Rise of the Giants
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hile smaller airlines have once again grabbed the laurels, it is the dramatic improvement of many of the largest carriers that is the standout feature of Aviation Week’s Top-Performing Airlines (TPA) study this year. W
Panama’s Copa Airlines achieved the highest score overall and was first among midsize carriers, edging out, which was second overall and best of the small-airline category. They continue the long-established TPA trend of well-run niche carriers being heavily represented at the top of the overall rankings.
However, there has also been a strong resurgence by major carriers that have been through the upheaval of restructuring or mergers in recent years.and are the standard-bearers for this group—JAL highlighting its rise from the ashes of financial failure by winning the large-carrier category, and Delta leading a clutch of other majors in their march up the rankings table.
|Council of Advisers|
| George W. Hamlin |
President, Hamlin Transportation Consulting
| Craig Jenks |
President, New York-based
Airline/Aircraft Projects Inc.
| Raymond E. Neidl |
Nexa Capital Partners
| Bryan Terry |
Transportation and Logistics, PwC
Further broad trends are also revealed by the study. The Asia-Pacific region was generally weaker, while the other main regions—particularly the Americas—improved. The performance of the global airline industry continues to pick up due in large part to capacity constraint, although potential pitfalls lie ahead.
The TPA study uses a range of data from the last full calendar year to score airlines in four areas—financial health, earnings performance, capital efficiency and business model performance. This yields a total score, that is used to rank the airlines. They are divided into three tiers according to annual revenue size, and the scores also determine the top carriers overall. The tier rankings are on page 54, and a fuller explanation of the methodology can be found on page 59.
Only publicly traded airlines are included, as their data reporting is more extensive. This means major Middle Eastern carriers and others likedo not appear in the rankings.
In previous years, there has been little evidence in the TPA study to suggest that legacy airlines have boosted their performance through mega-mergers, restructuring under bankruptcy protection, or both. This year’s study, however, strongly indicates that such efforts are paying off.
Several airlines that have followed these paths saw their scores jump. For example, Delta, Latam Airlines Group, International Airlines Group andall achieved double-digit increases compared to the previous year, while and - also saw an uptick.
The TPA council of advisers agrees that benefits from the wave of mergers are beginning to be reflected in the TPA results. “They are going to be successful, and I think they’re proving [the mergers] were justified,” says Nexa Capital Partners analyst Raymond Neidl. “The stock market is more or less confirming that.”
JAL returned to the rankings this year after a lengthy absence stemming from its delisting and a lack of financial reporting during a spell in bankruptcy protection. There is now enough post-reorganization data to score them accurately, and the airline topped the large carrier category by a wide margin. It also ranked the highest of all Asia-Pacific airlines.
This highlights the remarkable financial results JAL has been achieving since its emergence from bankruptcy. Its turnaround has been controversial, though, as rival(ANA) has pointed out that the government tilted the competitive playing field through its financial assistance to JAL.
JAL is proving it is able to continue reducing unit costs three years after its major reorganization, says Craig -Jenks, of New York-based Airline/Aircraft Projects. “The restructuring appears to have created a new culture at JAL that embeds cost control,” he notes.
TPA project manager Michael Lowry says JAL had “a really good reorganization,” that was not complicated by merger integration issues and had strong government support. “They cleaned up a lot of evils, and we are seeing improved productivity as a result of their realignment.”
However, Lowry also cautions that JAL is “still enjoying the honeymoon from its reorganization,” and it will start to come under the same pressures as ANA. It is yet to be determined how deeply seated JAL’s new cost-control mentality is, because the restructuring “artificially created its lower cost base,” he says.
Another large carrier that stands out is Delta. Its score rose by 19.4 points—the biggest increase of any of the carriers in the large category. This was enough to vault it into 12th place overall, third among large airlines, and the highest-scoring of the North American majors.
Delta is reaping the benefits of its 2008 merger deal with Northwest Airlines, which occurred soon after both emerged from bankruptcy protection. The integration work that followed has made this the most successful of any of the large airline mergers in recent years, the TPA advisers concur.
“The merger was a catalyst, but management has since played a strong role—they have had a good game plan and strategy,” says George Hamlin of Hamlin Transportation Consulting. Delta has been “the most aggressive” of the newly merged airlines in cutting surplus hub capacity.
Neidl agrees that the Northwest deal gave Delta “a very good tailwind, and they have built on that” to a degree that other merged airlines have not.
The advisers note that Delta’s management is making bigger bets and larger decisions than other U.S. carriers. Examples include purchasing an oil refinery, buying into Virgin Atlantic, putting itsrelationship at risk by building a Seattle hub, and investing in and forging partnerships with GOL and Aeromexico.
A year ago many of those moves looked risky, but because Delta’s underlying strength is growing, it would now not matter as much if some ventures are unsuccessful, Jenks says.
While almost all of the recently merged carriers boosted their scores, the degree of improvement varied widely. For example, United Airlines, which was ranked similarly to Delta in last year’s study, only saw a gain of 3.8 points. According to the TPA advisers, United has struggled to gain the same integration advantages Delta is enjoying. They say it is still too early to judge the success of the American Airlines- marriage.
The big three European airline groups—which have all been through mergers or acquisitions—are “making progress but have not yet achieved the same level of integration or consolidation benefits as the U.S. carriers,” PwC’s Bryan Terry says. He notes that many of the carriers involved continue to operate separately under holding companies, which often leaves redundant processes and technologies in place, including mission critical reservations, maintenance and staffing systems.
As in previous TPA studies, many airlines from the small category are punching above their weight this year—comprising three of the top five overall. But Terry observes that smaller does not always mean better, as carriers from this category are also well represented in the bottom third of the overall list. The message appears to be that “as you get bigger, it constrains your ability to outperform, but being small does not necessarily enable you to succeed,” he says.
Another major theme to emerge from the TPA study is the relative underperformance of Asia-Pacific airlines. This was the only one of the main regions with a median score decline in this year’s study (see graph, page 58).
Of the 30 carriers in the TPA study that saw their scores drop, 19 are from Asia-Pacific—almost double the number from this region that increased their scores. Asian airlines also accounted for 11 of the 15 largest declines in score.
Financial trends revealed in the TPA study emphasize that the Asia-Pacific airline industry has recently become “markedly weaker” than in other regions, Jenks says.
One of the major reasons is that the capacity constraint being exercised elsewhere is not as evident in Asia. While capacity grew at a slower rate than traffic in the other regions, Asia-Pacific saw capacity increase slightly faster than traffic.
“There is probably over-ordering” of aircraft by Asian low-cost carriers, says Jenks. However, network carriers are also to blame—Asian majors, particularly those from China, are heavily represented among the airlines with the highest total value of aircraft deliveries in 2013.
Another noteworthy factor is the comparatively large number of rival international connecting hub operations in East Asia, Jenks says. There are 17 such long-haul hub operations in this sub-region, compared with about 12 in the U.S. and eight in Europe. And while these hubs are operated by just three airlines in the U.S. and eight in Europe—most of which are in long-haul joint ventures—the East Asia hubs are run by 15 carriers, with very few joint ventures.
There is little consolidation happening to offset the Asian hub fragmentation. Whereas airline mergers can occur within Europe and the U.S.—and even within Latin America—effective consolidation in Asia is largely ruled out by cross-border restrictions.
MOST-IMPROVED AIRLINES, YEAR-ON-YEAR
|3||Delta Air Lines||19.4|
|5||Latam Airlines Group||14.0|
|7||American Airlines Group||11.7|
|8||International Airlines Group||11.1|
|9||Volaris Aviation Holdings||9.8|
|Note: Excludes airlines with total scores less than 40. Source: TPA Study|
Jenks says the situation in Asia is “the opposite of what we have seen in Europe and the U.S., where the priorities have been rationalizing capacity, mergers, and a reduction in the number of players.” Terry notes that while European Union rules restrict governments’ ability to pour money into failing carriers, there are far fewer limitations in Asia.
Exposure to China’s cooling market is also a contributor to the Asia-Pacific slide. The big three mainland Chinese airlines all experienced TPA score declines and are in the bottom third of TPA scores overall. Other Asian carriers that rely on their proximity to this market also suffered.
is a notable exception, achieving a solid score bump after a two-year decline. , a former TPA heavyweight, had a second successive year of essentially flat score growth, allowing others to overtake it. It is taking steps to adjust its approach, however, such as helping launch a joint venture airline in India.
In contrast to Asia, the TPA study reveals healthy gains for the other regions. Latin America had the greatest rise in median score—eight points—with all the carriers from this region boosting their individual scores. Four—GOL, Latam, Volaris and Copa—are among the Top 10 most improved (see table page 56).
Copa Airlines has the best score of any airline this year, which is no surprise given that it has been among the TPA leaders for many years. Copa is strong across the board—it is the only carrier ranked in the top five in all four of the scoring segments. No other airline is even in the Top 10 in all sections.
Copa benefits from advantageous geography, with its Panama City base well situated as a connecting hub for Latin America and the U.S. It also operates in a stable political environment—not always a given in Latin America—and a rapidly growing economy.
Added to these natural advantages is a solid management team that adheres to a very effective business plan and fleet strategy, the TPA advisers say. While Copa does not have a low-cost carrier model, it does have a low-cost mindset.
Terry says poor management has been a feature of many Latin American carriers in the past, although this is changing as new leadership emerges across the region.
Another important factor for Latin America is that it is more like Europe than Asia when it comes to airline liberalization. “There are now two mega-players in Latin America that are fundamentally cross-border in their identity and business model, which is a very healthy thing,” Jenks says.
|SOURCE: TPA STUDY|
Highlighting the structural changes underway in the region, Hamlin observes that Latin American airlines “have probably gone the furthest in shedding their old skins.” Future success in this region will depend on the stability of the Brazilian and Argentine economies, and whether airport infrastructure can keep pace with growth.
North America was close behind Latin America in terms of median score improvement, with a 6.4-point rise. Industry consolidation is playing a large role in this region. “There are two interconnected factors here—the gains from the three big mergers, and capacity discipline,” Hamlin says.
U.S. carrier Allegiant Air—last year’s overall winner—was less than a point behind Copa in this year’s TPA rankings. This carrier is well-known for having a business model unique in the U.S. market, which -Neidl describes as being a travel company that happens to run an airline.
Allegiant is a low-cost carrier that predominantly focuses on connecting a broad range of secondary U.S. cities to leisure destinations, with an older fleet that allows it to operate low frequencies profitably. And it has been a leader among U.S. carriers in the use of ancillary fees and selling additional travel services.
While Allegiant operates in a profitable niche, Hamlin points out that this is also a carrier “that continues to execute extremely well.”
Neidl says Allegiant is not in danger of reaching the limit of its niche, and it still has enough growth opportunities for another 10 years at least. Jenks notes that Allegiant’s planned entry into short-haul international markets will be important, and the airline’s U.S. network lends itself well to supporting international routes.
Europe also saw a lift in median TPA scores. The increase was just 2.5 points, but as with most of the other regions, it represented a reversal from two years of decline.
Legacy carriers in Europe are being hurt by competition from the Middle East airlines on long-haul routes, and by LCCs on short-haul routes. European carriers are also being hampered by government regulation, Terry says. Labor rules, airport restrictions, taxes, and emissions regulations are “disproportionately burdening” airlines based in Europe.
Once again, the low-cost carrier giants Ryanair and EasyJet score higher than the large European network airlines. This year EasyJet has drawn ahead of Ryanair, after they had essentially the same score in last year’s TPA study. EasyJet has an advantage over Ryanair due to its greater appeal to business travelers, says Jenks.
Another European standout is Aegean Airlines, which achieved the highest year-on-year improvement of all carriers that scored more than 40.
The TPA study highlights trends in the state of the global industry as well. The global median score, based on data through the end of 2013, rose by 1.9 points to 45.5. While the rate of increase is gradual, it shows that the upward cycle--—following the last trough in 2012—is underway. This generally aligns with other economic assessments of the airline industry.
Terry says the industry cycle historically follows a bell-curve pattern, and he estimates that the industry is now about halfway through the upward phase. This suggests that there is still some improvement to come before the peak of the cycle is reached. Airline performance should be better in North America, Europe and Latin America next year, although the Asia-Pacific region may be flat due to capacity concerns, Terry says.
Jenks points out that an examination of airline performance in the key transatlantic market supports the cycle timeline, as it is “no longer in early upswing, but is now moving to mid-upswing.”
Neidl notes that the broader economic climate in most regions is still tepid, and businesses remain cautious about travel spending. Yet despite this macroeconomic backdrop, airlines in North America and Europe “are still doing very well—if this was the old airline industry, they would be losing tons of money.”
There is a lot of upside potential for the airline industry simply because it will perform better when economies do start to perk up more, Neidl says. Mergers and consolidation—particularly in the U.S. but increasingly in other regions, too—have put the industry on a sounder footing. This also means it will be better able to endure economic downturns, he says.
Lowry warns that the industry is far from out of the woods financially. On average, airlines from all three TPA categories “have yet to generate sufficient profitability to satisfy their debt service requirements and reward equity investors with an adequate return,” he says. “We need to see even stronger results as this cycle matures.”
Some significant potential challenges remain, however, with excess capacity growth heading the list. “The industry is doing a good job controlling growth, but historically it has never been able to rein in capacity for long,” Hamlin says.
Terry highlights the fact thatand logged more than 3,000 aircraft orders between them in 2013, and he notes that if all of these ultimately enter service, it will likely result in another capacity glut.
Labor costs are also a wildcard. As airline financial performance improves, unions will become mor56 insistent that they share in the gains, says Neidl. Lowry agrees that labor costs could replace fuel prices as the industry’s biggest challenge.
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