TAP Air Portugal’s Bitter Pill

Madhu Unnikrishnan

December 13th, 2020 at 1:50 PM EST

  • For TAP Air Portugal, 2015 seemed like a turning point. It was the year that Portugal’s government privatized the airline, which badly needed capital and investment. The buyer was a consortium led by airline entrepreneur David Neeleman, the man behind JetBlue and Azul. TAP’s chief appeal was its impressive Brazilian network, and South American network more generally, conveniently accessible from all of Europe through the carrier’s well-situated Lisbon hub. TAP’s collection of routes in Portuguese speaking Africa was another draw. And with its new investors, the company was able to renew its fleet, expand in North America, improve distribution, densify seating, rebrand its fares, increase ancillary sales, divest unwanted assets, and develop partnerships with Azul and China’s Hainan Airlines.

    For a time around 2017, Portugal was one of the world’s fastest growing airline markets, benefitting from a surge in inbound tourism. TAP, all the while, boasted of its four-continent Lisbon hub serving Europe, Africa, South America, and North America. Long-range A321 NEOs were on the way, opening new route opportunities like Montreal. So were A330 NEOs. In 2016, the first full year after privatization, TAP delivered a robust 9% operating margin.

    But that, alas, was the high point. Margins dropped sharply in 2017, and then turned red in 2018. Last year, TAP produced a small operating profit but a $119m net loss (influenced by losses at its maintenance business in Brazil). One of TAP’s biggest problems in recent years was the drop in oil prices. Huh? It sounds counterintuitive, but cheap oil — and a crash in commodity prices more generally — badly hurt the economies of Brazil and lusophone African countries like Angola and Mozambique. In the meantime, the Iberian tourism boom lured huge LCC expansion — think Ryanair and easyJet. What’s more, TAP’s new owners fought bitterly with unions and politicians, the latter groups irate about bonuses paid to executives. Ownership and management had their own reasons to be angry, notably about the underdeveloped state of Lisbon airport, frustrating the carrier’s expansion plans. Government plans to handle traffic at a nearby military airport, at the urging of LCCs, didn’t help ease tensions — on the contrary, TAP said it would never fly there.

    Already by the start of 2020, TAP grudgingly announced a two-year suspension of growth. Neeleman, reports suggested, was looking to sell out, courting TAP’s fellow Star Alliance members Lufthansa and United. That was the situation as Covid-19 began ravaging Europe in February. When overseas flights stopped shortly thereafter, there was little hope of TAP surviving without government aid. In June, Lisbon notified the European Union it was lending TAP $1.3b to address its near-term liquidity needs. It then renationalized the airline by upping its ownership stake from 50% to 73%. Neeleman was out.

    After a $647m net loss in Q2 ($431m excluding special items), TAP’s losses last quarter eased to $138m, or $243m excluding items). A partial reopening of shorthaul tourist markets helped. But Q3 operating margin was a still-painful negative 94%. Revenues dropped 81% y/y on 79% less ASK capacity. Total operating costs declined 59% with help from a 49% decrease in labor costs. Having heavy longhaul exposure isn’t a good thing right now. But thanks to large Portuguese communities living overseas and across Europe, TAP has a large component of family-visit traffic, which is a good thing right now. It’s a small palliative though, especially with tourism down again for reasons related to both seasonality and Covid.

    This winter, TAP plans to operate just 30% to 40% of its normal capacity. It’s in the meantime busy cutting costs, variablizing costs, renegotiating contracts, suspending investments, and trying to reach longterm concession deals with resistant unions. More broadly, a management team, with the help of external consultants, devised a longterm turnaround plan submitted for E.U. approval last week. Unlike Lufthansa, Air France/KLM, and others receiving state money without EU approval, TAP’s bailout doesn’t qualify for a Covid exception because of its history receiving subsidies pre-crisis. As it waits for the Eurocrats in Brussels, the airline is preparing for next summer with several new leisure routes to Spain, Croatia, and North Africa.

    If all goes as planned with vaccinations, TAP and the rest of Europe’s airline sector might be pleasantly surprised with summer 2021 conditions, characterized not unrealistically by the flowering of pent-up leisure demand, dramatic reductions in seat supply, cheap fuel, and lower input costs all around. Even TAP’s longhaul routes might revive rather quickly given their heavy leisure and family-visit orientation; Lisbon longhaul doesn’t depend on corporate traffic as much as say, Frankfurt longhaul.
  • Figures published by the U.S. Bureau of Transportation Statistics (BTS) show Frontier with a negative 70% Q3 operating margin. The LCC, backed by the Indigo group and not publicly traded, performed in line with Spirit (which reported a negative 62% Q3 margin) but considerably worse than Allegiant (negative 39%). It certainty helped that Denver, a market holding up relatively well during the pandemic, is Frontier’s largest market by far. It’s also big in the leisure hotspots of Florida and Las Vegas, both seeing at least some measure of revival.

    The summer months of Q3, however, aren’t when these markets peak. The real test for Frontier’s Florida franchise in particular, will be next quarter, especially February and March. Looking beyond the near-term, the airline is unshaken from its growth ambitions. It never cancelled any of its Airbus orders; in fact, it just received its 100th aircraft, an Alabama-built A320 NEO. Another 160 more are on order, some of them XLR versions with expanded mission capability. It continues to add more routes as well, most recently announcing new services from Denver and Orlando, among other cities. It also told elite members of other airline loyalty plans that it will match their status. Glancing at Q1 schedules for next quarter using Cirium, Frontier’s most aggressive capacity growth is in Miami.
  • Sun Country’s Q3 numbers, also revealed through last week’s BTS data release, were impressive. The Minneapolis-based carrier posted a negative 31% operating margin, which was better than Allegiant’s and indeed, the best of any U.S. airline. It even showed a small net accounting profit, though this was due to a one-off gain. The BTS data doesn’t show anything beyond mere numbers, but it’s safe to say that Sun Country owes its relative success to a new cargo deal it signed with Amazon.

    On the passenger side, its important charter business is surely recovering with college sports teams on the road again. As for scheduled flying, Sun Country’s specialty is linking its home city Minneapolis to warm-weather destinations like Florida. One thing Sun Country didn’t do before the crisis was order airplanes. That puts it in a good position to take advantage of the big drop in aircraft prices if it decides to buy now.
  • The U.S. regional Mesa Air announced its calendar Q3 results, which featured an official $11m net profit. That included federal wage subsidies, however, without which margins were negative. Operating margin, more specifically, was negative 16%. Mesa doesn’t quite have the scale of its rival SkyWest. But its cost base is lower. That’s helped it win new and extended flying assignments from United and American. Most recently, American agreed to continue a CRJ-900 contract for five additional years.

    More unorthodox is Mesa’s new B737-400 flying from Cincinnati for the cargo operator DHL. This helped it avoid furloughs this year. Back at the core passenger business, Mesa flew about half of its normal block hours in Q3 but expects to get back to full levels soon. It was among the airlines partaking in Washington’s CARES Act loan program. It also received some balance sheet help from United.   

Madhu Unnikrishnan

December 13th, 2020 at 1:50 PM EST