Pushing Back: Inside This Issue
It was New Year’s Day when reports first began surfacing of a mysterious SARS-like virus spreading in the Chinese city of Wuhan. Nearly two months later, public health officials are still struggling to contain the outbreak, deploying tactics that have largely frozen the entire Chinese economy. Air travel, unsurprisingly, is dramatically down, hitting not just Chinese or even just Asian airlines, but all carriers with heavy Asian exposure. Air France/KLM and Qantas both gave financial damage assessments that reach into the hundreds of millions of dollars. IATA sees the Covid-19 virus shock erasing nearly $30b from industry revenues this year. It also foresees a y/y decline in traffic, for the first time since the 2009 global recession.
How much worse will the crisis get? The impact is now spreading to markets outside Asia, including Europe where Venice just cancelled its Carnival celebrations. Korea, like Italy, is also seeing a jump in Covid-19 cases. The odds are increasing, meanwhile, that the outbreak will take a meaningful toll on the global economy.
In earnings news last week, Air France/KLM’s Q4 numbers dampened hopes of a quick rise in margins following new labor accords and many new turnaround initiatives. Air Canada’s figures, similarly, failed to erase doubts about the company’s ability to earn decent margins during winters. Qantas, reporting for the six months to December, again did well thanks to robust domestic profitability. Elsewhere, Gol did phenomenally well and SpiceJet did well relative to all the capacity it added. TAP Air Portugal’s losses, combined with management-government friction, could lead to the airline’s sale — Lufthansa and United are reportedly sniffing around.
“I think the way the TWU has been behaving is outrageous and disgraceful. With the challenges that we have with the tourism industry in Australia today, with the bushfires and with coronavirus, for them to take this disruptive action is a complete disgrace.”Qantas CEO Alan Joyce, attacking unions for engaging in labor unrest
October-December 2019 (3 months)
Net result in USD; operating margin
*Net profit excluding special items (all operating figures exclude special items)
- Air France/KLM: $173m; 1%
- Air Canada: $117m/$136m*; 3%
- Gol: $106m; 26%
- SpiceJet: $10m; 1%
July-December 2019 (6 months)
- Qantas: $305m; 10%
- TAP Air Portugal: $16m; 7%
- Air France/KLM’s latest business plan, presented to investors in November, is now in full swing. The goal: To earn profit margins that look more like its European rival IAG. From 2011 to 2014, the Franco-Dutch carrier amassed net losses excluding special items that exceeded $5b. Fortunes improved after the 2015 fuel bust, but never to the point where it was earning high returns. Operating margins floated within a lowly band of 3% to 6% from 2015 to 2018, the latter a year in which labor strikes erased nearly $400m from would-be profits.
Alas, the mediocrity continued in 2019, when operating margin was just 4%. As usual, the problem was Air France, with a margin just over 1%, not KLM, whose margin was a more respectable 7%. The group’s low-cost unit Transavia managed a 7% figure as well, an encouraging result relative to Lufthansa’s troubles with Eurowings. Operating margin for the group’s maintenance business was 6%. Looking at just the fourth quarter of the year, groupwide results were very similar to what they were in the same quarter a year earlier. Operating margin was just 1%, with Air France itself negative 1%, KLM positive 4%, Transavia negative 8% (its business is highly seasonal), and maintenance positive 8%.
Overall, Q4 revenues rose nearly 2% y/y while operating costs rose 1%. ASK capacity grew 2%. With the euro still rather weak, the airline wasn’t fully able to take advantage of falling fuel prices. But helped by new fuel-efficient widebodies, its total Q4 fuel bill increased just 4%.
Labor costs rose 4% too, though the most important fact about the carrier’s labor force is that it’s no longer threatening to storm the Bastille. Air France secured labor deals with all major work groups, including pilots who agreed to scrap several archaic contract restrictions that led to grossly sub-optimal aircraft configurations and fleet deployments. As testament to Air France’s new era of good feelings, operations ran normal even during nationwide strikes to protest government efforts at pension reform.
KLM secured new labor deals too, albeit rather expensive ones. The only major unsettled labor matter left for Air France/KLM, in fact, concerns its pilots at Hop, which operates domestically within France and on shorthaul routes from secondary French cities. In general, passenger supply and demand conditions were generally positive last quarter (unlike the cargo situation, which was awful).
Air France, KLM, and both Transavia France and Transavia Netherlands, benefited from the capacity squeeze in Europe’s shorthaul market. Longhaul markets like Japan, Korea, and India did well. Latin markets like Brazil, Argentina, and Chile remained challenging but showed some improvement. Leisure demand was strong on routes to Caribbean and Indian Ocean resort destinations. Africa was “OK.”
Unit revenues dropped in the important North America market, mostly as Air France defended its position in the giant New York/Newark-Paris market, which is now served by Norwegian, with French Bee and Corsair soon to enter. Norwegian will in fact link Paris Charles de Gaulle to nine U.S. cities this summer, including new routes like Chicago and Austin. On the other hand, transatlantic player XL Airways no longer exists. Nor does Aigle Azur, which flew to Brazil and China, but more importantly had a collection of lucrative Algerian routes from Paris Orly that now belongs mostly to Transavia.
Even back at home in the French domestic market, unit revenues increased sharply thanks to another round of aggressive capacity cutting, designed to moderate what have long been heavy losses. It’s not easy to compete against subsidized high-speed rail service.
The biggest weak spot last quarter was the greater China market, especially Hong Kong. Now of course, the greater China market barely exists, at least for the next few weeks as carriers suspend flights amid the Covid-19 crisis. Unit revenue trends systemwide were actualy looking good for Air France/KLM in the first few weeks of January. But Covid-19 is expected to reduce operating results by something like $170m to $220m for the months of February, March, and April. The number could of course be larger if the outbreak continues beyond the spring. There’s concern too that other airlines will start reallocating Asia capacity to North America, leading to overcapacity there. Another worry is that lost Chinese tourists to Europe might infect shorthaul route performance.
That said, the airline also expects fuel costs for the entire year to drop by some $333m, which brightens the outlook. Air France/KLM still expects to lower non-fuel unit costs this year as well, even with CASK pressure from its big capacity cuts to China. It still plans to grow ASKs about 2% to 3%; Transavia itself will grow 4% to 6% as the French division expands its fleet in response to relaxed pilot scope restrictions. Management also says it’s better positioned than most to reallocate planes away from Asia given its geographically diversified network (It can put more planes into Africa, for example). China Eastern remains an important partner and even part owner of Air France/KLM.
But its most important partnership is the recently fused-joint venture iT has with Delta and Virgin Atlantic on North America routes. It plans to keep its close ties to Gol too, never mind Delta’s decision to abandon Gol for Latam. In the meantime, Air France/KLM continues to implement its impressively large number of reforms outlined in November. They include major fleet changes, i.e. the phaseout of A380s and the introduction of A220-300s. It’s studying A320 replacement and would love Airbus to build a larger A220-500. Air France is taking more A350-900s. KLM is taking more B787-9s and -10s as it phases out B747s.
Air France is adding business class seats on domestic flights for connecting passengers. It’s adding more flat-bed seats on longhaul flights and optimizing overall seating configurations.
That and a whole host of other reforms (see Skift Airline Weekly’s Nov. 11, 2019 issue). Air France/KLM doesn’t reject the idea of buying other airlines. But it seems keener on taking advantage of the consolidation that others do the dirty work of achieving. Of course, consolidation in Europe is developing not just through takeovers (i.e. IAG buying Air Europa, previously a prospective Air France/KLM JV partner) but at least as importantly through airline failures. And no, Air France/KLM is not interested in Alitalia.
What’s the ultimate goal? Maybe IAG-like margins are a bridge too far, for now. Instead, management eyes a steady-state groupwide operating margin of between 7% to 8% by 2024.
- Air France/KLM can look to Qantas for inspiration. Early last decade, the Australian carrier was itself earning Air France-like margins while embroiled in nasty labor disputes. Then came 2015, when a series of tough reforms began to pay dividends.
That year, its operating margin jumped to 11%, trailing off only modestly during the subsequent four years. Last year, Qantas posted an operating margin just above 8%, earning more than $1b in operating profits. That’s despite some slowing demand trends from Australian businesses and households during the year. Weakness in the important Hong Kong market was another notable setback.
Qantas reports financial results just twice a year, and last week presented figures for the last six months of calendar year 2019 (July to December). That tends to be its stronger half, as it was again this time with operating margin nearly hitting the double-digit 10% mark. There was a tiny bit of y/y deterioration as revenues rose a little less than 3% while operating costs were up a little more than 3%. ASK capacity for the half was flat.
Qantas earns its highest margins in the Australian domestic market, where it competes with the struggling Virgin Australia. Last half, mainline domestic operating margin was 14%. Jetstar, which also makes a lot of money domestically, earned 10%, with some additional profit contributions from Jetstar Japan (a joint venture with Japan Airlines). The Qantas loyalty plan was as usual extremely profitable, adding about a point or two to groupwide margins.
Mainline international flying, by contrast, tends to earn just modest margins — only 3% last half. This marked some y/y improvement though as many foreign competitors shrink their Australian presence. Demand was mixed at home, with Jetstar experiencing some leisure softness and most industrial sectors flying less. The important resource sector, however, showed strength. The overall trend did improve some as the half progressed, particularly in the domestic market.
On the other hand, Jetstar suffered from labor unrest last month, Hong Kong was still weak, and Australian airport costs rose, a particular frustration for the airline. Unfortunately, mid-January of this year marked an inflection point, when Covid-19 fears began reversing the modest demand recovery evident toward the end of 2019. Australia’s big wildfires might have caused additional softness. Some segments are still holding up, notably demand from the resource sector.
But business and leisure are otherwise softening, and not just to China. Japan is hurting too. So are shorthaul routes. The only exception seems to be U.S. and U.K. routes, which seem resilient for now. Overall, Qantas expects the Covid-19 scare to erase about $70m to $100m from calendar first-half operating profits. There are of course the offsetting cost declines from cheaper fuel. In addition, the domestic leisure market could strengthen if Australians decide to holiday closer to home. Inbound foreign tourists by the way, account for just 8% of the traffic flying Qantas and Jetstar domestically. For tourists from Asia alone, that figure is just 2%.
In any case, Qantas is reacting cautiously by cutting more capacity (see Routes section). Strategically, one of the Flying Kangaroo’s most important projects is the joint venture it’s building with American. That’s supporting a number of new U.S.-Australasia routes by both carriers. There are no current plans for Alaska to join their JV, but it’s an important partner for Qantas, nonetheless, especially following the new Alaska-American partnership and Alaska’s oneworld intentions.
Another big strategic effort — “Project Sunrise” — is flying A350-1000s on ultra-ultra-longhaul routes to London and New York from Australia’s east coast. It won’t finalize plane orders, however, unless pilots agree to pay and work-rule terms management considers acceptable. Going around the pilot union, Qantas is preparing to next month ask pilots to vote directly on an offer.
Qantas still has joint ventures with Emirates and China Eastern. It still counts Singapore as an important gateway to Europe and other parts of Asia. B787 Perth-London flights seem to be a success. A380s are getting new configurations with more premium seats. Jetstar gets A321 LRs next year, followed by XLRs a few years later. Qantas, meanwhile, still finds A220s or perhaps E2-EJets a good fit. It’s also evaluating B737 MAXs and additional NEO XLRs. It liked the Boeing NMA idea too.
- How important is the MAX to Air Canada? With 24 of them on hand at the time of their grounding, they accounted for roughly one-quarter of the airline’s entirely narrowbody fleet (not counting E190s). The lost capacity has meant higher unit costs, operational complexities, fewer connecting passengers, and disruptions to profitable markets like Hawaii.
The carrier did wind up flying about 97% of its planned 2019 capacity anyway, by retaining planes it was planning to retire, grabbing planes from Rouge and Jazz, extending leases, and even wet-leasing jets from other airlines including Air Transat (something U.S. airlines aren’t doing because of pilot contract restrictions). Because it doesn’t have prior-generation B737s, Air Canada has nothing for its MAX pilots to fly while they wait for the ungrounding.
As with most MAX-affected airlines though, Air Canada got a Q4 bump in unit revenues from the loss of so much market capacity — rival WestJet is a big MAX operator suffering lost capacity too. This RASM bump was especially evident on U.S. transborder routes, which also saw healthy gains in premium demand. Transcon routes, meanwhile, did “very well” for Air Canada last quarter.
Other positive developments include strong connecting flows though the airline’s Montreal hub and good performance in longhaul markets that peak counter-seasonally, i.e. India and the Middle East. Management happens to see India as a promising growth market. New routes to São Paulo, Auckland, and Quito, all counter-seasonal as well, have delivered “positive results with a favorable outlook.” And importantly, the transatlantic market to Europe “continues to be a very robust part of our network,” with more opportunities to grow.
So how did Air Canada fare financially last quarter? Not so great. Its 3% operating margin signals more work is needed to boost offpeak winter-half results. Q4 revenues rose 5% y/y but operating costs rose 6%, all on 3% more ASM capacity.
Air Canada unfortunately has a pretty large exposure to greater China, with the mainland accounting for about 6% of total ASMs and Hong Kong another 3%. In response to Covid-19, it’s moving planes from Asia to Europe. Cargo was another area of weakness, with revenues dropping 14%. Add that to its MAX woes, the China shock, some weakness in western Canada, some aggressive transatlantic pricing, and some labor inflation, all of which should again drive down y/y margins in Q1, despite the health of many areas of its business.
Air Canada is also experiencing some momentary hiccups with the introduction of its new Amadeus reservation system, a giant undertaking. As it happens, agents are getting a trial by fire on the new system as large numbers of customers on China routes need to be re-accommodated or refunded. Ultimately, the new system should drive higher revenues. So should a new loyalty plan coming soon.
Most dramatically, Air Canada is awaiting regulatory clearance to buy its rival Transat — the airline expects to hear something around May. In the meantime, Air Canada continues to build on long-standing strategies like cultivating international connecting traffic and expanding Rouge. A220s are now arriving. A330 interiors are getting a makeover. Rouge will need new planes before long. New routes include Montreal-Toulouse, Montreal-São Paulo, Montreal-Bogota, Toronto-Vienna, Toronto-Brussels, Toronto-Quito, and Vancouver Auckland.
For all of 2019, by the way, Air Canada’s operating margin was 9%. Compared to U.S. rivals, only American did worse. Indeed, there’s more work to be done, even after coming so far from where it once was, i.e. bankruptcy.
- Stunning. That’s the only way to describe how Gol is faring in the wake of last year’s collapse of Avianca Brasil. The LCC reported a mesmerizing 26% Q4 operating margin excluding special items, its highest figure since 2004, when it was just three years old. Q4 happens to be peak season in Brazil.
But even across all of 2019, Gol performed exceedingly well, posting a 19% operating margin. It wasn’t just Avianca Brasil’s disappearance that drove up margins. Falling fuel costs, aided by lower fuel taxes, were also a big factor. In Q4, Gol’s fuel bill dropped 11% y/y despite 6% more ASK capacity, and despite further currency depreciation. The Brazilian real hovered around all-time lows versus the U.S. dollar.
No less important was a sharp recovery in corporate travel demand, which Gol is well-placed to capture even as a low-cost carrier. Why? Because of its privileged slot position at key airports — its market share is particularly strong in Rio de Janeiro. Gol also has products and services catering to corporate fliers, and a large loyalty plan called Smiles (more on that in a moment).
As a result of the corporate demand resurgence, Gol’s Q4 unit revenues jumped by double digits. Total revenues spiked 19%, even as operating costs (adjusted for non-recurring items) declined 8%. Other than fuel, Gol’s most important cost declines came in the areas of airport fees and maintenance, the latter mostly because of prior year costs associated with redelivering B737-NGs to lessors. It didn’t redeliver as many this time, given the need to replace lost capacity from its seven grounded B737 MAX 8s. Gol also by the way faced the temporary loss of some NG capacity due to unplanned safety inspections.
In general though, Gol is managing its fleet and capacity well, content with growing modestly even with Avianca gone. It contrasts this with competitors Azul and Latam, which Gol seems to think are growing too aggressively. Executives in fact don’t appear too perturbed about their MAX issues, perhaps because it’s much easier to find replacement capacity when yourpeak season is most of the world’s offpeak season. The airline did say that leisure demand has been much slower to recover than business demand.
But it nevertheless expects another outstanding year in 2020, expecting operating margin to again hit 19%. It sees something similar for 2020 as well. ASK growth this year will be roughly 7% to 9%.
Is Gol upset about getting dumped by Delta? Not at all. It says a new partnership with American will be even stronger, given American’s hub in Miami. Gol will have about twice as many American seats to sell (via codeshare) than it had with Delta. It’s at the same time retaining ties to Air France/KLM, while also adding new partners like Colombia’s Avianca, with which it will codeshare.
As for Smiles, Gol regrets an earlier decision to sell a big stake. So it’s trying to buy it back, with its latest proposal subject to a vote next month by the loyalty company’s minority shareholders.
Other pursuits include the launch of a new maintenance unit, partnerships with small carriers to build a better regional network, opening new international flights (i.e. São Paulo-Lima), growing its profitable cargo unit, and adding capacity to areas of the country with higher economic growth, like the northeast. MAXs, meanwhile, remain a critical piece of Gol’s longterm business strategy. It has 129 more still to come, including 30 MAX 10s.
- TAP Air Portugal, though not publicly traded, disclosed a 7% operating margin for the second half of 2019, offsetting heavy losses in the first half of the year. In the end, TAP eked out a small 2% operating margin for the entire year, but losses were deep ($119m) at the net level. The net result, to be clear, was burdened by ongoing losses at the company’s Brazilian maintenance unit.
When investors led by JetBlue and Azul founder David Neeleman bought effective control from Portugal’s government in 2015, TAP was an airline with decent profits but a weak balance sheet. The new owners injected lots of money to buy lots of new Airbus planes, including A330 NEOs and A321 LRs. They also revamped the carrier’s brand, added routes to the U.S. and Africa, optimized cabin configurations, implemented LCC-like pricing, and raised ancillary revenues.
Unfortunately, while 2015 saw a big drop in fuel prices, it also marked a big downturn for TAP’s two most important overseas markets: Lusophone Africa and Brazil. A few years later, Portugal became one of the world’s fastest growing markets due to an influx of tourists. But that story also featured a big expansion by LCCs like Ryanair.
Today, TAP is in constant confrontation with Portugal’s government, which feels misled by promises of profitability. Most recently, politicians are irate over executive bonuses despite last year’s net loss. Azul asks for a little more appreciation for the 900 new workers it hired last year, and the billions of dollars it’s investing in Portugal.
It’s also up in arms about the sorry state of Lisbon’s airport, whose severe congestion creates big cost and operational headaches, never mind the network opportunities TAP must forego because of expansion limitations. The airline now says it will stop growing for the next two years because of Lisbon airport constraints. Its CEO actually called it the “worst airport in the world.” Vinci, the French company that runs Portugal’s airports, is developing a low-cost facility for Lisbon at Montijo airport. TAP, alas, insists it will never fly there.
An unrelated setback this month relates to Venezuela, where TAP had to temporarily suspend service because of a political dispute. A new joint venture with Azul is better news.
The biggest question though is whether Neeleman wants to stick around, or alternatively sell his stake to another airline. Lufthansa wouldn’t mind some more Latin exposure; it’s now talking with United about a possible TAP takeover, reports Portugal’s Jornal de Negocios.
- India’s SpiceJet somehow managed to grow its ASK capacity a massive 59% y/y last quarter, even with its MAXs out of service. The key was taking on a bunch of B737-NGs idled after Jet Airways stopped flying.
All of SpiceJet’s Indian rivals, as it happens, only fly Airbus narrowbodies, so were uninterested in Jet’s planes. Impressively, the LCC’s calendar Q4 operating margin was stable y/y despite all that growth, staying above break even at 1%. For the entirety of 2019 though, SpiceJet’s operating margin was negative 1%, more reflective of management’s short-term emphasis on expansion over profits.
The airline is now a solid second behind IndiGo in terms of domestic Indian market share. Revenues and operating costs both rose about 46% y/y last quarter, with fuel costs alone rising just 39%. Fuel prices are down sharply again this quarter, which should greatly boost the Indian economy — the country is one of the world’s biggest oil importers.
By the IMF’s count, India in fact just surpassed France and the U.K. to become the world’s fifth-largest economy (only the U.S., China, Japan and Germany are bigger). On the other hand, as President Trump visits this week, he’ll see an India whose economic growth has slowed in recent years. Airline demand, measured by RPKs, increased just 5% last year, depressed by Jet’s collapse.
SpiceJet’s voracious growth might lift the market in 2020. It’s even now wet-leasing some A320s from a Bulgarian company. It did receive some compensation from Boeing for its MAX troubles. Will it buy widebodies? Nothing new to report on that front. It does however plan a new airline in the UAE (see feature story). It’s also cooperating with Emirates and Gulf Air. Overall, SpiceJet has added more than 40 planes to its fleet since Jet’s death in April. It now has 121 planes, including five it uses for cargo operations.