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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

H&M to Shut Stores as Quarterly Results Plunge

 2 min read / 

H&M Results

Fashion retailer H&M announced today that it will be shutting down more stores after it experienced its biggest drop in quarterly sales in at least a decade.

Although group sales rose by 4% over the year, fourth quarter sales shrank by 4% year-on-year, to 50.4bn kronor ($6bn), as fewer customers visited its stores. This was far below the retailer’s expectations. Shares in H&M have now hit their lowest level in eight years.

H&M plans to adapt to changes in the market by closing more stores and selling the brand through Chinese online platform Tmall. It aims to integrate its physical and digital stores more, and will give more details on their strategy changes at a meeting with investors on February 14.

The company said:

“The quarter was weak for the H&M brand’s physical stores, which were negatively affected by a continued challenging market situation with reduced footfall to stores due to the ongoing shift in the industry[…] In addition, there have been imbalances in parts of the H&M brand’s assortment composition.”

The company’s rival, Inditex, the owner of high street brand Zara, as well as Massimo Dutti, Bershka and Pull&Bear, has continually outperformed H&M, as it expands more into e-commerce. However, this week, the Spanish giant also reported a slowdown in sales in its third quarter but said sales improved again in November given the colder weather.

Keep reading |  2 min read

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Snapchat is adding another trick to its repertoire by allowing users to add branded animations to the existing arsenal of augmented reality lenses. This is not a wholly new innovation as advertisers can already sponsor lenses, although there is a hefty minimum spend of $300,000 and a current need to work closely with Snap’s design team. However, the new studio will enable advertisers to create their own adverts, which will then need to be accepted by Snap before they are given the green light. The move is part of Snap’s wider efforts to diversify their revenue streams.

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Japan Is Behind Bitcoin’s Rise

Japan Bitcoin

Deutsche Bank released a research note saying that Japanese investors account for bitcoin’s meteoric rise.

Deutsche Bank analysts have said they believe that individual Japanese foreign-exchange (FX) traders are instead moving towards leveraged cryptocurrency trading in the search for astronomical returns. Already, Japan makes up 50% of the world’s leveraged FX trading and Nikkei recently said that 40% of cryptocurrency trading was denominated in yen throughout October and November. Evidently, the Japanese are growing tired of years of ultra-low interest rates and are turning to the blockchain to boost their savings.

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