The UK’s vote to exit the EU as well as terrorism sent shockwaves through Europe, prompting some of the region’s most successful airlines—including EasyJet, International Airlines Group (IAG) members and Ryanair—to lower their profit forecasts. The question now is: Will 2017 be any less challenging?
Probably not. Threats of terrorism, the rise of populism, uncertainties over Brexit and overcapacity will further erode demand and yields. France was still at the maximal terror threat level at year-end and Belgium at Level 3. The U.S. State Department on Nov. 21 warned of a heightened risk of terrorist attacks throughout Europe, particularly during the holiday season.
Elections in the Netherlands, France and Germany in 2017, repercussions of the Dec. 4 referendum in Italy on the stability of the EU and the eurozone economy, and more public austerity in Greece are expected to compound this grim outlook. Some major airline groups such as IAG and Turkish Airlines already have begun trimming capacity growth and capital spending, while others are stepping up measures to cut costs.
“The higher-than-normal levels of business and political uncertainty right now across Europe [have created] a very adverse environment for airlines,” says Jonathan Sullivan, a partner at Seabury Consulting. “Demand for air travel tends to slow down in this environment. If we couple that demand with the continued expansion of the super-connector group of airlines, the imbalance between demand and supply that has formed will continue to get worse.”
Most analysts are expecting an increase in the price of oil in 2017. “Higher fuel prices on top of a situation of oversupply and low demand will put a lot of pressure on airline management teams to significantly lower the cost base,” Sullivan asserts.
EasyJet, for instance, already has launched a review of its structure and processes, to prepare for the tougher operating environment in 2017 and maintain its relative cost advantage over legacy rivals. The review, CEO Carolyn McCall says, should result in a simpler, more efficient organization and will deliver “meaningful” annualized savings once implemented. EasyJet reported a 22% drop in net profit to £427 million ($512.4 million) for the fiscal year ended Sept. 30—its first decrease in annual profit since 2009. McCall expects the market will remain difficult next year and pricing will continue under pressure, which she notes is good for consumers but will affect the bottom lines of EasyJet and airlines across Europe. “We do not see a reversal of the trend next year.”
To provide greater flexibility to decrease capacity in case the challenging market persists, EasyJet concluded a sale-and-leaseback arrangement for 10 Airbus A319s. The London Luton Airport-based low-cost carrier (LCC) also has renegotiated further fleet flexibility with its suppliers and now has a shorter window for deciding whether to defer aircraft deliveries.
The UK’s vote to leave the EU is giving EasyJet major currency issues as the value of the pound fell against the euro and U.S. dollar. The LCC, though, is having a more profound Brexit headache: how and where to establish an air operator certificate (AOC) in another EU member-state to secure traffic rights to the 30% of its network that remains wholly within and between EU states, excluding the UK.
On the legacy airline front, Lufthansa is trying hard to lower costs, but pilots in November once again resisted management’s efforts to conclude a new labor agreement and push through additional productivity measures to allow it to compete more effectively with the Gulf carriers and European LCC rivals. Lufthansa has suffered a series of pilot and cabin-crew strikes in recent years, and the November industrial action called by the Vereinigung Cockpit pilots’ union cost the airline €10-15 million ($10.7-16.1 million) in lost revenue per day.
The German carrier is aiming to grow its low-cost subsidiary Eurowings, and in 2017 intends to exercise a call option to acquire the 55% of Brussels Airlines it does not yet own. Lufthansa Group CEO Carsten Spohr wants to integrate Brussels Airlines, or at least part of it, into Eurowings, a move resisted by the Belgian shareholders of Brussels Airlines. They also want assurances that Lufthansa will retain the Brussels Airlines brand, its successful Africa network, its Brussels hub function in the group and membership in the Star alliance.
As part of expansion plans for Eurowings to fend off the rapidly increasing inroads of EasyJet and particularly Ryanair into the German market, Lufthansa this summer plans to take over 40 Airbus A320-family aircraft (38 on wet leases and two on dry leases) from struggling Air Berlin.
The German air travel market, Europe’s second largest, will see a fundamental change next year as Air Berlin downsizes and splits its operations in three to cut losses. Under its latest restructuring plan, the “new” Air Berlin is to become a dedicated, focused network carrier serving higher-yielding markets from Berlin and Dusseldorf, with a core fleet of 75 aircraft—about half of what it operated in 2016. The leisure business will be separated into a new, independently operated company and combined with Air Berlin’s Austrian Niki subsidiary and German airline tour operator TUI. Under the proposed deal, which needs regulatory approval, TUI and Air Berlin’s core shareholder Etihad Airways would each hold 24.9% stakes in the new company, which would be 51% owned by an Austrian foundation to protect EU traffic rights. The new leisure airline would deploy 62 aircraft operating to a broad network of destinations from Austria, Germany and Switzerland.
While Lufthansa is focusing on expanding Eurowings, Air France-KLM is halting plans to expand Transavia into a pan-European LCC after disappointing results at its new Munich base. The Franco-Dutch group instead will focus growth of Transavia on its French and Dutch home markets and establish a new “lower” cost airline for long-haul routes to fight growing competition from Gulf carriers. “Boost,” as the project is named, will start flying in the 2017 winter timetable with a fleet of up to 10 widebody jets.
“There is a lot of talk about these low-cost, long-haul models, but it is too early to say if they will work well. They have not yet been tested by a high-fuel, relatively low-demand environment,” Sullivan points out. He expects the “real” low-cost long-haul carrier will materialize with the new long-range narrowbodies. “What we are seeing now are lower-fare, long-haul airlines.”
Conversely, he adds, 2017 will see continued growth of truly pan-European LCCs such EasyJet, Norwegian, Ryanair, Vueling and Wizz Air. Ryanair, Sullivan says, will still lead the European airline business in 2017 and “for some time.” The Dublin-based LCC, Europe’s largest by passenger count, is a “really good business, posting some remarkable results,” he says.
Ryanair has reduced its full-year profit outlook, mainly due to an 18% drop in the exchange rate for the pound against the euro following the Brexit vote—and 26% of its revenue is in the pound—and lower fares across its network. But CEO Michael O’Leary notes: “We [still] expect to deliver very significant profitability and very significant cash flows at those lower prices. The question is which of our competitors can match that performance? I’m not sure any of them can or will.” Ryanair expects net profit for the fiscal year ending in March 2017 will grow by about 7% to €1.3–1.35 billion, while it had been projecting profit growth of about 12%.
Moreover, the carrier’s traffic performance is expected to be better than forecast. It will take delivery of 31 new Boeing 737-800s and open six bases this winter, as scheduled. Ryanair is anticipating 119 million passengers in the current fiscal year, which will represent 12% growth on the previous year’s €106 million. The LCC also has increased its long-term traffic outlook by 10% and now expects to carry 200 million passengers per year by March 2024. This equates to about an additional 13 million passengers per year.
From a regulatory perspective, it will be important to see, in 2017, how the ownership and control rules are applied. The European Commission is working on new guidelines and new rules on fair competition.
“From a passenger’s, and a region’s perspective, it makes no difference whether an airline serving a European market is owned by a European or non-European, as long as it serves that market reliably, so that the market’s trade benefits from planning stability,” says Ulrich Schulte-Strathaus, managing director of the Brussels-based consultancy Aviation Strategy & Concepts.
“It is important for Europe to attract European, and possibly non-European investors into the aviation sector, as airlines need size to compete within Europe, and even more clout to compete internationally,” he notes.
Schulte-Strathaus expects there will be further acquisitions within Europe, although Sullivan warns that mergers and acquisitions are not easy. “They are a massive headache for those that have to do it,” Sullivan says, while stressing that some governments might want to hold on to their flag carriers. “Whatever they say about politicians, they do have a pretty good understanding of how air services work for the economy for the long term. Maintaining a national carrier is not just a matter of national pride. It is a matter of national economics.”
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