Gol is Performing Well but Hobbled by Debt
Pushing Back: Inside the Issue
It’s the heart of earnings season now. Major airlines from across the world reported their second-quarter results last week. In Asia, Singapore Airlines enjoyed another fantastic quarter. All Nippon’s performance was good but not great. In the U.S., the domestic goliath Southwest earned a respectable double-digit operating margin that nevertheless looked a bit sickly compared to its peers. One of those peers, Alaska Airlines, produced margins that topped even Delta and United, never mind that Delta and United are currently riding an unprecedented intercontinental boom.
The intercontinental boom certainly helped IAG and Air France-KLM in Europe, though the latter continues to deliver sub-par margins. Interestingly, Air France continued to outperform KLM. IAG, meanwhile, got a boost from booming leisure demand in the Spanish market, a market Airline Weekly profiled in a feature story last week. This week, our feature story looks at the Brazilian low-cost carrier Gol, whose second quarter operating margin was great (especially for an offpeak period) but whose net margin was dreadful. Read on to find out why.
Why does Ryanair think fares might be too high? Why is Hawaiian Airlines still losing money? When will Volaris get a chance to expand across the U.S. border? Answers ahead.
Airline Weekly Lounge Podcast
Both Ryanair and Alaska reported some decline in yields in the second quarter and continuing into the third. But they also made clear: Overall travel demand remains robust on both sides of the Atlantic. Listen to this week’s episode, and find a full archive of the Lounge here.
Weekly Skies
Asked point blank if International Airlines Group sees any decline in airfares or travel demand, CEO Luis Gallego was blunt. “We don’t see that,” he said last week during the groups second-quarter results call.
The group, which includes Aer Lingus, British Airways, Iberia, and Vueling, is doing extremely well. Travel demand is robust with about 80% of its third-quarter schedule already booked. And that is driving higher yields — a rough proxy for airfares — across its businesses, and not just long-haul international markets. In fact, IAG made its largest gains in domestic markets — Spain and the UK — and in Europe where yields, measured in passenger unit revenues, were up 19% and 18%, respectively, in the second quarter. Group yields increased just over 13% with improvements in every segment.
“We continue to see strong demand in the third quarter,” IAG Chief Financial Officer Nicholas Cadbury said.
U.S. airlines are seeing different yield trends. There, domestic yields are falling (see Alaska and Southwest below). But that is not indicative of travel demand, which remains robust. It’s more about comparisons to the record yields airlines made last year, and elevated levels of capacity growth in the U.S. as the industry pushes towards a full recovery. And results at network carriers American, Delta, and United were buoyed by their longhaul networks.
Corporate traffic, however, is “recovering more slowly than we thought,” Gallego said. That’s no surprise given the similar comments from other airlines around the world. What stands out though is the differences within IAG. At British Airways, corporate volumes are only back to roughly 61% of 2019 levels while revenues are at roughly 69%. But at Iberia, the same two metrics are 82% and 95% recovered. Gallego attributes that gap to different return-to-office rates in Spain and the UK.
IAG maintains expectations that corporate travel revenues will recover to roughly 85% of 2019 levels, just maybe a little later than planned. And while the recovery at British Airways leveled off in the second quarter, the airline’s CEO Sean Doyle said they see “very early signs” of the rebound resuming in the quarter beginning in October.
Operating at British Airways and Aer Lingus are still issues, as they were last year. Only 57% of British Airways flights left on-time in the second quarter, and 64% of Aer Lingus flights. The issue this year is not staffing so much as a mix of aircraft maintenance needs, supply chain issues, and air traffic control constraints over Europe, Gallego said.
IAG understands the situation and is working to improve operations at both Aer Lingus and British Airways, he said citing the group’s success with reliable operations in Spain. Iberia achieved a 90% on-time departure rate in the second quarter.
On Air Europa, which IAG launched a new bid to acquire earlier this year, the group is in the process of submitting information to European Commission regulators for approval of the $441 million deal. As part of that, it is in talks with partners over potential “remedies” — for example, agreements to divest slots at key airports like Madrid to competitors — that could help it secure antitrust approval, Gallego said.
Asked how this bid differs from IAG’s first failed attempt to takeover Air Europa, Gallego said they plan to offer more potential remedies to regulators, and are working diligently to show how the combination would be good for travelers. He made no mention of any potential interest in TAP Air Portugal, which the Portuguese government plans to privatize later this year.
IAG reported a strong 9% operating margin on a $1.4 billion operating profit in the first half of the year. As noted yields increased, as did capacity that was up 31% year-over-year. Iberia was the stand out financial performer in the group with an 11% operating margin excluding special items in the first half.
Looking forward, IAG maintains plans to operate 97% of its pre-pandemic capacity in the second half and for the full year. It expects “strong margins,” as well. And, to support its future growth plans, the group ordered seven more long-haul planes — one Airbus A350-900 for Iberia and six Boeing 787-10s for British Airways — for delivery in 2025 and 2026.
Air France-KLM Looks to Raise Loyalty-Backed Funds
Air France-KLM is talking to Apollo Global Management about raising funds to improve its balance sheet, in a deal that would involve spinning off its loyalty plan into a new entity. The disclosure came as the airline reported its latest quarterly financial results.
Benefitting from “very strong” revenue trends and significantly lower fuel costs, Air France-KLM reported last week a solid 10% operating margin for this year’s April-to-June quarter. This follows a negative 5% operating margin in the offpeak January-to-March quarter, underscoring the seasonal variability that continues to challenge the company’s full-year margins. For the first six months of 2023 combined, operating margin was 3%.
The underwhelming first-half results also underscore the divergence in profitability between Air France-KLM and its U.S. partner Delta, whose first-half operating margin was eight points higher, or 11%. More worrying, it highlights Air France-KLM’s chronic pattern of underperforming its peers, especially IAG.
Air France-KLM, however, is making progress. Its 10% second quarter operating margin was about four points better than the 6% figure it posted in both the second quarter of 2022 and 2019. The improvement was driven by Air France’s business, which has started to outperform KLM. In the nearly two decades since Air France and KLM merged, the latter has routinely posted much stronger profits than the former. But that’s changing as KLM faces heightened operating difficulties at its Amsterdam Schiphol hub. It faced some fleet issues at its regional Cityhopper unit last quarter as well. Longer-term, KLM’s business model faces a significant threat from its own government, which is working to severely curtail the number of flights at Schiphol.
KLM in Amsterdam, more so than Air France in Paris, depends on connecting traffic, which in turn depends on network effects that could diminish as fewer flights are permitted. Some see Schiphol becoming more like hyper-congested London Heathrow, where demand has long outstripped handling capacity, compelling airlines to use larger aircraft. Amsterdam, however, generates much less origin and destination demand than London; in other words, travelers starting or ending their journeys there, not just flying there to connect.
The group also suffered as cargo revenues plummeted by a third year-over-year, and as its large maintenance business confronted labor shortages and supply chain disruptions, preventing it from capturing ample growth opportunities (there’s currently a worldwide shortage of aircraft maintenance capacity). Operating margin at the maintenance unit fell to 4%, from 6% in the same quarter a year ago. The group’s low-cost airline Transavia, meanwhile, which earned a double-digit operating margin in the spring quarter of 2019, dropped to break even this spring.
As the U.S. Big Three have made crystal clear, transatlantic demand has been red-hot this spring and summer, fueled by American tourists flying to Europe. Air France-KLM reported “very strong yield performance” on routes to Latin America as well, especially for close-in bookings typically made by business travelers. The group’s Asia capacity is still just two-thirds of what it was in 2019. Capacity is down on Caribbean and Indian Ocean routes as well. Africa is currently showing “strong traffic dynamics.” And on shorthaul routes within Europe and its periphery, yields are up but air traffic controller strikes are having an impact.
The current July-to-September quarter is typically Air France-KLM’s strongest. And bookings sure enough appear healthy, including those for Transavia. Operational reliability, management insists, is improving. Groupwide, capacity in ASK terms will be at about 95% of pre-pandemic levels in the second half of 2023. Unit costs for the year will be up in the low single digits, pressured by higher labor costs (including profit sharing). Fleet renewal and earlier headcount reductions should help with unit cost control longer-term. Over what management calls the “medium-term,” Air France-KLM is aiming for annual operating margins of 7-8%. For reference, it earned 4% in 2019. Make no mistake, though: 7-8% is nobody’s idea of great. A better adjective might be mediocre.
Along with its goal of boosting margins, the company is keen on improving its balance sheet. It has a new arrangement with the private equity giant Apollo to raise about $540 million. Apollo will lend the money to an Air France-KLM entity holding a pool of maintenance components, earning about 7% annual interest for three years and higher rates thereafter (the bonds Apollo will buy are perpetual, never maturing).
More interestingly, Air France-KLM is now in talks with Apollo about potentially raising another $1.6 billion, this time involving its Flying Blue loyalty plan. Apollo would receive regular fixed payments from a new entity with the right to issue and sell Flying Blue miles. But critically, the airline would retain full ownership rights to the valuable Flying Blue customer database.
Southwest to Rework Network to Match New Travel Patterns
Southwest former CEO Gary Kelly‘s firm belief that the industry was in for a slow corporate travel recovery is looking increasingly prescient. Southwest is undertaking the not-so-simple task of redesigning its network to reflect a future with fewer road warriors for some years to come.
“I expect business to come back, but I think it’s going to trail the restoration of leisure for a while,” Southwest’s current CEO Bob Jordan, who replaced Kelly in February 2022, said last week.
While Jordan did not say when he expects corporate demand to recover from the pandemic, given we’re already three years into the rebound, Kelly’s forecast of a 5-10 year business travel recovery is looking increasingly accurate. Southwest’s network changes, which Jordan said will contribute to roughly $500 million in incremental pre-tax profits next year, will only begin in January — or four years into the Covid recovery, and only a year shy of Kelly’s expectations.
The return of corporate travelers has broadly stalled in the U.S. Airline executives put the recovery, at least among large, managed accounts, at roughly 75-80% of 2019 levels. Most are optimistic that the recovery of corporate demand will resume after Labor Day, the symbolic end of summer in the U.S., but in a measured, gradual manner.
Regardless, Southwest is preparing for a future where there are fewer road warriors who need a 6 a.m. flight from, say, Chicago to Columbus, and more travelers — whether for a business, leisure, or blended trip — from Chicago to Phoenix, or Columbus to Tampa. Hence the network rejig.
The changes are four-fold as Southwest Chief Operating Officer Andrew Watterson explained. The first is to remove some short-haul flights in favor of more medium- to long-haul ones; for example, Southwest will end service between Burbank and San Francisco in January. Second, the carrier will reduce flying on Tuesdays and Wednesdays — the weekdays with the lowest travel demand — by 7-10% compared to other weekdays; previously it only reduced its schedule by roughly 2% on those days. Third, Southwest will shift some early morning and late night flights to more attractive times of day. And, fourth, the airline will reduce some of its Hawaii flying to reflect seasonal demand shifts, with executive comments suggesting a pull back in inter-island capacity.
The changes to Southwest’s network are set to be complete by March. And, as a result, the airline plans to slow overall annual capacity growth to the “mid-single digits” in 2024 from up 14-15% this year as it continues to rebuild from the pandemic.
Asked by J.P. Morgan analyst Jamie Baker if the slow corporate travel recovery is in any way connected to Southwest’s operational meltdown during the year-end holidays last year, Jordan responded with a firm no.
“As you think about demand for the brand, demand for the product that shows up, obviously, in bookings,” Jordan continued. “We’re just not seeing any sign of weakness.”
Yields, and airfares, at Southwest peaked last summer. Unit revenues, measured in RASM, at the airline decrease 8.3% year-over-year in the second quarter, and are forecast to fall 3-7% in the third quarter. Chief Commercial Officer Ryan Green said fares remain elevated but, when compared to the records set in 2022, the comparisons are difficult. And he is right, unit revenues at Southwest, while down from last year, are still up 12% from 2019 levels.
“We’re seeing leisure booking and yield strength continue throughout the summer travel season with July revenue, which is essentially booked, expected to also be a record,” Green said.
Southwest posted a $795 million operating profit in the second quarter, and an 11.5% operating margin excluding special items. Revenue increased nearly 5% year-over-year to $7 billion, while expenses rose faster at 12% to $6.2 billion. The faster cost growth was attributed to higher labor expenses and maintenance needs for the airline’s fleet of Boeing 737-800 aircraft. Unit costs, excluding fuel and special items, were up 8%.
Ryanair Posts Strong Profits but Sees Some Close-In Softness
“I would welcome a softening in pricing.” Doesn’t sound like something from the mouth of an airline CEO. But then again, Ryanair’s Michael O’Leary is anything but an ordinary airline CEO. O’Leary was speaking during Ryanair’s calendar second-quarter earnings call, in which the headline theme was another muscular profit — operating margin reached 19.5%, up from 8% in the same quarter last year (and 12% in 2019).
One reason for the profit was a 42% year-over-year surge in average fares. To be clear, the increase was distorted by the start of the Ukraine war last spring, which initially caused demand throughout Europe to weaken, before coming back strongly last summer. Still, airfares were by historical standards elevated this summer. And O’Leary suggested they might be triggering some “customer resistance,” based on “a slight softening in the close-in fares in late June and early July” detected in the past few weeks. “Nothing that I would be overly worried about at the moment,” he added. But it’s something Ryanair is watching.
O’Leary was quick to assure that Ryanair’s prices are still in fact attractive, especially compared to rivals—its average fare last quarter was just €49 ($54). And longer term, “the narrative that the era of low fares is over and is never coming back is not a correct one. There is still lots of low-fare availability.” Keep in mind that O’Leary does have a history of downplaying expectations about yields, perhaps in part to support his perennial claims that unions, airports, and other Ryanair stakeholders needs to temper their demands.
O’Leary does see further consolidation in Europe, pointing to Lufthansa’s planned takeover of ITA Airways, as well as TAP Air Portugal’s planned privatization. Would Ryanair itself participate in consolidation? It did after all purchase Buzz in Poland and Niki in Austria. But both takeovers were “painful bloody experiences.” O’Leary remarked: “Large-scale M&A [mergers and acquisitions], I would say it’s highly unlikely. We tend to avoid large-scale M&A. You’re generally inheriting somebody else’s problems.”
In addition, “there is a shortage of aircraft, both new and lease, that I think will run on until the end of this decade out to 2030.” This too will allow higher-cost rivals to increase their fares. As for O’Leary’s hopes for Ryanair, “I would hope to see modest fare rises over the next 2 or 3 years.” The recent signs of softness in close-bookings notwithstanding, demand overall this summer is extremely strong, supported by American and Asian tourists (arriving to Europe on other airlines of course) flying throughout the continent on Ryanair.
Travelers certainly have plenty of choice, with the airline offering 190 new routes this summer. This hints at the massive scale it’s achieved, including a fleet of more than 550 planes and another nearly 400 on order. These include the Boeing 737-10s it just ordered this spring. Boeing delivery delays remain an issue, but Ryanair’s operation is nevertheless about 25% larger than it was pre-Covid. Industry-wide European capacity is still about 7% shy of what it was pre-Covid. Interestingly, Ryanair is eager to resume flying to Ukraine in a big way, as soon as it’s deemed safe. Another growth market is Albania. O’Leary says the airline is well-staffed and in fact incurring some labor inefficiencies to ensure that flights are completed during air traffic control delays.
For its current fiscal year, Ryanair has 75% of its fuel needs hedged at $89 a barrel, which means it’s paying above the current spot price. But it’s locked in about one quarter of next year’s needs at just $74.
Alaska Sees Shift to International Travel Hurting Domestic Fares
The surge in U.S. domestic flying, be it revenge travel or new blended business and leisure trips, appears over. Alaska executives said that the second quarter — June to be exact — may be the zenith of the domestic recovery even as overall travel demand remains robust. Unit revenue at the Seattle-based airline, measured in RASM, fell 3% year-over-year in the second quarter. That compares to a 15% increase in the first quarter, and an eye-popping nearly 50% increase in the second quarter of 2022. And the decline is not over yet: Alaska expects unit revenue to fall another roughly 9% in the third quarter, even as total revenue is forecast up as much as 3%.
“Demand is still very strong on the domestic side,” Alaska CEO Ben Minicucci said last week. The decline in airfares, he added, is “really due to the surge in international. If you really look at it, international is going to be strong from maybe June through September, October. But as kids get back to school, and things start to normalize, I do think this thing is going to find its equilibrium.”
“Overall, we’re coming off the high across the network, across the system from historically peak unit revenues,” Alaska Chief Commercial Officer Andrew Harrison added.
Alaska plans to grow capacity by 10-13% from 2022 levels in the third quarter, and full-year 2023 capacity by 11-13%. Capacity at the carrier was up 10% in the second quarter. Harrison noted that the growth benefits from the arrival of new, larger Boeing 737-9 aircraft that allow it to add capacity with fewer flights.
Overall U.S. market capacity was also up in the second quarter by 2.5% compared to 2019, according to Cirium Diio data. It is scheduled up more than 5% in the September quarter. That increase in capacity, coupled with roughly flat travel demand, is contributing to the airfare declines.
And to be clear, U.S. airline capacity growth remains constrained. Alaska, like most of its competitors, continues to operate at lower productivity levels than before the pandemic. New Airbus and Boeing aircraft continue to arrive late. A national air traffic controller shortage has limited the number of flights into and out of New York and elsewhere. And a persistent captain shortage, coupled with the rising cost of regional air service, has seen major airlines drop more than 70 destinations from their maps.
Alaska, despite Wall Street’s concerns, arguably has some of the biggest potential upside among U.S. domestic airlines. Travel on the West Coast, its main geography, is among one of the last regions to recover nationally. And corporate travel, particularly among the big tech companies that are based on the West Coast, also lags national trends. This has Alaska executives confident of significant upside when those road warriors do return, whether it is this fall or next year. Alaska’s managed business travel volumes were unchanged at roughly 75% of 2019 levels in the second quarter.
The airline had what Minicucci described as a “solid” second quarter. Alaska reported a $337 million operating profit and exceeded its margin guidance with an 18% operating margin excluding special items. Revenues increased 7% to a record $2.8 billion. Unit costs, measured in CASM, excluding fuel increased 2% year-over-year.
Alaska forecasts a 14-16% adjusted pre-tax margin in the third quarter. And for the full year, adjusted pre-tax margin is estimated at 9-12%, total revenues up 8-10% year-over-year, and unit costs excluding fuel down 1-3%.
Volaris Still Waiting for U.S. Safety Regulators to Lift Growth Restrictions
Mexico’s Volaris, one of two low-cost carriers competing with Aeromexico, earned a positive 6.5% operating margin for the second quarter. This compares to negative 3% in last year, and a positive 8% in 2019. Volaris is forever waiting for the U.S. to lift the safety rating of Mexico’s aviation sector, which would allow it to resume its aggressive U.S. growth. In the meantime, it’s been adding capacity domestically, and from Central America to the U.S. In fact, Volaris announced the opening of 40 new domestic routes last quarter, “the highest number of routes we’ve opened in one quarter in the history of the company.”
But Aeromexico and Viva Aerobus, themselves prevented from adding U.S. flights, are dumping capacity into the Mexican domestic market as well. That has resulted in what Volaris described a “slight excess of capacity in the domestic market, driven by the fact that our competitors have very few places other than the domestic market to allocate new capacity coming into their fleets.” Nevertheless, demand has been strong overall, both domestically and on existing U.S. routes.
Appreciation of the Mexican peso has helped control costs, which in any case haven’t been as inflationary for Volaris as has been the case at airlines in the U.S. for example. “Contrary to what has happened in other jurisdictions, Volaris has controlled labor costs without any significant bump and has kept its local currency increase in line with the Mexican inflation rate.” In addition, jet fuel costs are down, Mexico’s manufacturing and logistics sector is enjoying a foreign investment boom, and ancillary revenues now account for nearly half of the airline’s total revenues.
One new offering is an “All-You-Can-Fly” annual membership program modeled on what Frontier is offering; Volaris and Frontier are both controlled by Indigo Partners. Mexico City airport infrastructure remains a headache, aggravated by a government decision to reduce the number of available slots. As a reminder, Volaris primarily chases price-sensitive travelers, including Mexicans that typically travel by long-distance busses.
In Other News
- Asia’s airlines began reporting their calendar second-quarter results. One was Singapore Airlines, which continues its streak of excellent results. During the April-to-June quarter, its operating margin was 17%. For reference, that was equal to what Delta and United earned. Singapore said low-cost division Scoot made money as well, without disclosing its margins. And it assured that the Air India–Vistara merger remains on track, with Singapore set to take a 25% stake in the combined entity. Demand, it added, is robust across all routes and regions. The carrier is busy rebuilding its network to China. But it warned that competition is intensifying and cargo demand is weakening.
- All Nippon did well also, though not quite as well. Its calendar second quarter operating margin was 9.5%, boosted by strong demand but hurt by the weak Japanese yen, which prevented the airline from fully taking advantage of falling fuel prices. One area of focus is now is capturing demand between North America and China through Tokyo, given the dearth of nonstop flights.
- Back in the U.S., there were green shoots, but also new issues, at Hawaiian. Travel demand in Japan, Hawaiian’s largest non-U.S. market and a key to its recovery, is rebounding with bookings for the third quarter already double the entire second quarter. And the airline’s new freighter division with Amazon, which will generate new revenues, launches this fall. But at the same time, a recall of Pratt & Whitney geared turbofan engines on Hawaiian’s Airbus A321neo aircraft could cut capacity this fall, and the arrival of its first Boeing 787-9 is delayed (again) to January. All told, Hawaiian is “encouraged about what we can accomplish for the rest of the year and into next year,” Senior Vice President of Revenue Management and Network Planning Brent Overbeek said last week. The airline reported an operating loss of $9.6 million in the second quarter, and a negative 2% operating margin.
- The U.S. regional airline SkyWest announced a 4% operating margin for the second quarter. During its earnings call, management said, “It will take some time over the next couple of years to regain our crew balance and restore production and full utilization of our fleet.” Captain attrition has stabilized, it said, but First Officer attrition has inched up. SkyWest hopes to return to pre-pandemic profit margins when it returns to full fleet utilization.
Landing Strip
- Traffic neared or exceeded pre-pandemic levels at some of the largest airports in Europe and the U.S. during the first six months of the year. At London Heathrow, the busiest airport in Europe pre-pandemic, numbers recovered to 96% of 2019 levels — or 37.1 million passengers — in the first half of the year. However, Heathrow describes traffic as “consistently below pre-pandemic levels,” and suggests that numbers may not fully recover this year. In Spain, operator Aena said traffic fully recovered at its airports in Spain, Brazil, and London Luton to 144 million during the first half of the year. Aena’s core airports in Spain, including Madrid and Barcelona, saw numbers increase 1% from 2019 levels to 129 million passengers during the period. And across the Atlantic, traffic at the three main New York City airports — JFK, LaGuardia, and Newark — was also up 1% from 2019 levels to roughly 69 million passengers in the first six months of 2023, Port Authority of New York and New Jersey data show.
- Speaking of the Port Authority, the operator last week opened seven more gates in the new $2.7 billion Terminal A at Newark airport, bringing the total to 28 of 33 operating gates. The newly opened gates are split between JetBlue and United, with the latter understood to be using six of the seven. The final five gates in Terminal A will open over the next 60 days, or by the end of September, and be used by Delta. The additional gates will likely help reduce ramp congestion at Newark, which was at the center of systemwide operational issues for United at the end of June.
- The drama at Schiphol isn’t over yet. KLM and at least eight other airlines have appealed the Dutch government’s plan to cut flight movements at the Amsterdam airport to the country’s supreme court. This is the second appeal for the case that initially went in airlines’ favor — blocking the flight reductions — in April, before that ruling was overturned earlier in July by the Amsterdam Court of Appeals. The crux of the case is how to cut noise pollution at Schiphol: the government argues this is best done by cutting total flights by 12%, or to 440,000 annual movements from 500,000, over several years, while airlines claim they can achieve the sought after noise reductions by using new aircraft, modernizing takeoff and landing approaches, and reducing night flying.
Routes and Networks
International Airlines Group and Qatar Airways, the national airline of IAG’s shareholder Qatar, are expanding their commercial ties. Iberia is joining the existing joint venture between British Airways and Qatar Airways, an addition that includes new daily Iberia-operated flights between Madrid and Doha on an Airbus A330-200 from December 11. The trio will have a nearly 14% share of seats between Europe and the Middle East — excluding the planned new route — based on 2023 seat capacity, according to Cirium Diio data. That’s second to only Emirates with its 20% seat share.
The JV is significant in several ways. For one, Doha will become Iberia’s furthest destination to the east, at least until Tokyo flights, suspended during the pandemic, resume. And coordinated connections with Qatar Airways, something that is only possible under an immunized JV and not with a codeshare, will increase Iberia’s reach in the Middle East and Asia — regions key to IAG’s ambition of building Madrid into a “three-hundred and sixty-degree hub.” But the deal is also significant for Qatar Airways. The airline is slowly solidifying its franchise in Europe through deep partnerships with its fellow Oneworld alliance members; in addition to British Airways and Iberia, the carrier also has a JV with Finnair. Despite the two partnerships, Qatar Airways and its partners remain behind Emirates in Europe-Middle East seat share with just over a 14% share this year.
But Iberia’s joining the British Airways-Qatar Airways JV will likely mean network growth beyond just a new Madrid-Doha nonstop. Since the original partners launched the pact in 2016, their combined Doha-UK seat capacity will be up 42% this year, per Diio. New routes include Qatar Airways between Doha and both Cardiff and London Gatwick (launched in 2016), and British Airways between Gatwick and Doha (launched in 2021). Qatar Airways serves Barcelona, Malaga, and Madrid in Spain, which leaves ample opportunity for further growth.
Route Briefs
- More signs of weakness in the U.S.-Cuba market. American is seeking a dormancy waiver for 15 of its weekly flights to Cuba from the Department of Transportation. If granted, the carrier would suspend two of its eight daily Miami-Havana flights on Tuesdays and Wednesdays; flights between Miami and both Santiago de Cuba and Varadero on Tuesdays and Wednesdays; and one of two daily flights between Miami and Santa Clara for the IATA winter season from October 29 to March 30, 2024. The moves come nearly two months after United notified the DOT that it will end its Newark-Havana nonstop at the end of October. American cited “market conditions that present continued challenges to the rebound of passenger demand” to Cuba.
Separately, American is adding two new routes at its Phoenix hub. Daily flights to Pasco, Wash., and Tijuana, Mexico, on Embraer E175s begin in February. The latter addition, Tijuana’s only U.S. route, is curious given the border city’s proximity to San Diego and Tijuana’s Cross Border Xpress bridge that allows it to compete with San Diego for U.S. travelers. The area around Tijuana, for the record, is experiencing a lot of new economic activity as companies relocate their production facilities and warehouses closer to the U.S. - Route tidbits: Latam was allocated slots at London Heathrow for a new nonstop from its Lima hub, launch date TBD. Alaska will connect San Francisco and Burbank thrice daily from December 14, a few short weeks before Southwest exits the route. Canada’s second airline, WestJet, is adding more sun runs this winter: Calgary to Tampa, Edmonton to Montego Bay, Toronto to Bonaire, and Winnipeg to Huatulco. All four routes are seasonal and operate once weekly. And competitor Porter is adding a new east-west link between Ottawa and Edmonton from October 2. Pegasus has launched new four-times weekly service to Montenegro’s capital, Podgorica, from its Istanbul Sabiha Gökçen hub. And Iceland’s Play will add Frankfurt to its map in December.
Fleet
It was a busy week of financial reporting for aerospace equipment manufacturers. Airbus and Boeing both presented their second quarter results, as did Raytheon, parent company of engine manufacturer Pratt & Whitney. Dominating headlines was the latter’s distressing announcement about its troubled geared turbofan (GTF) engines, specifically that it needs to do a recall and inspect certain units produced between the fourth quarter of 2015 and third quarter of 2021.
The problem relates to a “rare condition in powdered metal used to manufacture certain engine parts … [that] may reduce the life of those parts.” Pratt anticipates that “by mid-September, approximately 200 PW1100 engines [on A320neos] will be removed for enhanced inspection.” Beyond the initial 200 engines, Pratt also anticipates that roughly another 1,000 PW1100 engines will need to be removed and inspected within the next 12 months. Airbus made certain to stress that the recall “does not impact engines currently being produced,” at least not directly — it might potentially strain Pratt’s overall production capabilities. Pratt separately remarked, “The big question in everybody’s mind will be, what are we going to have to do in terms of compensation to the airlines.” And added, “This is obviously a difficult situation for our customers, especially given the strong demand for travel. We’re truly sorry for the impact of this disruption, and we will do all we can to support our customers.”
Airbus, as mentioned, insisted Pratt’s recall won’t affect current production. It still intends to build 75 A320-family jets per month by 2026, with a more immediate goal of reaching 65 a month, which was roughly the number it produced on the eve of the Covid crisis. At that time, it operated eight A320-family final assembly lines, four of them A321 capable. Before long, it will have 10 such lines, all of them A321 capable. It separately mentioned that A321XLRs should start test flying in the second quarter of next year, though the plane’s range will be down somewhat from initial expectations due to some adjustments required by safety regulators. As for the A220, Airbus’ smallest product, plans are in place to build 14 per month by the “middle of the decade.” On the widebody end, Airbus targets A330 production of four per month next year. The A350 plan is nine per month by the end of 2025. “The pace of the ramp-up will continue to depend on our supply chain and its capability to perform.” Airbus, remember, is also building a new freighter version of the A350, scheduled to enter service in 2026. Longer-term, it’s experimenting with planes that radically reduce carbon emissions; hydrogen power is one avenue of research.
Boeing, meanwhile, joined Airbus in celebrating a very strong demand environment, made evident at this year’s Paris Airshow. The problem is no longer winning plane orders, it’s building planes to fulfill the orders. Boeing is currently working toward a production rate of 38 737 Max jets per month, up from 31 today and rising to 50 sometime in 2025 or 2026. It’s still just building four 787s per month, rising to five by year-end. By 2025 or 2026, the rate should reach 10. Recall that it has a big backlog of Maxes and 787s already built but not delivered. The 737-7 and -10 variants remain uncertified by regulators. Interestingly, CEO Dave Calhoun spoke about a future generation Transonic Truss-Braced Wing aircraft that might eventually replace the Max. “We’re heavily invested in this. We like what it could potentially deliver to this market, a level of performance that the industry is used to seeing with brand-new programs.” He added, “We can use existing power, but we would prefer, frankly, to have a bigger fan diameter ultimately and maybe even open rotor someday.” He separately dismissed threats of a potential Airbus A220-500 that could challenge the smaller Max variants. Also on Calhoun’s crowded agenda: Getting the 777X into service and selling more planes to China, a giant market that hasn’t ordered any Boeing planes in a long time.
Feature Story
At first glance, Gol looks like a superstar Forward. Despite the second quarter being offpeak in South America, the Brazilian low-cost carrier managed a striking 13% operating margin. That’s after hitting 17% in the busy first quarter. What’s not to like?
Indeed, Gol is performing unequivocally well at the operating level this year, matching (almost identically) its strong performance from the first half of 2019. Demand is strong, unit revenues are up sharply, unit costs are trending down from pandemic-era highs, and competition remains subdued — the Brazilian domestic market is still a de facto tri-opoly, spawned by the collapse of Avianca Brasil in mid-2019.
But Gol is playing injured. What’s not to like about the results are the heavy net losses, excluding the impact of unrealized accounting gains from exchange rate swings. Excluding these and other one-off distorting items, Gol’s net margin for the second quarter was a dismal negative 10%.
It’s a $152 million problem. That’s the amount Gol had to pay to its lenders and lessors last quarter, an amount that’s recorded in net results but not operating results. It’s a problem that Gol’s rival Azul has faced as well, and Latam too in the Brazilian market. It was a major reason why Latam was forced to restructure in bankruptcy, and why Azul was nearly forced to file as well. Gol, too, has avoided bankruptcy by negotiating some relief from its financial obligations. It continues to do so in fact, noting in its second quarter earnings call that it is still seeking a final resolution on its liabilities with aircraft lessors in particular. Gol, by the way, is paying a princely average interest rate of 19% on its local currency-denominated loans, and a 13% rate on its dollar-denominated loans.
Having to borrow money in U.S. dollars is a necessary evil for most airlines outside the U.S., because they need dollars to pay for things like fuel and aircraft. Normally, this foreign exchange exposure is a manageable risk. But not in Brazil these past few years, as the value of local reais plummeted versus the dollar. At the start of 2019, one real was worth about 27 U.S. cents. It’s currently worth about 21 cents, and on several occasions during the past three years, it dropped below 18 cents. To illustrate the problem, consider that Gol ended the second quarter with 11 billion reais worth of bond debt, and 9.7 billion reais worth of aircraft lease debt. At a rate of 27 cents to the real, that would imply an obligation of $3.7 billion. At 18 cents, that’s an obligation of $5.6 billion. That’s an almost $2 billion difference!
The fact that aircraft markets are so tight right now makes it difficult for Gol to extract relief from lessors — why would they take a haircut when there’s so much demand for Boeing narrowbodies elsewhere in the world? On the other hand, Gol is a large and important customer with a stable future and durable business model. It leases, by the way, 100% of its planes (143 Boeing 737s at the end of June, 38 of them Maxes, specifically -8s; it currently has 107 more Maxes on order, 37 of these -10s).
The good news is that positive operating margins mean a boost to cash flows. Last quarter, operating cash inflows exceeded outflows by about $200 million. Cheaper fuel, strong demand, subdued competitive pressures, and some recent real appreciation are all helping. In July, the real has been worth about 21 U.S. cents, up from 19 cents in January.
Gol does face new threats at Sao Paulo’s downtown airport Congonhas, where Azul acquired new slots. Business traffic still lags pre-pandemic levels by about 25%. And though Gol’s aircraft utilization is up to nearly 11 hours per day, it’s aiming for more. The airline’s international flying, meanwhile, is down sharply from 2019.
Nevertheless, management just raised its full-year financial guidance, thanks to fuel costs trending lower than expected, plus anticipation of higher yields as it trims some capacity. Gol now expects to earn a 2023 operating margin of 15%; it previously said 14%. That might even put it in contention for the Airline World Cup, awarded (by Airline Weekly, anyway) to the airline with the world’s highest annual operating margin.
Longer-term, Gol is betting on revenue diversification, eyeing more proceeds from its Smiles loyalty plan (now 22 million members strong), its fast-growing cargo operation, its aircraft maintenance business, and soon a new unit selling tour packages. Its biggest bet is on consolidation, having merged with Colombia’s Avianca to form the new Abra Group. The merger has attracted less attention than some other big airline deals because it’s limited in scope — the two carriers will remain independent operationally. But Gol hopes to realize synergies in areas like procurement and loyalty. It also counts American as an important partner, and one that last year bought about 5% of its shares (Gol previously worked with Delta before the Atlanta-based giant fell in love with Latam).
These are the kind of things Gol wants to be focused on — strategically growing, forming new partnerships, working to raise revenue and lower costs. It will, however, at least for a little longer, need to dedicate lots of attention to reducing debt. Without strong net results, after all, an airline with a strong operating margin is like Neymar playing with an injury. He might be scoring goals. But if not careful, he might soon be out of action.
By the Numbers
