Korean Air, Turkish Lead in Second Quarter

Jay Shabat

August 15th, 2022

Round of applause for Korea’s largest airline. Thanks to one of the industry’s largest air cargo operations, Korean Air sailed through the pandemic with consistent operating profits. Last quarter, with cargo still booming amid bottlenecked global supply chains, the airline delivered grand slam earnings once again, with an operating margin reaching a stratospheric 22 percent. That displaces Southwest Airlines’ 17 percent as the highest margin of any passenger airline reporting so far. It’s also a level that Korean Air could barely dream of before the pandemic, when it was at best a modestly profitable airline. In 2019, it managed just a 2 percent operating margin, alongside a steep net loss. Let’s be clear: Korean Air has basically been just a cargo airline these past two-plus years. A full 77 percent of its revenues came from cargo, with passengers contributing just 11 percent. In 2019, cargo was 24 percent of revenues. Note that the company has an aerospace manufacturing business and other subsidiaries as well. Looking ahead, Korean Air expects passenger traffic to recover more slowly than originally forecast for the second half of 2022, owing to lingering travel restrictions in Asia, as well as high oil prices and its impact on economic growth. For now, more than half of its passenger revenues are coming from routes to and from the Americas, with the key Chinese and Japanese markets still largely dormant. One notable strength currently — as Japan’s ANA and JAL recently noted — is with people connecting between North America and Southeast Asia via Seoul Incheon. Japan is now slowly opening up and China is relaxing quarantines. Korean Air still seeks to merge with rival Asiana, which ran out of money early on in the pandemic.

Turkish Airlines is also a pandemic success story. While nowhere near Korean Air or Southwest’s operating margins, its own 12 percent number in the second quarter is respectable. That is especially true considering that it did it on the back of the return of long-haul connecting passengers — a segment that is still in the early stages of recovery for Korean Air. Turkish Chief Financial Officer Murat Şeker attributed its results to the early restoration of its long-haul network that gave it a “first mover advantage” over its European competitors, as well as a strong local market. Being one of the few international airlines still serving Russia was also a benefit for Turkish financially, thought Şeker said the yield gains were partially negated by the loss of traffic to both Russia and Ukraine. No matter the reason, Turkish’s results were impressive: total revenues increased nearly 43 percent year-over-three-years to $4.5 billion on 12.3 percent more passenger capacity. Cargo revenues alone soared 171 percent to $1.1 billion. Turkish turned an operating profit of $520 million, and a net profit of $576 million. The airline anticipates further capacity growth compared to 2019 in the second half — 10-20 percent in the September quarter, and 5-15 percent in the fourth quarter — and profits for the full year.

Several months before anyone ever heard of Covid-19, civil unrest caused Hong Kong’s air traffic to plummet. Now, several months after international air travel has begun rebounding from Covid elsewhere the world, Hong Kong’s air traffic remains severely depressed. For Cathay Pacific, Hong Kong’s top airline, it’s been three full years and counting of downright misery. Thank goodness for cargo, which prevented an even nastier financial massacre. But cargo too, was impacted by strict quarantine rules for air crews, which prevented Cathay from flying a full schedule of freighters. Last week, Cathay unveiled a $641 million net loss for the first six months of 2022, with a chunk of that attributable to its 18 percent stake in money-losing Air China. HK Express, Cathay’s low-cost unit, itself posted a $106 million net loss for the half-year. The core flying operations of Cathay suffered a negative 4 percent operating margin, which again would have been worse if not for strong cargo demand. In addition, Cathay enjoyed a $255 million fuel hedge gain, though that still doesn’t erase bad memories of massive hedge losses in years past. There’s at least some brightness on the horizon. Quarantines have been steadily relaxed, and Cathay foresees about a quarter of its pre-pandemic passenger capacity returning by the end of the year. To prepare, it plans to hire more than 4,000 front-line workers. Uncertainty, however, still looms large. Hong Kong’s status as a global hub is in doubt following major changes in its relationship with mainland China. In a case of terrible timing, the changes came just as Hong Kong’s airport opened what was once a badly needed third runway.

A few other brief earnings updates from around East Asia: Taiwan’s China Airlines, despite heavy cargo exposure, only managed a 3 percent operating margin for the April-to-June quarter. Its similarly-sized rival Eva Air, also a major cargo player, did better at 7 percent. Besting both was Philippine Airlines, a longtime financial basket case that got a burst of life from its controlling family — a burst in the form of a half-billion dollars in new capital — and a U.S. Chapter 11 bankruptcy restructuring that wrapped at the beginning of the year. With the help of cargo, plus a large diaspora of overseas Filipino workers that still needed to get places during the pandemic, PAL had an excellent first half of 2022, highlighted by an 11 percent operating margin. This was its first money-making first half since 2016.

Much ink has been spilled about the future of Spirit Airlines. Its planned merger with Frontier Airlines is off and a deal with JetBlue Airways is on after the latter won a bidding war for the Florida-based discounter. But, as CEO Ted Christie said last week, it’s “business as usual” at the airline for the time being. And that means recovering from the pandemic that, due primarily to what executives called U.S. aviation infrastructure issues — including but not limited to air traffic control staffing issues at the FAA’s Jacksonville center — will not occur until next year. Spirit underutilized its staff and aircraft by roughly 15 percent in the second quarter; or, put another way, its planes flew about 2 hours less per day than they did in 2019. That, coupled with high fuel prices, pushed perennially profitable Spirit to a $45 million operating loss and a negative 1.2 percent operating margin in the second quarter. But once the airline trains all its new staff, and the infrastructure issues ease, the demand is there to support a successful Spirit. Revenues jumped 35 percent year-over-three-years and unit revenues 23 percent. Capacity was up nearly 10 percent compared to 2019.

Sun Country Airlines faced challenges achieving a full pandemic recovery in an area that has become all too common among U.S. airlines: staffing. The Minneapolis-based carrier has all the pilots and crews it needs, but it faces a training backlog that is not expected to ease until at least the end of the year. Sun Country, which operates a resilient business model that includes scheduled passenger, charter, and cargo flights, was forced to dedicate the pilots it had to the latter two categories to meet its contractual obligations; that forced it to fly less higher-yielding passenger capacity than it wanted in the second quarter. “We weren’t able to add … flying due to crew constraints,” CEO Jude Bricker said last week. The good news for Sun Country is the June quarter is historically one of the weakest on its calendar, and the year-end target to get all of its crews through training sets it up well for its busiest period next year, the January-March quarter. In the meantime, Sun Country posted a $3.4 million operating profit and $3.9 million net loss in the second quarter. Revenues and passenger unit revenues — not including its charter and cargo businesses — both jumped 29 percent compared to 2019.

The last thing anyone expected of Latam Airlines Group pre-pandemic was a U.S. bankruptcy filing. But with limited government support to cushion the epic demand shock, South America’s largest airline had little choice but to seek protection from its creditors two years ago. Now, as demand starts to normalize, Latam still faces challenges, including more cost-competitive rivals, several of whom underwent their own bankruptcy restructurings. Latam itself hopes to exit bankruptcy in the fourth quarter, with help from financial backers Delta Air Lines and Qatar Airways, after a judge approved its restructuring plan in June. Delta is particularly important strategically, teaming with Latam to form a “TransAmerican” joint venture that the U.S. DOT tentatively approved last month. Latam is separately expanding its dedicated freighter fleet and building on early post-pandemic passenger strength in its major domestic markets (i.e., Brazil, Chile, and Colombia). The airline’s domestic capacity, in fact, has already surpassed 2019 levels. Latam did lose money in the second quarter, however, posting a negative 8 percent operating margin.

Brazil’s Azul, which attempted a hostile takeover of Latam during the larger rival’s bankruptcy, has performed strongly of late. Like Gol, it did post a large official net loss last quarter, tied to the accounting treatment of foreign exchange movements. Unlike Gol, however, which posted a negative 6 percent operating margin, Azul turned in a 3.5 percent operating profit margin. Azul was 36 percent larger in the second quarter than it was in 2019, measured in available seat kilometers. Before the pandemic, Azul was already taking advantage of Avianca Brasil‘s collapse and, after the crisis began, of Latam‘s capacity cuts in bankruptcy. A number of other factors also explain Azul’s success. One is a collection of high-margin auxiliary businesses, including cargo, loyalty, and vacation packages. Many of its routes face no direct competition. New Airbus A320neos and Embraer E-Jet-E2s are serving it well. Azul is now poised to roughly double its presence at São Paulo’s high-yield, corporate-heavy downtown Congonhas airport thanks to government slot reallocations.

The demand recovery was no less palpable in the Gulf region of the Middle East, where two low-cost carriers reported solid second quarter results. Air Arabia‘s operating margin was 14 percent, while the figure for Kuwait’s Jazeera Airways was 11 percent. Air Arabia, based close to Dubai in neighboring Sharjah, added 16 new routes in the first half of 2022, not just from its home base but also from Morocco, and Egypt — it operates joint-venture airlines in both places. It’s now backing new airline ventures in Pakistan and Armenia. Jazeera is adding routes too, with Qauassim coming online later in August following the additions of Prague, Vienna, and some additional destinations in Saudi Arabia in June and July. LCCs are watching as the Saudi government looks to develop more tourism. There’s new competition, however, from startups like Wizz Air‘s new Abu Dhabi venture, and possible Saudi venture. Air Arabia has a two-year old Abu Dhbai-based joint venture in partnership with Etihad Airways as well. For Jazeera, by the way, a quarter of its demand comes on routes to India, with Egypt accounting for another 18 percent.

U.S. regional Mesa Air Group said traffic in the second quarter remained strong, “and our partners continue to request more hours,” i.e., flying assignments, but that “the industry-wide pilot shortage impeded our ability to meet that demand.” CEO Jonathan Ornstein last week described the U.S. regional sector as “caught in an unprecedented squeeze,” characterized by the “highest levels of pilot attrition in history and a shrinking pool of qualified commercial pilots without the necessary amount of hours.” Mesa’s problem is in one sense the same problem faced by its partner airlines: under-utilization of planes and other assets. “You’ve got these high-cost fixed assets that you just have to fly.” Ornstein added: “when you think about it, who would have ever thought that it’s easier to go into Covid than it was to go out of Covid.” Mesa, by the way, reported a roughly breakeven second quarter operating margin.

Edward Russell and Jay Shabat

In Other News

  • Allegiant Air priced $550 million in senior secured notes due in 2027 at a coupon of 7.25 percent last week. Proceeds from the issue will be used to refinance the $533 million outstanding under the Las Vegas-based carrier’s variable-rate Term Loan B due in 2024. The notes are secured by Allegiant’s non-aircraft assets, including its loyalty program and intellectual property; Allegiant’s Sunseeker Resort is excluded from the collateral pool. Fitch Ratings, which rated the debt a speculative BB+, noted that the transaction smooths out Allegiant’s debt maturity profile that previously peaked in 2024, and gives the airline financing flexibility for its new Boeing 737 Maxes that begin arriving next year. The transaction also involves a new $100 million revolving credit facility due in 2024, per Fitch.
  • The U.S. is considering creating airline seat size standards for the first time in history. Earlier in August, the Federal Aviation Administration solicited comments on “minimum seat dimensions necessary for safety of air passengers.” It will accept responses for 90 days, or until November 1. The move comes amid increasing pressure to rectify what passenger advocates say is a health and comfort problem: ever-shrinking airplane seats even as Americans have gotten larger. The FAA was first mandated to do something about seat size in its last funding reauthorization bill in 2018. “The FAA has been slow rolling this thing for going on four years,” FlyersRights President Paul Hudson said.
  • Frontier and Denver International Airport broke ground last week on a $183 million expansion of the ground-level boarding gates on the airport’s Concourse A. The budget airline will move to what will be a 14-gate facility after construction wraps in 2024. “The use of ground boarding will cut boarding and deplaning times in half by allowing customers access to aircraft from the front and rear and will help support our expansion” in Denver, Frontier CEO Barry Biffle said.

Edward Russell & Ted Reed

Jay Shabat

August 15th, 2022