, its important business travel market should grow as companies look for value in tough times — that’s been the case in every past economic downturn. In the meantime, easyJet is talking to governments across Europe about possible aid. It says the crisis has moved more people online when it comes to purchasing things.

    It acknowledges a changed competitive landscape in markets like London but doesn’t fear invaders like Wizz Air. Environmental commitments include aggressive carbon offsetting, fleet renewal, and partnerships to develop new aircraft technology. Increasingly, it observes, environmental credentials are a factor when Europeans select which airline to fly. For an airline with a big portfolio of slots at airports like London Gatwick, the temporary suspension of usage rules is helpful. London Stansted is no longer of interest, so easyJet last week surrendered most of its slots there to Ryanair.

    Systemwide this quarter, the orange-clad carrier will only fly about 20% of its normal capacity. Next quarter could be subdued as well. But then comes peak season 2021. Plenty of Europeans seem eager and ready to take their holidays. But will travel restrictions be gone by then? That’s the big question.
  • EasyJet’s rival Jet2 reported results for the half year through September as well, with a somewhat better story. Its operating margin for the six-month period was negative 37%, not terribly bad considering its planes were grounded from mid-March through mid-July. When flights did resume however, a decent number of British families were willing to take their Mediterranean holidays. Jet2 flexibly maneuvered its schedule to serve destinations not subject to the U.K. quarantine. That meant a lot of flying to Greece and Turkey for much of the summer.

    Almost 60% of its passengers during the half year, Jet2 said, had purchased a travel package that included a hotel. That’s where Jet2 tends to earn its best margins, hence the intent of easyJet to do more holiday package business itself. By marketing attractive packages, furthermore, Jet2 can distinguish itself from lower-cost Ryanair. Of course, capacity was down sharply y/y, such that the airline had to furlough 80% of its U.K. staff. It also cancelled some deals to lease extra planes for the summer — a key aspect of its business model is flexing up a lot in summer and down a lot in winter.

    This winter half, capacity will be just half of what it was last winter. But as of now, Jet2 plans to offer just as much summer 2021 capacity as it did in summer 2019. It’s also opening a new base in Bristol, challenging easyJet there. Summer demand looks encouraging but with a high level of uncertainty — uncertainty about quarantines, and border closures, and Covid case counts, and vaccine timing, etc. At the moment, the U.K. government is discouraging all discretionary outbound travel. Encouragingly, there are signs that the tightened restrictions are working, with Britain’s infection rates starting to taper.
  • Korea’s Asiana was a big newsmaker last week. As discussed in this week’s Feature Story, it struck a deal to become part of Korean Air, long its archrival. It separately published its Q3 income statement last week, appearing (to its great delight) in all black ink. At a time when just about every airline in the world finds itself in the red, Asiana managed a $2m net profit and a positive 1% operating margin. How was this possible? Cargo, cargo, cargo. But the modest profits are not nearly enough to erase a legacy of deeply troubled finances, hence the need for a white knight.

    Asiana ended Q3 in fact, with liabilities almost equal to its assets, implying negligible equity. As revenues, they declined only 53% y/y, while operating costs fell even more: 55%. Passenger ASK capacity declined 76%. Asiana filled just 35% of its seats in the quarter, but cargo yields surged 57%. The company’s two LCCs, Air Busan and Air Seoul, respectively, didn’t have the benefit of cargo and thus suffered operating margins of negative 110% and negative 63%, respectively.
  • Throughout the Americas, Mexico’s domestic airline market has recovered more than any other. In fact, based on published capacity and estimated load factors, traffic there should be higher in December than it was in the same month a year earlier, before the Covid crisis started. Brazil isn’t quite that rejuvenated, but it’s more rejuvenated than most. Azul, which reported Q3 earnings last week, expects Brazilian domestic RPK demand next month to be about 56% of where it was a year ago, compared to 44% for Australia’s domestic market and 33% for U.S. domestic.

    Azul itself, meanwhile, anticipates recapturing more than 80% of its December 2019 level of RPK demand. Losses remained high in Q3, at $227m net. Operating margin was negative 83%. But look beyond those numbers and Azul is pleased with how the recovery is progressing. Importantly, Covid cases are trending down in Brazil as the country enters the summer. Sao Paulo in fact, is now allowing a full return to offices and partial reopenings of restaurants, shopping malls, and gyms. The local state government, furthermore, expects to have vaccines imported from China ready for distribution in January, pending federal approval.

    Financially, Azul was so successful in cutting fixed costs, variablizing labor costs, and extracting concessions from suppliers and creditors that it didn’t have to raise any new cash externally in either Q2 or Q3 — it brags of being one of the “very few airlines in the world” for which that was true. It did sell convertible bonds this quarter, while separately selling its equity stake in TAP Air Portugal. Also this quarter, it received permission from lenders to further extend the due date on some of its debt repayments. Cash burn from operations, meanwhile, should decline to just $300k per day this quarter. That’s better than originally forecast thanks to encouraging domestic demand.

    With borders largely still closed, wealthy Brazilians can’t vacation in Orlando, New York, Paris, or London right now. So many are spending time in northeastern Brazilian beach cities like Recife, where Azul’s hub is already back to pre-crisis levels of capacity. The same is true for the carrier’s chief hub in Campinas outside of Sao Paulo, where it can distribute connecting traffic throughout the country. Much of the recovery, it says, is coming from travelers outside of Sao Paulo and Rio de Janeiro, Brazil’s two largest cities. But the archetype weekday Sao Paulo-Rio shuttle flier, likewise, is flying to the northeast and maybe renting a beach house.

    Demand recovery really took off after the Sept. 7 Independence Day holiday. Since then, there have been some weeks when average leisure fares were actually up y/y, at times significantly. What’s still missing is large numbers of corporate travelers, particularly from cities like Sao Paulo and the capital Brasilia, where Azul’s domestic capacity remains down by a lot y/y. Total Q3 capacity, by the way, was down 67% (60% domestic, 88% international). But the declines have progressively gotten smaller with each successive month. Normally, corporate traffic accounts for about 60% of Azul’s total revenue. That’s now just 25%. Energy companies are starting to travel again but the situation for finance companies is more mixed, with Azul mentioning one of its big bank clients that’s traveling a lot and another that’s barely traveling at all.

    Importantly, the cash flows from new bookings are comfortably covering the variable costs of the flights Azul is currently flying. And it won’t add more flying unless that flying is cash positive. Azul also, of course, has a fast growing and currently booming cargo business. Its loyalty plan is holding up well. Widebodies normally used for intercontinental flying are performing well on domestic missions in markets like Campinas-Recife, buttressed by cargo contributions. Orlando will be its first overseas A330 market when borders reopen. Very significant is a new codeshare with Latam, easing competitive pressures in a market that last year saw the collapse of Avianca Brasil, rendering the Brazilian market a triopoly.

    Azul, furthermore, feels good about all the NEOs it has, and the flexibility afforded by its wide range of aircraft sizes (everything from ATR turboprops to those A330s). It’s now converting some older E-Jets to cargo planes and sending some others to Breeze (that’s founder David Neeleman’s new airline in the U.S.). Will Azul look to take advantage of Latam’s retreat from Argentina? No way — “Brazil is a big enough headache for us.” Brazil, Azul believes, remains a longterm growth market. And even in the short term, demand should get a boost when schools reopen, and when Carnival starts early next year.

    What about Zoom calls replacing business travel? CEO John Rodgerson isn’t concerned: “We often say, look, the first deal you lose because your competitor visited your client, your butt’s going to be back on an aircraft.”
  • Going into 2020, there were few things more certain in the airline world than the prospect of Copa Airlines earning a profit. Last year, it earned a towering 16% operating margin, maintaining a decades long money-making streak. It had lots of new stuff planned for this year: New routes, expanded airport facilities, cabin densification, returning MAX jets, E190 phaseouts, improved digital distribution, basic economy fares, expanded maintenance capabilities, upgauging at its LCC Wingo, a three-way joint venture with United and Avianca, and a push to get non-fuel unit costs below six cents a mile.

    Overnight, however, Copa went from riches to rags, at least momentarily. It’s one of the most ill-positioned airlines to deal with the Covid catastrophe, lacking a domestic market and lacking any material cargo exposure. Therein lies the explanation for the carrier’s bloody $122m net loss, together with an operating margin of negative 330%. Copa remained largely inactive during the quarter, with ASM capacity down 99% y/y. Only with some revenues from unredeemed tickets did revenues drop not 99% but 95%. Operating costs dropped only 76%, with labor costs alone down 61%. Copa did operate a few flights starting in mid-August, ultimately ending the quarter with a network of 15 destinations. By mid-October, Panama eased restrictions on flight operations and reopened its borders to foreigners. Copa now operates close to 40 destinations, rising to about 50 by year end. Normally, it serves about 80 cities. In ASM terms, it hopes to be back to roughly 40% of normal capacity next month.

    It continues to simplify its fleet by divesting E190s and B737-700s too — all of them. It’s still talking to Boeing about MAX compensation, which should come soon. Copa’s MAX 9s themselves should be back in action soon. Copa reaffirms its belief in the power of Panama as an airline hub, expecting even more itineraries to require a good hub post-crisis. It plans to move cautiously with its low-cost carrier Wingo in Colombia, though with Avianca in retreat, Wingo will grow its fleet to six planes soon. Mainline seating densification, on hold for now, should resume shortly.

    The airline seemed a bit more hedged on the prospects for realizing its United and Avianca joint venture given Avianca’s bankruptcy proceedings — it’s “hard to tell what’s going to happen right now,” cautioned CEO Pedro Heilbron. On a brighter note, Copa is starting to carry a bit more leisure and business traffic as Latin American travel restrictions are relaxed, in some places more than others. Family visit traffic is resilient. Monthly cash burn should drop to about $25m by year’s end. And it optimistically thinks that with all the cost cutting it’s done, non-fuel unit costs can be back to 2019 levels upon returning to about 80% of normal capacity.  
  • Just how far has the airline industry fallen? Bankrupt Thai Airways, in its Q3 financial report, trumpeted the popularity of its “deep-fried dough served with a cup of dipping sauce made from purple sweet potato and egg custard.” Yum. It’s selling first-class meals to people as well, tours of its flight training facilities, and trips to nowhere for religious worshippers. Among large countries, few are as dependent on foreign tourism as Thailand.

    But unlike some other big tourism-dependent economies — Mexico and Turkey, for example — Thailand completely shut its borders to protect against Covid. The tough approach worked — the country is largely Covid free today. But without any traffic, Thai Airways — already ailing before the crisis — had little choice but to file for bankruptcy. Its ASK capacity decreased 95% y/y last quarter, typically an offpeak period in Thailand. Net losses exceeded half a billion dollars even after removing one-time accounting charges. Operating margin was as unhealthy as that deep-fried dough: negative 310%.

    The question now is can Thai Airways survive? It’s working on a new business plan to present to the bankruptcy court. But cash reserves are dwindling. There wasn’t too much help from cargo revenues, which declined 83%. Thailand does have a sizable domestic market which is open and busy again. But it’s a hyper-competitive market crowded with joint venture subsidiaries of foreign carriers like AirAsia, Lion Air, and VietJet. Thai is cutting pay and jobs, trying to sell older planes, and starting to reopen routes as Bangkok last month began welcoming visitors from some low-risk countries including China.   
  • Bangkok Airways is in a good position to benefit from the woes of Thai Airways, which go far beyond the immediate headaches of the Covid carnage. Thai will emerge from bankruptcy a lot smaller than it was, assuming it remerges at all. For now, Bangkok has its own worries, reflected in its negative 127% Q3 operating margin. Even with lots of domestic exposure, its ASK capacity declined 90% y/y (domestic alone was down 81%). Revenues dropped 87%, while operating costs were down 67%.

    In yet another “who would ever have thought” statistic, Thailand last quarter received zero international visitors. Foreign entry was essentially banned for six months starting in April. Only last month did some measure of relaxation begin. Domestically, government efforts to stimulate tourism include extended holiday periods for workers. Bangkok Airways faces additional competition at Bangkok’s main airport (Suvarnabhumi) following Thai AirAsia’s decision to fly there. On the other hand, it dominates the beach market in Samui, where it owns and runs the airport.

    Singapore, Cambodia, and Myanmar will be quick to rejoin the network when possible. Hong Kong and the Maldives will follow. And after that will come several Chinese cities led by Chengdu and Chongqing. Like Thai Airways, Bangkok Airways has big plans for the Utapao market near Pattaya, which Thailand’s government is developing as a major aviation hub, and one positioned to serve as an alternative gateway for Bangkok. But keep in mind: Construction on the new Utapao airport won’t begin until 2022.

    One final note for the Thai airline market in 2020: VietJet in particular, is aggressively growing its domestic market share, carrying 15% of all passengers in Q3; its market share in Q3 last year was just 5%.  
  • Philippine Airlines, according to an income statement it filed with the Manila stock exchange, recorded a negative 81% operating margin from July through September. If that doesn’t sound too bad relative to what others have reported, it’s because — good guess — cargo. Carrying stuff rather than people generated 22% of total company revenues in the quarter. And that was critical given the severity of travel restrictions to and within the Philippines. Total revenues declined 77% y/y while total operating costs fell 61%.

    PAL continues to operate flights around the world but only with limited frequency. Manila-Los Angeles, for example, one of its busiest routes, is running just four times per week this month. Japan’s ANA, by the way, is a major PAL shareholder.
  • As of this writing, AirAsia X is still alive. But just barely. Its negative 712% Q3 operating margin tells you all you need to know. It’s an airline currently working through a bankruptcy-type proceeding, trying to get enough creditor concessions to devise something resembling a credible turnaround plan. Revenues in the quarter decreased 94% y/y. Operating costs decreased 53%. At stake is a large A330 NEO order, which Airbus desperately needs.

Madhu Unnikrishnan

November 22nd, 2020

 Rob Hodgkins