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Global Aviation: A Continued Hard Landing?

 10 min read / 

Last week Monarch Airlines, once the UK’s fifth largest airline, closed forever. It was a sad end to a firm with a rich history, but financial losses and lower than market passenger numbers ultimately led to the firm’s demise – leaving 100,000 passengers stranded and 300,000 future bookings cancelled. More than two thousand staff have lost their jobs.

In the preceding week, Ryanair, the budget carrier, had announced two waves of flight cancellations on some 18,000 flights because of staff shortages over the winter months – a consequence of owing its pilots holidays. This caused a storm, with 650,000 affected passengers who were initially not being offered adequate compensation. Once the Civil Aviation Authority stepped in, however, Ryanair was quick to attempt to make amends.

For the airline itself, the wider question remains of how the reputational fallout of dubious customer service and poor business practice impacts the bottom line. Recognising this issue, Ryanair is expecting 6m fewer passengers in 2018 as well as the risk of further flight cancellations being likely if pilots’ concerns are not addressed.

European Carriers Cannot Hide

In the European market, the industry’s woes are also prevalent. Earlier in the summer British Airways, the UK’s largest airline, suffered an IT failure that cost the firm £100m. The failure, the second in as many months, is in part a consequence of the firm’s operational cost-cutting to streamline the airline. At the same time, IAG, British Airways’ parent, announced a 2% increase in profits to £872m. The few comforts passengers have come to expect – in-flight drinks and meals – are being phased out on short-haul flights as the firm moves its offering from premium to an economy segmentation in the face of market conditions.

In a catalogue of issues, British Airways has also suffered a series of commercially damaging strikes from an on-off industrial dispute, as 1,400 staff took strike action over pay and conditions, reviving continued discontent amongst staff.

Further afield, the European airlines Alitalia, Italy’s national carrier, and Air Berlin, Germany’s second-largest carrier after Lufthansa, are buckling under increasing pressures – debts, high operating costs, overcapacity in European short-haul seat numbers, and a race to the bottom on fare prices. Competition is indeed rife.

The problem for Air Berlin, which continues to operate after securing a temporary €150m loan from the German government, is the debt it has accrued in the ten years running up to 2016, when its losses were €782m. But, as the BBC reported, customers have abandoned the airline, dramatically decreasing the likelihood of any organic revival. Interestingly enough, the airline’s demise is in contrast to the German aviation market, which is actually increasing as passenger numbers are on the rise.

Additionally, early in the summer, Etihad Airlines – the largest individual shareholder in Air Berlin (30%) – announced it would continue its important relationship with the airline, as talks continued with the tour operator TUI Travel about creating a joint venture holiday airline. This, however, ultimately failed when Etihad ended the deal, as reported by Reuters, and then refused to pay for the airline to operate any longer in August.

In the case of Alitalia, a €600m loan from Prime Minister Paolo Gentiloni’s government has kept the airline in the air, but for how much longer?

Interestingly, Etihad Airways surfaces once more. This is because it took a 49% stake in Alitalia in 2014 as part of a global expansion strategy. That investment is now all but lost and merely an additional headache for Etihad, who are already facing a number of financial and geopolitical issues of their own, just as the firm announced record losses of $1.87bn for 2016. For the wider Italian economy – the world’s 8th largest  – the collapse of Alitalia would be an embarrassing outcome and economically significant in terms of how the nation is viewed as an economic opportunity and its ability to attract investment. Internally, can the Italians afford to lose thousands of jobs in Milan and Rome?

But, as the Financial Times commented in May, Alitalia – and now AirBerlin as well – may ultimately go the way of Iberia, the Spanish carrier that became part of IAG alongside British Airways. But with consolidation comes a concentration of market power and risk, less choice, and not (as some analysts suggest) the required decline in capacity that will raise prices and profits.

After all, some of the beneficiaries of the airlines’ demise are owned by existing competitors, such as Austrian Airlines, Eurowings and Swiss International Air Lines, which are all owned by Lufthansa. Ryanair, the other leading proposed buyer, now has its own problems. Crucially, an investor appetite for only the best assets and flight schedules has to be a consideration as the question a few have asked is: who would be interested in inferior European Airlines, when opportunities exist elsewhere?

Geopolitical Headwinds

Fresh from being burnt by its European investments, Etihad Airways and its fellow airlines in the Gulf are besieged with problems. From terrorism to domestic financial black holes, the Gulf States, and the airlines that carry their names, are having to cut back and ride out the storms.

Perhaps hardest hit is Qatar Airways- diplomatically cut off from its neighbours, it is unable to fly over Saudi Arabia’s airspace and has limited routes through Bahrain and the UAE. Whilst the firm, and indeed the country, have shown admirable resilience, its competitive position is clearly at risk.

Meanwhile, Emirates and Etihad are suffering from a reduction in state subsidies, as the UAE tries to recover from the oil price slump. At the same time, a reduction in passenger numbers across the region has been a noticeable consequence of the diminishing price of oil. Mixed in with financial pressures and fewer passengers are the U.S. travel restrictions on a select number of countries in the Middle East. These recent events act as a further headwind; The Economist states demand recently fell by 35% on Emirates Airlines American routes.Emirates Airways, the largest airline in the region, certainly hasn’t been unscathed. Notwithstanding the airline’s core qualities and market position, according to Tanya Powley and Simeon Kerr of The Financial Times:

‘They [the Gulf airlines] have tempted travellers with competitive pricing, superior service and luxurious premium cabins and have turned the Gulf into the stopover destination in global air travel. In the process they even earned themselves a nickname: the “superconnectors”.

Even still, Emirates Airways witnessed an 82% slump in profits for 2016-17 and growth was down by 2%. All of these issues have fuelled talks of a potential Emirates-Etihad super merger.

Geopolitically, the region is as hot, if not hotter, than it has been in decades. The Qatar crisis – whether deserved or not – is an obvious starting point, but a civil war in Yemen (itself a proxy war between Saudi Arabia and Iran), the ongoing Syrian civil war, ISIS, Turkish political unease, and increasing scrutiny of the Iranian government by the USA, are all taking their toll on profits and passenger perceptions of the Middle East. Take, for example, the experience of Turkish Airlines and Pegasus Airlines, where a failed coup, a terrorist attack on New Year’s Eve in Istanbul, and an ongoing war with the PKK in the East have put a tremendous strain on both carriers, as The Telegraph reported in January.

It is no coincidence that these situations bear a remarkable resemblance to past performance problems. For example, a recent report conducted by the management consultancy firm, Boston Consulting Group, entitled Taking Advantage of Risk examines the impact of geopolitical, non-commercial, events on airline passenger numbers and underlying revenues. It established that there was a positive correlation between events and airline revenues.

The reports’ authors noted that ‘many companies do a good job of analysing and planning for competitive risks, such as new market entrants or the threat of substitution, but they give only pro forma attention to…natural disasters, and geopolitical risks – even though the impact of these can be immediate and catastrophic’. It could thus be said that Etihad and Emirates should have been better prepared.

A Far East Experience

The problems of the global aviation industry are almost systemic.

A case in point would be Malaysia Airlines’ nationalisation, the result of two tragic plane losses that crushed consumer confidence in the firm. And yet even before it was nationalised in 2015 by the then newly created Malaysia Airlines Berhad (its parent), the airline had suffered three years of sizable losses and dwindling market share as a consequence of fierce low-cost competition from new market entrants. The firm then lost its CEO to personal circumstances after less than a year at the helm.

In Singapore, the experience is not too dissimilar as Singapore Airlines battles to lower its costs as the intensification of competition continues. The Financial Times reported that Singapore made a $100m loss in the Q1 2017 only to rebound in the Q2 as reported by Bloomberg; although a strategic review of the firm’s strategy is ongoing. What is more, Singapore Airlines’ biggest rival, Cathay Pacific of Hong Kong, posted its first loss in 20 years in July, citing competition and declining passenger numbers.

Behind the headline, the problems at Cathay Pacific are more deep-rooted and, as the South China Morning Post (SCMP) reported as early as March 2017, that the entire business model and continuing mismanagement of Cathay Pacific are at the heart of the issue. SCMP claimed that a loss of identity, huge fuel costs of poorly managed futures contracts, and an inability to ‘compete as a discount airline and unable to sustain a premium brand’ as the root cause of the airlines’ problems.

Meanwhile, the impact of a new, nuclear, Korean war is a frightening prospect that creates an impeccably difficult scenario for airlines to plan for.

Where Next?

Ultimately, the global aviation industry has more turbulence to come, as premium players look at attracting economy-class passengers via new ticket types and cheaper long-haul travel. For short-haul players, the prospect of multiple mergers and acquisitions seems likely as firms die off and others are divested from global domination strategies, like that of Etihad, as a way of removing oversupply. In the background, geopolitical events look set to intensify, not decrease, and Europe’s domestic terrorism will soon start to impact on the flow of tourists.

In a wider context, the concentration of aircraft suppliers, the financing of leasing planes and engines may, in time, become additional facets of concerns. To that end, if the Airbus-Bombardier-Boeing competitive landscape becomes even more fraught, then things could well boil over.

In the end, the likelihood of budget carriers offering new destinations, more choice, better prices, and perhaps even the full premium services of firms like Virgin Atlantic could cause a frenzy of price wars, when the reality is that what is needed for sustainable staffing and healthy finances would be an increase in pricing to secure margins and halt a ‘race to the bottom’.

Equally, with executives more concerned about the ramifications of geopolitical events, according to the latest Economic Conditions Snapshot released by McKinsey & Co, the industry could do with looking at how to create financial buffers on safer routes to ensure all operations can meet customers’ needs. Either way, passengers should get more choice, albeit from fewer airlines, as airlines look set to fight for the spoils as geopolitical affairs continue to interrupt.

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Companies

Amex: Troubled Credit Card Company Reports $1.2bn Net Loss

 2 min read / 

Amex annual report

On Thursday, American Express, or Amex, reported a net loss of $1,197m in the fourth quarter, the first net loss the company has experienced for 26 years.

Although the company stated that revenue from interest expenses was up 10% to $8.8bn, Amex said recent reforms to the US tax code meant the company incurred extra costs, including a repatriation cost on its foreign assets as well as a devaluation of its deferred tax assets. It estimates total costs amounted to $2.6m.

For the full year, net income was $2.7bn compared with $5.4bn the company earned in 2017. However, even with the estimated $2.6m the company claims it incurred from the recent tax charge, net earnings were still $5.3bn, $100m lower compared to last year.

In New York, American Express shares (AXP) took a near 1% tumble at the beginning of trade with shares finishing the day on $99.90.  JPMorgan Chase and Goldman Sachs anticipate greater earnings for 2018.

“Overall, we believe the Tax Act will be a positive development for both the U.S. economy and American Express” said CEO and chairman Kenneth Chenault. Chenault also said he will be leaving Amex in “very strong hands” when his successor, Steve Squeri takes over next month.

American Express has suffered from an ever-reducing share in the credit card market and ended its 14-year relationship with American warehouse chain Costco who in 2016 made an agreement with the market leader, Visa.

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Tencent Extends Facebook Lead

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Tencent has shot past Facebook to become the world’s most valuable social network.

Editor’s Remarks: Although Tencent briefly overtook Facebook in terms of market cap in November, the recent selloff of Facebook shares prompted the Chinese tech titan to regain the lead. Facebook investors responded negatively to news that Mark Zuckerberg’s plans to highlight family and friend-based content on the newsfeed would reduce the amount of time people spent on the site. Shares in Facebook have fallen 5% since that announcement, enabling Tencent to gain a $19bn lead over the US company. Tencent’s growth has been spurred on by its diversification away from its flagship messaging app, WeChat, and into video games.

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Apple Returns Overseas Cash

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Apple has agreed to invest $30bn in the US and pay $38bn in tax to the government. 

Editor’s Remarks: The tech giant announced that it will repatriate hundreds of billions of dollars that it currently holds in various offshore accounts. A total of $38bn in tax will be paid by the company on the sum, with a further $30bn pledged towards domestic jobs, manufacturing and data centres. The capital expenditures will be rolled out over the next five years and are estimated to create around 20,000 jobs. On the news, Apple’s share price rose 1.7% as it was widely perceived that the move would reduce the flak the company has recently been receiving for its tax avoidance schemes.

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