European airlines are realizing they have restructured too little, too late
The days of getting by for struggling European airlines are coming to an end. Malev Hungarian Airlines may become the first financially troubled airline unable to ride out the region's economic turbulence, but it will almost certainly not be the last.
The suffering of Europe's airlines has three main causes. Markets are weak, and they are forecast to remain so at least for this year. Some governments have added passenger taxes—such as the U.K. Air Passenger Duty or the German departure tax—that airlines have not been able to pass on to customers and have had to add to their cost bases. More importantly, however, many airlines are learning the hard way that they did not do their homework when times were good. Central European carriers like Malev, CSA Czech Airlines,and Air Baltic have been kept afloat by their respective governments, but structural reform has been slow.
The weak financial situation of Europe's airlines raises the question of whether there will be more foreign investment along the lines of's entry as the largest shareholder of . and the Irish government denied they were in talks with over a similar deal. Qatar is rumored to be interested in Spanair, too. But there are many more shares of carriers up for sale, including a significant stake in .
Even the most successful legacy carriers,- and , are still struggling to overcome their structural weakness in short-haul markets. Both are in the process of launching new rounds of cost-cutting measures. Without changes to legacy procedures, work rules and networks, there are tight limits to what can be achieved.
For the time being, no major aircraft order cancellations are expected, but airlines are retiring existing fleets earlier than planned and deferring some deliveries. For the most part, weaker carriers have not placed major aircraft orders at this stage, though LOT signed a commitment for eight and Air Berlin for 15.
The(IATA) expects European carriers to post a combined loss of $600 million in 2012. Based on estimates, they made a profit of $1 billion in 2011, a 1.2% margin.
The situation is most dramatic in Hungary, where national airline Malev appears to be on the brink of collapse yet again. The country's government says it has accepted a European Commission ruling that financing granted to Malev in 2007-10 “constitutes illegal state aid.” The commission asserts that “Malev would not have been able to obtain similar financing from the market on the terms conceded by the Hungarian authorities.” It also makes clear that “Hungary now needs to recover the unlawful aid from the beneficiary.”
The EC found that several transactions that took place in the past five years do not comply with European Union regulations stipulating that governments must behave like private investors in supporting airlines or other state-owned companies, following the “market economy investor principle.” The illegal state financing under investigation is estimated at $350 million at current conversion rates.
Malev has no way to pay back anything near that amount, given its huge debt burden and dearth of cash reserves. The airline depends on state aid to keep operating and was granted another $21 million loan at the end of December, which has not been part of the investigation. Malev is trying to quell worries of suppliers and customers by insisting in public statements that normal operations will continue.
Hungary's government says it will discuss the Malev situation and make a decision about it at a cabinet meeting on Jan. 16. The development ministry says it is in the country's interest to have a national airline based in Budapest. However, even if state aid is allowed to continue, the government can no longer afford to prop up Malev.
The EC warns that Hungary's insufficient progress in cutting its deficit will limit Budapest's ability to inject further money into the carrier. The commission proposes going on to the next stage, the Excessive Deficit Procedure (EDP), which forces European countries to comply with public deficit limits. It says it could make new recommendations to Hungary “with a view to bringing to an end its excessive government deficit.”
Hungary may be forced by the EC not only to stop supporting Malev, but also to try to sell the airline, as was the case for Portugal, which must privatizePortugal. Hungary has tried to sell the national carrier several times in the past few years but could not find a buyer.
Air France-KLM, Europe's biggest airline, is also in trouble and launched a restructuring program with the goal of reducing annual costs by €1 billion ($1.28 billion). Measures include a pay and hiring freeze, slower than planned capacity growth and some aircraft deferrals.
The airline made clear in a statement that over the next three years it will only grow by 5% cumulatively, a move that analysts and observers have pushed for.
Fleet investment will be down to €5 billion over the next three years, compared to €6 billion in 2009-11. Air France-KLM plans to defer delivery of oneto 2016 from 2014, and two Airbus that were to be delivered this year will arrive in 2013 and 2014, respectively. It will take one -300ER in 2016 instead of 2015 and cancel two options. The airline is sticking to its plans to acquire 25 Boeing 787s and 25 . While the 787 order has been finalized, Air France CEO Alexandre de Juniac says the A350 deal is likely to be signed “in the next few weeks.”
Air France-KLM's net debt is to be reduced by some €2 billion to €4.5 billion by the end of 2014.
Wages will be frozen at Air France for two years; KLM will have a policy of “wage moderation,” meaning only small increases will be made. The group plans to reduce overhead costs, improve efficiency and cut the network where needed, but no layoffs are planned for the time being. The airline says negotiations with unions over the measures are to “begin rapidly.” While the focus will be on the passenger business, “cargo and maintenance will also have to redefine their conditions for profitability,” Air France-KLM says.
The company admits that “the structural decline in unit revenues has led to deepening losses” in the short- and medium-haul business. It estimates those losses totaled €700 million in 2011. “Long-haul operations, also subject to increasing competition, cannot alone offset these losses,” Air France-KLM says, and so it is striving for “better utilization of aircraft and assets.” The company says it is not ruling out “more extensive outsourcing in some areas,” though it offered no details. It aims to break even in the short- and medium-haul segments by 2014.
Air France-KLM plans to issue a progress report in March and present all details of the transformation plan in the summer.
Lufthansa is in far better shape than Air France-KLM and most of its other competitors, but even it sees a need for further restructuring. Another cost-cutting program will be announced in the coming weeks, but no details are yet available. Its restructuring program, dubbed Climb 2011, targeted—and achieved—€1 billion ($1.28 billion) in annual savings. The group also disposed of the unprofitableBritish Midland, which is being taken over by the International Airlines Group.
Austrian Airlines, fully owned by Lufthansa, is reinforcing its efforts to finally reach profitability in 2012. New CEO Jaan Albrecht admits the original goal of breaking even in 2011 was unachievable; the airline posted an operating loss of close to €66 million.
Austrian plans to phase out its 11NGs as soon as possible, replacing them with seven Airbus A319s and A320s. Albrecht concedes that Austrian itself does not have the money to finance the replacement, though it has secured financial support from the Lufthansa group, contingent on significant improvements to its cost structure.
Albrecht says Austrian is battling serious structural disadvantages. According to the airline, air fares have dropped 50% since 2006, with the opposite trend in fuel prices. Also, the airline's staff costs have risen steeply. In the 2012 budget, they are where they were in 2009, but that is with 1,500 fewer employees after the huge layoffs of the past two years. Austrian says the increase in staff costs are mainly due to regular pay raises and adjustments for inflation.
“We have to eliminate our structural deficiencies and problems,” Albrecht asserts. His target is to reduce personnel costs without layoffs. Two-thirds of the needed improvements are to be achieved through further cost cuts and one third through revenue growth. Austrian plans a more aggressive sales initiative for local small and medium-sized businesses.
Albrecht is launching another effort to reduce airport and air traffic control costs and wants to open new negotiations with Vienna International Airport in particular. He is also pushing for the abolition of Austria's newly introduced air passenger tax that he considers to be another serious cost burden.
On the other hand, the formerCEO sees growth on long-haul routes as the key to returning the carrier to profitability. Austrian plans to add two aircraft to its long-haul fleet in 2013. However, it faces the daunting task of replacing its six aging -300ERs, at least in the medium term.
It is not just flag carriers with deep structural problems that are suffering. Poor sales in December have added to the financial woes of U.K.-based regional carrier, which is warning that revenue will fall short of expectations and is not expected to improve notably for the remainder of the carrier's financial year, which ends on Mar. 31. The shortfall in revenue is “significant,” the airline acknowledges. Year-on-year, Flybe saw an 8% drop in revenue in the third quarter for its U.K. operation, which represents 70% of its total annual revenues. The airline notes that yields have held steady, while conceding that it did not achieve the planned growth in that area.
However, Flybe is not deferring its expansion plans. “Management believes current market conditions will force further rationalization of the European regional and short-haul airline market, from which Flybe is well-positioned to benefit,” the company says.