WORLD AVIATION Yearbook 2013 EUROPE

WORLD AVIATION Yearbook 2013 EUROPE 1 PROFILES western europe TOP 10 AIRLINES SOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | Week starting 31-M...
Author: Allison Bennett
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WORLD AVIATION Yearbook 2013 EUROPE

1

PROFILES western europe TOP 10 AIRLINES

SOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | Week starting 31-MAR-2013

Western Europe Outlook

T

he European airline market has a number of dividing lines. There is little growth on routes within the continent, but steady growth on long-haul. Most of the growth within Europe goes to low-cost carriers, while the major legacy groups restructure their short/medium-haul activities. The big Western countries see little or negative traffic growth, while the East enjoys a growth spurt ...

2 AIRLINE LEADER | MAR-APR 2012

Ranking CARRIER NAME

SEATS

1

Lufthansa

1,739,886

2

Ryanair

1,604,799

3

Air France

1,329,819

4

easyJet

1,200,528

5

British Airways

1,025,222

6

SAS

703,817

7

airberlin

609,008

8

KLM Royal Dutch Airlines

571,584

9

Iberia

534,125

10

Norwegian Air Shuttle

494,828

western europe TOP 10 Airports

SOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | Week starting 31-MAR-2013

Ranking CARRIER NAME

SEATS

1

London Heathrow Airport

1,774,606

2

Paris Charles De Gaulle Airport

1,421,231

3

Frankfurt Airport

1,394,143

4

Amsterdam Airport Schiphol

1,052,624

5

Madrid Barajas Airport

1,016,791

6

Munich Airport

1,007,000

7

Rome Fiumicino Airport

812,178

8

Barcelona El Prat Airport

768,004

9

Paris Orly Field

683,097

10

London Gatwick Airport

622,909

... On the other hand, the big Western airline groups continue to lead consolidation, while many in the East struggle to survive. Many legacy flag carriers post losses, while LCC profits grow. Among the LCCs, the two larger established players make record profits with relatively slow traffic growth and the newer, smaller ones have less consistent profits but double-digit traffic growth. All these divides were clear in 2012 and will remain sharp in 2013. IATA reported that European airlines saw passenger traffic (RPK) growth of 5.3% in 2012, driven by long-haul, while cargo traffic fell by 1.5%. Association of European Airlines (AEA) members’ RPKs grew by 4.1%, although passenger numbers grew by only 2.2%. Members of the European Low Fares Airline Association (ELFAA) carried

western europe capacity SEATS per week

western europe projected delivery dates for aircraft on order

SOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | Week starting 31-MAR-2013

SOURCE: CAPA - CENTRE FOR AVIATION | Week starting 31-MAR-2013 1,739,886

Lufthansa

150

1,604,799

Ryanair

1,329,819

Air France

1,200,528

easyJet Britis Airways SAS

100

1,025,222 703,817

50

609,008 571,584

8,249,594

Other

0M

2M

4M

6M

747

8M

western europe breakdown for aircraft in service SOURCE: CAPA - CENTRE FOR AVIATION | Week starting 31-MAR-2013

777

A350

737

A380

787

ERJ170

ATR

A320

A330

CSERIES

CRJ

AN148

20 28

20 27

20 26

20 25

20 24

20 23

20 22

20 21

20 19

20 20

20 18

20 17

20 16

20 13

20 14

0

534,125

20 15

airberlin KLM Royal Dutch Airlines Iberia

western europe most popular aircraft types in service SOURCE: CAPA - CENTRE FOR AVIATION

0.2% 5.2% 0.1% 9.9%

Narrowbody Jet

12.3%

A320

Widebody Jet

737

Regional Jet

A330

Turboprop

CRJ

Small Commercial Turboprop Piston Engine Aircraft

ERJ170

Military Transport

18.6%

28.8%

31.5%

777

3.7%

747

3.7%

53.8%

20.6%

3.9%

Others

3.9% 3.9%

western europe capacity SEATS share by alliance

SOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | Week starting 31-MAR-2013

western europe fleet

SOURCE: CAPA - CENTRE FOR AVIATION | Week starting 31-MAR-2013

0.4% 5k

15.7%

4,396

41.5%

4k

Unaligned Star

17.0%

SkyTeam

3k 2k

oneworld oneworld (affiliate)

915

1k 0

190

In service

In storage

On order

25.4%

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7.2% more passenger than in 2011. In spite of this growth in passenger traffic, Eurocontrol reported that the number of flights in Europe fell by 2.4% in 2012. The apparent discrepancy is explained by a trend towards higher load factors, reflecting tight capacity control, and a higher average number of seats per aircraft. The latter point is explained by the superior growth of high seat density LCCs and of long-haul traffic. Spain was the weakest major European market, with a 6.5% drop in the number of flights, and none of Europe’s five biggest countries saw growth in flight numbers in 2012. By contrast, Turkey saw strong growth, followed by Norway, Poland and Ukraine. This pattern of a decline in flights in Western Europe, but positive growth in Turkey and Central/Eastern Europe, is forecast to continue in 2013, albeit at a lesser rate (Eurocontrol forecasts total movements will fall by 1.3%). For charter carriers, 2012 brought some welcome relief as flight numbers recovered from the impact of the Arab Spring in 2011, although they are still on a longer-term downward trend. Traditional carriers saw a fall in their share of flights in 2012 and this looks set to continue as LCCs are projected to increase their share further. The main point of comfort for traditional carriers is that growth rates to destinations outside Europe are forecast by Eurocontrol to be higher than within Europe. Passenger traffic growth should again be positive in 2013, outpacing the change in flight numbers. Western Europe is likely to be sluggish overall, with passenger growth led by Turkey and the Eastern countries and by LCCs. 2012 was a year of losses for many legacy carriers, including IAG, Air France-KLM, SAS and Alitalia, while Finnair, Aer Lingus and the Lufthansa Group managed positive results. AEA, which mainly represents legacy carriers, estimates a combined 2012 EBIT loss for its members. By contrast, the principal LCCs Ryanair, easyJet, Vueling and Norwegian Air Shuttle all saw their profits grow. According to IATA, European airlines posted an aggregate breakeven financial result in 2012 (IATA forecasts this again in 2013).

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This pattern of a decline in flights in Western Europe, but positive growth in Turkey and Central/Eastern Europe, is forecast to continue in 2013... In 2012, the Big Three legacy flag carrier groups made moves to restructure their short/medium-haul operations. IAG launched Iberia Express, a lower cost subsidiary to feed its Madrid hub, in spite of a series of strikes by staff protesting against its lower wage structure. IAG later announced a wider Iberia transformation plan that led to a further series of strikes in early 2013. Lufthansa announced plans to phase the transfer of all domestic and European flights outside its Frankfurt and Munich hubs to its LCC subsidiary Germanwings from summer 2013. Air France-KLM proceeded with its French regional bases plan and, in early 2013 created a new regional subsidiary Hop, the merger of a group of regional carriers Brit Air, Regional and Airlinair. The Big Three intend to continue with a cautious approach to capacity growth in 2013. IAG plans a capacity cut of 1.9% with Iberia capacity down 10% and BA capacity up around 2%, fuelled by its first A380 deliveries. BA’s launch route for its A380 will be Los Angeles. Air France-KLM plans passenger capacity growth of 1.5% in 2013 (+2.4% long-haul, -2.1% medium-haul). Lufthansa’s 2013 plan indicates capacity growth of 1.0% (+2.9% long-haul, -2.6% short-haul). All three either continued with existing cost reduction programmes, or announced new ones. IAG’s bullish target to exceed 2011’s EUR485 million operating profit in 2013 will depend on a successful implementation of the Iberia transformation plan. Air France-KLM has not set a profit target for the year, noting that 2013 started “amid an uncertain environment”. It will “maintain strict control over capacity and investments” and expects a reduction in unit costs excluding fuel, currency effects and pension charge increases. Lufthansa aims to beat 2012’s EUR524 million operating profit in 2013. SAS proceeded with its own cost cutting plan, referred to by its CEO as the “final call if there is to be a SAS in the future”. Alitalia turned to its shareholders for a life support loan in early 2013 after almost running out of cash at the end of 2012. The Italian flag carrier then parted company with its CEO, while Finnair’s boss left to join a cargo handler. Both airlines are seeking replacements. Virgin Atlantic’s long-serving CEO announced his retirement in 2012, to be replaced by Craig Kreeger, formerly SVP customers at American Airlines, whose first challenge will be to tackle an expected annual loss for 2012-13. Virgin Atlantic also signed an alliance deal with Delta Air Lines after the latter agreed to acquire the 49% stake in Virgin Atlantic

In 2012, the Big Three legacy flag carrier groups made moves to restructure their short/medium-haul operations.

previously owned by Singapore Airlines. In a busy period for Virgin Atlantic, the carrier is starting short-haul services for the first time in its 29 year history, with flights from Heathrow to Manchester, Edinburgh and Aberdeen under the new brand ‘Little Red’ and using aircraft and crew wet-leased from Aer Lingus. Ryanair delivered another record profit in 2011-12 and is set for yet another in 2012-13 after carrying 79.6 million passengers in calendar 2012 (4.2% up on 2011, in spite of cutting capacity and traffic in the winter months). In 2013, Ryanair will establish its first non-European bases at Fes and Marrakech in Morocco. easyJet also achieved record profits and increased its regular dividend, pleasing its founder and largest shareholder Sir Stelios Haji-Ioannou. Less pleasing to Sir Stelios was the airline’s consideration of a possible major new aircraft order. The easyJet share price increased two and a half times from the start of 2012 to midMar-2013, suggesting that his fellow shareholders are happier than Sir Stelios. Norwegian Air Shuttle grew passenger numbers by 21% and equalled its best ever pre-tax profit in 2012. In 2013, when it plans a 25% increase in ASKs, it will establish its first base in a major capital city outside Scandinavia (at London Gatwick) and set up a base in the highly competitive mainland Spanish market. Moreover, Norwegian will also launch its first long-haul routes, from Oslo and Stockholm to New York and Bangkok. Vueling became the object of an IAG takeover bid and reported the second highest profit in its history after seeing passenger growth of 20% in 2012. Emboldened by this, and by its knowledge that IAG needs Vueling more than it needs IAG, it is holding out for a higher price. There were a number of European airline bankruptcies in 2012, most notably Spanair, Malev, and Wind Jet, but also including Denmark’s Cimber Sterling, Iceland Express (operations acquired by Wow Air), Czech Connect, Germany’s Cirrus Airlines, Strategic Airlines Luxembourg, Poland’s OLT Airlines and Sweden’s Skyways. The demise of Spanair led to a rush of new capacity at its principal hub Barcelona El Prat from Vueling and Ryanair. The latter also moved significant new capacity into Budapest to fill the space left by Malev. In other consolidation moves, ownership of bmi was transferred from Lufthansa to IAG, with bmi baby subsequently closed, and Ryanair made a third attempt to buy Aer Lingus (only to be blocked yet again by the EU competition authorities, a decision that Ryanair intends to appeal). TAP Portugal’s privatisation fell at the final hurdle when the Portuguese Government abandoned the process after receiving a bid from Synergy Aerospace and no major European airline, although it may restart it in 2013. The end of the long-standing British Airways-Qantas joint venture was announced in 2012 after Qantas’ eye was turned by new partner

There were a number of European airline bankruptcies in 2012, most notably Spanair, Malev, and Wind Jet...

21%

Norwegian Air Shuttle passenger numbers growth in 2012

Emirates. BA got over it soon enough, sponsoring Qatar Airways’ application to join oneworld (expected in late 2013 or 2014), and signing a codeshare with Cathay Pacific on Hong Kong to Australia routes. airberlin joined oneworld in 2012, but also announced a three-way codeshare with SkyTeam member Air France-KLM and airberlin shareholder Etihad. Etihad also took a stake in, and signed a codeshare with, Aer Lingus. On the regulatory front, there are hopes for progress on emissions trading and the Single European Sky in 2013, both areas that have been stuck in a political quagmire. Aviation was officially brought into the European Emissions Trading Scheme in 2012, despite opposition from the industry and almost every significant non-EU nation. To allow more time to reach a global solution at the ICAO General Assembly in autumn 2013, the EU exempted flights into and out of Europe for the time being, while enforcing the scheme for intraEuropean flights. Progress towards a Single European Sky faltered again as a number of member states missed the Dec-2012 deadline to create Functional Airspace Blocks. Following the European Commission’s proposal on a charging framework for air navigation services for the period 2014-2019, Europe’s airline bodies (AEA, European Business Aviation Association, ELFAA, European Regions Airlines Association, and the International Air Carrier Association) jointly said: “All initiatives to achieve a harmonised and efficient European airspace have so far failed to deliver”. The airlines are likely to keep up the pressure on the Commission to improve the proposals before they are finalised in Dec-2013. Meanwhile, most airline managements cast regular looks over their shoulder at the tortured debt positions and political manoeuvring in many eurozone countries, hopeful that none of the trouble spots erupts into something worse.

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PROFILES Eastern europe TOP 10 AIRLINES

SOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | Week starting 31-MAR-2013

Eastern Europe Outlook

E

astern Europe continues to be a very active region in commercial aviation, with a number of developments in 2012 indicating the ever-unpredictable transformation of the region’s aviation industry. Across the region, restructuring processes at full-service carriers began or continued as pressure from international carriers from Western Europe grew. Low-cost competition also grew and will continue to do so in 2013, although not at the rate seen in recent years in Western Europe. The next specific area to watch for low-cost carrier growth will be Russia as the Russian Government plans to amend existing legislation to make way for low-cost carrier operations ...

6 AIRLINE LEADER | MAR-APR 2012

Ranking CARRIER NAME

SEATS

1

Turkish Airlines

972,677

2

Aeroflot

459,435

3

Pegasus Airlines

305,424

4

Wizz Air

248,400

5

S7 Airlines

213,056

6

Transaero Airlines

165,438

7

UTair Aviation

164,688

8

LOT - Polish Airlines

125,487

9

Rossiya - Russian Airlines

79,706

10

CSA Czech Airlines

73,862

Eastern europe TOP 10 Airports

SOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | Week starting 31-MAR-2013

Ranking CARRIER NAME

SEATS

1

Istanbul Ataturk Airport

1,125,132

2

Moscow Domodedovo Airport

603,184

3

Moscow Sheremetyevo Airport

596,057

4

Istanbul Sabiha Gokcen Airport

304,585

5

Athens International Airport

255,410

6

Warsaw Frederic Chopin Airport

242,805

7

Prague Václav Havel Airport

226,843

8

Ankara Esenboga Airport

225,944

9

Saint Petersburg Pulkovo Airport

216,130

10

Moscow Vnukovo Airport

204,695

... It seems few Eastern European countries were left unscathed by airline restructuring or failures in 2012, with major airlines from Hungary, Latvia, Estonia, Poland, Slovenia, Ukraine and Czech Republic either launching restructuring processes or shutting down operations. The European Commission has also been kept busy with the multiple instances of state aid being involved in many cases. As a result of these restructurings and failures of vulnerable state carriers, airline networks across the region have been reduced while multi-type fleets have also been curtailed. The start of 2012 began with the collapse of 66-year-old Malév Hungarian Airlines on 03-Feb-2012. The Hungarian national carrier initially left a significant hole

Eastern europe capacity SEATS per week

Eastern europe projected delivery dates for aircraft on order

SOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | Week starting 31-MAR-2013 Turkish Airlines

SOURCE: CAPA - CENTRE FOR AVIATION | Week starting 31-MAR-2013

972,677 459,435

Aeroflot Pegasus Airlines

305,424

Ryanair

279,153

Wizz Air

248,400

Lufthansa

232,204

S7 Airlines

213,056

Transaero Airlines UTair Aviation

100

75

50

25

165,438 20 25

20 24

20 23

20 22

20 21

20 20

20 19

20 18

20 17

20 16

20 15

20 13

20 14

0

164,688 2,577,262

Other

A320

0k

500k

1,000k

1,500k

2,000k

2,500k

A350 747

A380

SSJ

CRJ

ERJ170

777 42

787 YUN7

Eastern europe most popular aircraft types in service

Eastern europe breakdown for aircraft in service

SOURCE: CAPA - CENTRE FOR AVIATION

SOURCE: CAPA - CENTRE FOR AVIATION | Week starting 31-MAR-2013

3.9%

A330 737

3.3%

21.4%

9.4%

39.3%

11.9%

51.9%

19.6%

A320

Narrowbody Jet

737

Turboprop

AN24

Regional Jet

AN26

Widebody Jet

CRJ

Small Commercial Turboprop Military Transport

2.8% 3.0%

Eastern europe capacity SEATS share by alliance

SOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | Week starting 31-MAR-2013

TU154

21.2%

IL76 Others

3.4% 3.7%

5.2%

Eastern europe fleet

SOURCE: CAPA - CENTRE FOR AVIATION | Week starting 31-MAR-2013

6.7% 2,500

14.4%

2,295

2,000 Unaligned Star

48.3%

SkyTeam oneworld

1,500 1,000 618

500 138

30.6%

0

In service

In storage

On order

7

in the market however this was soon filled and exceeded, especially by low-cost carriers such as Hungarian Wizz Air and Ireland’s Ryanair which subsequently established a base in Budapest. A number of Eastern European carriers commenced restructuring processes in 2012 including airBaltic, Estonian Air, LOT Polish Airlines, Adria Airways and CSA Czech Airlines. 2013 will be a formative year for cementing these airlines’ futures. airBaltic’s ReShape plan, launched in 2012, was reported to be a success by CEO Martin Gauss in Nov-2012 with the airline’s labour cost reduced by 15% and the airline on track to breakeven in 2014. The airline is planning to reduce capital expenditure in 2013 while renegotiating existing leases on its aircraft. The European Commission launched an investigation in Nov-2012 into various public support measures from the Latvian Government to ensure they were in line with EU state aid rules. Fellow Baltic carrier Estonian Air also launched plans to turn its operations around in 2012. The airline is attempting to secure its future with significant reductions to both its network and fleet. The airline has received almost EUR25 million in loans from the Estonian Government, which are now under investigation by the European Commission. LOT Polish Airlines’ latest restructuring was launched in late 2012 following the granting of an emergency EUR96.4 million loan from the Polish Government. This was followed by a leadership change in early 2013. The airline’s turnaround has also been hampered by the fleet-wide grounding of Boeing 787-8 aircraft since late Jan-2013. These aircraft are a key factor in the airline’s fleet and network restructuring and a compensation settlement will be expected to follow their re-entry into service. A new restructuring plan is to be announced in Mar-2013 under which approximately 700 jobs are expected to be lost and its fleet size potentially halved. Meanwhile the Polish Government is also planning a law change which would allow for a potential sale of the carrier. Slovenia’s Adria Airways also underwent a restructuring process in 2012. The airline

8

As a result of these restructurings and failures of vulnerable state carriers, airline networks across the region have been reduced while multi-type fleets have also been curtailed. hired a privatisation advisor in early 2012 to assist the airline in finding strategic partners and/or investors. The European Commission also launched an investigation into the airline in Nov-2012 due to concerns of illegal state aid. CSA Czech Airlines was yet another legacy carrier in the region which underwent restructuring in 2012 with its network and fleet reorganised and new employee collective agreements signed ahead of privatisation. The airline’s privatisation was launched in Dec-2012 and received a boost in early Mar-2013 with Korean Air submitting a bid for a 44% stake in the carrier as part of efforts to strengthen its network in Europe. Korean Air said it recognises the rapid growth of the Eastern European market and intends to establish a stronger presence in the region. The airline’s bid for a large slice of the Czech national carrier and subsequent agreements between the airlines may be an interesting development in 2013. Also in privatisations, Romania’s TAROM may be looking into options in 2013 after the company’s privatisation was postponed to the end of 2013. This delay followed government elections during which the privatisation of state controlled entities were postponed. In late 2012 and early 2013, the Ukrainian aviation market was shaken up by the bankruptcy of Aerosvit. The previously largest carrier in the Ukrainian market substantially reduced its network over the first two months of 2013 and has since suspended all operations. It reportedly plans to resume a select number of long-haul services in northern hemisphere summer 2013 however time will tell whether Aerosvit will return to its former flag carrier status. Ukraine International Airlines (UIA), as well as Air Onix, UTair Ukraine and Wizz Air’s Ukrainian unit, Wizz Air Ukraine, have since stepped up to take over much of Aerosvit’s previous network, enlarging and strengthening their operations. Wizz Air Ukraine will see its fleet double in the coming months while its network will also significantly expand. Much of this is as a result of it taking advantage of network gaps left by Aerosvit’s bankruptcy. Wizz Air Ukraine’s Hungarian parent, Wizz Air, also continued to expand its network and fleet across not only Eastern Europe but in Western Europe in 2012. The airline opened a number of new routes and bases across Europe in 2012 with its total network increasing from 203 routes to over 250 routes in 2012. This is set to continue in the coming

In late 2012 and early 2013, the Ukrainian aviation market was shaken up by the bankruptcy of Aerosvit.

Russia will be a major country to watch in 2013 as the Russian Government plans to amend legislation which would allow for the establishment of true low-cost carrier operations in the country.

years with a significant number of aircraft on order. Russia will be a major country to watch in 2013 as the Russian Government plans to amend legislation which would allow for the establishment of true low-cost carrier operations in the country. The country’s only home-based low-cost carriers in the past were Sky Express (operational from 2007 until 2011) and Avianova (operational from 2009 until 2011). Avianova entered bankruptcy while Sky Express merged with Kuban Airlines (which itself collapsed in Dec-2012). Current Russian legislation requires airlines to provide refundable fares, checked luggage and in-flight service on all flights. All parts of the traditional fare product which is unbundled by low-cost operators in order to offer low cost fares. The Russian Government is planning to amend legislation to allow for true low-cost carrier operations in the country. Russia’s largest carriers Aeroflot and Transaero have both indicated interest in establishing low-cost carrier subsidiaries. Aeroflot has said it will be able to launch a low-cost airline within six months of the necessary law changes. Meanwhile the Russian Federal Air Transport Agency (Rosaviatsia) plans to reduce the number of aircraft required by scheduled airlines from the current requirement of three aircraft with capacity of up to 55 seats or eight aircraft with more than 55 seats. This is expected to see new airlines emerge with small fleets from 2013. While this is underway, British budget airline easyJet commenced services to the country in Mar-2013, further increasing the overall presence of low-cost carriers in the eastern-most country of Eastern Europe. Ryanair has also signalled interest in potentially launching services to/from and maybe within the country. Further plans may be announced if or when the relevant law changes come about. Elsewhere in the region, new Georgian start-up carrier FlyGeorgia launched in Aug-2012. Other new airlines may be launching in 2013,

2013 will see low cost carrier capacity continue to grow across the region, and into new markets including Russia. including Georgia’s Air Caucasus and Lithuania’s Air Lituanica. The future of some existing carriers in the region is uncertain however, including that of Bosnia and Herzegovina’s B&H Airlines and Russia’s Red Wings. While many of the aviation developments in Eastern Europe in 2012 seemed to be somewhat negative, the end result of these airline restructurings will hopefully be the creation of a new era in Eastern European aviation. Stronger, more dynamic airlines with more effective route networks and efficient fleets will bring about more effective competition and improved services. 2013 will see low-cost carrier capacity continue to grow across the region, and into new markets including Russia. New start-ups will also see new developments and potentially new destinations on the departure boards across airports in the region.

9

European airlines’ financial results in 2012; Net profit of biggest 13 down 72% for the year The biggest 13 European airline companies for whom 2012 accounts are available reported an aggregate fall in net profit of 72% in 2012 to just EUR69 million. At the level of operating profit, which provides a more accurate view of underlying performance, the aggregate result fell by a more creditable 17% to EUR 1,662 million (71% of this from the four LCCs in the sample) and the operating margin fell by 0.5ppts to 1.5%. Total revenues grew by a healthy 8.0%, but total costs grew faster, by 8.5%. Costs were inflated by an 18.9% increase in fuel costs, whose share of revenues increased to 28%, up from one quarter in 2011. Excluding fuel, all other costs grew by 4.8%, appreciably slower than revenues. LCCs grew faster, had higher load factors and, while their collective operating margin fell slightly, from 9.8% to 9.5%, this was vastly superior to the legacies’ collective 2012 margin of just 0.5%. At the individual airline level, Ryanair was the most profitable (although its margin slipped slightly), while Vueling, Turkish Airlines and Norwegian grew the fastest. Lufthansa was the only one of the European Big Three to post a positive operating result and Aer Lingus was the only predominantly short/medium-haul non-LCC to be profitable. Loss-making Alitalia, airberlin and SAS are trapped in the sub-1,500 km average sector danger zone, too close to the LCCs and with cost bases that are not competitive. Group of 13 major European airlines* 2012 financial and operating statistics EUR million Revenue Operating profit Operating margin % Fuel cost Fuel as % of revenues Ex fuel cost Total costs Net profit

2011 2012 % change 100,528108,552 8.0% 2,002 1,662 -17.0% 2.0 1.5 -0.5 25,444 30,260 18.9% 25.3 27.9 2.6 69,596 72,916 4.8% 98,526 106,889 8.5% 243 69 -71.8%

Operating ASK bn RPK bn Pax m Load Factor % Average sector km RASK EUR cent CASK EUR cent CASK ex fuel EUR cent Fuel CASK EUR cent

10

2011 1,235 978 521 79.2 1,877 8.14 7.98 5.87 2.14

2012 % change 1,274 3.2% 1,026 4.9% 546 4.7% 80.6 1.3 1,881 0.2% 8.52 4.7% 8.39 5.2% 5.94 1.3% 2.47 15.0%

*Aer Lingus, AF-KLM, airberlin, Alitalia, easyJet, Finnair, IAG, Lufthansa Group, Norwegian, Ryanair, SAS, Turkish Airlines, Vueling Airlines Source: CAPA analysis of company financial statements

Europe’s biggest airlines added 3.2% more ASKs and saw load factor gains in 2012 The group of the 13 European biggest airline companies that have reported results for 2012 collectively added 3.2% more capacity (ASK) in 2012 and saw traffic (RPK) growth of 4.9% and passenger numbers up 4.7%. This resulted in a 1.3ppt gain in load factor to reach 80.6%. The collective figures for all European carriers, reported by IATA, were capacity up 2.9% and traffic up 5.1% – both very similar rates to those of the biggest carriers. The latter group’s load factor performance was better than that of Europe as a whole, which saw an increase of 0.7ppts to 79.6%.

Fuel costs, up 15%, hit CASK, but ex-fuel costs also rose Relatively modest capacity growth of 3.2% helped to push total revenue per ASK up by 4.7%, but total cost per ASK grew faster at 5.2%. Fuel cost per ASK increased sharply, by 15%, but costs ex fuel per ASK were also up, by 1.3%. The higher growth in CASK than in RASK explains the fall in margins. While this is mainly due to fuel cost increases, even a small increase in ex fuel unit costs makes a difference when margins are so slim. A clear divide between LCCs and the rest Dividing the group of 13 between legacy carriers and LCCs (not always a clear line, but which airline belongs to which category is commonly accepted), it is clear that there are significant differences between the two categories. (i) The LCCs grew faster (both ASKs and revenues), had higher load factors, shorter sector lengths and much higher margins than the legacies; and (ii) LCCs saw higher growth in unit revenues and in unit costs than the legacies, both coming from a much lower level. For the LCCs, fuel is a higher percentage of revenues (one third in 2012) and they saw a 25% increase in fuel costs in 2012. In spite of their good control over ex fuel unit costs (down by 0.4%), their overall unit cost still grew by 7.9%, just ahead of unit revenue growth of 7.6%. Thus, the LCCs’ collective operating margin fell slightly, from 9.8% to 9.5%, but this compares with the legacies collective 2012 margin of just 0.5%. At the net profit level, the aggregate loss of almost EUR1 billion of the 13 legacy carriers was more than offset by the aggregate profit of just over EUR1 billion of the four LCCs. Group of nine major European legacy carriers* 2012 financial and operating statistics EUR million

2011 2012% change

11

Revenue Operating profit Operating margin % Fuel cost Fuel as % of revenues Ex fuel cost Total costs Net profit

89,80596,205 956 488 1.1 0.5 22,14526,130 24.7 27.2 63,22065,874 88,85095,717 -579 -946

Operating 2011 ASK bn 1,014 RPK bn 796 Pax m 363 Load Factor % 78.5 Average sector km 2,191 RASK EUR cent 8.86 CASK EUR cent 8.76 CASK ex fuel EUR cent 6.55 Fuel CASK EUR cent 2.18

7.1% -48.9% -0.6 18.0% 2.5 4.2% 7.7% 63.3%

2012 % change 1,037 2.3% 829 4.1% 375 3.3% 79.9 1.4 2,209 0.8% 9.28 4.7% 9.23 5.3% 6.65 1.6% 2.52 15.3%

*Aer Lingus, AF-KLM, airberlin, Alitalia, Finnair, IAG, Lufthansa Group, SAS, Turkish Airlines Source: CAPA analysis of company financial statements

Group of four major European LCCs* 2012 financial and operating statistics EUR million Revenue Operating profit Operating margin % Fuel cost Fuel as % of revenues Ex fuel cost Total costs Net profit

2011 2012 % change 10,72312,346 15.1% 1,047 1,174 12.2% 9.8 9.5 -0.3 3,299 4,130 25.2% 30.8 33.4 2.7 6,377 7,042 10.4% 9,676 11,172 15.5% 823 1,015 23.3%

Operating 2011 ASK bn 221 RPK bn 182 Pax m 158 Load Factor % 82.5 Average sector km 1,155 RASK EUR cent 4.85 CASK EUR cent 4.38 CASK ex fuel EUR cent 4.01 Fuel CASK EUR cent 2.08

2012 % change 237 7.0% 198 8.3% 171 8.0% 83.5 0.9 1,158 0.3% 5.22 7.6% 4.72 7.9% 4.00 -0.4% 2.34 12.9%

* easyJet, Norwegian, Ryanair, Vueling Airlines Source: CAPA analysis of company financial statements

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The charts below further highlight the contrasting fortunes of the legacy carriers and the LCCs. The latter still represent a minority share of the number of airlines, ASKs, passengers and revenues, but dominate in terms of profits generated. Out of our group of 13 airlines, four are LCCs, accounting for 19% of ASKs, 31% of passengers, 11% of revenues, but 71% of operating profit and a collective net profit greater than the collective net loss of the nine legacy carriers. Group of 13 major European airlines* by business model type 2012

*Aer Lingus, AF-KLM, airberlin, Alitalia, easyJet, Finnair, IAG, Lufthansa Group, Norwegian, Ryanair, SAS, Turkish Airlines, Vueling Airlines Source: CAPA analysis of company financial statements

Group of 13 major European airlines* financial measures by business model type 2012 (EUR million)

Aer Lingus, AF-KLM, airberlin, Alitalia, easyJet, Finnair, IAG, Lufthansa Group, Norwegian, Ryanair, SAS, Turkish Airlines, Vueling Airlines Source: CAPA analysis of company financial statements

The Big Three are still the biggest by revenue, but Vueling, Norwegian and Turkish are growing fastest and Ryanair is most profitable In what follows, we present a number of charts ranking the 13 airline groups by a various measures, financial and operating, both absolute and by rate of growth in the measures. The big three legacy carriers dominate revenues, but revenue growth is being driven by LCCs (especially the smaller pair Vueling and Norwegian) and by Turkish Airlines.

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Ryanair is the most profitable carrier in Europe, in terms of operating margin, followed by easyJet, Turkish Airlines and Aer Lingus, although Ryanair’s operating margin fell slightly in 2012 (note we have looked at calendar 2012 for Ryanair, rather than its financial year, which ends in March). European airlines revenue 2012 (EUR million) and change from 2011 (%)

*Ryanair 4QFY2012+1-3QFY2013; ASK and RPK data estimates based on reported pax and load factor and FY2012 sector length **Alitalia RPK and ASK data based on reported capacity change, pax and load factor ***SAS Group 10m to Oct2012 Source: CAPA analysis of company financial statements

Finnair and Turkish Airlines recorded the highest percentage point improvements in their margins in 2012, For Alitalia, SAS and IAG, 2012 saw both an operating loss and a decline in the operating margin. Two other loss-makers at the operating level, Air France-KLM and airberlin, at least saw a narrowing of their margin of loss. European airlines operating margin 2012 (% of revenue) and change from 2011 (percentage points)

*Ryanair 4QFY2012+1-3QFY2013; ASK and RPK data estimates based on reported pax and load factor and FY2012 sector length **Alitalia RPK and ASK data based on reported capacity change, pax and load factor ***SAS Group 10m to Oct2012 Source: CAPA analysis of company financial statements

Ryanair carried more passengers than Air France-KLM

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As with revenues, the big three legacy flag carrier groups dominate ASKs thanks to their longhaul profiles, although Ryanair, Turkish Airlines and easyJet are also of significant size in capacity terms. Of course, Turkish Airlines' ASK capacity is boosted by a relatively long average sector length, whereas for easyJet and, in particular, Ryanair, ASK muscle reflects the sheer weight of seat numbers in the market place. A comparison of passenger numbers highlights this latter point further. Ryanair carried more passengers in 2012 than Air France-KLM and was second only to the Lufthansa Group, while easyJet carried more than IAG.

Alitalia and airberlin cut capacity as Vueling, Turkish and Norwegian grow As with revenues, Vueling, Turkish Airlines and Norwegian dominated growth in both ASKs and passenger numbers in 2012. By contrast, Alitalia and airberlin contracted. Winter capacity cuts by Ryanair meant that, unusually for the carrier, its ASK growth in 2012 (4.2%) was lower than for the group of 13 in aggregate (4.7%). European airlines capacity 2012 (ASK billion) and year-on-year change from 2011 (%)

*Ryanair 4QFY2012+1-3QFY2013; ASK and RPK data estimates based on reported pax and load factor and FY2012 sector length **Alitalia RPK and ASK data based on reported capacity change, pax and load factor ***SAS Group 10m to Oct2012 Source: CAPA analysis of company financial statements

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European airlines passenger numbers 2012 (million) and year-on-year change from 2011 (%)

*Ryanair 4QFY2012+1-3QFY2013; ASK and RPK data estimates based on reported pax and load factor and FY2012 sector length **Alitalia RPK and ASK data based on reported capacity change, pax and load factor ***SAS Group 10m to Oct2012 Source: CAPA analysis of company financial statements

Load factor is a poor indicator of profit The generally superior passenger load factors of the LCCs contribute to strong passenger numbers, although it is interesting to note that Air France-KLM ranks second in 2012 load factor (easyJet is number one, with a staggering 90.4%, calculated as RPK/ASK rather than pax/seats as usually reported by easyJet). The large majority of carriers in our sample saw load factor gains in 2012, with declines only at Ryanair (very slightly) and airberlin. The latter saw a heavy 3.2ppts load factor fall (calculated as RPK/ASK), in spite of a 2.8% cut in ASK. Load factor is an unreliable indicator of profitability: the top four places by load factor include the two highest margin carriers (Ryanair and easyJet) and two of the three lowest margin carriers (Air France-KLM and airberlin). European airlines passenger load factor 2012 (RPK as % of ASK) and change from 2011 (percentage points)

*Ryanair 4QFY2012+1-3QFY2013; ASK and RPK data estimates based on reported pax and load factor and FY2012 sector length **Alitalia RPK and ASK data based on reported capacity change, pax and load factor ***SAS Group 10m to Oct-

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2012 Source: CAPA analysis of company financial statements

The 1,500km average sector length – the great divide In addition to the LCC/legacy divide, the 13 airline groups that make up Europe’s largest players can be split according to average sector length, with an interesting dividing point somewhere around 1,500km. Above this point are the big three legacy flag carrier groups, for whom longhaul is key to profitability and whose significant long-haul networks are difficult to replicate and are therefore still something of a defendable niche. Also above the 1,500km mark are Finnair and Turkish Airlines, both pursuing long-haul growth strategies that, while different from one another, are based on their geographical positioning. For airline groups that are at or below 1,500km average sector length, there seems to be a simple message: get out of this zone or become a low-cost carrier. With the notable exception of Aer Lingus, airlines in this segment are either loss-making sub-scale legacy flag carriers or profitable LCCs. Aer Lingus has benefited from a significant cost cutting programme that helped to transform it from its days as a typical legacy flag carrier (and its average sector length is just over 1,500km). The challenge for SAS, airberlin, and Alitalia, languishing in losses at the shorter end of the sector length spectrum is significant. They must either develop (rapidly) their long-haul networks, or take on the LCCs at their own game by dramatically lowering costs. To some extent, all three are attempting both (they all increased average sector length in 2012 and are pursuing cost reduction programmes) and are developing partnerships and alliances to help them, but the outlook remains hazy at best. European airlines average sector length 2012 (km) and change from 2011 (%)

*Ryanair 4QFY2012+1-3QFY2013; ASK and RPK data estimates based on reported pax and load factor and FY2012 sector length **Alitalia RPK and ASK data based on reported capacity change, pax and load factor ***SAS Group 10m to Oct2012 Source: CAPA analysis of company financial statements

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Only SAS saw a fall in RASK All but one of the 13 airlines saw an increase in total revenues per ASK in 2012. Only SAS stood as the exception. This measure is not directly comparable between the groups as the larger groups such as Lufthansa generate a significant level of revenues from ground-based activities such as maintenance and catering, in addition to cargo, while LCCs such as Ryanair generate all revenues from passenger air traffic. The same is true of costs. Nevertheless, year-on-year changes in total revenue per ASK and cost per ASK help to explain changes in profit margins. European airlines year-on-year change in total revenue per ASK 2012 (%)

*Ryanair 4QFY2012+1-3QFY2013; ASK and RPK data estimates based on reported pax and load factor and FY2012 sector length **Alitalia RPK and ASK data based on reported capacity change, pax and load factor ***SAS Group 10m to Oct2012 Source: CAPA analysis of company financial statements

Finnair improved margin through CASK containment, but Alitalia and IAG saw high CASK growth Finnair’s 2012 margin improvement was largely due to a good performance in containing costs per ASK and this was due to a 5% reduction in ex fuel cost per ASK offsetting an increase in fuel cost per ASK. Among the loss-making carriers, airberlin and SAS managed to lower ex fuel cost per ASK, as did the more profitable Turkish and Vueling. Worryingly for loss-making Alitalia, total cost per ASK increased by more than 9% in 2012. The same is true for IAG, for whom cost per ASK increased by 11%, more than all the others.

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European airlines year-on-year change in total cost per ASK and ex fuel cost per ASK 2012 (%)

*Ryanair 4QFY2012+1-3QFY2013; ASK and RPK data estimates based on reported pax and load factor and FY2012 sector length **Alitalia RPK and ASK data based on reported capacity change, pax and load factor ***SAS Group 10m to Oct2012 Source: CAPA analysis of company financial statements

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Europe: Selected airlines Lufthansa Group........................................................pp.23 “Lufthansa: why being the best of the Big Three is not good enough” First published on www.centreforaviation on 15th March, 2013

Air France-KLM............................................................pp.41 “Air France-KLM: why it must Transform, as medium haul and cargo operations hurt the bottom line” First published on www.centreforaviation on 26th February, 2013

iag...................................................................................pp.58 “IAG slips into losses, targets immediate bounce-back. But further austerity will be needed all round” First published on www.centreforaviation on 1st March, 2013

Turkish airlines..........................................................pp.72 “Turkish Airlines’ 2012 operating profit almost triples; 2013 more doubtful, with 20% seat growth” First published on www.centreforaviation on 19th March, 2013

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easyjet..........................................................................pp.88 “easyJet SWOT analysis - Is Sir Stelios strength, weakness, opportunity and threat all in one?” First published on www.centreforaviation on 5th February, 2013

virgin atlantic airways.............................................pp.99 “Virgin Atlantic, the flying enigma – a great brand in need of greater financial discipline” First published on www.centreforaviation on 14th March, 2013

airberlin.......................................................................pp.112 “airberlin: in need of a cap that fits after another underlying loss” Due for publishing on www.centreforaviation on 21st March, 2013

alitalia..........................................................................pp.128 “Alitalia battles for survival in 2013, again, despite operational improvements” First published on www.centreforaviation on 6th March, 2013

sas..................................................................................pp.143 “SAS SWOT: final call to establish a sustainable Scandinavian Airlines” First published on www.centreforaviation on 12th March, 2013

Norwegian air shuttle..............................................pp.158 “Norwegian Air Shuttle: at a critical turning point” First published on www.centreforaviation on 19th February, 2013

air astana.....................................................................pp.173 “Air Astana plans more rapid regional growth as Kazakhstan emerges as world’s fastest growing market” First published on www.centreforaviation on 16th January, 2013

tajik air.........................................................................pp.189 “Tajik Air faces increasing pressure as Somon Air expands and new start-up enters the domestic market” First published on www.centreforaviation on 29th January, 2013

22

Lufthansa  Group  

 

 

 

                     

 

Key Data Fleet and Orders Deutsche Lufthansa AG Fleet Summary: as at 10-Apr-2013

23

Source: CAPA Fleet Database

Deutsche Lufthansa AG projected delivery dates for aircraft on order: as at 8-Apr-2013

Source: CAPA Fleet Database

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Route area pie chart Deutsche Lufthansa AG international capacity seats by region: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Top routes table Deutsche Lufthansa AG top ten international routes by seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile Lufthansa schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Share price 2012/2013

Source: CAPA - Centre for Aviation and Yahoo! Financial

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Lufthansa: why being the best of the Big Three is not good enough Lufthansa is the most consistently profitable of the Big Three European legacy flag carrier groups and the only one to make a positive operating result in 2012. With 236 aircraft on order and a strong balance sheet that should facilitate funding these deliveries, it appears to be in a league of its own in Europe. However, group operating profit, which fell from EUR820 million in 2011 to EUR524 million in 2012, has been on a downward path since 2007. Results at the core Lufthansa Passenger Airline fell into loss, making it the group’s weakest performer in 2012, a shocking reinforcement of the need to change. Lufthansa is taking radical steps to restructure non-hub short-haul routes using its LCC subsidiary Germanwings after similarly radical restructuring at its Austrian Airlines subsidiary and is determined to push through with its SCORE cost savings programme. For 2013, it is targeting only a better operating result than last year, but its 2015 target of an operating result of EUR2.3 billion would represent its best ever three year improvement.

Lufthansa was the only one of Europe’s Big Three with a positive operating result in 2012 The Lufthansa Group saw a fall in its operating result in 2012 to EUR524 million, from EUR820 million in 2011. No dividend was proposed for only the second time since 2004. Nevertheless, it was the only one of Europe’s Big Three legacy flag carrier groups (the other two being IAG and Air France-KLM) to post a positive operating result in 2012 and it has been the most consistently profitable of the three through the cycle, achieving a positive result for each of the past 10 years. The improvement in net profit was mainly due to the sale of shares in Amadeus and the sale of bmi. Deutsche Lufthansa financial highlights 2012

*Passenger Airline Group revenue per ASK **Flying segment costs only (net of other operating income) Source: CAPA – Centre for Aviation; Deutsche Lufthansa

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Profits on a downward path driven by the passenger business However, setting aside the dramatic slump and recovery in 2009 and 2012 respectively, Lufthansa’s operating result has been on a downward path since the peak pre-crisis year of 2007 after rising strongly from 2003 to 2007. Deutsche Lufthansa revenues, net profit and operating profit (EUR million) 2003 to 2012

Source: CAPA – Centre for Aviation; Deutsche Lufthansa

The pattern of a rising group operating result to 2007 and a downward trend since then largely reflects the performance of the Passenger Airline Group segment, which is the largest of Lufthansa’s divisions and comprises the individual passenger businesses of Lufthansa itself, Germanwings, SWISS and Austrian Airlines. In 2012, this segment made an operating profit of EUR258 million, down from EUR349 million in 2011. Within the segment, Lufthansa’s own passenger business was the worst performer, with an operating loss of EUR45 million, compared with profits of EUR191 million at SWISS and EUR65 million at Austrian Airlines. This was Austrian’s first positive result since its acquisition by Lufthansa in 2009, reflecting the success of its restructuring which saw operations transferred into its subsidiary Tyrolean Airways. Although SWISS was again the best performer, its operating result fell by EUR68 million, partly due to the strong Swiss franc hitting revenues. The progressive transfer of Lufthansa’s non-hub European flights to LCC subsidiary Germanwings from this year is aimed at improving the result of the core Lufthansa business. Looking at the operating result of the other segments, the Logistics (cargo) division has been very volatile and its heavy loss in 2009 almost brought the whole group into an operating loss. By 28

contrast, the MRO division (Maintenance, Repair and Overhaul) has been very steady in its profitability. The Catering segment, while only a small contributor to group profits, has also avoided an operating loss over the past 10 years. IT Services has made losses in this period, most recently in 2009, but nothing like the scale of its losses in 2003 and 2004 and typically is a low margin business for Lufthansa. Deutsche Lufthansa operating profit by business segment (EUR million) 2003-2012.

Source: CAPA – Centre for Aviation; Deutsche Lufthansa

Lufthansa's balance sheet is strong In terms of its balance sheet, Lufthansa has a reputation for a prudent approach. It has high levels of liquidity and low net debt. The group has consistently covered its capital expenditure needs out of operating cash flow (and, on occasion, asset disposals). Its gross liquidity at the end of 2012 was almost EUR5 billion, equivalent to two months of group revenues and much higher than its minimum target of EUR2.3 billion. For a number of years before 2009 it had a net cash position and its net debt of just under EUR2 billion at the end of 2012 gave it a fairly low gearing ratio (net debt to equity) of 24%. It makes very little use of operating leased aircraft and so its adjusted net debt, which includes capitalised operating leases, would not be much different. Deutsche Lufthansa development of net debt and cash 2003-2012

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Source: CAPA – Centre for Aviation; Deutsche Lufthansa

High historic capacity growth boosted by acquisition, but much slower in 2012 The group has seen relatively strong passenger capacity growth over the past 10 years, at an average of 8.6% p.a., but this has been boosted by acquisitions (eg SWISS consolidated from 3Q2007, Austrian from 3Q2009). The underlying average growth rate for passenger capacity growth of the Lufthansa airline over this period is around 5% p.a. In 2012, it was much slower at only 0.6% for the group. Passenger load factor was on an upward path until 2007, since when it has oscillated between the levels of around 78% to 80%, suggesting that further gains may be a challenge (although further load factor increases have been seen in Jan-2013 and Feb-2013). Deutsche Lufthansa development capacity (ASK, million) and load factor (%) 2003-2012

30

Source: CAPA – Centre for Aviation; Deutsche Lufthansa

In 2012, the Lufthansa Passenger Airline Group saw yield growth of 3.7%, assisted partly by currency movements (without currency effects, yield was up by 1.0%) and also by the tight capacity control. Yield growth was strongest on the Americas, reflecting a capacity cut of 0.4% to the region. Deutsche Lufthansa change in capacity (ASK), yield (revenue per RPK) and load factor (%) by geographical region 2012

Source: Deutsche Lufthansa

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RASK-driven revenue growth in 2012 Group revenues grew by 4.9% in 2012, driven by the Passenger Airline Group, which accounted for 78% of total revenue. This revenue growth was mainly due to higher RASK, itself a combination of yield and load factor gains. The cargo business saw a fall in revenues of 8.7%, with cargo traffic volume down 6.1%. The importance of cargo to the group remains on a long term downward trend, falling to 8.9% of group revenue in 2012 from 13.6% 10 years earlier (and around 17% in the mid to late 1990s). Lufthansa’s freighter fleet of 18 MD-11Fs has not grown for a number of years; in 2006 there were 19 MD-11Fs and in 2003 Lufthansa had 22 freighters (14 MD-11Fs and eight Boeing 747Fs). Lufthansa Technik, the group’s MRO business, is the world’s leading independent provider of commercial aircraft maintenance services, with 61% of its revenues from customers outside the group. Its revenues fell slightly in 2012, but this was due to lower sales to the group and its external revenues grew by 5% and its operating result increased. Deutsche Lufthansa revenues (EUR million) 2011 and 2012

Source: CAPA – Centre for Aviation; Deutsche Lufthansa

Breaking down the group’s passenger revenues by individual carrier, Lufthansa itself (including LCC subsidiary Germanwings) accounted for 73% of passenger revenues in 2012, SWISS 18% and Austrian 9%. SWISS grew its passenger revenues fastest, at 7.1%, reflecting higher capacity growth (+5.0%), whereas Austrian cut its capacity by 4.0% and Lufthansa was almost flat at 0.3%. The growth at SWISS focused on its intercontinental network. Lufthansa Passenger Airline Group passenger revenues by carrier 2012 (EUR million)

Source: CAPA – Centre for Aviation; Deutsche Lufthansa

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Lufthansa more dependent on Europe for revenues than IAG and AF-KLM Europe accounted for 46.3% of Lufthansa’s group passenger traffic revenues in 2012, considerably more than for the other major European legacy flag carrier groups Air FranceKLM and IAG. The North Atlantic took the biggest share of revenues among intercontinental destination regions with almost 21%, closely followed by Asia/Pacific on 19%. Lufthansa Passenger Airline Group geographical breakdown 2012 by share of traffic revenues (%)

Source: Deutsche Lufthansa

Cost growth outpaced capacity in 2012, fuelled by fuel costs Group costs grew by 4.3% in 2012, faster than the 0.6% growth in passenger capacity. Fuel costs, the biggest category at 23% of total costs, grew by almost 18%. Excluding fuel, all other costs grew by 0.8%, only just ahead of capacity growth and slower than revenue growth. Labour expenses, which account for 22% of the total, grew by 5.6% in spite of a fall in average group headcount of 0.6%, due to some extent to currency movements, higher pension costs and restructuring costs (which should lead to future benefits). Deutsche Lufthansa operating costs 2011 and 2012, EUR million

Source: CAPA – Centre for Aviation; Deutsche Lufthansa

33

Labour productivity trends slip Although Lufthansa Group average headcount fell in 2012, labour cost productivity measures deteriorated. As noted above, the trends were distorted by impacts that should not recur, but management will not want to see further deterioration in 2013. Revenue productivity improved, but costs will need to be the main focus. Deutsche Lufthansa group labour productivity measures 2011 and 2012

Source: CAPA analysis of Deutsche Lufthansa results

In order to make closer comparison with other airlines that do not have such a wide range of non-flying business (eg maintenance and catering) that have large numbers of ground-based personnel, we also look at labour productivity for the flying segments of the Lufthansa Group. On this analysis, Lufthansa looks more efficient than the other major European flag carrier groups, but, again its measures were trending in the wrong direction in 2012 on the cost side. See related article European airlines' labour productivity. Oxymoron for some, Vueling and Ryanair excel on costs Lufthansa Passenger and Cargo segment labour productivity measures 2011 and 2012

Source: CAPA analysis of Deutsche Lufthansa results

The Lufthansa Group’s fleet has shrunk Lufthansa Group's fleet has an average age of 11.2 years and consists of 627 aircraft, down from a peak of 722 in 2009, the first year that saw Austrian and bmi consolidated into the group. The 34

group currently has 236 aircraft on order, of which 34 will be delivered in 2013. A further longhaul aircraft order is being considered and may be placed later this year. The focus of new aircraft will be to replace older ones, rather than significant growth in the fleet. Lufthansa plans on average to grow at half the expected market growth rate in Europe to 2025. Deutsche Lufthansa Group aircraft in service year end 2003 to 2012

Source: CAPA – Centre for Aviation; Deutsche Lufthansa

Deutsche Lufthansa Group fleet at 31-Dec-2013 and outstanding orders*

*Before the order announced on 19-Mar-2012 for six 777-300ER, two A380 and 30 A320 and 70 A320/321neo Source: Deutsche Lufthansa

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In addition to the orders noted in the tables above and below, on 19-Mar-2012, Lufthansa announced an order of 108 aircraft for the group, consisting of six 777-300ERs for SWISS, two A380s and 30 A320s for Lufthansa Passenger Airlines and a further 70 A320/321neo (still in negotiation). These aircraft are scheduled for delivery between 2015 and 2025, with no further delivery details currently specified. Deutsche Lufthansa Group deliveries 2013 to 2018*

*Before the order announced on 19-Mar-2012 for six 777-300ER, two A380 and 30 A320 and 70 A320/321neo Source: Deutsche Lufthansa

Only 1% passenger capacity growth and a higher operating result in 2013 In 2013, the Lufthansa Passenger Airline Group plans capacity growth of 1.0% overall, with short-haul cuts of 2.6% and long-haul growing by 2.9%. In the northern hemisphere summer season, these trends will be more pronounced: short-haul down 2.9% and long-haul up 4.1%, for a total of 1.5% capacity growth. Lufthansa Group's capacity growth in 2013 will not stem from fleet growth, but, rather, from two other factors. First, increased number of seats per flight (though reducing business class seats and increasing economy seats on many long-haul routes and through the use of A380s and 747800s on old 747-400 routes) and, second, higher aircraft productivity. In terms of a financial target for 2013, Lufthansa is aiming for a higher operating result than the EUR524 million recorded in 2012. Given a target under the group’s SCORE programme to reach a EUR2.3 billion operating result in 2015, this goal for 2013 would seem an absolute minimum.

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Lufthansa Passenger Airline Group capacity growth plan 2013

Source: Deutsche Lufthansa

Corporate restructuring and the SCORE cost programme; LSG Sky Chefs for sale? Lufthansa’s CEO Christoph Franz took time at the 2012 results presentation to remind those present of the corporate restructuring measures and disposals since 2011. Lufthansa has been reported to be working on the sale of parts of its LSG Sky Chefs catering business, so further such measures could be on their way. He also emphasised the group’s cost saving programme SCORE, which made EUR618 million of savings in 2012 and under which the group has an ambitious target to reach an operating result of EUR2.3 billion in 2015. The 2013 target under SCORE is for EUR740 million of savings and the most significant project is the development of the new Germanwings starting on 01-Jul. Mr Franz believes it will offer Europe’s best price-performance ratio among the low-cost airlines and contribute EUR200 million of improvements to the group result by 2015. The group did not report separate results for Germanwings in 2012, but its 2011 results showed that its average revenue per passenger was around EUR91 (and that it made a loss), compared with the Lufthansa Passenger Airline Group’s average traffic revenue per passenger of EUR121 on European routes, so it should be lower priced than the parent group. However, these figures compare with EUR58 for Ryanair, and EUR75 to EUR80 for Vueling and easyJet. It remains to be seen if its performance (however defined) will be significantly superior to these LCCs.

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Corporate restructuring since 2011 and SCORE programme measures

Source: Deutsche Lufthansa

Deutsche Lufthansa SCORE programme targets to 2015

Source: Deutsche Lufthansa

Lufthansa has controlled ex fuel CASK but fuel costs and volatile RASK trends undermine this As for many other European airlines, the bounce-back from poor profitability in 2009 (losses for most; a low, but positive, operating result for Lufthansa) was driven by improved unit revenues in 2010. Lufthansa has seen a broadly upward trend in RASK since then, although it fell in 2011 and remains below the levels reached in 2008.

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It has focused with some success on unit costs. Although these have risen quite sharply since 2009, this has mainly been due to fuel cost increases. Ex fuel unit costs have been fairly stable since 2009, but Lufthansa has not managed to match the steady fall in ex fuel CASK seen from 2006 to 2009. Deutsche Lufthansa – index of operating cost per ASK and fare revenues per ASK (each indexed to 100 in 2010)

Source: CAPA – Centre for Aviation; Deutsche Lufthansa

The chart below compares Lufthansa’s unit costs and average sector length with those of a number of other European competitor airlines. The individual passenger airlines of the Lufthansa Groups are shown, in addition to the unit cost position of the Group as a whole (but excluding the maintenance, catering and IT segments from the cost base). This chart demonstrates, first, how short Lufthansa’s average sector lengths are compared with the other legacy groups. Lufthansa is much more dependent on domestic and European traffic than any other big European flag carrier group. This reflects the fact that its main hub, Frankfurt, is based in a relatively small city with small O&D market, meaning that Lufthansa must generate feed from a much wider catchment area to sustain its long-haul network. It is also due to the relative size and de-centralised nature of Germany compared with other major European countries, such as the UK and France, which means that there is more point-to-point domestic traffic connecting major non-hub cities. The chart also demonstrates that the group needs to make further efficiencies if it is to become more competitive. Lufthansa Group airlines’ unit costs are currently broadly in the pack of legacy carriers, but significantly above the LCCs and above the more efficient legacy carriers such as Finnair and Aer Lingus.

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It no doubt generates higher unit revenues than these carriers, but, as noted above, RASK cannot be relied upon. The Tyrolean restructuring at Austrian, the Germanwings-based restructuring at Lufthansa and other SCORE projects demonstrate that management understands this. Unit costs (cost per available seat kilometre) and average sector length for selected European legacy and low-cost carriers 2012*

*Financial year ends as follows: Lufthansa, Aer Lingus, IAG, Iberia, BA, Air France-KLM, Finnair, Norwegian, Vueling Dec-2012; SAS Oct-2012; easyJet Sep-2012; Ryanair Mar-2012, Virgin Atlantic Feb-2012. Source: CAPA analysis of company accounts and traffic data

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Air  France-­‐KLM                      

 

Key Data Fleet and Orders Air France-KLM Fleet Summary: as at 10-Apr-2013

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Source: CAPA Fleet Database

Air France-KLM projected delivery dates for aircraft on order: as at 8-Apr-2013

Source: CAPA Fleet Database

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Route area pie chart Air France-KLM international capacity seats by region: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Top routes table Air France-KLM top ten international routes by seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile Air France-KLM schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Share price 2012/2013

Source: CAPA - Centre for Aviation and Yahoo! Financial

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Air France-KLM: why it must Transform, as medium haul and cargo operations hurt the bottom line Air France-KLM has now reported a cumulative net loss of EUR3.8 billion since March 2008 and a loss of EUR439 million since the merger between Air France and KLM in 2004. Although operationally solid, with load factors reaching 83% in 2012, it remains financially the weakest of the big three European legacy flag carriers and at the wrong end of the scale when it comes to labour productivity. Its medium-haul passenger network and its cargo business are significant drains on its profitability. Management has set in motion a number of initiatives to plug these drains and to improve productivity, including headcount reduction, the restructuring of its French regional bases, the reorganisation of Air France’s regional airlines into Hop, an increase in capacity for its leisure brand Transavia, a reduction in freighter capacity and the development of its alliances and partnerships. Its ‘Transform 2015’ targets, to lower unit costs by 10%, to increase EBITDA by between EUR1.1 billion and EUR1.6 billion from 2012 levels, and to reduce net debt by a further EUR1.5 billion, look very ambitious. If these targets are not achieved, any return to a falling unit revenue environment could spell disaster for the group. Operating loss narrows, net loss widens in 2012 Air France-KLM reported a 2012 operating loss of EUR300m, 15% narrower than its loss in 2011, while its net loss widened by 47% to EUR1,192 million (adversely affected by a EUR471 million restructuring charge, which should reap benefits in future years). Net debt fell from EUR6.5 billion to EUR6.0 billion. Air France-KLM financial highlights 2012

*pro-forma based on calendar 2011 (year end was changed from March to December) Source: Air France-KLM

A cumulative loss since the merger of Air France and KLM

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The group has reported losses in four out of the past five years, during which time its cumulative net loss has been EUR3.8 billion. In the first years after the 2004 merger between Air France and KLM, it appeared that the synergies generated by the combination had led to a structural change in their profitability and it enjoyed rising operating profits – until the year to March 2008. Then came the global financial crisis and profits fell off a cliff as Air France-KLM was the worst affected of the big European legacy flag carrier groups. The group has reported a cumulative net loss of EUR439 million for the period of its post merger existence. It seems that there was no step change in profitability and that the merger synergies were mainly revenue-related, all but evaporating as soon as the revenue environment became difficult. Air France-KLM net profit and operating profit (EUR million) 2005-2012

*proforma. Note: accounting year end changed from March to December in 2011 Source: Air France-KLM

The passenger segment dominates profits, but cargo is very volatile Looking at profits by business segment, the chart below highlights the importance of the passenger business to the group and also the volatility of the cargo business, whose operating margin has varied from -17.9% to +5.8% since 2005. The maintenance segment has proved to be the most stable and profitable business, but it remains small by comparison to the passenger business. The passenger business saw its operating loss narrow to EUR235 million in 2012 from EUR375m in 2011. Within the passenger business, Air France-KLM said at the results presentation that medium-haul losses increased by around EUR100 million in 2012. These increased losses stemmed from the regional networks of Air France due to the ‘challenging’ launch of the French regional bases and the weak domestic French economy; KLM’s medium-

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haul network saw slightly improved profits and the results of Air France’s hub activities were broadly stable. The profitability of all long-haul networks improved in 2012. Air France-KLM operating profit by business segment (EUR million) 2005-2012

*proforma. Note: accounting year end changed from March to December in 2011 Source: Air France-KLM

Net debt is high, but has stabilised The group’s net debt fell steadily during the early years after the merger, but jumped dramatically from 2008 to 2010, once the global financial crisis hit, as operating cash flow plummeted while group capital expenditure initially remained at pre-crisis levels. Net debt has stabilised over the past four years – reflecting one of management’s key goals – due to lower levels of capex and disposal proceeds (in particular from the group’s holding in Amadeus). At the end of 2012, Air France-KLM’s net debt position fell to EUR6.0 billion from EUR6.5 billion at the end of 2011, mainly the result of EUR600 million of proceeds from selling part of its holding in Amadeus and lower capital expenditure. Capex was cut from 2011’s EUR2.1 billion (EUR1.3 billion net of proceeds from sale and lease-back) to EUR1.6 billion (EUR0.9 billion net of sale and lease back). The group had gross cash of EUR3.9 billion at end 2012 and undrawn credit lines of EUR1.85 billion. This gross cash position is the equivalent to 55 days of revenues and represents a reasonable cushion, but is less than Lufthansa’s 60 days, easyJet’s 77 or Ryanair’s remarkable 232 days.

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Air France-KLM development of net debt and cash 2005-2012

Source: Air France-KLM

Passenger capacity growth has been modest, but load factors up 4% The group’s passenger capacity has grown at a fairly modest compound average growth rate of 2.5% since 2005. This modest capacity growth has contributed to an increase in passenger load factor from 78.9% in the year to Mar-2005 to 83.1% in the year to Dec-2012 (and also helping RASK in recent years). Air France-KLM development of capacity (ASK, million) and load factor (%) 2005-2012

Source: Air France-KLM

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Long-haul passenger network drives 2012 revenue growth, but cargo lost The less competitive long-haul environment continues to help the group. Group revenues grew 5.2% in 2012 to EUR24.6 billion. Passenger revenues were up 7.2%, in spite of capacity up only 0.6% (below its original budget of more than 2%), driven by a 5.9% increase in unit revenues (RASK). Excluding the beneficial impact of exchange rate movements on RASK, underlying unit revenues were up 3.2%, driven mainly by long-haul activities in 2012, with long-haul ex-currency RASK up 5.0% and medium-haul ex-currency RASK down 1.3%. Supported by its metal neutral joint venture operations, North Atlantic RASK (ex currency) grew by an impressive 10.4%, helped by a 5.3% cut in capacity. Cargo revenues fell by 2.7% in 2012, the second year of falling cargo revenues, reflecting falling capacity (-3.5%). The maintenance unit saw steady revenues, while the fall in revenues in the ‘Other’ business segment was mainly due to the reclassification of Martinair’s leisure activities to the Passenger business segment. The separate components of the ‘Other’ division saw contrasting revenue trends, with leisure carrier Transavia reporting traffic revenue growth of 9% to EUR852 million and the Catering division suffering a 7% fall in third party revenues to EUR405 million. Air France-KLM revenues (EUR million) 2011 and 2012

*pro-forma Source: Air France-KLM

Air France-KLM revenues (EUR million) 2005-2012

*proforma Source: Air France-KLM

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Looking at traffic revenues by geographic area of destination, the importance of the mediumhaul (Europe and North Africa) to the group has shrunk since 2006, although it has returned to growth in the past three years (driven by non-domestic traffic). The regions that have seen the greatest growth since the year to Mar-2010 are ‘Americas and Polynesia’ and ‘Asia and New Caledonia’, perhaps reflecting the impact of the group’s partnership with Delta on the Atlantic and SkyTeam’s partners in Greater China. Geographical breakdown of traffic revenues by destination (EUR million) 2006-2012

*proforma Source: Air France-KLM

Geographical breakdown of short and medium-haul revenues by destination (EUR million) 2010-2012

*proforma Source: Air France-KLM

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Fuel costs leap by 14% and staff costs by 3% Operating costs increased in 2012 by 4.8% (this would have been 1.7% excluding exchange rate effects), a little slower than revenues, in spite of a 13.8% increase in fuel costs, which accounted for 28% of total costs. Staff costs grew by 2.7% and accounted for 30% of costs. Air France-KLM operating costs 2011 and 2012, EUR million

*proforma Source: Air France-KLM

Labour productivity is at the lower end of European scale, targetted by Transform 2015 As the biggest cost item, and the main 'manageable' cost, labour remains a key focus for Air France-KLM management. Labour cost growth in 2012 of 2.7% was less than the growth in total costs, but headcount fell by 1.2% and so employee costs per employee went up by 4%. Labour productivity, measured by ATK per employee was almost flat year-on-year, but employee costs per ATK increased by 3.7%. The good news is that revenue per employee grew by 6.5%. By comparison with other European airlines, Air France-KLM’s labour productivity remains at the lower end of the scale. Air France-KLM labour productivity measures 2011 and 2012

*proforma Source: CAPA analysis of Air France-KLM results

Improving labour productivity is an important aim of the group’s Transform 2015 plan, which is aimed at reducing unit costs by 10%, restoring profitability and strengthening the balance sheet. New agreements on working practices with KLM unions were concluded in Dec-2012. The only outstanding Air France employee group not to have finalised an agreement is the cabin crew, 51

whose three representative unions have signed an agreement that is now being submitted for consultation with employees by mid-Mar-2013. The draft agreement proposes a freeze in cabin crew pay for the years 2012 and 2013 (2013 and 2014 for KLM), a freeze in promotion to 2016, new working conditions on the long-haul fleet, including a reduction of one or two cabin crew per aircraft, and changes to training and other internal activities. New working conditions are due to be implemented from 01-Apr-2013, with the aim of increasing employee flexibility and the average time worked. The group also aims to continue to lower headcount, mainly through voluntary departure schemes at Air France. Air France-KLM summary of employee cost initiatives

Source: Air France-KLM

Aircraft deliveries at a minimum level Air France-KLM group's fleet amounted to 605 aircraft (of which 573 in service) at the end of 2012. Its 2012 annual report shows that it has firm commitments for only 24 new aircraft deliveries over the next five years and for 43 aircraft in total, including the years from 2018 onwards. The biggest outstanding order is for 25 Boeing 777.

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Air France-KLM fleet at 31-Dec-2012

Source: Air France-KLM

Air France-KLM new aircraft commitments at 31-Dec-2012

Source: Air France-KLM

Management will stay very busy in 2013 The 2012 results presentation contained a great deal more detail on the outlook than the usual guidance on capacity, capital expenditure and unit costs. Air France-KLM management has its 53

hands full, with many initiatives aimed at turning around the group’s financial performance, mostly within the Transform 2015 plan. These include initiatives surrounding labour (as outlined above), the restructuring of the medium-haul network, the new regional carrier Hop, measures to reduce losses in the cargo segment, developments with partner airlines, and corporate governance/organisation.

Modest capacity growth planned in 2013 Air France-KLM expects to increase passenger capacity by a modest 1.5% (+2.4% long-haul, 2.1% medium-haul) in 2013 and targets a reduction in unit costs excluding fuel, currency effects and pension charge increases. Its own expectation of its markets is that total capacity will grow by between 2% and 2.5%.

Medium-haul restructuring continues The medium-haul network will see a reduction in capacity of 2.1%, driven by a 6.1% cut in point-to-point medium-haul capacity and a fall of 0.4% at the hubs. At the same time, the group is targeting increases in daily utilisation hours for Air France’s A320 fleet, which will reduce in number by 16 aircraft in the summer schedule, and for KLM’s Boeing 737 and Embraer 190 fleets. Air France’s regional bases project will see reduced schedules in 2013, with a further evaluation planned for Sep-2013, suggesting perhaps that this long-planned initiative is not gaining the hoped-for traction. The group's low-cost leisure unit Transavia will see capacity increase by 12% and Transavia France’s fleet will grow from 8 to 11 aircraft. Air France-KLM summary of medium-haul network plans for 2013

Source: Air France-KLM

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Air France’s regional airlines, Brit Air, Regional (both Air France subsidiaries), and Airlinair (a 40% owned associate) and their fleets of Canadair, Embraer and ATR regional aircraft are to be combined in a new company, Hop, with more than 3,000 staff, offering 530 daily flights and 136 destinations in the summer of 2013. Hop will have a fleet of 98 aircraft in 2013, reduced from 116 aircraft operated by its predecessor companies in 2012.

Cargo capacity cuts, aimed at EUR140 million savings Air France-KLM has targeted measures to reduce losses in the cargo business by around EUR140 million. Cargo capacity will fall modestly in 2013, by 0.5%, with dedicated freighter capacity down by a more aggressive 6%. The cargo fleet will see three aircraft returned to the lessor, one wet-leased to Etihad and one used in a JV with Kenya Airways on China-Africa routes. The group expects these capacity measures to yield EUR50 million in cost benefits and sees a further EUR40 million of cost savings from the group’s Transform 2015 programme. In addition, it has identified new commercial and revenue management policies that it expects will provide around EUR50 million of revenue benefits.

Partnerships to develop, including North Atlantic, Etihad The North Atlantic JV with Delta has been renewed for a further 10 years and looks likely to benefit from the imminent new partnership between Delta and Virgin Atlantic, which, it is hoped, will join the existing Air France/KLM/Alitalia/Delta joint venture. It is worth noting at this point that Air France-KLM does not plan to increase its stake in the Italian partner beyond its 25% holding. The new partnership with codeshare partner Etihad will take a small further step in 2013 with the wet lease by Etihad of one freighter and one A340. (As a possible pointer to the group's future relationship with Etihad, the UAE carrier has just announced a codeshare JV with SkyTeam's Kenya Airways, in which KLM holds a 27% equity share.) With regard to China, Air France-KLM has JVs with China Southern and China Eastern, generating revenues of more than EUR700 million in 2012, and a codeshare with Xiamen Airlines. In addition, SkyTeam also embraces Taiwan's China Airlines in the Greater China region. The low yielding Chinese market is a difficult one, but SkyTeam is well placed with its partnerships.

RASK vs CASK; unit cost reductions are vital to long term sustainability Since the year to Mar-2010, when AF-KLM recorded its biggest operating and net losses, its narrowing of losses has been driven mainly by unit revenue growth. Unit costs ex fuel have been contained, falling modestly from the year to Mar-2010 to the year to Dec-2011, but climbing slightly in 2012 (due to adverse exchange rate affects). Overall unit costs have however grown as a result of increased fuel costs. The chart below illustrates these RASK and CASK trends and highlights how crucial it will be to make greater unit cost reductions to prepare the group for any return to a falling RASK

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environment. Fluctuations in RASK have tended to be much greater (and less controllable) than those in CASK. Air France-KLM – index of operating cost per ASK and fare revenues per ASK (each indexed to 100 in year to Mar-2010)

*proforma Source: Air France-KLM, CAPA – Centre for Aviation

The two key Tensions within ‘Transform 2015’ The keys to the success of the ‘Transform 2015’ plan will lie in Air France-KLM’s ability to: (1) lower unit costs without significant capacity growth; and (2) lower net debt without diluting product perception and fuel efficiency as a result of an ageing fleet. A continued benign unit revenue environment – largely outside management's control – will also be very helpful to the achievement of its targets. A central goal of the plan is to lower unit costs by 10% relative to 2011 levels by 2014. Of course, RASK improvements are not all accidental, helped by a cautious approach to capacity growth, and management retains a cautious stance on capacity. The flip side to this is that more rapid capacity growth would facilitate CASK reduction. A further goal of Transform 2015 is to continue to lower the group’s net debt to EUR4.5 billion by the end of 2014 (from EUR6.0 billion at the end of 2012). This means improving operating cash flow (through better profitability) and containing investments.

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The group intends to keep capital expenditure at the low levels seen in recent years, planning EUR1.2 billion of capex (EUR1.1 billion net of sale and lease-back) in 2013 and EUR1.4 billion in 2014, compared with capex levels of around EUR2 billion or more in the mid-2000s. These lower levels will help cash flow, but risk damaging passenger perception of an ageing fleet, while also limiting Air France-KLM’s access to more modern and efficient lower cost aircraft. With an average fleet age in double digits and the only substantial outstanding aircraft order for 25 787-9s (mostly for delivery in 2017 and beyond), this is going to become a considerable issue.

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International  Airlines  Group                           Key Data Fleet and Orders IAG Fleet Summary: as at 10-Apr-2013

Source: CAPA Fleet Database

IAG projected delivery dates for aircraft on order: as at 8-Apr-2013 58

 

Source: CAPA Fleet Database

Route area pie chart Air France-KLM international capacity seats by region: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

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Top routes table Air France-KLM top ten international routes by seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Share price 2012/2013

Source: CAPA - Centre for Aviation and Yahoo! Financial

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IAG slips into losses, targets immediate bounce-back. But further austerity will be needed all round Reversing the rising trend that began before the 2011 merger of British Airways and Iberia, IAG slipped back into losses in 2012. Quite simply, unit costs grew faster than unit revenues. Iberia’s losses widened again and BA’s profits declined. Labour productivity, a key factor in airline profitability, fell in 2012. This was partly due to the integration of bmi and also to capacity cuts at Iberia being implemented ahead of headcount reductions, but 2013 will need to see an improvement in this area. In 2013, IAG plans a capacity cut of 1.9% with Iberia capacity down 10% to 15% and BA capacity up around 2%, fuelled by its first A380 deliveries. The Iberia capacity cuts, together with a planned workforce reduction of 3,800, are the subject of a bitter dispute with labour unions in Spain. Management’s ability, or otherwise, to see its plans through will be a defining feature of the year ahead. IAG’s bullish target to exceed 2011’s EUR485 million operating profit in 2013 will depend on this, regardless of whether or not Vueling fully joins the group this year.

Red ink returns in 2012 accounts IAG slumped to a net loss of EUR885 million in 2012, after two years of positive results for the British Airways-Iberia combination. The net result suffered from a number of one-off items, including EUR202 million of provisions related to Iberia restructuring, EUR87 million of bmi restructuring, a EUR343 million impairment charge in connection with Iberia (lowering of value of Iberia recorded in IAG group accounts) and a EUR266 million non-cash pension-related charge. The operating result better reflects underlying performance and this, too, fell into negative territory with a loss of EUR23 million, mainly resulting from a wider loss at Iberia, but also due to lower profits at BA. Exchange rate effects resulted in a net adverse impact on operating loss of EUR107 million. The operating loss, however, was narrower than the EUR120 million that IAG had guided the financial markets to expect and better than the EUR88 million consensus forecast loss (source: Bloomberg).

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IAG financial highlights (EUR million except where stated): 2012 vs 2011

**2011 based on full year combination of BA and Iberia (merger completed on 21-Jan-2011) Source: IAG

Previous positive profit trend reversed The merger of BA and Iberia, to form IAG, completed on 21-Jan-2011. The chart below shows the net profit and operating result that it would have reported if the merger had been in place for the full years 2009 to 2012. After heavy losses in 2009, the year of global economic contraction, results returned to profit in 2010 and 2011 driven by a rising sales trend. The return to an operating loss in 2012, in spite of further sales growth, highlights the precarious nature of IAG’s profitability. IAG revenues, net profit and operating profit (EUR million): 2009* to 2012

*2009, 2010 proforma (pre-merger). **2011 based on full year combination of BA and Iberia (merger completed on 21Jan-2011) Source: IAG

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Another loss for Iberia Iberia has not achieved an operating profit throughout the period 2009 to 2012 and has been on a downward trend since 2010, the year before the merger. BA has been profitable since 2010, but its fall in operating profit should not be ignored amid all the focus on Iberia. IAG operating profit by business segment (EUR million): 2009*-2012

*2009, 2010 proforma Source: IAG

IAG's net debt is rising IAG’s net debt has been on a rising path since 2010 and its cash position has been declining. Its 2012 year end net debt of EUR1.9 billion would be EUR5.3 billion if operating leases, capitalised at eight times annual lease payments, were added. While IAG’s financial gearing, or net debt (adjusted for operating leases) to equity ratio, of 106% is well within the range of competitor airlines and BA’s historical levels, it is sharply up from 77% in 2011. IAG management will not want to see it increase further.

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IAG development of net debt and cash: 2009*-2012

*2009, 2010 proforma (pre-merger). **2011 based on full year combination of BA and Iberia (merger completed on 21-Jan-2011) Source: IAG

Modest capacity growth for the group, with cuts at Iberia IAG increased its passenger capacity by 2.8% in 2012, with BA up 5.4% and Iberia down by 3.3%. Excluding the impact of the bmi acquisition, IAG’s capacity growth was just 0.7% (lower than the originally planned 2.5%) and BA’s like for like growth was 2.5%. BA and Iberia’s combined passenger capacity has grown on average by a modest 2.0% p.a. since 2009 (all due to BA growth; Iberia has contracted), reflecting soft demand conditions and a focus on trying to improve cost efficiency rather than grab market share. Partly as a result of this capacity caution, load factor has improved by 1.7ppts since 2009 (1.2ppts in 2012 alone).

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IAG development capacity (ASK, million) and load factor (%): 2010*-2012

*2009, 2010 proforma (pre-merger). **2011 based on full year combination of BA and Iberia (merger completed on 21-Jan-2011) Source: IAG

Strong RASK in 2012, assisted by currency impacts, drives revenue growth IAG’s revenues were up 10.9% in 2012, in spite of modest capacity growth, reflecting a 9.4% increase in passenger revenue per ASK. Exchange rate effects helped this RASK performance – it would have been up by 3.9% at constant exchange rates. British Airways’ reported EUR revenue grew by 15.9%, while Iberia’s fell by 1.1%. BA’s GBP reported revenue grew by 8.4%, with GBP reported RASK up 2.9%. In terms of region of sale, growth was strongest in the UK, Spain and the USA, at more than 17% in each of these countries. Given that Iberia saw an overall revenue decline, this growth in sales in Spain presumably reflects a strong performance by BA, most likely in bringing Spanish passengers to its London hub for onward connections.

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IAG revenues (EUR million): 2011 and 2012

Source: IAG

IAG geographical breakdown of traffic revenues by area of sale (EUR million): 2010*-2012

*2011 consolidated revenues exclude Iberia in the first 21 days of Jan-2011 Source: IAG

Costs (+14.4%) grew faster than revenues (+10.9%) in 2012 IAG’s operating costs grew by 14.4% in 2012, faster than the growth in revenues (10.9%) and much faster than the growth in capacity (2.8%). This largely reflects a 20% increase in fuel costs, which were more than one third of total costs in 2012. Labour costs, the second biggest item, grew by 12.2%, with average headcount up 4.9%. IAG says this rapid rise in employee costs reflects adverse exchange rates, wage awards, increased volumes and employee provisions. The acquisition of bmi contributed to a lowering of productivity, as did capacity cuts at Iberia that took place prior to headcount reductions. IAG operating costs (EUR million): 2011 and 2012

*Combined BA and IB for full year 2011 Source: IAG

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IAG has hedged 60% of its 2013 jet fuel needs to give an average price of USD1,013/mt (average of hedged prices and unhedged prices using current levels). This leads to an estimated full year 2013 fuel bill of EUR6.0 billion (down slightly from 2012’s EUR6.1 billion). Reported unit costs (costs per ASK) increased by 11.3% and ex fuel unit costs grew by 8.5%, with all cost areas (in particular labour) contributing to this growth. Adverse currency movements also contributed – ex-fuel unit costs at constant exchange rates would have been up 3.8%. BA’s GBP ex-fuel unit costs were up 4.3%. IAG unit cost growth: 2012

Source: IAG

As noted above, labour productivity declined year on year and employee costs per ATK increased by 8.9%. IAG will have to demonstrate in 2013 that it is in control of this measure. Revenue per employee grew by 5.7%. IAG’s labour productivity remains in the middle of the pack of European legacy carriers, as noted in our analysis ‘European airlines’ labour productivity’, 15Feb-2013. This disguises considerable differences between BA, which is among the better performing legacy flag carriers, and Iberia, which is among the worst. CAPA has previously analysed both BA and Iberia’s labour productivity separately from IAG, but the group has not yet published individual company accounts to allow the updating of this analysis beyond a look at IAG. IAG labour productivity measures: 2011 and 2012

Source: CAPA analysis of IAG results

Modest capacity cuts are planned for 2013, deeper in summer IAG is planning a 1.9% cut in capacity (ASKs) in 2013, with the summer season seeing deeper cuts of more than 3%. The group plans ASK growth of around 2% for BA and a 10% to 15% cut for Iberia in 2013. Much of BA’s growth will result from bringing three A380s into its fleet, with 67

the first due in July. BA expects to announce its first A380 route in the next couple of weeks (Hong Kong, Singapore, New York are the favourites). BA is also due to take delivery of the 787 from May this year, but the timetable is now likely to slip. Speaking at the 2012 results presentation, IAG CEO Willie Walsh said that he does not see this as a major problem, as BA would continue with its 767s. He remains confident that Boeing will resolve the problems faced by the 787, adding that he regards it as a “fantastic aeroplane”. Mr Walsh told the 2012 results meeting that “Iberia will only grow when Iberia can grow profitably”. The Iberia transformation plan, in addition to capacity cuts, proposes headcount reductions and is currently in consultation until 12-Mar-2013 with employee groups, who have indicated their opinion by calling strike action. IAG planned capacity (ASK) changes by quarter 2013

Source: IAG

Unit revenue outlook mainly stable for passenger business, weak for cargo The company says that the outlook for unit revenues is stable for premium cabins, although competitive in short haul premium. In non-premium it sees soft unit revenues on short-haul, while long-haul unit revenues are stabilising. Cargo unit revenues continue to be weak, with overcapacity still evident. Mr Walsh said that there were some signs that the cargo decline might be bottoming out, especially in Asia.

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IAG’s unit revenue environment Source: IAG

IAG's Group target is to beat 2011 operating profit in 2013 Other than its capacity plans, IAG is refraining from giving any forecasts for 2013, pointing out that the outcome of the Iberia transformation plan negotiations, and any associated costs and losses, will be critical. Nevertheless, subject to these caveats, the company expects a better pre-exceptional operating result than in 2011, when it recorded EUR485 million. This looks like an ambitious target, although it is still small in terms of margins. In 2011, this operating profit represented a 3.0% margin, but after revenue growth of nearly 11% in 2012 and assuming little or no revenue growth in 2013, this would represent a margin of only around 2.5% if achieved.

IAG’s offer for Vueling proceeds, but will IAG increase the price? IAG is proceeding with its EUR7 per share offer for the 54% of Vueling that it does not already own. At the 2012 results presentation, Mr Walsh observed that Vueling has a good track record, a very good management team and a great cost base, commenting also that the real opportunity in acquiring Vueling would be to allow it to develop as it has done as a stand-alone entity. This makes sense, given the different cultures and strategic approaches of the two companies, at least in the near to medium term. No doubt, if the acquisition is successful, IAG would consider closer integration over the longer term. CFO Enrique Dupuy said that the tender process allowed for a different price to be negotiated with the Vueling board if it did not feel that it could recommend the offer to shareholders. Given that Vueling shares have been trading close to EUR8, and Mr Walsh’s positive comments about Vueling, a revised (higher) offer price looks likely. The deal is expected to complete some time in April, if accepted by Vueling shareholders.

RASK has been strong with capacity discipline, but CASK is also on the increase As with many European airlines, IAG’s unit revenues (RASK) have been on an upward curve in recent years as a result of capacity discipline better matching supply to demand than in previous times of economic weakness. IAG’s own modest capacity growth, in addition to its premium branding and BA’s strength at the capacity-constrained and high-yield Heathrow, has contributed to its strong RASK performance, but ultimately RASK is unreliable and can fall dramatically when conditions outside management control weaken.

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Consequently, management will need to concentrate on costs and IAG/BA/Iberia have made a fair stab at controlling ex-fuel unit costs – although the increase in 2012 means that they are almost 10% higher than in 2009. Of course, the focus on ex-fuel unit costs does not avoid the need to pay for fuel and IAG’s overall unit costs are 19% higher than in 2009. Even with RASK growth, profits deteriorated in 2012 as CASK grew more quickly. This further emphasises the imperative to reduce CASK in anticipation of any conditions that might lead to a fall in RASK. IAG – index of operating cost per ASK and fare revenues per ASK (each indexed to 100 in 2010)

*2009, 2010 proforma (pre-merger). **2011 based on full year combination of BA and Iberia (merger completed on 21-Jan-2011) Source: IAG, CAPA – Centre for Aviation

The focus is on Iberia, but IAG should not forget about BA As demonstrated by Iberia’s ongoing losses and its poor labour productivity, IAG is right to concentrate on the Iberia transformation plan in order to restore group profitability. Nevertheless, the fall in profit at BA should also be a warning, especially given that its ex-fuel unit costs, as reported in its domestic GBP currency, increased by 4.3% in 2012. BA has lower unit costs than Iberia, but it also has a longer average sector length. Comparing CASK and average sector length for BA and Iberia with other major European carriers, both are close to the trend line for the big flag carrier groups, which are all much higher cost than the LCCs. Recent moves at BA, such as offering hand-luggage only tickets to five destinations from Gatwick at discounted prices, suggest that IAG continues to look at ways to make BA more competitive. Moreover, Mr Walsh has already implemented some restructuring and new working practices at BA; but the UK arm of IAG is not flying through clear skies. 70

The addition of Vueling to the group would be welcome, but would not avoid the need to continue to attack costs at both of IAG’s flag carrier airlines. According to Mr Walsh, the performance of Iberia Express has been “stunning” operationally and it was profitable from its third month after launch at the end of Mar-2012. However, he continues to balance the need to increase the use of this lower cost subsidiary with avoiding further aggravating labour unions and this will be an ongoing challenge in the current industrial relations environment. IAG will not be alone in hoping the effects of the recent Italian election result do not fuel further toxic austerity disenchantment across Europe. Unit costs (cost per available seat kilometre) and average stage length for selected European legacy and low-cost carriers: 2011, 2012*

*Financial year ends as follows: IAG, Iberia, BA, Air France-KLM, Finnair, Norwegian, Vueling Dec-2012; Lufthansa Dec-2011; SAS Oct-2012; easyJet Sep-2012; Ryanair Mar-2012. Source: CAPA analysis of company accounts and traffic data

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Turkish  Airlines            

 

 

 

           

Key Data Fleet and Orders Turkish Airlines Fleet Summary: as at 10-Apr-2013

Source: CAPA Fleet Database

Turkish Airlines projected delivery dates for aircraft on order: as at 8-Apr-2013

Source: CAPA Fleet Database

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Route area pie chart Turkish Airlines international capacity seats by region: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Top routes table Turkish Airlines top ten international routes by seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile Turkish Airlines schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Share price 2012/2013

Source: CAPA - Centre for Aviation and Yahoo! Financial

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Turkish Airlines' 2012 operating profit almost triples; 2013 more doubtful, with 20% seat growth In 2012, Turkish Airlines saw its operating profit grow almost threefold, with revenues up 26% on passenger capacity growth of 18%. It has the youngest fleet of any significant network carrier in Europe and its 7.0% operating margin puts it behind only Ryanair and easyJet. This financial success is built on one of Europe’s most efficient cost structures and a very productive work force. THY’s fleet of 211 aircraft will be expanded by the recently announced order for 117 Airbus narrowbodies to add to existing orders for narrow and widebodies from both Boeing and Airbus. In 2013, Turkish Airlines plans a further 20% capacity increase in pursuit of its expansion strategy based on increasing transfer traffic and is seeing particularly strong growth on routes to Latin American and Africa this year. It does not expect a unit revenue increase, so CEO Temel Kotil will need to engineer a fall in unit costs if profits are to continue to climb. This will not be easy, given likely fuel cost increases and that 2012 was the only year to see a fall in ex fuel unit costs since 2007.

Turkish Airlines' operating profit almost tripled in 2012 after falling in 2010 and 2011 Turkish Airlines reported an operating profit of TRY1,048 million in 2012, up from TRY359 million in 2011. The net profit figure of TRY1,113 million compares with just TRY19 million in 2011. Turkish Airlines financial highlights: 2012

Source: Turkish Airlines, CAPA – Centre for Aviation

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Revenues have been on a strong upward curve for a number of years, but profits had been on a downward trend since the 2009 operating profit peak before 2012 saw a recovery in both operating profit and net profit to record levels. Turkish Airlines revenues, net profit and operating profit (EUR million): 2003 to 2012

Source: CAPA – Centre for Aviation and Turkish Airlines

THY is now one of Europe’s most profitable airlines Margins have varied significantly since it embarked on its growth strategy in 2006, between 2% in 2006 and 12% in 2008, but, with a 2012 operating margin of 7.0%, Turkish Airlines is now one of Europe’s most profitable carriers, behind only Ryanair and easyJet.

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European airlines operating margins (% of revenues): 2012*

*Financial year ends as follows: Turkish Airlines, Lufthansa, Aer Lingus, IAG, Air France-KLM, Finnair, Norwegian, Vueling Dec-2012; SAS Oct-2012; easyJet Sep-2012; Air Berlin 12 months to Sep-2012; Ryanair Mar-2012 Source: CAPA analysis of company accounts

Debt levels back under control Debt levels increased sharply after 2009 as Turkish Airlines rapidly grew its fleet in the face of falling profits, but the increase in debt in 2012 was relatively modest. Its net debt of TRY6,835 million at the end of the year was 126% of its book equity value, down from 138% for 2011. Adding capitalised operating leases at eight times annual payments, the adjusted net debt figure of TRY9,338 million was 173% of equity, down from 209% in 2011. These gearing levels are quite high compared with the fairly recent past (in 2009, gearing was 50% and adjusted gearing 114%), but are coming down again. Strong traffic growth is driven by international transfer traffic, now 42% of total Turkish Airlines is sometimes referred to as the fourth Gulf carrier, as it aggressively empowers its hub expansion. It has grown its capacity (ASK) by an average annual rate of 18% since 2005, with passenger traffic (RPK) growing at an average of 20% p.a. In 2012, Turkish Airlines’ transfer passenger numbers grew by 30% to reach 16.5 million, 42% of the total. International to international transfer passengers grew by 44% to reach 23% of the total number of passengers. This reflects the carrier’s strategy to use its Istanbul hub to tap into eastwest global traffic flows to connect its narrowbody catchment area of Europe, the Middle East 77

and North Africa with the Americas and Asia, in addition to offering connections to passengers flying between the Americas and Asia. Turkish Airlines development of capacity (ASK, million), traffic (RPK, million) and load factor (%): 2005-2012

Source: CAPA – Centre for Aviation and Turkish Airlines

Turkish Airlines international to international transfer passengers (000): 2005 to 2012

Source: Turkish Airlines

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North America and Africa saw fastest growth in 2012 Traffic growth (RPK) of 28% in 2012 was especially driven by international routes, as domestic growth was only 10.8%. On the international network, THY saw an increase of 49% to North America, 48% to Africa, 31% to the Middle East and 28% to Europe. Load factor, while higher in 2012 than in 2005, has not shown such a consistent upward curve over recent years, probably a result of the high number of new routes. Nevertheless, load factor grew by an impressive 4.8ppt in 2012, a significant factor in the improved profitability of the group. Load factor gains were particularly strong on routes to the Far East and the Americas. Turkish Airlines scheduled passenger traffic by region: 2012

Source: Turkish Airlines

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Turkish Airlines’ transfer strategy has fuelled the company’s growth in recent years, which has also been assisted by the faster growing Turkish economy relative to the rest of Europe. From 2006 to 2012, THY more than doubled its share of AEA scheduled passengers. In its recent medium term traffic forecasts, Eurocontrol forecast that Turkey will be the fastest growing market in Europe for flights to 2019, with average annual growth of 7.0% p.a., compared with 2.3% for Europe as a whole. Turkish Airlines market share of AEA airlines scheduled traffic: 2006 to 2012

Source: AEA/Turkish Airlines

Passenger revenues were up 28% in 2012 Group revenues grew by 26% in 2012 to TRY14.9 billion, driven by a 28% increase in scheduled passenger revenues. This, in turn, was driven by an 18% increase in capacity and an 8% increase in unit revenues (RASK). Traffic revenue growth was particularly strong on routes to Africa (up 51%), the Americas (up 48%) and the Far East (up 32%). Europe (excluding domestic Turkey), the carrier’s biggest region accounting for one third of traffic revenues, saw revenue growth of almost 24%. The domestic segment saw the slowest growth, at ‘only’ 16%.

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Turkish Airlines revenues (TRY million): 2011 and 2012

Source: Turkish Airlines

Turkish Airlines traffic revenues by region (TRY million): 2011 and 2012

Source: Turkish Airlines

Costs grew more slowly than revenues, in spite of fuel, 37% of total Turkish Airlines’ operating costs grew by 21% in 2012, slower than revenue growth, but a little faster than capacity growth. Fuel costs, the biggest category at 37% of the total, grew by 29%. Sales and marketing costs were up almost 31% and this sharp increase may be an inevitable feature of THY’s ambitious growth involving new routes and new destinations as it seeks to build a global brand image and presence. Other cost categories performed well and total ex fuel costs grew by just under 17%, well below capacity and revenue growth. Turkish Airlines operating costs (TRY million): 2011 and 2012

Source: CAPA – Centre for Aviation and Turkish Airlines

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Labour productivity, already strong, improves further Turkish Airlines achieved significant growth in capacity and traffic in 2012 with a virtually stable headcount. Labour costs increased by 10%, all driven by increased employee costs per employee. Making the assumption that total capacity, measured in ATKs grew at the same 18.4% rate at which ASKs grew (the company has not yet published total ATK figure for 2012), then labour productivity also grew by 18.4%. Factoring in the increased pay rates, employee costs per ATK were down by 6.7%, a strong result on a measure where it leads all European airlines with the exception of Vueling and Ryanair. Moreover, revenues per employee were up by an impressive 26%. Turkish Airlines group labour productivity measures: 2011 and 2012

Source: CAPA – Centre for Aviation and Turkish Airlines

European airlines employee cost per ATK (EUR cent): 2012*

*Financial year ends as follows: Turkish Airlines, Lufthansa, Aer Lingus, IAG, Air France-KLM, Finnair, Norwegian, Vueling Dec-2012; SAS Oct-2012; easyJet Sep-2012; airberlin 12 months to Sep-2012; Ryanair Mar2012; Virgin Atlantic Feb-2012; Iberia, BA Dec-2011 Source: CAPA analysis of company accounts and traffic data Source: CAPA - Centre for Aviation analysis of airline company financial and traffic statements.

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Fleet expansion further boosted with large Airbus order for 117 narrow bodies Turkish Airlines currently has a fleet of 211 aircraft, with an average age of 6.6 years. By the end of 2020 it plans to have 375 aircraft, with an average age of five years. On 15-Mar-2013 Turkish announced an Airbus order for 25 A321, four A320neo, 53 A321neo and options for 35 additional A321neo. Of the total of 117 aircraft in this recent Airbus order, 13 are to be delivered in 2015, 14 in 2016, six in 2017, 27 in 2018, 25 in 2019 and 32 in 2020. The company already had outstanding orders at the end of 2012 for nine A321, 20 A330-300, two A330-200F, six 737-900, 16 737-800 and 20 777-3ER for delivery between 2013 and 2017. Turkish Airlines fleet at 18-Mar-2013

Source: CAPA - Centre for Aviation and Turkish Airlines

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Turkish Airlines deliveries 2013 to 2020

Source: Turkish Airlines

Turkish Airlines total fleet development: 2003 to 2012 and plan for 2020

*Plan Source: CAPA – Centre for Aviation and Turkish Airlines

2013 to see further strong capacity growth, but no RASK growth For 2012, Turkish Airlines targets a further 20% increase in capacity (ASK) and expects passenger numbers to grow by 18% to 46 million, with load factor up another 1.4ppt to 78.8% (this would bring load factor very close to the AEA 2012 average of 79.1%).

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For the first two months of 2013, it has reported ASK growth of 22.6% and load factor up 4.7ppt to 76.5%. The strongest growth has been to Africa and South America so far this year. While it has not set a 2013 profit target, it budgets in dollar terms for a 17% increase in revenues from USD8.3 billion in 2012 to USD9.7 billion in 2013 and expects the fuel bill to increase from USD2.9 billion to USD3.7 billion (up 28%). Allowing for some further depreciation of the Turkish lira, this revenue outlook implies that RASK will be flat to slightly down and yield down by a little more in 2013. The anticipated fuel cost increase suggests an increase in fuel costs per ASK of around 8%.

New routes focus on Latin America, Africa and Europe THY will continue to open new routes in 2013, pursuing its global transfer strategy. In percentage terms, the highest growth will be seen in Latin America, where it had only two routes (Buenos Aires and Sao Paulo) at the end of 2012. In 2013, it will add Bogota, Caracas, Havana and Mexico City. Africa is also seeing significant growth, with 11 new destinations to add to the 33 existing cities, and 13 new destinations are being added to the existing 84 in Europe. Turkish Airlines destinations at Dec-2012 and planned new destinations for 2013

New destinations in red Source: Turkish Airlines

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CASK ex fuel fell in 2012, but track record is patchy In the years of improving profits from 2006 to 2008, Turkish Airlines saw a steep upward movement in RASK while CASK rose less steeply. Ex fuel CASK stayed flat over this period, but then rose steadily from 2008 to 2011 before dipping slightly in 2012. The fall in RASK in 2009 came when capacity grew by 22% and the world fell into a recession. CASK also fell in 2009 and so operating profit held steady, but this fall in RASK is a signal that a high growth strategy can run into trouble when severe economic weakness hits. The fall in operating profit between 2009 and 2011 was the result of CASK rising more rapidly than RASK. Rising fuel costs contributed to this CASK growth, but ex fuel CASK also went up. The improved control over ex fuel CASK and continued RASK growth led to higher profits again in 2012. If the company is to see a further increase in profits in 2013, it will require another fall in ex fuel unit costs, assuming that THY’s budgeted increase in fuel costs per ASK and slight fall in RASK prove accurate. Its track record of recent years, when it has done well merely to keep ex fuel RASK stable, suggests that cutting it will be a challenge. Turkish Airlines – index of operating cost per ASK and fare revenues per ASK (each indexed to 100 in 2009)

Source: CAPA – Centre for Aviation and Turkish Airlines

THY has an efficient cost base and needs to keep it that way The following chart compares THY’s unit costs (CASK) and average sector length with those of a number of other European competitor airlines. It highlights the very cost efficient nature of Turkish Airlines, which has the lowest unit cost among European network carriers. As noted above, it has very good labour productivity and this goes some way to explaining its cost competitiveness.

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Nevertheless, cost efficiency against European carriers is not the whole picture. As THY continues to grow on routes into developing regions such as Latin America, Africa and Asia, its competition is increasingly local carriers in those regions and the Gulf carriers. Unit costs (cost per available seat kilometre) and average sector length for selected European legacy and low-cost carriers 2012*

*Financial year ends as follows: Turkish Airlines, Lufthansa, Aer Lingus, IAG, Iberia, BA, Air France-KLM, Finnair, Norwegian, Vueling Dec-2012; SAS Oct-2012; easyJet Sep-2012; Ryanair Mar-2012, Virgin Atlantic Feb2012. Source: CAPA – Centre for Aviation and analysis of company accounts and traffic data

As the company continues to follow its ambitious fleet expansion programme and to add capacity, it should be well placed to maintain this low unit cost structure. However, as noted above, Turkish generally needs to lower its unit costs in order to increase profits and it also faces a challenge in maintaining a positive RASK trend in times of economic weakness. Maintaining RASK growth is also challenging when pursuing high growth based on transfer traffic, which tends to be lower yield than point-to-point traffic, particularly when faced with strong competition from transfer carriers based in the Gulf.

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easyJet            

 

 

 

               

Key Data Fleet and Orders easyJet Fleet Summary: as at 10-Apr-2013

Source: CAPA Fleet Database

easyJet projected delivery dates for aircraft on order: as at 8-Apr-2013

Source: CAPA Fleet Database

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Route area pie chart easyJet international capacity seats by region: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Top routes table easyJet top ten international routes by seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile easyJet schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Share price 2012/2013

Source: CAPA - Centre for Aviation and Yahoo! Financial

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easyJet SWOT analysis - Is Sir Stelios strength, weakness, opportunity and threat all in one? Last month’s quarterly trading update reported an 8% increase in unit revenues for the Oct-Dec quarter and forecast a significant narrowing of first half pre-tax losses from GBP112m to between GBP50m and GBP75m. Since the trading update, easyJet’s founder and largest shareholder, Sir Stelios Haji-Ioannou, has sold a small portion of his holding as a warning to management against making a new aircraft order and he remains a vocal critic of the company. In addition, easyJet Chairman Sir Mike Rake, often criticised by Sir Stelios, has announced his resignation in the summer of 2013. The share price of Europe’s second biggest low cost carrier is up 13% since the trading update and up 97% over the past 12 months, so it seems that other shareholders have been persuaded of easyJet’s strengths and opportunities. So is Stelios right to focus on the weaknesses and threats or is he the biggest of them? This SWOT analysis is the first in series of CAPA features.

easyJet's Strengths Pricing. In competing against legacy carriers, easyJet’s main advantage is its price structure, which sees its average fares somewhere around 50% lower than those of the major carriers on short haul routes and 20% to 40% below those of most other lower cost competitors. In addition to this average fare advantage, easyJet’s highly dynamic revenue management system adjusts fares to demand levels in order to maximise revenues, rather than always to charge the lowest fare. The only significant European airline with average fares below those of easyJet is Ryanair. Unit cost. The only way to sustain a price advantage is to have a sustainable unit cost advantage. easyJet’s cost per seat advantage relative to the major flag carriers is similar to the average price differential noted above. This unit cost advantage stems from a number of factors, including high seat density (as noted above), high load factors (88.7% for easyJet in the year to September 2012 versus just below 80% for AEA carriers), a point-to-point strategy that allows high aircraft utilisation, a young and efficient fleet, lean overheads, labour productivity and a lack of legacy pension costs. Airport network and market share. easyJet has a presence in 49 of the top 100 market pairs in Europe, more than any other carrier (see Chart 1). Crucially, 46 of these involve primary airports, versus 24 primaries for Ryanair and 34 for IAG. This presence puts easyJet within reach of a large proportion of the European population and its primary airports are beneficial to its yields. Across Europe as a whole, it is number two by passengers, with a share of 9%, just behind Ryanair with 12%. Moreover, like Ryanair, but unlike the legacy carriers, easyJet has bases all over Europe with locally based aircraft and crews. Not only does this raise its visibility locally, but it also enables a 91

genuine network of routes between its destinations, rather than the more limited radial routes from one or two major hubs typically operated by legacy carriers. Presence in Europe’s top 100 market pairs: easyJet vs competitors

Source: easyJet presentation

Fleet. Since its last two Boeing 737s exited the fleet earlier in 2012, easyJet’s fleet now consists of a single aircraft family, the Airbus A320, giving advantages in terms of crew certification, training and maintenance. At 30-Sep-2012, it had 160 Airbus A319s, with 156 single class seats (a more standard two class configuration has 124) and 54 A320s, with 174 seats (versus 150 more commonly). This higher seat density gives a unit cost advantage against legacy carriers operating the same aircraft and easyJet is continuing to grow the number of A320s in its fleet, further enhancing its unit cost advantage. easyJet's average fleet age is around four years, versus 9-11 years that is typical for European flag carriers, giving advantages in terms of fuel efficiency, maintenance costs and customer perception.

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easyJet fleet at 30 September 2012

Source: easyJet

Brand. Although still seen as a no-frills low cost carrier offering a commoditised product, easyJet has improved its brand perception in recent years. It already enjoyed good brand awareness, particularly in the UK, but this has now spread to other countries and has been supplemented by improved customer satisfaction (in itself due in no small measure to improved on-time performance). Although it is early days, easyJet is showing increasing willingness to hybridise to enhance the brand, both through introducing the opportunity for a form of brand loyalty - but without the costs of a formal FFP - through its deal with UK loyalty card programme, Nectar, and for example in its linking with Emirates and its FFP, Skywards. Financial performance. Under its (not so) new management team of CEO Carolyn McCall and CFO Chris Kennedy, easyJet has improved its financial performance over the past couple of years. Its strong balance sheet and cash generation and returns that exceed the cost of capital make it all too rare in the airline industry globally. Management targets a minimum Return on Capital Employed of 12% (including capitalised operating leases in the capital base) or 15% excluding operating leases. In the year to September 2012, it achieved ROCE of 11.3% including operating leases, or 14.5% ex operating leases, just short of its targets, but comfortably ahead of its cost of capital. Stelios. Although Stelios, easyJet’s founder and largest shareholder, is no longer involved in managing the company and is not even on the board, it has benefited from being associated with him and the development of his ‘Easy’ brand and its positive brand attributes (although, at the same time, recognition of the Easy brand is almost entirely due to the success of easyJet).

easyJet's Weaknesses Cost base is not as low as that of Ryanair. As noted above, easyJet has a unit cost advantage against most competitors, but not against Ryanair. Its cost per seat is around 50% higher than Ryanair’s, so it is vulnerable to direct competition on airport to airport pairs or even city to city 93

pairs from its Irish rival. Although the two only compete head to head rarely, this competition could increase in the long term as each exhausts growth from its existing network and as the opportunities to add new airports become less frequent. Brand vs legacy carriers. easyJet’s brand is probably stronger than many LCC competitors, but LCCs as a whole probably still suffer from a brand disadvantage relative to the major legacy carriers. As noted above, however, this is slowly changing as easyJet improves its on-time performance, continues to focus on primary airports and offers additional product features such as allocated seating and re-ticketing flexibility (for a premium). Nevertheless, the product still has fewer ‘frills’ than that of legacy full service carriers and this means that price will remain the key dimension of competition. Seasonality of earnings. As for the industry in general, easyJet’s earnings are highly seasonal, with its profits increasingly relying on a strong summer half year (April to September) to offset a loss-making winter (October to March). This makes it vulnerable to any unexpected problems in the summer in an industry that is beset by ‘one-offs’. easyJet’s half yearly profit before tax (GBP, mill): 1H2005/06 to 2H2011/12

Note – September year end. Source: easyJet

Stelios. Disputes in recent years between Stelios and management have generated adverse publicity and arguably damaged the brand, particularly where they drew attention to factors such as poor on-time performance. Moreover, some of Stelios’ public comments have had a negative impact on the share price. Share price volatility, if sustained, adds to a company’s cost of capital.

easyJet's Opportunities Market growth. Although notoriously cyclical and currently going through a sluggish phase, the aviation sector remains a growth industry in the medium to long term, by common consensus. easyJet, as a significant market player, is well placed to participate in this growth. Moreover, given its cost and price advantages and current capacity cuts from most of its legacy carrier competitors, it looks set to enjoy market share gains too. As the carrier takes cautious steps into connecting with other airlines, the opportunities that come with partnerships will also open new doors.

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Further cost cutting. In order to maintain its price advantage, easyJet must ensure that it maintains its unit cost advantage against legacy carriers that are continually looking to trim costs and are transferring significant parts of their short haul networks to low/lower cost subsidiaries. The ‘easyJet Lean’ initiative has identified areas for cost reduction, such as airports, ground handling, engineering and fuel, and aims to cut costs by GBP190m by 2015, of which it had delivered c.GBP100m to the end of September 2012. Fleet. Management is currently assessing its options for a major new order to drive fleet growth from 2017 and considering its interim fleet plans for 2014-2017. Based on scheduled deliveries and options under its existing Airbus contract, it has significant fleet growth flexibility to 2016. It could choose to track typical market growth rates of 3%-5% pa, or to cut the fleet by 2% pa, depending on demand levels. easyJet fleet count and flexibility in fleet planning to 2017

Source: easyJet presentation

The evaluation of a possible new aircraft order provides easyJet with a significant opportunity to secure its long term growth with modern, new generation, fuel efficient aircraft. It will also hope that its size and purchasing power can secure a price advantage for these aircraft, although it seems unlikely that it will match the massive discounts secured from Airbus in 2002, given the much bigger order backlog currently enjoyed by both Airbus and Boeing. easyJet is considering airframes from Airbus, Boeing and Bombardier and engines from Pratt & Whitney and the GE/Snecma JV CFMi. If easyJet were to change from Airbus, it would presumably only do this if the price was very favourable to offset initial diseconomies in terms of crew certification, training and rostering and maintenance costs. Indeed, on a recent conference call with analysts, CFO Chris Kennedy was keen to stress that “we will not do a deal [with any manufacturer] if we can’t get the right price”.

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Business passengers. In 2011, 18% of easyJet’s passengers were flying for business purposes and easyJet aims to increase this to 20%-24% over three to five years. Success in this initiative should be beneficial for yields, given that business travellers book later and pay a premium as a result. Indeed, CEO Carolyn McCall stressed on the Q1 analyst conference call that yield benefit and not market share is the goal for its business passenger initiatives. Attractions for business travellers include its primary airports, a relative focus on higher frequencies (compared with other LCCs) and its flexible fares product, which allows a passenger free date changes. In addition, and in contrast to LCCs such as Ryanair, easyJet inventory is available through GDSs and easyJet has recruited a sales force to target TMCs and corporate travel departments. Allocated seating should also help to attract business travellers. Allocated seating. Following trials on 4-5% of its capacity that commenced in April 2012, easyJet announced in October that it would roll out allocated seats across the network. Although management is cagey about its possible impact on revenues, surveys during the trial period revealed that it was popular with both passengers and flight staff and easyJet’s initial focus has been on operational performance. This should enhance yields and does not so far appear significantly to have added to complexity or adversely affected turnaround times. Stelios. As noted above, comments by Stelios have sometimes had a negative impact on the brand and share price. Nevertheless, his role as an ‘activist’ shareholder has helped to focus management in areas such as capacity growth and dividend payments, with eventual benefits for its finances and share price. This kind of pressure on management, together with the association with Stelios’ ‘Easy’ brand, could lead to further benefits in the future.

easyJet's Threats Airport price increases. easyJet’s presence at a number of high cost primary airports, most of which enjoy regulatory price increases, provides a headwind in its drive to streamline its costs. Labour unrest. As with any labour-intensive service industry, airlines are vulnerable to labour unrest, not only among their own staff, but also among key airport-based suppliers such as ATC, ground-handling, security and ground transport. While easyJet has a much better history of labour relations than most legacy carriers, its size, geographical diversity and growing unionisation increase the risk of internal labour disputes, as illustrated by the recently averted strike among its Spanish ground workers. Increasing complexity. As the airline has grown and its business model has developed to include unbundled pricing, ‘frills’ such as allocated seating and distribution channels such as GDSs, it has also added complexity. This increasing complexity could be a threat if management were to lose its focus. Return of competitor capacity growth. easyJet is currently benefiting from a more disciplined and rational approach to capacity growth in its markets than has often been the case in the past. Any loss of this discipline among competitors, for example as the legacy airlines' low cost alternatives enter new markets, could threaten the benign yield environment that easyJet is enjoying.

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Competitor capacity cuts vs Easyjet growth

Note – H1 refers to Oct 2012 to March 2013. Source: OAG quoted in Easyjet presentation

Stagnant economies/austerity. In an industry that remains highly sensitive to economic fortunes, all airlines are vulnerable to continued economic sluggishness. That said, easyJet appears to have benefitted in the current downturn from capacity cuts by legacy competitors and increased consumer focus on value for money. Moreover, a recent easyJet survey found 86% of Britons plan to take two or more overseas breaks in 2013, up 6% year-on-year. External events. Air travel, regardless of the carrier, is vulnerable to geopolitical events and natural phenomena such as earthquakes and volcanic ash disruption. easyJet’s relatively focused geographic exposure arguably mitigates this exposure relative to airlines with a more global network. With a hitherto unblemished record when it comes to fatal accidents, public perception could be adversely affected if easyJet were to be involved in a major accident. Fuel price and currency movements. The price of jet fuel, which accounts for around 30% of easyJet’s costs, is highly volatile. This reflects not only the unpredictable price of crude oil, but also variations in the crack spread, or refinery premium. In addition, 35% of easyJet’s costs, but no revenues, are in US dollars, making it vulnerable to a strengthening of the dollar against the pound and the euro. To mitigate these risks, easyJet systematically hedges its fuel price and currency exposures, but, even after hedging, the company says that a US$10 per metric tonne movement in jet fuel prices could affect its pre-tax profits by USD4m, a USD1cent movement in GBP/USD by GBP1.6m and a EUR1cent movement in GBP/EUR by GBP1.2million (year to September 2013). Air travel taxes. Due to price elasticity, increases in air travel taxes reduce demand. In general, these taxes represent a higher percentage of the price of a short haul ticket than a long haul ticket, making easyJet vulnerable to recent increases in air taxes in countries such as the UK. Stelios. Although the relationship between Stelios and management appears to be more constructive and less adversarial than it was previously, any serious disagreement in the future could provide a distraction for management.

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Management has had to swot up on Stelios’ views, but will he swat them away? easyJet has considerable strengths in its cost base and ticket pricing against the legacy carriers and a strong airport network across Europe, served by a modern and efficient fleet and backed by an increasingly visible brand. Its improving financial results have been reflected in impressive recent share price performance. However, its cost base and pricing are higher than those of Ryanair, which means that it must try to avoid direct head to head competition with Europe’s leading LCC, and its earnings are highly dependent on the summer season. easyJet share price (pence): Feb-2012 to Feb-2013

Source: CAPA

That said, there are likely to be profitable growth opportunities for both, given competitor retrenchment, and easyJet could capitalise on these if it can secure a new aircraft order for deliveries from 2017, at the right price, and provided that management continues to target measured growth rates in the low to mid single digit range. Moreover, its network, frequencies, allocated seating, availability on GDS’s and through TMC’s and pricing should make it increasingly appealing to higher yield business passengers. Sir Stelios’ public campaign against a number of aspects of easyJet strategy has helped to focus management on increasing the shares’ appeal to shareholders by targeting more steady growth, Return On Capital Employed and paying dividends. However, any return to more frequent public spats between him and management would not be helpful. Perhaps his recent implied threat to sell his shares if management places an aircraft order in the next four to five years points to the only real solution to such disagreements.

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Virgin  Atlantic  Airways            

 

Key Data Fleet and Orders Virgin Atlantic Airways Fleet Summary: as at 10-Apr-2013

Source: CAPA Fleet Database

Virgin Atlantic Airways projected delivery dates for aircraft on order: as at 8-Apr-2013

Source: CAPA Fleet Database

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Route area pie chart easyJet international capacity seats by region: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Top routes table easyJet top ten international routes by seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile easyJet schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Virgin Atlantic, the flying enigma – a great brand in need of greater financial discipline Virgin Atlantic is something of an enigma. Growing from nothing to become the UK’s second largest airline by ASKs in the lifetime of a typical passenger jet and earning a reputation for innovation, attractive branding and a quality service, it is also loss-making, insufficiently costfocused, under-capitalised and (until recently) strategically isolated. Last month saw new CEO Craig Kreeger take control from his long-serving predecessor Steve Ridgeway; this month sees the start of new domestic services wet leased from Aer Lingus; later this year should see the implementation of the new joint venture with Delta and the entry of the latter into Virgin Atlantic’s share register. Mr Kreeger’s challenge will be to unpick the enigma, bringing greater financial discipline to the airline, while maintaining its attractive qualities.

Short-haul deal with Aer Lingus looks sensible Starting from the end of Mar-2013, Virgin Atlantic will offer domestic UK services for the first time in its 29 year history. Using four Airbus A320-200 aircraft wet leased from Aer Lingus, operating under Virgin’s new “Little Red” brand, the carrier will connect London Heathrow to Manchester, Edinburgh and Aberdeen. Virgin Atlantic had previously been interested in buying 101

bmi to help secure feed to its long-haul network, but, when the latter was sold to IAG, VA decided to find an alternative solution. The three domestic routes will provide feed to VA’s 20 long-haul routes from Heathrow, in addition to onward feed for VA’s new partner Delta Air Lines. They will not provide direct feed to VA’s 15 long-haul routes from Gatwick, but perhaps this may be an option in the future, as may adding further short-haul routes from Heathrow. Adding such short routes to a long-haul network provides challenges, especially given VA’s lack of previous short-haul experience. London-Manchester is just 243 km and London-Aberdeen only 649 km, while VA’s shortest long-haul route from LHR is Lagos, at 5,008 km. Comparison of the estimated size of Virgin Atlantic’s new short-haul business with its existing long-haul business

*Based on financial year to Feb-2012 Source: CAPA analysis of data from CAA, Virgin Atlantic and Innovata

The bmi/IAG deal led to a requirement for BA to give up some LHR slots to allow competition on these routes. Where bmi was previously the only competitor to BA, this position will now be taken by VA, who will offer roughly half of BA’s capacity on these routes from this summer. On Manchester, VA will offer 5,040 weekly seats, compared with BA at around 10,000; on Aberdeen VA will offer 3,780 weekly seats against BA with around 7,600; and on Edinburgh VA will have 7,560 to BA’s roughly 12,000. Of course, there is significant competition from LCCs between other London airports and the three cities, but that does not feed VA’s Heathrow hub and it is important for VA that another competitor has not taken up these three routes. The decision to outsource these three domestic routes to Aer Lingus appears to make sense. Aer Lingus has experience of operating short feeder routes to its Dublin hub and has a presence in all three UK airports to be linked to LHR. Moreover, Aer Lingus has a reasonably efficient cost base, with unit costs below those of other legacy flag carriers, especially on its short-haul network.

Virgin's profit record is patchy at best, another loss expected As a privately-owned company, Virgin Atlantic does not directly publish detailed accounts, but it does report both its profit and loss account and balance sheet to the UK’s Civil Aviation Authority (CAA), which publishes these financial statements and traffic data on its website. VA’s financial year end is February and it will be some months before FY2012-13 accounts are available. It has been reported that an internal memo from CEO Craig Kreeger refers to an expected loss that is “well behind where we expected”, with a loss figure of GBP135 million quoted (source: The Sunday Times). Mr Kreeger is reported to have initiated a broad-based cost-cutting plan 102

and a pay freeze. Further losses would be serious after a big loss in the last reported financial year (to end Feb-2012). In FY2011-12, data from the CAA show that Virgin Atlantic Airways Ltd saw revenue growth of 6%, but made an operating loss of GBP92 million (profit of GBP26 million the previous year). The CAA data are only for Virgin Atlantic Airways Ltd, rather than for the whole group, which includes Virgin Holidays and differ slightly from those reported in Virgin Atlantic’s press releases for group results. Nevertheless, the CAA data are much more detailed than any VA press release and show the performance of the core airline business of the group. This report analyses the last reported accounts in some detail below. Virgin Atlantic Airways Ltd revenue, operating profit and pre-tax profit (£000) 2011 and 2012 (financial year to end Feb)

Source: Civil Aviation Authority

Virgin Atlantic Airways Ltd revenue, operating profit and pre-tax profit (£000) 2003* to 2012 (financial year to end Feb)

*2003 year to end April. **2004 10 months only Source: Civil Aviation Authority and CAPA - Centre for Aviation

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Revenue growth driven by capacity increase in FY2011-12 Virgin Atlantic Airways Ltd saw revenue growth of 6.1% in FY2011-12, bringing total revenues to GBP2.4 billion, just above the level seen in FY2008-09 before they collapsed in FY2009-10. Passenger revenues are the most important category and these grew by 4.9%, driven by a capacity increase of 5.8% and a fall in unit revenues of 0.8% (itself a result of a drop in load factor). Cargo revenues and, in particular ‘other revenues’ outpaced passenger revenue growth in FY2011-12. Virgin Atlantic Airways Ltd revenues (£000) 2011 and 2012 (financial year to end Feb)

Source: Civil Aviation Authority

Costs growing much faster than revenues Costs increased by 11.5% in FY2011-12, much faster than the growth in revenues and capacity, leading to the operating loss. Fuel costs, which accounted for 38% of the total, grew by 15.5%, but excluding fuel costs also grew faster than revenues – by 9.1%. Mr Kreeger’s reported cost reduction initiative would seem long overdue. Virgin Atlantic Airways Ltd costs (£000) 2011 and 2012 (financial year to end Feb)

Source: CAPA – Centre for Aviation analysis of data from Civil Aviation Authority

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Virgin Atlantic’s balance sheet is weak At the end of its financial year to Feb-2012, Virgin Atlantic Airways Ltd had gross cash of GBP489 million. This was equivalent to 74 days of revenues, a reasonable cushion against unexpected events. Its balance sheet had only GBP100 million of debt (not including GBP110 million of liabilities to other group companies), meaning that the company was in a net cash position of GBP389 million. However, VA makes significant use of operating leased aircraft and these are not shown on the balance sheet. Capitalising them at eight times annual rental payments would add GBP1.6 billion to VA’s debt, bringing it to an adjusted net debt position of GBP1.2 billion. With shareholder’s equity of only GBP106 million at the end of Feb-2012, this means an adjusted gearing ratio (adjusted net debt to equity) of 1,170%, a very high level indeed. An expected loss in the year to Feb-2013 will further erode the equity base, making the balance sheet look even more fragile. As a privately owned company, this may not be as important as it would be for a company with publicly traded shares (there may be shareholder guarantees in place, for example), but it does suggest that a significant capital injection may be necessary unless Delta is prepared to stand as guarantor in respect of aircraft financing (VA has a major delivery programme from 2014-15 – see below). Before the Delta deal was announced, controlling shareholder Sir Richard Branson was prepared to consider the sale of a controlling stake in the airline, but the weak balance sheet may have deterred potential buyers.

Delta complements VA’s Atlantic focus, but does not give it cash CAPA has covered in some detail Delta’s planned purchase of the 49% share in Virgin Atlantic previously owned by Singapore Airlines Prompted by its growing strategic isolation as one of the world’s very few long-haul point-topoint carriers and as a high profile airline not part of one of the global alliances, the situation had become more critical when BA gained antitrust immunity for its Atlantic JV with American Airlines. VA had been seeking a new partner, one with whom it could more actively engage and which reflected the importance of the Atlantic in its network (see below). It got this, not so much through the transfer of the shareholding, but through an agreed metal neutral joint venture across the Atlantic and 31 joint services between the US and London, with nine of those between London Heathrow and New York’s JFK and Newark airports. According to Delta, the deal will create a USD3 billion revenue JV. Moreover, it also has the prospect of joining SkyTeam and the Air France-KLM/Delta JV. Chief commercial officer Julie Southern said joining the SkyTeam will “probably make sense”, although no decision on alliance membership has been made (source: The Financial Times, 17Feb-2013). If Virgin joins SkyTeam, it will move from ploughing a lone furrow with 5% of seat capacity on Europe-North America to being part of a team with a 30% share. On UK-US, it will move from a 21% share of seats to being in a JV with 28% (source: Innovata database 29-Jul2013 to 04-Aug-2013). The share purchase and the JV are expected to be implemented by the end of 2013, subject to competition authority approvals.

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What Virgin does not get from Delta is a new injection of capital, which might well be needed in the not too distant future (see below), since Delta’s USD360 million investment all goes to Singapore Airlines. However, the presence of Delta on its share register is likely to assist VA with financing (depending on the details of the shareholders agreement and governance processes) and the JV is likely to improve VA’s profitability. It is also possible that Delta has made some contingency for investing more cash directly into Virgin when necessary, although this cannot be taken for granted. Delta is likely to want evidence that VA is doing all it can to make itself more sustainably profitable and would expect other shareholders (ie Sir Richard Branson) to invest alongside it in any capital raising exercise.

All long-haul route structure dominated by North America Excluding the new domestic services, 58% of Virgin Atlantic’s seat capacity is to North America and 13% to the Caribbean. Only one of its top 10 routes (Hong Kong-Sydney) does not involve the Atlantic Ocean: eight are UK-US and one is UK-Caribbean (Gatwick-Bridgetown). Out of its top 10 bases, only Hong Kong is not in the UK, US or Caribbean. It is not a coincidence that the word ‘Atlantic’ has remained part of the airline’s name for 29 years. Virgin Atlantic Airways capacity by region (% of seats) 13-May-2013 to 19-May-2013

Source: CAPA – Centre for Aviation and Innovata

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Virgin Atlantic Airways top 10 routes by seats 13-May-2013 to 19-May-2013

Source: CAPA – Centre for Aviation and Innovata

Virgin Atlantic Airways top 10 hubs/bases/stations by seats 13-May-2013 to 19-May-2013

Source: CAPA – Centre for Aviation and Innovata

Passenger traffic is below its pre-recession peak and load factor has been volatile The chart below shows VA’s annual traffic and capacity development for its financial years since FY2003. Its last reported financial year ended in Feb-2012, but the most recently reported CAA traffic data are for Nov-2012 and so the chart also shows the 12 month period to Nov-2012. Capacity and traffic volume peaked in FY2007-08, before falling for three years. FY2011-12 saw ASKs grow by 5.8% and the 12 month period to Nov-12 saw growth of 3.8%. A striking feature of the chart is the volatility in VA’s load factor over the past 10 years. Load factor has been inversely correlated with ASK growth in recent years, falling sharply in FY2011107

12 when VA resumed capacity growth after three years of cuts. The most recent data show that load factor has stabilised, but remains short of previous peaks. Virgin Atlantic Airways development of passenger capacity (ASKs), traffic (RPKs) and load factor (%) 2003* to 2012 (financial year to end Feb)

*2003 year to end April. **2004 10 months only Source: CAPA – Centre for Aviation and Civil Aviation Authority

Virgin has a relatively young fleet VA’s fleet contains 12 Boeing 747-400s, whose average age is almost 14 years and 15 Airbus A340s averaging 9.5 years. Nevertheless, its 10 A330s only came into the fleet from early 2011, first to replace ageing A340s and then to provide growth. The overall average age of its fleet is less than nine years, younger than most major European network carriers. Note the fleet details in the table below do not include four Airbus A320-200 aircraft to be wet leased from Aer Lingus for services connecting London Heathrow to Manchester, Edinburgh and Aberdeen under Virgin’s new “Little Red” brand from the end of Mar-2013.

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Virgin Atlantic Airways Fleet Summary: as at 13-Mar-2013

Source: Virgin Atlantic and CAPA – Centre for Aviation

Virgin Atlantic told CAPA that it does not yet have an exact delivery schedule, but 787 deliveries are due from summer 2014 and A380s from 2015. Given possible delays in all 787 deliveries by Boeing, it would not be a surprise if these dates slipped and we suggest a possible delivery schedule in the chart below. Virgin Atlantic Airways projected delivery dates as at 11-Mar-2013

Source: CAPA – Centre for Aviation

RASK vs CASK trends show weak cost control As the chart below demonstrates, using data on Virgin Atlantic Airways reported to the CAA, VA’s unit revenue (RASK) was on a broadly upward path over the 10 years to Feb-2012. It fell in FY2009-10, as it did for many airlines, but recovered sharply in FY2010-11 as VA cut capacity for the third successive year.

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In FY2011-12, RASK fell once more as VA added 5.8% more ASKs (this was all seat growth as there was no increase in average stage length). This fall in RASK was due to lower load factors, as passenger yield (revenue per RPK) actually increased in FY2011-12, and was contrary to global trends. Unit costs (CASK) have also been on a 10 year upward path, broadly following the RASK trend until FY2001-08. This rise in RASK was mainly due to increasing fuel costs, particularly until the financial crisis, but more recently ex fuel RASK has increased quite sharply. The rise in ex fuel CASK in FY2009-10 and FY2010-11 coincided with significant capacity cuts, demonstrating that VA was not cutting its costs in line with its capacity. The increase in CASK ex fuel in FY2011-12, when capacity once more returned to growth, is perhaps more worrying, especially as it was accompanied by a fall in RASK. These trends suggest that VA has not had a strong cost control culture and that, in spite of its strong branding, it has been unable to fill its aircraft sufficiently to cover its costs. Virgin Atlantic Airways – index of operating cost per ASK and passenger revenues per ASK financial years ended Feb 2003* to 2012 (each indexed to 100 in 2010)

*2003 year to end April. **2004 10 months only Source: CAPA – Centre for Aviation analysis of data from Civil Aviation Authority

Unit costs look efficient vs other European airlines, but is that good enough? Aer Lingus looks to be a sound move The chart below, which compares unit costs and average sector length for a number of European legacy carriers and LCCs, suggests that Virgin Atlantic has a fairly efficient cost base for a carrier 110

with such a long-haul route structure. However, it is the only European airline with a pure longhaul business model and so there are no direct European comparable carriers. Moreover, many of its competitors – those in Asia and the Gulf, but also in the US – typically have lower unit costs than European network carriers. So it may be the case that merely looking cost competitive against European flag carriers is not enough. The chart also highlights Aer Lingus – both its overall unit cost position and estimated longhaul and short-haul unit costs (based on Aer Lingus’ overall unit cost and its reported revenue split between long-haul and short-haul). This shows that Aer Lingus is competitive on shorthaul against the flag carriers that form the main competition at VA’s Heathrow hub. Assuming that it can broadly replicate its cost base when carrying out its wet leased services for Virgin, the latter appears to have chosen a fairly efficient partner for its new domestic services (depending also on the exact terms of the commercial arrangements between Aer Lingus and Virgin). Unit costs (cost per available seat kilometre) and average sector length for selected European legacy and low-cost carriers 2011, 2012*

*Financial year ends as follows: Aer Lingus, IAG, Iberia, BA, Air France-KLM, Finnair, Norwegian, Vueling Dec2012; Lufthansa Dec-2011; SAS Oct-2012; easyJet Sep-2012; Ryanair Mar-2012, Virgin Atlantic Feb-2012. Source: CAPA analysis of company accounts and traffic data

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airberlin                  

                     

Key Data Fleet and Orders airberlin Fleet Summary: as at 10-Apr-2013

Source: CAPA Fleet Database

airberlin projected delivery dates for aircraft on order: as at 8-Apr-2013

Source: CAPA Fleet Database

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Route area pie chart airberlin international capacity seats by region: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Top routes table airberlin top ten international routes by seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile airberlin schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Share price 2012/2013

Source: CAPA - Centre for Aviation and Yahoo! Financial

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airberlin: in need of a cap that fits after another underlying loss Air Berlin PLC returned to a net profit in 2012 for the first time since 2007. However, if the one-off proceeds of the disposal to Etihad of 70% of its topbonus FFP are excluded, the operating result would have been a loss of EUR114 million. This is a narrower figure than 2011’s shocking EUR247 million loss, helped by airberlin’s entry into oneworld and its deepening strategic partnership with Etihad. Wolfgang Prock-Schauer, CEO since Jan-2013 after only joining the company in Oct-2012, rightly assesses that “we have not yet reached our goal – namely sustainable profitability”. airberlin's cost structure is quite low versus European legacy carriers, but not LCCs, but its revenue base is too close to LCC levels. Thus the airline must simultaneously reduce costs and grow revenues. Further capacity cuts and another efficiency programme are under way, but much will depend on the further successful development of its relationship with oneworld and, in particular, Etihad. After years of trying on every cap – charter carrier, LCC, full-service carrier, short-haul, long-haul, M&A predator and prey – airberlin needs to find one that fits.

A profit in 2012, but still a loss if FFP sale is stripped out For airberlin, 2012 was a year of cuts, with capacity (both seats and ASK), passenger numbers and the number of flights falling. Seat load factor and yield increased, assisted by capacity cuts, so that RASK grew by 5.0%, helping to push revenues up by 2.0%. Costs grew at a slightly slower rate, 1.1%, and so the operating result improved from a loss of EUR247 million in 2011 to a reported profit of EUR70.2 million in 2012. The net result improved from a loss of EUR272 million in 2011 (since restated to a loss of EUR420.4 million) to a profit of EUR7 million. The net and operating results benefited to the tune of EUR184 million from the sale of a majority 70% stake in the frequent flyer programme topbonus to Etihad Airways. This means that the underlying operating result was a loss of EUR114 million, rather than the profit reported (albeit a smaller loss than the previous year) and the underlying net result was also negative. Air Berlin PLC highlights 2012

Source: airberlin, CAPA – Centre for Aviation

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Will Etihad be asked to provide more capital? The group’s balance sheet looks very undercapitalised, although net debt came down from EUR813 million to EUR770 million and the group hopes to reduce it further, to around EUR500 million, by the end of 2013. Its 2012 net debt figure was almost six times its book equity and, adding in operating leases at eight times annual rentals, the adjusted net debt figure of EUR5.5 billion is a staggering 42 times book equity of EUR130 million. When Etihad increased its holding in airberlin from 3% to 29% in early 2012 (providing EUR73 million of fresh equity capital), it also arranged debt financing of USD255 million with a term until Dec-2016. This ensured the group’s medium term survival, but its operating cash flow remains negative and it has 66 aircraft on order. Etihad also provided EUR184 million of a 70% stake in the group’s FFP topbonus, but it would not be a surprise if Etihad is asked for more at some stage.

airberlin has transformed itself many times airberlin has been through a number of phases in its history, emerging from its background as a charter carrier taking Germans on holiday, then adding scheduled traffic with a holiday destination focus, then focusing on scheduled services and adapting the ‘LCC’ tag, then adding long-haul and developing alliances and partnerships and embracing the ‘full-service carrier’ tag. It is Europe’s seventh largest airline by passenger numbers and the number two in its core market of Germany, Austria and Switzerland. Development of airberlin seats and passenger numbers: 1992 to 2011

Source: airberlin

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Still mainly a short/medium-haul airline Despite extensions into long haul markets, airberlin is still a predominantly short/medium haul operator. airberlin Group destinations (including codeshare)

Source: airberlin

Its principal hubs are Berlin Tegel, where it is the biggest carrier with 46% of seats, and Düsseldorf, where it has 29% and is number two to Lufthansa (source: Innovata, 18-Mar-2013 to 24-Mar-2013). Although it operates a long-haul network, around one third of its seat capacity is domestic and 80% of passengers are on its European routes. Its largest ex Europe market (by seats) is the Middle East, not surprising given its Etihad relationship, followed by North Africa and North America. airberlin Group international capacity (seats) by region: 18-Mar-2013 to 24-Mar-2013

Source: CAPA – Centre for Aviation and Innovata

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Another efficiency programme The group’s cost savings programme, launched in 2011 and named ‘Shape and Size’, contributed EUR250 million of bottom-line effects in 2012, according to the company. Since the launch of this programme, additional factors including the continued difficult economic environment, aviation taxes, fuel prices and the delays in opening the new Berlin airport have prompted the company to implement an additional programme aimed at structural changes to adapt the business model. This initiative is called ‘Turbine’ and aims to have a positive impact of more than EUR200 million in 2013 and EUR400 million in 2014. airberlin Group expects a reduction in unit cost ex fuel in 2013.

Labour productivity deteriorated in 2012, but should be addressed in 2013 airberlin has a reasonably productive workforce compared with other European carriers, although 2012 saw deterioration on the key measures of employee costs per employee and revenue per employee. In 2013, airberlin is taking measures to improve labour productivity. For example, the group plans to consolidate the number of crew stations in Germany. It currently has 15 stations and is reviewing six of these. The company is also looking for productivity gains through seasonal adjustments, which are under negotiation, to agree secondments with Etihad and other partners and to reduce headcount by 180 full time equivalents in 1Q2013. Overall, Mr Prock-Schauer has identified around 900 posts to be eliminated, roughly 10% of the workforce. airberlin labour productivity 2011 and 2012

Source: CAPA analysis of airberlin financial statements

Fleet reduction is to continue airberlin reduced its fleet from 170 aircraft to 155 at the end of 2012 and plans to reduce this further to 143 in 2013. Eight new aircraft will enter the fleet, but 20 will exit following lease expiry/early termination. At the end of 2012, the average age of the fleet was 5.2 years, making it one of the youngest among European network carriers. 118

airberlin fleet 2011 and 2012

Source: airberlin

airberlin fleet and end 2012 and plan 2013

Source: airberlin

airberlin projected aircraft deliveries of aircraft on order as at 19-Mar-2012

Source: CAPA – Centre for Aviation

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Etihad relationship should deliver mutual benefits Etihad is airberlin's largest shareholder, with a 29% stake, and is also its number one codeshare partner, with codeshares on close to 100 routes. Through airberlin's hubs at Berlin and Düsseldorf, Etihad has access to more than 50 destinations from Abu Dhabi. As an EU airline group, airberlin could not be controlled by a non-EU national, but the relationship with Etihad seems as close to a takeover as could be achieved, especially given the financing dimension (see earlier). The two carriers are working on a number of areas for future synergies, including the harmonisation of product standards; joint procurement of seats and IFE for the Boeing 787; joint marketing; joint placement of insurance contracts, fuel tendering and lessor negotiations; and operational cooperation such as pilot exchanges, joint training and common cargo operation from Abu Dhabi. According to airberlin, the strategic partnership with Etihad involved 323,000 ‘common guests’ in 2012 and generated EUR50 million of additional revenues for airberlin in 2012. Etihad/airberlin codeshares*

Source: airberlin

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Etihad/airberlin development of common passengers 2012 (000)

Source: airberlin

airberlin joined oneworld in 2012 airberlin's entry into oneworld saw it benefit from a similar number of ‘common guests’ as were involved in its Etihad codeshare. Although airberlin has not said how much additional revenue this brought the company, it seems reasonable to assume that it may have been of a similar order of magnitude. Nevertheless, it appears that its involvement in oneworld, whose other members have only a small presence at airberlin’s Tegel and Düsseldorf hubs, is more tactical and opportunistic than its more strategic involvement with Etihad.

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oneworld/airberlin development of common passengers 2012 (000)

Source: airberlin

2013 outlook: further capacity cuts, but long-haul growth In 2012, airberlin plans to cut the number of flights and seats by around 5%, with ASKs down by the lesser amount of 3%, reflecting a focus on growing long-haul. Short-haul capacity (flights, seats and ASKs) will be down 12%, medium-haul down 4%, but long-haul will see an increase of more than 10% to reach more than one quarter of the group’s capacity. It expects load factor and yield improvement as a result of capacity cuts and greater partner traffic. As a result, airberlin expects revenue growth in spite of capacity cuts in 2013. Its overall financial target for 2013 is to reach “operational profitability”.

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airberlin 2013 capacity plans

Source: airberlin

Through refocusing the network on core markets with higher frequencies and better utilisation of the hubs at Berlin and Düsseldorf and further building codeshare activity, airberlin aims to improve asset utilisation in support of a more cost efficient operation in 2013. Berlin will see the group build on its Eastern Europe activities, while Düsseldorf will see growth in the North American business. Palma de Mallorca, where airberlin is number one with 40% of seat capacity, will see additional flights and Vienna will see added leisure capacity through group company NIKI. airberlin network changes 2013

Source: airberlin

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Track record of profitability is weak as CASK has outgrown RASK airberlin revenues, net profit and operating profit (EUR million): 2005 to 2012

Source: CAPA - Centre for Aviation, airberlin

airberlin's highest operating result, EUR64 million came in 2006, the year of its IPO. Since then it has struggled to breakeven and has made three operating losses (including 2012 if the disposal gain on the topbonus FFP transaction is deducted from the reported profit). The chart below illustrated the development of unit revenues (RASK) and unit costs (CASK) since 2006. The company has experienced significant growth in RASK over the period, up 30%, in spite of a fall in 2010. The problem airberlin has faced is that CASK has grown faster – up 39% since 2006. Even ex fuel CASK has grown by 34%, so the rise in unit costs cannot be blamed on fuel. Moreover, airberlin’s average sector length has increased over the period and CASK is typically lower the higher the sector length. The group already has a relatively productive work force, but it will need to improve this further and focus strongly on costs other than fuel and labour.

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airberlin – index of operating cost per ASK and fare revenues per ASK (each indexed to 100 in 2006)

Source: CAPA – Centre for Aviation, airberlin

Cost structure is efficient, but not low enough given RASK pressure Comparing airberlin's unit costs and sector length with those of other European airlines, the chart below shows that it is relatively cost efficient compared with many legacy carriers with a similar average sector length. However, compared with the nearest comparable carrier in sector length, Aer Lingus, it has higher unit costs and, as we have seen, its CASK has grown for a number of years. Moreover, its strong short-haul dependence brings it into significant competition with the LCCs and its unit costs are significantly higher than theirs. Having a cost structure that is below those of the major legacy carriers ought to allow profitable operations, but this requires that unit revenues are sufficiently strong. As noted above, airberlin has not been able to grow RASK fast enough to cover increases in CASK since 2006.

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Unit costs (cost per available seat kilometre, EUR cent) and average sector length for selected European legacy and low-cost carriers: 2012*

*Financial year ends as follows: airberlin, Turkish Airlines, Lufthansa, Aer Lingus, IAG, Iberia, BA, Air FranceKLM, Finnair, Norwegian, Vueling Dec-2012; SAS Oct-2012; easyJet Sep-2012; Ryanair Mar-2012, Virgin Atlantic Feb-2012. Source: CAPA analysis of company accounts and traffic data

airberlin's difficulty is perhaps best illustrated simply by comparing its average cost per passenger and revenue per passenger, against average sector length, with other carriers. Looked at this way, its cost base is between the LCCs and the legacy carriers, but its revenue base is much closer to the LCCs. The need to improve this weak revenue structure explains airberlin’s moves to develop alliances and partnerships, to improve product quality and to cut capacity. The dilemma is that these developments can also add to unit costs. The carrier now appears to have set course on a long term direction, with partners in place and a more focussed plan. But it will not all be plain sailing.

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Costs per passenger (EUR) and average sector length for selected European legacy and low-cost carriers: 2012*

*Financial year ends as follows: airberlin, Turkish Airlines, Lufthansa, Aer Lingus, IAG, Iberia, BA, Air FranceKLM, Finnair, Norwegian, Vueling Dec-2012; SAS Oct-2012; easyJet Sep-2012; Ryanair Mar-2012, Virgin Atlantic Feb-2012. Source: CAPA analysis of company accounts and traffic data

Total revenue per passenger (EUR) and average sector length for selected European legacy and low-cost carriers: 2012*

*Financial year ends as follows: airberlin, Turkish Airlines, Lufthansa, Aer Lingus, IAG, Iberia, BA, Air FranceKLM, Finnair, Norwegian, Vueling Dec-2012; SAS Oct-2012; easyJet Sep-2012; Ryanair Mar-2012, Virgin Atlantic Feb-2012. Source: CAPA analysis of company accounts and traffic data

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Alitalia                        

                     

Key Data Fleet and Orders Alitalia Fleet Summary: as at 10-Apr-2013

Source: CAPA Fleet Database

Alitalia projected delivery dates for aircraft on order: as at 8-Apr-2013

Source: CAPA Fleet Database

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Route area pie chart Alitalia international capacity seats by region: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Top routes table Alitalia top ten international routes by seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile Alitalia schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Alitalia battles for survival in 2013, again, despite operational improvements In 2012 Alitalia lost EUR280 million, bringing its cumulative net loss to EUR843 million since the ‘new Alitalia’ was created in 2009. In Feb-2013, with its cash reserves almost evaporated, it had to ask its shareholders for a EUR150 million loan to fund its operations. Following the 2012 results announcement, CEO Andrea Ragnetti resigned his position after only a year with the company. A permanent replacement is being sought while chairman Roberto Colaninno takes the controls on an interim basis. Since 2009, there have been operational improvements, leading to rising load factors and much improved on-time performance, and a major fleet replacement and renovation programme. Unfortunately, these positive developments have not set Alitalia on the path to financial health. Moreover, while its cost base is fairly competitive against full service network carriers, it remains very high cost compared with the short-haul point-to-point LCCs with whom it increasingly competes. Alitalia looks strategically isolated between these two sets of competitors and it now seems unlikely that Air France-KLM will throw it the once anticipated life vest. Loss-making, bleeding cash and currently leaderless, Alitalia faces a battle for survival in 2013.

Another year, another loss for Alitalia (but this time it’s worse) Alitalia’s losses widened in 2012, with the operating loss growing to EUR119 million from EUR6 million in 2011 and the net loss reaching EUR280 million (EUR69 million loss in 2011).

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Alitalia is a privately owned company and does not provide detailed accounts and operating data, but the table below summarises the available data. Alitalia financial highlights 2012

Source: Alitalia, CAPA – Centre for Aviation

‘New Alitalia’ has not made a profit since its creation in 2009 Alitalia has not made a profit since the new company came into existence in 2009, when a consortium of Italian industrial and financial investors acquired the main flying-related assets of the ‘old Alitalia’ out of bankruptcy. The Italian government was the major shareholder at the time of the bankruptcy. The deal also involved leaving a substantial portion of the debt with the government (although EUR652 million of debt was transferred to the new owners) and the merging of domestic competitor Air One into the new concern. Air France-KLM then bought a 25% stake in the new entity from the consortium and was given pre-emption rights to buy shares from the other shareholders from 2013. It was expected at the time that the Franco-Dutch group would eventually take control of its Italian partner, but Air France-KLM has recently indicated that it does not intend to exercise these rights since it has its own problems to face. Alitalia revenues, net profit and operating profit (EUR million) 2009 to 2012

Source: Alitalia

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Although losses narrowed from 2009 to 2011, the trend took a wrong turn in 2012. In 2012, passenger numbers fell by 1.3%, with capacity down by 2.6%. Load factor improved by 1.9ppt to reach 74.6% and total revenue per passenger grew by 4.7% to nudge revenues up by 3.3%. However, total operating costs grew faster, by 6.6%, meaning that losses widened. Alitalia has not published details of its revenues and costs, but the press release announcing the 2012 losses states that “2012 was one of the worst years for the European carriers characterized by the financial crisis which invested the Eurozone, and in particular the Mediterranean countries including Italy, where the recession has proven to be deeper and longer than expected, causing a substantial decrease in the demand.” One detail Alitalia has revealed is that international passenger revenues have grown to represent 64% of total passenger revenues, up from 62% in 2011. This probably reflects growing competition from LCCs on domestic routes as much as Alitalia’s growth on international routes. Alitalia Passenger revenue split

Source: Alitalia

Alitalia’s liquidity reached crisis point at the end of 2012 Perhaps not surprisingly, given the ongoing losses, Alitalia’s net debt has grown steadily from 2009 to 2012, when it reached more than EUR1.0 billion (growing by EUR174 million through 2012). This has happened in spite of aircraft-related debt falling over the period 2009 to 2012, suggesting that increased borrowing has been in order to fund working capital. Worryingly, Alitalia’s liquidity position deteriorated to only EUR75 million at the end of 2012 (from EUR326 million at the end of 2011). This is defined as cash, cash equivalents and unused credit lines and the figure was equivalent to only just over a week of revenues, a very inadequate cushion. Alitalia has been through a significant fleet replacement programme since 2009, but, since its fleet is largely leased, its worsening liquidity is mainly due to poor operating cash flow. Recognising the perilous nature of its finances, Alitalia proposed in Feb-2013 that its shareholders subscribe to a loan of up to EUR150 million, in proportion to their shareholdings. The loan is convertible into shares after one year and up to 2015 (when the loan will automatically convert into shares). Shareholders representing 12% of the total voted against the proposal, suggesting that a maximum of EUR132 million was raised. Whether this sum will be sufficient remains to be seen, but, given the EUR174 million cash burn through 2012 and the very low level of liquidity before the loan, the carrier will remain financially on tenterhooks.

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Alitalia development of net debt and cash 2009-2012  

Source: Alitalia

Passenger growth has been modest, but load factors and on-time performance have climbed Alitalia has seen passenger numbers grow by only 11% from 2009 to 2012, with a fall of 1.3% in 2012. Its load factors have risen strongly over the period, reaching 74.6% in 2012, up from 65% in 2009. This reflects much better matching of supply to demand, both in terms of routes and also the size of the fleet. Nevertheless, Alitalia load factors continue to lag the AEA average of 79.1% for 2012. This may reflect Alitalia’s higher proportion of capacity on domestic routes (18% of ASKs vs 6% average for AEA member airlines), where load factors tend to be lower, but also points to further potential for improvement. Alitalia has also seen a positive trend in on-time performance since 2009, when its record of punctuality was one of the worst in Europe, and it aims to rank first on this measure in 2013. Alitalia’s subsidiary Air One, which operates from Milan Malpensa, Pisa, Venice and Catania, saw passenger numbers grow rapidly in 2012, from 1.4 million in 2011 to reach 2.0 million (up 45%). Primarily a domestic carrier (83% of its seat capacity), it also operates to destinations in central Europe and north Africa. Air One is aimed at the lower cost and leisure segments of the market.

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Alitalia development of passenger numbers (million), on time performance (%) and load factor (%) 2009-2012

Source: Alitalia

Fleet renovation plan is complete The Alitalia Group had a fleet of 140 aircraft at 01-Mar-2013, including 10 Airbus A320s of Air One, with an average age of 6.5 years. The fleet renovation plan, started in 2009 when the average age was 9.3 years, was completed by the end of 2012. The project saw Alitalia take delivery of 55 new aircraft (of which 21 in 2012) and phase out 67 aircraft (of which 41 in 2012). Older types such as the MD80 and the Boeing 767 have been replaced by A320 family aircraft and A330s. The fleet is predominantly Airbus, apart from 10 777s and 18 Embraer regional aircraft. The project has also seen cabin reconfiguration of the medium-haul and long-haul fleets. Alitalia Group fleet at 01-Mar-2013

Source: Alitalia

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Alitalia development of fleet numbers and average age at year end

Note: 2010 fleet number not available Source: Alitalia

Alitalia aircraft orders at 05-Mar-2013

Source: CAPA – Centre for Aviation

Alitalia is still Italy’s largest airline Alitalia remains the largest airline in Italy by seat capacity, according to the Innovata database for 04-Mar-2013 to 10-Mar-2013, with a 24% share. This rises to 29% for the group (including Air One and Alitalia Express), ahead of Ryanair on 19% and easyJet on 11%. Given the superior load factors of the latter two, the market share gap between them and Alitalia is likely to be less in passenger terms.

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Top 10 Airlines in Italy by capacity (seats) 04-Mar-2013 to 10-Mar-2013

Source: CAPA – Centre for Aviation & Innovata

Focusing on the domestic Italian market, the Alitalia Group is still clinging onto a seat capacity share of just over 50%, but this has fallen from more than 52% in 2009 and is likely to be well under 50% now in passenger terms. LCCs Ryanair and easyJet have both seen their share increase since 2009, with Ryanair in particular benefiting from the demise of Wind Jet in 2012. Top Airlines in Italy by domestic capacity (seats) 2009* and 2013**

*16-Feb-2009 to 21-Feb-2009, source: OAG Max Online **4-Mar-2013 to 10-Mar-2013, source: CAPA – Centre for Aviation & Innovata

Rome Fiumicino is the main hub and Alitalia is its biggest airline Rome Fiumicino is Alitalia’s main hub, although Milan Linate remains an important base in northern Italy’s principal business market. The Rome hub gathers domestic traffic for Alitalia’s long-haul network, which focuses mainly on North America, Japan and Latin America, in

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addition to links to major European cities. This domestic feed is increasingly vulnerable to LCC competition. Alitalia’s joint venture with Air France and membership of SkyTeam’s North Atlantic JV with Air France, KLM and Delta mean that it is very much a junior partner when it comes to direct long-haul services. Alitalia top 10 bases by capacity (seats) 04-Mar-2013 to 10-Mar-2013

Source: CAPA – Centre for Aviation & Innovata

Alitalia is Fiumicino’s biggest airline, with 46% of seat capacity, rising to 49% for the Alitalia Group when Air One Smart Carrier is included. LCC easyJet is number two on 8% Rome Fiumicino airport top 10 carriers by share of capacity (seats) 04-Mar-2013 to 10-Mar2013

Source: CAPA – Centre for Aviation & Innovata

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Most of Alitalia’s top routes by seats are domestic Alitalia’s biggest route by seat capacity links its Rome hub to its base at Milan Linate. Its other key routes from Rome Fiumicino are domestic links to its bases at Catania, Turin and Venice and also to Palermo. Its most important international route is to the Paris CDG hub of SkyTeam partner and 25% Alitalia shareholder Air France-KLM, followed by Rome to London Heathrow. Outside Europe, its most important route by seats is Rome to New York JFK, followed by Rome to Tokyo Narita. Alitalia also operates Milan Malpensa to Narita and Rome to Osaka. Other important intercontinental routes include Latin American destinations Rome to Buenos Aires, Sao Paulo, Rio de Janeiro and Caracas. Its most important North Atlantic routes aside from JFK are Rome to Miami and Toronto. Apart from the Rome to Milan Linate route, the latter base does not feature in Alitalia’s biggest domestic routes and only Milan-Paris CDG and Milan-London Heathrow feature in its top 10 international routes. Alitalia top 10 domestic routes by capacity (seats) 04-Mar-2013 to 10-Mar-2013

Source: CAPA – Centre for Aviation & Innovata

Alitalia top 10 international routes by capacity (seats) 04-Mar-2013 to 10-Mar-2013

Source: CAPA – Centre for Aviation & Innovata

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Alitalia top 10 international capacity (ASK) by region 04-Mar-2013 to 10-Mar-2013

Source: CAPA – Centre for Aviation & Innovata

At its Milan Linate base, Alitalia has a seat capacity share of 39%, rising to 48% with Alitalia Express, and LCCs are largely excluded from the airport. However, LCCs have a strong share at Milan Malpensa, where the Alitalia Group’s share of seat capacity is just 9%, giving it a 23% share of the two Milan airports combined seats. If Bergamo is also included, now referred to as Milan Bergamo, where Ryanair’s seat capacity is larger than that of the Alitalia Group at the other two Milan airports combined, then its share of the three airport system is only 18%. Milan Linate airport top 10 carriers by share of capacity (seats) 04-Mar-2013 to 10-Mar-2013

Source: CAPA – Centre for Aviation & Innovata

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Milan airport system (Linate, Malpensa and Bergamo) seats by carrier 04-Mar-2013 to 10Mar-2013

Source: CAPA – Centre for Aviation & Innovata

Cost per passenger on the rise again in 2012 after falling from 2009 to 2011 Due to a lack of published data, it is not possible to calculate CASK and RASK data, but the chart below shows the development of cost per passenger and revenues per passenger form 2009 to 2012. After managing cost per passenger downwards from 2009 to 2010, Alitalia has seen this measure of unit cost increase in 2012. This may be partly due to modest sector length growth. The trend in revenues per passenger has remained positive throughout the period, but this has not been sufficient to restore profitability and unit costs will need to be an area of focus in 2013.

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Alitalia – index of operating cost per passenger and revenues per passenger (each indexed to 100 in 2009)

Source: Alitalia, CAPA – Centre for Aviation

Cost per passenger looks competitive against FSCs, but not against LCCs. A tough assignment for a new CEO As noted earlier, it is not possible to calculate CASK, which, together with a comparison of average sector lengths is the usual measure for comparing unit costs among airlines. Nevertheless, an analysis of Alitalia’s cost per passenger and average sector length against those of other European carriers shows that its cost base is quite competitive against other full service carriers (see chart below). Given an average sector length at the low end of the scale for FSCs, its cost per passenger is also at the low end of the scale and actually below the line of best fit for FSCs. Having said that, its average sector length is much closer to the LCCs, but its cost per passenger is significantly higher than theirs are. This shows it to be somewhat stuck in a strategic no-man’s land: neither truly a network carrier with a significant long-haul operation, nor truly short-haul point-to-point with a competitive cost base. Moving in either direction presents significant hurdles: up the average sector length curve and making use of a lower cost base, or down the curve into short-haul.

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Costs per passenger and average sector length for selected European legacy and low-cost carriers 2011, 2012*

*Financial year ends as follows: Alitalia, IAG, Air France-KLM, Finnair, Norwegian, Vueling Dec-2012; Lufthansa Dec-2011; SAS Oct-2012; easyJet Sep-2012; Ryanair Mar-2012. Source: CAPA analysis of company accounts and traffic data

Alitalia plans nine new international routes this summer in its medium-haul network and, on the long-haul, it is increasing frequencies on its New York service and evaluating possible new routes to South Africa and Latin America. However, with a widebody fleet of only 22 aircraft, it will continue to rely on alliance and codeshare partners to reach a large part of the globe. As for a more short-haul strategy, its cost base still has a lot of trimming to be done and it has been gradually losing market share over time. Alitalia’s ‘caught-in-the-middle’ strategic positioning, coupled with weak finances, will present an enormous challenge to its next CEO, when he or she arrives. Restructuring on a large scale would appear to be unavoidable – but that will not be without considerable pain, at a delicate time in Italy's political evolution.

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SAS                        

           

 

 

                     

 

Key Data Fleet and Orders SAS Fleet Summary: as at 10-Apr-2013

Source: CAPA Fleet Database

SAS projected delivery dates for aircraft on order: as at 8-Apr-2013

Source: CAPA Fleet Database

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Route area pie chart SAS international capacity seats by region: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Top routes table SAS top ten international routes by seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile SAS schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

SAS SWOT: final call to establish a sustainable Scandinavian Airlines SAS has been through many restructuring programmes and capital raisings over a number of years. Yet it still has high unit costs and poor labour productivity, is loss-making and has a weak balance sheet. In 1QFY2013 (Nov-2012 to Jan-2013), the group's loss before tax and nonrecurring items widened to SEK801 million from a SEK656 million (EUR78.7 million) loss a year earlier. Nevertheless, it continues to target a positive pre-tax result and an EBIT margin of more than 3% for FY2013. The Nordic region contains a more efficient long-haul operator (Finnair) and is experiencing increasing penetration by short-haul low-cost operators from elsewhere in Europe. Also, in Norwegian Air Shuttle, SAS has a low-cost local operator that competes with it on both shorthaul and (from this summer) long-haul. In Nov-2012, CEO Rickard Gustafson called the ‘4Excellence Next Generation’ plan, which aims to achieve SEK3 billion (EUR360 million) of annual savings by 2015, a “final call if there is to be a SAS in the future”.

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SAS' Strengths Biggest carrier in Nordic region The biggest carrier overall in the region, SAS is the number one carrier in its three Scandinavian home markets Sweden, Norway and Denmark and number two in the fourth Nordic market, Finland. With an average of 1,111 daily departures in Jan-2012 to Oct-2012, it also had the highest departure frequency in the region. In 2012, it opened 38 new routes, many to leisure destinations, and it plans 45 new routes for 2013. SAS Group market shares for passengers %

Source: SAS and official airport statistics for the Nordic region (as shown in SAS 2012 annual report)

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SAS new routes 2012 and 2013

Source: SAS

Geography SAS is the biggest carrier in a region of Europe that is relatively remote from a geographical point of view. This was historically a positive for SAS as other competitors showed little interest in the region until the relatively recent advent of low-cost carriers. (See also weaknesses.) Punctuality Scandinavian Airlines was the second most punctual airline in Europe in 2012, although in 1QFY2013 (Nov-2012 to Jan-2013), its 15 minute punctuality measure fell to 84.9% from 87.5% a year earlier (source: SAS). Innovation SAS has a history of aviation firsts. For example, it was the first airline to introduce Tourist Class (1952), in-flight entertainment (1968), separate check-in and lounges for business class passengers (1982), sleeper seats (1992), windows in business class toilets and biometric check-ins 147

across a whole domestic market (Sweden, 2006). It recently became the first airline to achieve IATA’s Fast Travel Award Platinum status, by offering more than 80% of all its passengers the self-service options that make up the IATA Fast Travel programme. Star Alliance SAS is a member of the world’s largest airline alliance, the Star Alliance and this has enabled it to offer customers a significant global network through partner carriers. In Scandinavia, Europe and North America, Star Alliance partners receive more passengers from SAS than they feed it, whereas in South America, Africa and Asia the reverse is true. SAS and the Star Alliance Jan-Oct-2012

Source: SAS

SAS' Weaknesses Cost base SAS’ unit costs (cost per ASK) are among the highest in Europe and, to a large extent, this reflects poor labour productivity. Labour accounted for one third of SAS Group revenues in the year to Nov-2012, the biggest cost category. Mainly as a result of its high cost base, SAS has been loss-making since 2008.

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Unit costs (cost per available seat kilometre) and average stage length for selected European legacy and low-cost carriers 2011, 2012*

*Financial year ends as follows: IAG, Iberia, BA, Air France-KLM, Finnair, Norwegian, Vueling Dec-2012; Lufthansa Dec-2011; Finnair Oct-2012; easyJet Sep-2012; Ryanair Mar-2012. Source: CAPA analysis of company accounts and traffic data

Fleet The group had 208 aircraft, of six manufacturers and 10 types, with an average age of 13 years at 31-Jan-2013. The MD-80 aircraft in the fleet have an average age of 23.7 years and the Boeing 737 Classics 19.7 years. The diversity and age of the fleet has been a contributor to SAS’ high cost base. (See also opportunities.) Aircraft utilisation In the 12 months to Jan-2013, the Scandinavian Airlines fleet had an average daily utilisation rate of 8.3 hours per day and the Widerøe fleet 6.8 hours. These figures compare with a European average of more than 10.5 hours per day (source: Airline Monitor). Although Scandinavian Airlines’ utilisation rates are climbing, they are now only just above where they were four years ago.

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Scandinavian Airlines aircraft utilisation (rolling 12 months)

Source: SAS

Load factor Although it has been on an upward path, the load factor of Scandinavian Airlines (including Blue1) is below the AEA average. It reached 75.1% in calendar 2012, compared with the AEA average of 79.1%. To some extent, this reflects SAS’ shorter average sector length (1,099km in calendar 2012 vs AEA average of 2,347km). Indeed, AEA average load factors were 73.5% for international short and medium-haul in 2012, but LCCs such as Norwegian Air Shuttle and easyJet achieved load factors of 78.5% and 88.9% respectively in calendar 2012. Balance sheet SAS has an equity/assets ratio of 29% (at 31-Jan-2013) compared with its own target of more than 35%. It had SEK1,721 million (EUR206 million) of cash and cash equivalents at 31-Jan2013, which is equivalent to only just over two weeks of revenues. Including unused credit facilities of SEK3,955 million (EUR474 million), its overall liquidity corresponded to SEK5,676 million (EUR681 million), or 20% of the group’s fixed costs at 31-Jan-2013. SAS’ own target is for this measure, referred to as financial preparedness, to be more than 20%. While SAS is just meeting its target, its financial preparedness stood at 33% a year earlier. Net debt was SEK7.8 billion (EUR936 million) at 31-Jan-2013, well below the SEK20 billion (EUR2.4 billion) peaks of the early 2000s, but on an upward path over the past two to three years.

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SAS Group net debt 1993 to 2012 (SEK millions)

Source: SAS

Pension liabilities Accounting changes, to be applied by SAS from Nov-2013, will lead to a reduction in group equity. To mitigate this, SAS will transfer the majority of employees from the current defined benefit plan to a defined contribution plan, thereby not only reducing the impact on equity by an estimated SEK2.8 billion (EUR336 million), but also reducing defined benefit obligations by SEK19 billion (EUR2.2 billion) (58%). Geography In addition to being in some ways an historic strength, SAS’ location in a geographically peripheral part of Europe is also a weakness in that Scandinavia lacks sufficient population to support an extensive long-haul network. Its network focuses mainly on domestic routes and on connecting its three Scandinavian home markets with each other and the rest of Europe. Longhaul accounts for less than 3% of its seat capacity. This has meant that SAS has lost traffic to larger European network carriers, as passengers often need to connect via other hubs for long-haul destinations, and to lower cost rivals in its core short-haul markets. SAS international vs domestic capacity (share of seats) 11-Mar-2013 to 17-Mar-2013

Source: CAPA – Centre for Aviation & Innovata

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SAS international capacity by region (share of seats) 11-Mar-2013 to 17-Mar-2013

Source: CAPA – Centre for Aviation & Innovata

Ownership structure All three Scandinavian countries have a stake in the shares of SAS: Sweden 21.4%, Denmark 14.3% and Norway 14.3%. Although they do not control the airline, some initiatives require the approval of the governments and/or parliaments of all three countries (a recent example being the provision of a new credit facility by the government shareholders). While all national carriers, regardless of ownership, are often under the public spotlight and the subject of political scrutiny, if not active interference, the presence of three governments on the SAS shareholders’ register increases this attention. SAS also often requires agreement from eight (of its many more) unions before moving ahead with some major initiatives. This can make decision-making cumbersome and slow, reducing its ability to react to changing circumstances. Moreover, SAS’ ownership structure has probably been a disincentive to potential acquirers of the airline, who would have to negotiate with all three states in addition to the owners of the publicly traded shares.

SAS' Opportunities Cost reduction The SAS Group has a cost reduction target of SEK3 billion (EUR360 million) by FY2015 through its ‘4Excellence Next Generation’ plan. This plan involves new collective bargaining agreements with flying crew and maintenance personnel (wage rates have been agreed and new schedules are to be implemented in 2Q2013), new pension scheme arrangements (to be implemented through 2013), the centralisation of administrative functions (81% of administration posts will be in Sweden in 2015, up from 49% in 2012), headcount reductions, outsourcing of ground handling and call centres and IT restructuring. Unit costs are on a downward path, falling by 22% from 2009 to 2012 and by a further 2.7% in 1Q2013. Labour costs’ share of revenues fell to 33.4% in 1Q2013 from 34.1% in 1Q2012. 152

Change of ownership A change in SAS’ ownership structure, further reducing or eliminating government holdings could facilitate decision-making and encourage other potential owners to consider bidding for the group. Disposals/outsourcing In addition to cost saving targets, the ‘4Excellence Next Generation’ plan aims to achieve approximately SEK3 billion (EUR360 million) of increased liquidity from asset sales. SAS has initiated the process of selling its Norwegian regional subsidiary airline Widerøe and also aims to sell some of its airport-related real estate. It recently competed a sale and lease-back of 19 spare engines with an estimated market value of USD120 million. SAS has signed a letter of intent to outsource ground handling activities to Swissport and signed an agreement with Sykes for the outsourcing of call centres. Additional liquidity has also been provided through a new SEK3.5 billion (EUR420 million) revolving credit facility provided by banks and the three national shareholders. Fleet SAS has a fleet modernisation plan that is already well in progress. From 2014, its short/medium-haul fleet will consist of only one aircraft type for each of its three bases: A320 family (including A320NEO from 2016) at Copenhagen, and Boeing 737NG at Oslo and Stockholm. The plan will see all SAS’ MD80 and 737 Classics replaced by 2014 through leased aircraft – no capital expenditure is planned before 2016. Its long-haul fleet is already exclusively Airbus, with A330/340 aircraft. The rationalisation and modernisation of aircraft types should allow savings in terms of fleet maintenance, crew training and fuel efficiency. SAS Group fleet 31-Jan-2013

Source: SAS

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SAS Group fleet rationalisation to 2014

Source: SAS

SAS fleet delivery plan to 2019

Source: SAS

SAS' Threats Growing competition from LCCs Over the past decade, the Nordic region, historically too geographically remote to attract significant competition from carriers based in other parts of Europe, has seen growing penetration by low-cost carriers such as Ryanair and easyJet. In addition, the ‘local’ player Norwegian Air Shuttle has taken a significant market share after re-inventing itself as an LCC. Ryanair plans a number of new routes this summer in SAS’ home countries (if not its hub airports) including services from Aarhus and Billund in Denmark; Gothenburg, Jönköping, Karlstad, Malmö, Skellefteå, Stockholm Skavsta, Stockholm Västerås and Växjö in Sweden; Haugesund, Oslo Rygge and Oslo Torp in Norway. easyJet plans new Copenhagen services to Rome and London Gatwick this summer. Norwegian continues to plan double-digit capacity growth and will launch a number of new routes to European destinations from Copenhagen this summer. Moreover, Norwegian is starting long-haul services in 2013 with routes from Oslo and Stockholm Arlanda to New York JFK and Bangkok. SAS operates from both Oslo and Stockholm to New York Newark and so Norwegian’s new service is a direct competitor. 154

SAS operates to Bangkok from its Copenhagen hub and previous connecting traffic into this service from Norway and Sweden may be undermined by Norwegian’s direct flights from those two countries. Norwegian will continue to add long-haul routes in competition with SAS in subsequent years. Share of capacity in the Nordic market, full-year 2012

Source: APG (as shown in SAS 2012 annual report)

LCC share of international capacity (seats)

Source: CAPA – Centre for Aviation with data provided by OAG a UBM Aviation business

Industrial relations As with any labour-intensive service industry, airlines are vulnerable to labour unrest, not only among their own staff, but also among key airport-based suppliers such as ATC, ground handling, security and ground transport. For SAS, labour costs are a higher percentage of total costs and employee costs per employee are higher than for any other significant European airline. Although its eight key unions have agreed to labour productivity improvement measures under the 4Excellence Next Generation plan, the extent of change required cannot be underestimated and any deterioration in industrial relations would be a serious threat to the turnaround plan.

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Employee cost per employee (EUR) 2012*

*2011 for Lufthansa, Turkish Airlines, TAP Portugal; Oct-2011 to Sep-2012 for Air Berlin; Nov 2011 to Oct-2012 for SAS; Apr-2011 to Mar-2012 for Ryanair and Flybe Source: CAPA analysis of company financial statements

Stagnant economies/austerity and external events In an industry that remains highly sensitive to economic fortunes, all airlines are vulnerable to continued economic sluggishness. In addition, air travel, regardless of the carrier, is vulnerable to geopolitical events and natural phenomena such as earthquakes and volcanic ash disruption. Fuel price and currency movements The price of jet fuel, which accounts for more than one fifth of SAS’ costs, is highly volatile. This reflects not only the unpredictable price of crude oil, but also variations in the crack spread, or refinery premium. In addition, 31% of its costs, but only 7% of revenues, are in US dollars, making it vulnerable to a strengthening of the dollar against the Scandinavian currencies.

Mr Gustafson is not overstating the case when he makes the "final call" SAS is planning capacity growth of 5% to 6% in 2013, with a focus on new leisure routes, moving away from its traditional dependence on the corporate travel market. This is likely to be higher than traffic growth rates in Europe and comes at a time when LCCs such as Ryanair and Norwegian are also planning additional routes from the Nordic region.

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In spite of good progress with unit cost reduction, and the 4Excellence Next Generation plan to reduce costs further and improve liquidity, SAS’ low labour productivity and high unit costs will bring challenges in making this capacity growth profitable. Europe’s major legacy airline groups are concentrating on their own problems and seem unlikely to come to the rescue if SAS cannot effect its own turnaround. Mr Gustafson’s analysis that this is the final call for SAS would seem spot on.

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Norwegian  Air  Shuttle             Key Data Fleet and Orders Norwegian Air Shuttle Fleet Summary: as at 10-Apr-2013

Source: CAPA Fleet Database

Norwegian Air Shuttle projected delivery dates for aircraft on order: as at 8-Apr-2013

Source: CAPA Fleet Database

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Route area pie chart Norwegian Air Shuttle international capacity seats by region: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Top routes table Norwegian Air Shuttle top ten international routes by seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile Norwegian Air Shuttle schedule by class of seat - one way weekly departing seats: as at 8-Apr2013

Source: CAPA - Centre for Aviation and Innovata

Share price 2012/2013

Source: CAPA - Centre for Aviation and Yahoo! Financial

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Norwegian Air Shuttle: at a critical turning point Norwegian Air Shuttle’s 2012 results confirmed its position as the Nordic region’s most consistently profitable airline and the one with the lowest unit costs. This year represents a critical turning point for Norwegian. In 2013, it will establish its first base in a major capital city outside Scandinavia (at London Gatwick) and set up a base in the highly competitive mainland Spanish market. Moreover, it will also launch long-haul routes to New York and Bangkok. Only time will tell if 2013 proves to be the point where Norwegian turned up or turned down. This may depend on what the future holds for regional competitors SAS and Finnair. On long-haul, it will encounter efficient competitors from much lower wage economies and well established strongly branded operators from Europe, while on short-haul it will meet embedded lower cost competitors that will not have the distraction of start-up long-haul operations. Looking further ahead, it will need more bases around Europe in order to achieve the doubledigit growth rates demanded by its ambitious fleet expansion over the next decade or so. It may also need to consider recapitalising its somewhat slight balance sheet. Key points of 2012 financial results: pre-tax profits almost quadrupled Norwegian’s pre-tax profit almost quadrupled in 2012 to NOK623 million (EUR84 million), some 3% ahead of the NOK603 million (EUR 81 million) forecast by analysts. Revenues grew by 22%, with capacity (ASK) up 18% and unit revenue up 4%. Norwegian Air Shuttle financial highlights 2012

Source: Norwegian Air Shuttle

Financial track record: profitable, but margins inconsistent and balance sheet is slight While Norwegian has been profitable for a number of years, its level of profitability has been variable. Although 2012’s NOK 623 million of pre-tax profit equalled its best ever result in 2009, its 2012 revenues were 76% higher than in 2009 and its 2012 pre-tax margin was 4.8% compared with 8.5% in 2009.

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Norwegian Air Shuttle pre-tax profit and operating profit (NOK million) 2005-2012

Source: Norwegian Air Shuttle

Norwegian has, for a number of years, spent more on capital expenditure than it generates in operating cash flow, meaning that debt levels have grown year by year. Net debt stood at NOK3.8 billion (EUR512 million) at the end of 2012. Although balance sheet gearing (net debt to equity) fell from 162% in 2011 to 157% in 2012, these levels are sharply higher than the 10% gearing of 2008. With a significant proportion of the fleet financed through off-balance sheet operating leases and more than NOK1 billion in annual lease payments, adding capitalised operating leases to net debt would add a further NOK7 billion or NOK8 billion to the NOK3.8 billion (EUR512 million) reported (as a rule of thumb, operating leases are capitalised at seven or eight times annual lease payments). Taking operating leases into account, Norwegian’s balance sheet looks a little slight and it may need to consider addressing this before completion of its ambitious aircraft delivery programme. At the end of 2012, Norwegian had a gross cash pile of NOK1,731 million (EUR233 million), equivalent to 49 days of revenues. In an industry beset with unexpected one-off events, this is a reasonable cushion, but is less than Lufthansa’s 60 days, easyJet’s 77 or Ryanair’s remarkable 232 days.

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Norwegian Air Shuttle development of net debt and cash 2007-2012

Source: Norwegian Air Shuttle

Strong double-digit passenger growth rates focused on Oslo and Nordic region Norwegian has seen strong growth in traffic in recent years, with passenger numbers growing at a compound average annual rate of 21% from 2005 to 2012. Norwegian Air Shuttle passenger numbers (million, left hand axis) and ASKs (million, right hand axis) 2005-2012

Source: Norwegian Air Shuttle

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Norwegian’s market share in its home base of Oslo has stabilised at around 38%, with little movement since 2009. In Stockholm it has settled at half of its Oslo share, at 19%. In the other key Nordic hubs, Copenhagen and Helsinki, its 2012 market share was 15% and 10% respectively and it saw growth in this share. At London Gatwick it had a stable 6% share in 2012, while its share at its Spanish bases grew from 6% in 2011 to 8% in 2012. Norwegian Air Shuttle development of passenger numbers and market shares in selected markets 2007-2012.

Source: Avinor, Swedavia, Copenhagen Airports, Finavia, Gatwick Airport, Aena as referenced by Norwegian Air Shuttle

The importance of Oslo and the Nordic region to Norwegian, in particular domestic routes, is further highlighted by looking at its top 10 domestic and international routes. Its four biggest routes by seat capacity are domestic and only three of its international routes would rank in its overall top 10. These three – Oslo to Copenhagen, Oslo to Stockholm Arlanda and Stockholm Arlanda to Copenhagen – are all intra-Scandinavian routes. Norwegian Air Shuttle top 10 domestic routes by capacity (seats), 18-Feb-2013 to 25-Feb-2013 Source: CAPA – Centre for Aviation and Innovata Key to airport codes (Norway unless stated): BGO Bergen; OSL Oslo; SVG Stavanger; CPH Copenhagen Denmark; AAL Aalborg Denmark; ARN Stockholm Arlanda Sweden; LLA Lulea Kallax Sweden; BOO Bodo; OUL Finland Oulu; TOS Tromso/Langnes; HEL Helsinki Finland; GOT Gothenburg Landvetter Sweden

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Norwegian Air Shuttle top 10 international routes by capacity (seats), 18-Feb-2013 to 25-Feb2013

Source: CAPA – Centre for Aviation and Innovata SXF Berlin Schoenefeld; LPA Las Palmas

Oslo is more than twice as important a hub to Norwegian, measured by its seat capacity at the airport, than its number two base Stockholm Arlanda. Only two of its top 10 bases, Gatwick and Las Palmas, are outside the Nordic region. Norwegian Air Shuttle top 10 hubs/bases/stations by capacity (seats): 18-Feb-2013 to 25-Feb2013

Source: CAPA – Centre for Aviation and Innovata

Revenue growth mainly from international routes Although domestic Norway routes are Norwegian’s most important by seat capacity, the proportion of its revenues coming from international routes has grown from 60% in 2009 to 68% 165

in 2012. Ancillary revenues accounted for 11% of total revenues in 2012, the same as in 2009, but down from a peak of 12% in 2010. Competitors such as Ryanair and easyJet generate around 20% of revenues from ancillary services and products, suggesting this may be an area for Norwegian to look for growth. Norwegian Air Shuttle revenues (NOK million) 2009-2012

Source: Norwegian Air Shuttle

Norwegian has seen a welcome reversal in what was a falling RASK trend, with modest increases in both 2011 and 2012 after three years of declines before that. These RASK increases have come in spite of increases in average sector length and suggest that Norwegian has developed real pricing traction in spite of strong capacity growth. This pricing power probably reflects greater capacity restraint on the part of near competitors and Norwegian’s still lower prices than rival flag carriers. Norwegian Air Shuttle unit revenues (passenger fare revenue per ASK, NOK) 2007-2012

Source: Norwegian Air Shuttle

Costs growing a little faster than revenues in 2012 Fuel remained Norwegian’s biggest operating cost in 2012, accounting for 34% of the cost base. Labour reduced its share of costs slightly from 20% to 19%, a welcome trend given the high wage rates in the Norwegian economy. Total operating costs grew by 23%, slightly faster than revenues.

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Norwegian Air Shuttle operating costs 2011 and 2012

Source: Norwegian Air Shuttle

Labour productivity improving in spite of Norway's high wages In our report ‘European airlines’ labour productivity’, we highlighted that Norwegian has high employee costs per employee, but also high productivity in terms of ATK per employee. These two measures combined put it somewhere in the middle of the pack among European airlines when it comes to employee cost per ATK. Our analysis for Norwegian was based on its 2011 results. When using 2012 figures, its labour productivity trends are all moving in the right direction, but the overall conclusion remains that Norwegian’s good productivity levels are handicapped by high wage rates in Norway. Norwegian Air Shuttle labour productivity measures 2011 and 2012

*Headcount for 2012 is CAPA estimate based on reported growth rates in Norwegian’s quarterly results through 2012 Source: CAPA – Centre for Aviation analysis of Norwegian Air Shuttle financial statements

This point was further highlighted by the airline’s 4Q2012 results presentation, which included a chart comparing wage rates in Norway with selected other countries. Norwegian’s plans to expand on long-haul routes will bring it into competition with carriers based in much lower wage economies, particularly in Asia and this competition will be a challenge to these plans.

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Monthly gross salary (NOK) in Norway and selected other countries

Source: International Labour Organisation as referenced by Norwegian Air Shuttle in 4Q 2012 results presentation

RASK and CASK both increased in 2012 after some years of falling Since 2008, when Norwegian recorded an operating loss and a pre-tax result only just above breakeven (this was principally due to its fuel costs more than doubling), its return to profit was characterised by unit cost reduction (helped in 2009 by a fall in fuel costs). Although unit costs fell each year from 2009 to 2011, they saw a slight increase in 2012. Over the same period, Norwegian’s unit revenues (RASK) initially fell at a slower rate than unit costs before rising alongside CASK in 2012. As noted above, Norwegian appears to have developed pricing power to offset cost increases with fare increases, but this should not reduce the focus on lowering unit costs ex fuel. Norwegian Air Shuttle – index of operating cost per ASK and fare revenues per ASK (each indexed to 100 in 2008)

Source: Norwegian Air Shuttle, CAPA – Centre for Aviation

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Fleet At the end of 2012, Norwegian had a fleet of 68 aircraft, with 58 Boeing 737-800s and 10 737300s. The five leased 737-300s will exit the fleet by the end of 2013, leaving only five owned 300s in a short-haul fleet that will almost be a single aircraft variant fleet. In 2013, it is also scheduled to take delivery of its first long-haul aircraft, the Boeing 787-8, of which it plans to have three by the end of the year (two leased and one owned). It continues to be a significant user of operating leases – 40 out of 68 aircraft (59%) at the end of 2012, but most of its new deliveries in the next three years will be owned, so that it expects to have 43 out of 102 aircraft leased at the end of 2015.

Outlook for 2013: strong capacity growth, new bases, long-haul launch Norwegian expects a 25% increase in capacity (ASKs) in 2013, due to fleet growth, an increase in average sector length (driven by its UK and Spanish bases) and the launch of long-haul operations. It qualifies this expectation by saying that capacity deployment will depend on the economy and developments in the market place. In Spring 2013, it will open new bases at London Gatwick, where it is already the number three carrier behind easyJet and British Airways by seat capacity, and Alicante (Spain), where it is number five behind Ryanair, easyJet, Iberia and Vueling. Planned long-haul route launches are summarised in the table below. Norwegian Air Shuttle planned long-haul route launches 2013

Source: Norwegian Air Shuttle

In terms of fleet growth, it has 14 new Boeing 737-800s scheduled for delivery in 2013 and also expects to take delivery of its first 3 Boeing 787-8s. Its long-haul launch will be dependent on whether or not Boeing proves able to deliver these Dreamliners as scheduled in April, June and November. Boeing has told Norwegian that the delivery schedule for the first aircraft is at risk, although it has not yet confirmed any delay. Norwegian has indicated that it plans to fulfil its long-haul schedule this year, whether it uses the 787s as planned or leases other aircraft as cover. Clearly it needs to provide certainty to its customers, but the short-term lease of other aircraft would bring additional cost (although it may possibly be able to seek compensation from Boeing) and operational complexity.

The largest order in European history In January 2012, Norwegian announced the largest order in European aviation history, for a total of up to 372 aircraft: 100 A320 NEOs and 50 A320 options, 22 Boeing 737-800s, 100 Boeing 737 MAX and 100 options for the 737 MAX. Aircraft under these orders are due for delivery from 2016. Together with earlier orders for 737s and Boeing 787s, it now has 276 undelivered firm aircraft (see below). 169

Norwegian Air Shuttle aircraft on order

Source: Norwegian Air Shuttle Q4 2012 results presentation

Norwegian Air Shuttle projected delivery dates for aircraft being purchased directly from manufacturers* as at 18-Feb-2013

Source: CAPA – Centre for Aviation * Excludes new aircraft that are coming from leasing companies Aircraft operated by subsidiaries/associates of the main carrier may be listed separately.

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Norwegian Air Shuttle current committed fleet plan to 2015

Source: Norwegian Air Shuttle Q4 2012 results presentation

Fleet expansion plans are ambitious and raise important questions Setting aside the financing of the orders, there are three key strategic questions arising from Norwegian’s fleet plans. 1) Will its markets be big enough to absorb the number of aircraft on order? 2) Will moving from a short-haul fleet with a single aircraft type (Boeing 737) to two aircraft types (adding A320 NEOs) reduce operational efficiency? 3) Will the addition of longhaul be successful? The answer to the first question – will Norwegian’s markets absorb the fleet growth? – is probably the most important of the three. Its fleet plans imply double-digit growth rates for most of the next decade, even after allowing for Norwegian’s policy of replacing aircraft after seven years. In an industry that typically delivers low to mid single-digit traffic growth, Norwegian will need to continue to capture market share gains in order to fill the new aircraft. With 268 shorthaul aircraft to be delivered out of the total on order of 276, this will mean increasing its share of European short-haul markets. It has achieved double-digit growth rates for several years, but this has mainly been in the Nordic region. It is taking steps to expand from its Nordic strongholds to other parts of Europe, particularly in the UK and Spain, but those markets already have well established lower cost competitors in the form of easyJet, Vueling and, in particular, Ryanair. Norwegian is presumably also taking the view that SAS will disappear. Regarding the second question, moving to a two-supplier fleet, CEO Bjorn Kjos said at the time of the order that “Norwegian has now reached a size where we will benefit from having two suppliers, both in terms of ensuring adequate flight capacity, flexibility and competition between two manufacturers”. The size of both the planned Boeing and Airbus fleets should ensure that it benefits from scale economies, although there are likely to be some initial inefficiencies when the new Airbus fleet is still small.

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To some extent, the answer to this second question also depends on how much Norwegian is paying for its aircraft and this, of course, is not public information. The scale of the orders should have helped Norwegian to get significant discounts from list prices and it should also have benefited from being the European launch customer for the 737 MAX. Nevertheless, it must be at least be open to question whether Norwegian managed to achieve the ‘once in a generation’ type of discounts that Ryanair, for example, achieved with its 737-800 order (especially given that Ryanair walked away from a new Boeing deal in 2010). In order to succeed on long-haul, Norwegian will need to compete with very efficient carriers from low wage economies in addition to well-established well branded airlines from Europe. It will be a challenge, but it may be able to carve out a long-haul niche from its Nordic bases and, possibly, its growing position at London Gatwick on targeted routes. It may also benefit from any further liberalisation of traffic rights on a global basis, if it can prove to be more nimble than its legacy carrier competitors. However, it is the short-haul network that is likely to be the key to Norwegian’s long-term success. If Norwegian’s fleet expansion plans are not successful, it may need to develop skills as a lessor in order to place all the unwanted aircraft.

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Air  Astana    

                                 

 

Key Data Fleet and Orders Air Astana Fleet Summary: as at 10-Apr-2013

Source: CAPA Fleet Database

Air Astana projected delivery dates for aircraft on order: as at 8-Apr-2013

Source: CAPA Fleet Database

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Route area pie chart Air Astana international capacity seats by region: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Top routes table Air Astana top ten international routes by seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile Air Astana schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Air Astana plans more rapid regional growth as Kazakhstan emerges as world’s fastest growing market Air Astana is planning to focus on further expansion of its short-haul international network in 2013 as it looks to leverage its position as the strongest carrier in the fast-growing Kazakhstan market and the Central Asia region. Air Astana plans to add capacity on several regional routes, most of which it has launched over the last two years as part of its extended home market strategy, while launching service to Kiev in the Ukraine and potentially Sochi or Ufa in Russia. Air Astana will take a hiatus in growing its long-haul network after significant expansion over the last six months, including the launch of services to Hong Kong and Ho Chi Minh. The carrier, which enjoyed its 10th consecutive year of profitability in 2012 and ended the year with a respectable albeit reduced profit margin of about 6%, plans to resume long-haul expansion in 2014. For now the opportunities regionally and domestically are too big to pass up. Kazakhstan is projected by IATA to be the world’s fastest growing passenger market over the next five years. Central Asia, a region bereft of IOSA-certified carriers, also has emerged as a major growth market that Air Astana is uniquely positioned to exploit.

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IATA expects annual growth in Kazakhstan exceeding 20% IATA in its 2012 to 2016 passenger traffic forecast that was released in Dec-2012, projects 20.3% annual growth for Kazakhstan’s international market and 22.5% growth for the country’s domestic market. This makes Kazakhstan the fastest growing market in the world, both in terms of domestic and international traffic, by a wide margin. Another Central Asian country, Uzbekistan, was identified by IATA as the second fastest international market with projected annual growth of 11.1%. A third Central Asian country, Azerbaijan, also made IATA’s top 10 fastest growing international market list with projected annual growth of 8.9%. Two countries in the wider CIS region also made the list – Russia (with growth of 8.4%) and the Ukraine (with growth of 8.8%). These figures hardly come as a surprise to Air Astana, which has been riding Kazakhstan’s rapid growth for several years. The flag carrier, which launched services in 2002, has seen its traffic more than double over the last six years from 1.5 million in 2006 to an estimated 3.3 million in 2012. Revenues have increased at a similar clip, more than tripling since 2005. Revenues grew about 12% in 2012 while passenger traffic grew about 9%, according to preliminary figures. Air Astana annual passenger traffic 2002 to 2012*

Source: CAPA – Centre for Aviation & Air Astana Note: *2012 figure is a preliminary figure

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Air Astana annual revenue 2002 to 2012*

Source: CAPA – Centre for Aviation & Air Astana Note: *2012 figure is a preliminary figure

According to IATA data, Kazakhstan’s market consisted of 4.9 million passengers in 2011, including 2.2 million domestic and 2.7 international passengers. Air Astana transported just over three million passengers in 2011, giving it about a 60% share of the world’s fastest growing market. Air Astana currently accounts for about 64% of Kazakhstan’s domestic market, according to the carrier’s own figures. It currently accounts for 51% of seat capacity in Kazakhstan’s international market, according to Innovata data. Kazakhstan international capacity share (% of seats) by carrier: 14-Jan-2013 to 20-Jan-2013

Source: CAPA – Centre for Aviation & Innovata

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Air Astana targets extended home market While Air Astana has benefitted significantly from Kazakhstan’s rapid growth, particularly domestically where it allocates about 55% of its seat capacity, the carrier has been working during the last two years on building its position to exploit the growth in all of Central Asia and parts of the CIS. Kazakhstan is well positioned geographically, located in the north end of Central Asia and just south of Russia. This puts its Almaty and Astana hubs in perfect position to connect Central Asia as well Russia. As its main long-haul hub of Almaty is located in the far eastern corner of Kazakhstan, Air Astana is also well positioned to tap into the fast-growing market connecting the Far East, including neighbouring China, with Central Asia. Almaty also happens to be located almost exactly halfway between Europe and Far East but Air Astana has no intentions of entering the highly competitive Asia-Europe market as it is much more profitable offering short-haul to short-haul and long-haul to short-haul connections that exploit the carrier’s unmatched strength in its home region. Air Astana has seen its transit business grow from virtually zero a few years ago to accounting for 20% of its passenger traffic in 2012. The carrier expects further rapid growth in transit traffic as it continues to build up its regional network from both of its hubs. Air Astana CEO Peter Foster told CAPA that the carrier aims to serve all its regional destinations daily from both Almaty and Astana within two years while also launching a few new regional destinations. Currently all of Air Astana’s regional destinations are served less than daily, providing less than ideal connection options particularly for the carrier’s main client base – business passengers. Air Astana has so far gotten by without offering the most convenient schedules as it is the only decent option for many city pairs. But it recognises it will need to thicken out its schedule as more airlines expand across Central Asia and the CIS.

Air Astana plans 16% seat capacity growth for 2013 as five aircraft are added Mr Foster said that most of the 16% capacity growth planned for 2013 will be allocated to the regional market. The focus will primarily be on expanding frequencies on existing routes but he said the carrier also plans to launch service by Jun-2013 to Kiev, which is a big white spot in its otherwise strong regional network across the CIS and Central Asia. Mr Foster said the carrier is also considering adding a new destination in Russia during 2013 with Sochi and Ufa currently being evaluated. The regional expansion comes as Air Astana expands its narrowbody and regional jet fleet by five aircraft. Mr Foster said the carrier has agreed to lease two additional E190s for delivery in May2013 and Nov-2013, which will give Air Astana a fleet of eight E190s by the end of 2013. He said the carrier has also committed to adding a ninth E190 in Feb-2014 and is now looking at possible further expansion of the E190 fleet in 2014. Mr Foster said Air Astana also plans to take in 2013 the three A320s it has on outstanding order, with deliveries slated in May, July and September. This will give Air Astana a fleet of 12 A320 family aircraft by the end of 2013. It uses its A320 fleet on domestic trunk routes and on all flights to Moscow, St Petersburg, Delhi, Abu Dhabi, Istanbul and Urumqi in western China. (Some frequencies to St Petersburg and Tashkent are also currently operated with A320s.) 178

Air Astana will deploy the additional A320s primarily in the domestic market as the carrier has no plans to expand in India or China in 2013. The additional E190s will be mainly used to further grow the carrier’s regional international operation.

E190 becomes main tool in Air Astana’s extended home market strategy Air Astana took its first three E190s, which the carrier operates in 98-seat two-class configuration, in 2011 and added three more in 2012. The E190 was selected in 2009 as it was seen as the ideal aircraft to build the carrier’s regional international network, supporting its new extended home market strategy. The new E190 fleet has also have been used to take over the carrier’s Fokker 50s, which primarily operated domestically and were retired between Apr-2012 and Nov-2012. Air Astana had six Fokker 50s but only a portion of its new E190 fleet needs to be deployed domestically as the E190 has twice the capacity of the Fokker 50 and Air Astana had to drop on 01-Dec-2012 service to two domestic airports which can only accommodate turboprops. (Air Astana hopes at some point to resume service to Uralsk, an important market for the energy and mining industry in remote northwest Kazakhstan, but there has not yet been any movement on plans to upgrade the airport to accommodate jets.) The regional international expansion began in 2011 with the first batch of E190s used on services from Almaty to Baku in Azerbaijan, Bishkek in Kyrgyzstan, Dushanbe in Tajikistan, Tashkent in Uzbekistan, Tbilisi in Georgia and Samara in Russia. Azerbaijan, Georgia, Kyrgyzstan, Tajikistan and Uzbekistan are all Central Asian countries. Tashkent and Tbilisi were new markets opened with the E190s while Bishkek and Dushanbe had previously been served by Fokker 50s, which offered limited capacity and a less than ideal outdated all-economy product. Baku had been served with A320s and was transitioned to the smaller E190. Of Air Astana’s five Central Asian destinations, all are currently served with E190s with the exception of some frequencies to Tashkent. As three additional E190s were added in 2012, routes were launched from Almaty to Kazan in Russia and from Astana to Omsk and Saint Petersburg in Russia, Tashkent and Tbilisi. All five of the new routes began with two to three weekly frequencies – which is Air Astana’s typical strategy for entering a new market.

Air Astana rapidly expands in southern Russia Kazan and Omsk (and Samara the prior year) are all new destinations in southern or central Russia that were opened with E190s. Air Astana now has seven destinations in Russia – Kazan, Moscow, Novosibirsk, Omsk, Saint Petersburg, Samara and Yekaterinburg. Kazan, Novosibirsk, Omsk, Samara and Yekaterinburg are all considered regional destinations given their proximity to Kazakhstan. Novosibirsk and Yekaterinburg were originally served with Fokker 50s. Kazan, Omsk, Samara and Yekaterinburg are now all served with three E190 weekly frequencies while Novosibirsk is served with four weekly E190 flights. Of these five destinations, Kazan and Samara is currently only served from Almaty while Novosibirsk, Omsk and Yekaterinburg are only served from Astana, which is located near the Russian border. 179

Moscow is Air Astana’s largest international destination with two daily flights from Almaty and one daily flight from Astana. St Petersburg in eastern Russia is served with three weekly A320 flights from Almaty and the two recently launched E190 flights from Astana. St PetersburgAstana is the longest E190 route in the network at almost four hours. Moscow and to a lesser extent St Petersburg is seen more as local point-to-point routes because, unlike the destinations in southern or central Russia, it has frequent non-stop links to most Central Asian destinations. Air Astana is the largest Central Asian carrier serving Novosibirsk and Samara and is the only Central Asian carrier serving Omsk, according to Innovata data. Samara is served by two other Central Asian carriers, Tajik Air and Uzbekistan Airways, but Air Astana has more capacity in the market as the other carriers only serve Samara with one weekly flight. At Omsk, Air Astana is one of only four carriers operating international services along with Turkey’s Pegasus and Russia’s S7 and IrAero. There are only two routes from Omsk to Central Asia – Air Astana’s thrice weekly E190 service to Astana and one weekly Bombardier CRJ200 flight by IrAero to Baku. Air Astana is not the largest Central Asian carrier in Kazan or Yekaterinburg but as it uses smaller aircraft is generally able to offer as many or almost as many frequencies as its competitors. Air Astana intends to gradually build up over the next two years frequencies to daily in its four regional Russian markets as well as its five international destinations in other Central Asian countries. As is the case with its regional Russian routes, none of its Central Asian destinations are served daily yet – Tashkent has six weekly flights (four from Almaty and two from Astana); Baku has five weekly flights (three from Almaty and two from Astana); and Bishkek, Dushanbe and Tbilisi have four weekly flights each (Almaty only). The carrier is also looking at adding the Russian markets of Sochi and Ufa. Neither currently has any non-stop service to Kazakhstan but both are already linked to a small group of other Central Asian destinations with low frequency service from Central Asian and Russian carriers.

Kiev completes regional network puzzle for Air Astana Kiev represents a much bigger potential market and a huge hole in Air Astana’s current network. The Ukraine is the only country among the top 10 largest destinations from Kazakhstan not currently served by Air Astana. The carrier has been keen to add Kiev to its network for some time but has until now avoided the market because of over-capacity. Until recently two Ukrainian carriers served Kazakhstan with Aerosvit serving five destinations and Ukraine International Airlines (UIA) also serving Almaty and Astana. While UkraineKazakhstan is a big local market, particularly during the peak summer season, the up to 4,000 weekly one-way seats which were in the market during 2012 was not seen as sustainable. To fill its seats from Kazakhstan, Aerosvit and UIA frequently offered low fares to sixth freedom destinations in Europe served beyond Kiev.

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Ukraine to Kazakhstan capacity by carrier (one-way seats per week): 19-Sep-2011 to 07-Jul2013

Source: CAPA – Centre for Aviation & Innovata Note: Innovata data shows Air Astana launching services to Kiev at the start of the Northern Hemisphere summer season at the end of Mar-2013 but this launch date has not yet been confirmed by Air Astana.

The Jan-2013 exit from Kazakhstan of Ukrainian carrier Aerosvit, which is currently restructuring while in bankruptcy, has changed the dynamics of the market significantly, paving the way for Air Astana to finally enter Kiev. Aerosvit was the second largest foreign carrier after Transaero serving Kazakhstan, with up to 6,000 weekly round-trip seats depending on the season. UIA will take over some of this capacity but not all, leaving enough of a void for Air Astana. Aerosvit had approximately a 6% share of total international capacity in Kazakhstan and its exit should help European carriers in Kazakhstan as much as Air Astana. Lufthansa and Turkish, which are now the second and third largest foreign carriers in Kazakhstan based on seat capacity, should particularly benefit as Aerosvit’s low Kazakhstan-Europe fares are pulled from the market. (There is currently a freeze on any non-stop capacity being added to the KazakhstanEurope market as Air Astana is not able to expand to the EU until Kazakhstan gets off the blacklist while Kazakhstan is unwilling to let any European carrier add capacity until the blacklist issue is resolved.)

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Mr Foster said Air Astana plans to start serving Kiev before Jun-2013, initially with three weekly flights from both Astana and Almaty. Capacity will likely be added over time in line with the strategy for thickening the schedule to all regional international destinations.

Air Astana focuses more on expanding its secondary hub at Astana While most of the growth in Air Astana’s early years was funnelled to Almaty, where Air Astana is headquartered, over the last year several regional routes have been added at the capital Astana. The new focus on Astana comes partly in response to rising demand as Astana grows as a city but also partly because of necessity. Several major businesses in recent years have moved their main offices to Astana, which has seen huge growth and some of the world’s most impressive construction projects since becoming Kazakhstan’s capital in 1997. This has led to steadily growing demand for international services from Astana, particularly from the corporate sector. Almaty will remain the country’s largest city and financial centre but growth at the Almaty airport is challenging due to infrastructure limitations. Air Astana has been lobbying for several years for expansion of the airport, which only has four gates, but there has been no movement. The current owners came close to selling the airport in 2012, which provided a ray of hope as the new owners were more likely to invest in expanding the facility. But the transaction wasn’t completed and Air Astana is now left again with the status quo, which means no space to expand during peak periods. Mr Foster said the current capacity is about 1,600 passengers per hour while during the morning peak typically over 2,000 passengers pass through in an hour. Without being able to expand its existing banks at Almaty, Air Astana has started building up a bigger operation at Astana. The Astana airport is a much more modern facility, having opened in 2005, and has space to grow as well as handle an influx of transit passengers. The airport, which is government owned, is also moving forward with an expansion that will further boost capacity ahead of EXPO 2017, which Astana will host. Air Astana top 10 hubs/bases/destinations by capacity (seats): 14-Jan-2013 to 20-Jan-2013

Source: CAPA – Centre for Aviation & Innovata

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While Air Astana will continue to serve Almaty, it may be forced to direct all expansion to Astana and use Astana for all or virtually all transit traffic while limiting Almaty to only local traffic. This is not the preferred outcome as Air Astana sees rapid growth for both of its hubs. But at least the carrier has an alternative in Astana, which also provides a much better experience for the carrier’s transit passengers. “It’s great for Astana but poor for Almaty,” Mr Foster said, pointing to the economic impact on Almaty should Astana emerge as the carrier’s primary hub.

Astana has regional connections but no long-haul services to the Far East Astana is already well positioned for regional routes given the several route launches over the last year connecting Astana with other Central Asian capitals and Russia. It also has one of the carrier’s three European routes which are spread out across the country with Frankfurt served from Astana, London from Almaty and Amsterdam from Atyrau in western Kazakhstan. But Astana is currently not well connected to Asia with the exception of China. Air Astana route map from Astana

Source: CAPA – Centre for Aviation & Innovata

Air Astana route map from Almaty*

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Source: CAPA – Centre for Aviation & Innovata Note: *includes planned Almaty-Kiev route

Air Astana significantly increased capacity to China last year as it launched two weekly flights from Astana to Beijing and upgraded Almaty-Urumqi service from three weekly flights to daily. The carrier also continues to operate three weekly Astana-Urumqi flights and five weekly Almaty-Beijing flights. Mr Foster says further China growth will not be considered until 2014 as the carrier first wants to let the capacity added in 2012 be absorbed. The China-Kazakhstan bilateral was extended in 2012 to allow a third gateway in China for Kazakhstani carriers but Mr Foster said additional capacity is more likely to be added to Urumqi and Beijing before a new route to mainland China is considered. Air Astana would be interested in expanding in India, currently served from Almaty with five weekly flights to Delhi, but is constrained by bilateral restrictions. Air Astana will also not look at growing in other East Asia markets until 2014 with the exception of adding capacity on the new Hong Kong route. Air Astana currently serves Bangkok, Hong Kong, Ho Chi Minh, Kuala Lumpur and Seoul – all only from Almaty. Hong Kong was launched in Aug-2012 with two weekly flights. Mr Foster expects a third frequency will be added by summer 2013 and potentially a fourth frequency by the end of 2013. Air Astana increased its Bangkok service to daily as it launched two weekly flights to Ho Chi Minh on 04-Jan-2013. The new flight operates on an Almaty-Bangkok-Ho Chi Minh routing. Kuala Lumpur is served with three weekly flights and Seoul with two weekly flights.

Air Astana looks at Singapore and Tokyo for 2014 Mr Foster said the carrier expects to add a new East Asia route in 2014 after it takes delivery of its third new 767-300ER. Singapore and Tokyo are currently being evaluated. Air Astana now operates two leased older model 767s, which are to be replaced in 2013 as two new 767-300s are delivered. Air Astana originally ordered in 2012 four new 767-300ERs but recently cancelled one of the four orders after a Lufthansa Consulting study determined a threeaircraft fleet was sufficient for at least the time being. But Mr Foster said the carrier will continue to review its long-haul fleet needs and could lease an additional “newer” 767. “I believe in the long-term we will have more than three 767s in the fleet,” he said. The 767s will eventually be replaced by the three 787s on order, which are now slated for delivery from 2017. Air Astana also operates five 757s on long-haul routes to Asia and Europe. The carrier has extended the leases on these aircraft until the 2017 to 2019 time period. Mr Foster said the economy cabin on its 757s will be retrofitted in 2013 with new seats and seatback IFE. The business class cabins were already retrofitted in 2011.

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Air Astana to evaluate A320neo and 737 MAX in 2013 While the 757s it the perfect aircraft for Air Astana’s network of several thin routes of about seven to eight hours (a by-product of its location roughly halfway between Asia and Europe) Mr Foster said the leases will not be extended again. He said the carrier plans to hold a competition in 2013 to evaluate the A320/A321neo and 737 MAX. The new generation narrowbody aircraft will replace its existing A320s as well as, it is hoped, its 757s. Based on preliminary conversations with Airbus and Boeing, Air Astana believes the A321neo and 737-9 MAX may have sufficient range for most of its Asian and European routes without payload restrictions. If Air Astana is able to put A321neos or 787-9 MAXs on its 757s routes, the 787s could potentially be freed up to launch new longer-haul routes such as North America. Another issue Air Astana may have to resolve is what it will do with its Asian flights should its primary hub shift to Astana. The more populated Almaty is a stronger market for its Asian flights as most traffic on these routes consists of holidaying Kazakhs.

Airport infrastructure challenge could derail growth The situation at Almaty is worrisome as without a bigger airport the growth figures for the overall Kazakhstan market that are projected by IATA are not achievable. “When you look at the growth figures obviously this constraint is going to become actually critical,” Mr Foster said. He added that there will be a “massive constraint” on growth unless there is a “radical” change and the Almaty airport is expanded. Mr Foster said the airport situation has started to become “a major national issue” as without expansion by 2017 Almaty is projected to lose USD1.4 billion per year in GDP contributions. But so far there has been no movement on the long overdue expansion of the outdated and badly congested airport. In addition to a lack of gates and aircraft parking spaces, the current airport’s departure and arrival halls are tiny. The airport also does not have a proper transit facility and has only a very small common use business class lounge. IATA’s projections for the Kazakhstan market could prove to be overly rosy as Air Astana and foreign carriers face possible limitations on growth at the country’s largest international airport. Even with Air Astana’s recent international expansion at Astana, Almaty now accounts for 63% of the country’s total international seat capacity, according to Innovata data Air Astana itself is relatively conservative and isn’t planning to grow nearly as rapidly as the IATA projections. Mr Foster said after 16% growth in 2013 the carrier’s business plan envisions annual growth of between 7% and 12% over the subsequent five years. If the market does end up expanding as IATA projects despite the infrastructure limitations, Air Astana could see its market share slip significantly. IATA projects Kazakhstan’s market will reach 12.9 million passengers in 2016, including 6.8 international and 6.1 million domestic passengers. But assuming growth of 16% in 2013 followed by 10% per annum in 2014 to 2016, Air Astana’s traffic will only grow to just over five million passengers in 2016, giving it only about 40% of the market compared to 60% currently. If IATA projections are accurate, Air Astana would need to 185

carry nearly 8 million passengers in 2016 to maintain its 60% share of the market - a difference of more 50% compared to the carrier's current five-year business plan. While Air Astana has a strong position in its home market, other local and foreign carriers are keen to expand rapidly and profit from the world’s fastest growing market. Kazakhstan’s second largest carrier, SCAT, has been growing faster than Air Astana, reporting 22% passenger growth in 2012 to 1.1 million passengers. SCAT, which operates a mixed fleet of western and Russian aircraft, reportedly carried 692,000 domestic and 404,000 international passengers in 2012. Air Astana also competes in the domestic market against several small carriers but Air Astana is the only Kazakhstan carrier that is IOSA certified and not on the EU blacklist. Most of Kazakhstan’s other carriers also do not operate western aircraft. The market has seen several start-ups in recent years and could eventually attract a start-up following a more western model. Russia’s UTair recently said it was considering establishing a subsidiary in Kazakhstan.

IPO could lead to accelerated expansion for Air Astana Air Astana could accelerate expansion, allowing it to maintain its current share of the fastgrowing Kazakhstan market. An initial public offering (IPO) could help provide funds to support an accelerated expansion plan. The Kazakhstan government, which owns the flag carrier in partnership with BAE Systems, was originally aiming to list Air Astana on the Kazakhstan Stock Exchange in 2012 with a future secondary listing potentially in Hong Kong or London. But the IPO has not yet proceeded as the carrier’s two shareholders have not yet met to discuss the IPO and agree on terms. Mr Foster said Air Astana continues to support the idea of an IPO as he would like to see the carrier develop a stronger equity base and not have to rely as much on the debt markets. “We do need to this happen,” he said. “It’s a shame that it hasn’t happened [yet].” Once the IPO process is started, which could happen in 2013, the airline should not have problems generating interest given its consistent profitability and domination of the world’s fastest growing market. Air Astana has not posted a loss since its launch year, 2002. Profits were down in 2012 for the second consecutive year, slipping about 15% from 2011 levels and about 32% from the peak in 2010, based on preliminary figures. But Mr Foster points out that 2012 was a challenging year given the high fuel prices and the carrier did particularly well in the second half after as seeing an 80% drop in profits in the first half. Mr Foster said 2013 is hard to predict but carrier is “not too pessimistic” as economic conditions in Kazakhstan remain favourable.

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Air Astana annual profits: 2002 to 2012*

Source: CAPA – Centre for Aviation & Air Astana Note:*2012 figure is a preliminary figure

Air Astana outlook remains bright despite prospect of intensifying competition Air Astana has a bright outlook and will likely look at some point to accelerate expansion, particularly if there is a successful IPO. But the carrier is not overly concerned about its market share potentially slipping, or competition intensifying, as interest in Kazakhstan and Central Asia increases. Air Astana is focused on the top end of the market and expects to see rapid expansion by other types of carriers, particularly domestically. Air Astana has already seen its domestic market share drop from nearly 80% a few years ago to 64%. Further drops are inevitable, particularly as the carrier no longer has turboprops, which are needed to access certain domestic airports. In the international market it is also inevitable more foreign carriers will begin serving Kazakhstan and local carriers will look to take on Air Astana on more routes. Sharajah-based LCC Air Arabia has increased capacity by over 50% over the last year and is now the fourth largest carrier serving Kazakhstan after Transaero, Turkish and Lufthansa. China Southern is now the fifth largest foreign carrier and has expanded its Kazakhstan capacity by over 20% over the last year, according to Innovata and CAPA data. Turkey’s Pegasus Airlines in 2012 became the second LCC to serve Kazakhstan. More LCCs as well as more full-service carriers will certainly be keen to enter the world’s fastest growing market.

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Air Astana isn’t the largest airline in Central Asia but it has the strongest position While it has by far the biggest international profile among Central Asian carriers, Air Astana is not currently the largest Central Asian international carrier. Uzbekistan Airways is slightly larger, currently offering about 44,000 weekly international seats compared to 42,000 for Air Astana. In the Central Asia-Russia market, Air Astana is currently only the fourth largest carrier – behind Uzbekistan Airways and three Russian carriers: Ural Airlines, S7 and Transaero. Air Astana is currently the largest carrier in the much smaller intra-Central Asia international market, which it has targeted over the last two years. Over the last year Air Astana has grown international seat capacity on international rotues within Central Asia by 32%, according to Innovata and CAPA data. But the carrier still currently only has 3,500 weekly seats deployed on international routes within Central Asia, which makes Central Asia the second smallest of the seven regions Air Astana serves. Central Asia now accounts for only 8.3% of Air Astana's total international seat capacity, compared to 7.6% one year ago. Air Astana international capacity (seats) by region: 14-Jan-2013 to 20-Jan-2013

Source: CAPA – Centre for Aviation & Innovata

Air Astana’s presence in the five Central Asian markets it serves is also limited despite its extended home market strategy. Air Astana currently has a 2% share of international capacity in Georgia, Kyrgyzstan and Uzbekistan and only a 1% share of international capacity in Azerbaijan and Tajikistan, according to Innovata data. (The Kazakhstan, Azerbaijan and Uzbekistan international markets are all approximately the same size while Tajikistan is slightly smaller and Georgia and Kyrgyzstan are much smaller). But size does not always matter. Air Astana is focused on the top end of the market and becoming the “preferred carrier” in the region, particularly in the corporate sector. This initiative has largely succeeded as Air Astana stands out in the region because it is run to western standards. This in turn has helped the carrier forge several partnerships including with Etihad and Asiana. The carrier’s strong position in an increasingly important and fast-growing market will help attract more airline partners over the next few years, including potentially Cathay Pacific, and eventually a global alliance. Air Astana may not grow quite as fast as the 20% plus clip projected for the Kazakhstan market, but the carrier will take more than its share of high yielding economy and premium passengers. 188

Tajik  Air    

                               

 

     

 

Key Data Fleet and Orders Tajik Air Fleet Summary: as at 10-Apr-2013

Source: CAPA Fleet Database

Tajik Air projected delivery dates for aircraft on order: as at 8-Apr-2013

Source: CAPA Fleet Database

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Route area pie chart Tajik Air international capacity seats by region: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Top routes table Tajik Air top ten international routes by seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile Tajik Air schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

Tajik Air faces increasing pressure as Somon Air expands and new start-up enters the domestic market Tajikistan’s national carrier Tajik Air faces an uncertain future as privately owned Somon Air expands its share of the Tajikistan market and continues to outperform its government-owned rival. Tajik Air could see more pressure in 2013 following the planned launch of Asian Express Airlines, which plans to initially serve the domestic market. Somon Air, which launched services in 2008, now accounts for a leading 28% share of international capacity to and from Tajikistan. Unlike many other carriers in the region, Somon Air operates a modern fleet that consists entirely of western aircraft. It is now planning to distinguish itself further by pursuing IOSA certification. There are currently no IOSA-certified carriers in Tajikistan.

Tajikistan’s Dushanbe Airport sees rapid traffic growth ahead of terminal expansion Tajikistan’s main gateway is Dushanbe International Airport where national carrier Tajik Air is based. Tajik Air also has a secondary hub at Khudzhand International Airport. The airport is owned and operated by the Tajikistani Government. Dushanbe Airport says it handled over one

191

million passengers in 2012 with departing passengers increasing 15.5% year-on-year to 696,804 passengers and arriving passengers increased 11.1% to 604,648 passengers. 2013 will see the airport continue improvements to its facility and airfield including the construction of a new passenger terminal. French company Vinci is constructing the terminal which is planned to be 11,000 square metres and be able to handle over 5,000 passengers per hour. The new terminal is expected to open in Nov-2014. The airport received a long-term low interest EUR20 million loan from France to fund the EUR27 million construction cost. Dushanbe International Airport is providing the remaining EUR7 million. There are currently at least five local airlines in the Tajikistan market including Asia Airways, East Air, Somon Air, Tajik Air and Samar Air. Somon Air and Tajik Air are the country’s main two carriers, while East Air provides charter services for Tajik Air, Iraqi Airways, Icar Air and Eastok Avia. Asia Airways and Samar Air reportedly operate limited services. While government-owned Tajik Air is the country’s flag carrier, Somon Air is now the country’s largest airline, also based at Dushanbe International Airport. Somon Air started in 2008 with a single Boeing 737-800. It has since steadily grown and now operates a fleet of six 737s. Tajikistan international capacity (seats) by carrier: 21-Jan-2013 to 27-Jan-2013

* indicates a foreign carrier Source: CAPA – Centre for Aviation & Innovata Note: This data does not include Asia Airways or Samar Air.

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New Tajikistani start-up Asian Express Airline to launch operations in 2013 New start-up Asian Express Airline is expected to commence operations in 2013. The start-up recently took delivery of its first ex-Vietnam Airlines A320 aircraft in Nov-2012. The airline already has two BAe Avro RJ100s and one RJ85 aircraft, and plans to add more A320s and RJ100s. Asian Express was originally planning to launch operations in 2007. It has since been acquired by new investors who had planned to have the airline operational in summer 2012. In Feb-2012 Asian Express announced plans initially to operate domestically in Tajikistan before launching services to destinations in bordering countries. In the medium-term the airline plans to operate to Iran, the Middle East, Pakistan, Russia and Turkey. The air transportation market in Tajikistan is mainly international, with limited domestic services from Dushanbe to Khudzhand, Khorog, Kulyab and Gorno-Badakhshan. There are no low-cost carriers currently serving the market.

Russia accounts for most international capacity in Tajikistan Tajikistan’s main international market is Eastern and Central Europe, which accounts for about 84% of the country’s total international capacity. Russia alone accounts for about 78% of international capacity to and from Tajikistan. The Middle East, Central Asia, North East Asia, South Asia and Western Europe account for the remaining 16% of capacity. Services to other Central Asian countries are particularly limited. There are currently only about 2,700 weekly seats between Tajikistan and its immediate neighbours. Somon Air only has 700 weekly seats within the region while Tajik Air only has 600 weekly seats, according to Innovata data. Almaty is the biggest Central Asian destination from Tajikistan but the Almaty-Dushanbe route is only served with eight weekly flights – four from Kazakhstani flag carrier Air Astana and two each from Somon Air and Tajik Air. Russia is the country’s major market with seven out of 10 of the country’s largest routes (based on seats per week) being to Russian destinations and 10 Russian carriers operating to Tajikistan. There are currently about 44,000 weekly seats between Tajikistan and Russia. The majority of Somon Air’s operations are its routes to Russia, where it currently operates to 14 destinations. Russia currently accounts for about 80% of Somon Air’s total seat capacity, according to Innovata data. Somon Air currently has about 12,000 weekly seats on its Russian routes. Despite its small size, Somon Air currently has more capacity in Russia than any other Central Asian carrier except Uzbekistan Airways. Russia is also Tajik Air’s main market, accounting for over 80% of its international capacity. Tajik Air currently has almost 8,000 weekly seats to seven Russian destinations. Tajik Air and Somon Air compete in four of these markets. According to the CIA World Factbook, up to one million Tajik citizens work in Russia due to low employment opportunities in Tajikistan. Tajikistan’s population was estimated to be 5.05 million in Jul-2012 with a GDP per capita in 2011 of USD2,100. This is much lower than other Central Asian nations such as Kazakhstan (USD13,000) and Turkmenistan (USD7,800). 193

Tajikistan international capacity (seats) by region: 21-Jan-2013 to 27-Jan-2013

Source: CAPA – Centre for Aviation & Innovata

Somon Air is the largest carrier at Dushanbe Airport with just over a quarter of international capacity. National carrier Tajik Air is the second largest with around 18% and is followed by Russia’s UTair Aviation and Ural Airlines providing around 15% and 12% of international capacity, respectively. Dushanbe Airport international capacity (seats) by carrier: 21-Jan-2013 to 27-Jan-2013

Source: CAPA – Centre for Aviation & Innovata

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Dushanbe Airport top 10 international routes ranked by capacity (seats): 21-Jan-2013 to 27Jan-2013

Source: CAPA – Centre for Aviation & Innovata Note: VKO = Moscow Vnukovo Airport; DME = Moscow Domodedovo Airport; LED = Saint Petersburg Pulkovo Airport; ALA = Almaty Airport; SVX = Yekaterinburg Koltsovo Airport; KJA = Krasnoyarsk Yemelyanovo Airport; URC = Urumqi Airport; KZN = Kazan Airport; REN = Orenburg Tsentralny Airport; KBL = Kabul Khwaja Rawash Airport.

Seven of the above 10 routes are to Russian destinations while the remaining three are to Almaty (Kazakhstan), Urumqi (China) and Kabul (Afghanistan).

Somon Air and Tajik Air only compete on seven international routes Tajik Air and Somon Air are the main competitors on services from Tajikistan however they compete directly on less than half of their route networks. Out of Somon Air’s 15 routes and Tajik Air’s 17 routes from Dushanbe, they currently compete on seven routes. In addition to the four Russian markets of Moscow, Saint Petersburg, Novosibirsk and Yekaterinburg, Somon Air and Tajik Air both serve Almaty, Istanbul and Urumqi. Tajik Air is the only Tajikistani carrier now serving Iran, India, Pakistan and Afghanistan. Somon Air has nine unique destinations in Russia – mainly secondary cities that are not frequently served – and is the only Tajikistani carrier serving Dubai, the Ukraine and Western Europe. Frankfurt is the only destination in Western Europe and is only served with one weekly flight. The airlines don’t appear to cooperate on any services however. Somon Air is more focused on the higher end market, offering a modern product with western aircraft. It has tried to take a similar approach to that of Air Astana, which launched services in 2002 and is one of only a few airlines from the region operating to western standards. In 2006 Air Astana was offered a startup role in Somon Air but declined. Somon Air, however, was able in Oct-2012 to hire Air Astana’s founding CEO, Lloyd Paxton. Mr Paxton has said he is bringing in experienced professionals to help the airline increase its standards to an international level, including pursuing EASA and IOSA certification. There are 195

only a handful of airlines from Central Asia which currently have IOSA certification including the region’s two largest carriers – Uzbekistan Airways and Air Astana. Securing IOSA certification will be a key step in Somon Air’s attempt to pursue premium international passengers and become one of the region’s leading carriers.

Somon Air looking to improve operations while Tajik Air is facing difficult times Somon Air has already performed relatively well since launching in Feb-2008, quickly becoming Tajikistan’s largest carrier. But the carrier is still very small, operating just six 737s, and Tajikistan is a small yet competitive market. Tajikistan has a weaker economy than most of its larger neighbours and Somon Air’s main international market, Russia, consists mainly of migrant worker traffic. This could make it challenging to attract the premium traffic and yields needed to support the carrier’s relatively upmarket position. Somon Air will also need to balance out its network if it is to become a leading carrier in the region. It currently does not serve any destinations in East Asia except Urumqi, which is in the far western corner of China. And it only has one weekly flight to one destination in Western Europe. Unlike Air Astana, Somon Air is free to expand its European operation as Tajikistan is currently not on the EU blacklist. But there is limited outbound demand in Tajikistan for services to most markets other than Russia and the inbound demand has not reached a point where most medium or long-haul routes can be sustained. While Somon Air could face challenges in expanding under a premium-focused strategy, its outlook is brighter than Tajik Air, which also appointed a new CEO in Nov-2012 with Firuz Khamroyev replacing Isakov Muzaffar Safarovich. Tajik Air is reportedly facing difficult times with services to Baku, Islamabad and Delhi to be suspended due to the airline’s financial difficulties. Mr Khamroyev reportedly said to Asia-Plus that the airline’s financial situation is not stable. According to its website, Tajik Air has a fleet of 36 aircraft, only 15 of which are currently operated. The operational aircraft include only three western aircraft – one 737-300, two 737500s and one 757-200. The rest of the operational fleet includes one Antonov An-24, one An26, two An-28, one Yakovlev Yak-40, one Xian MA-60 and three MI-8MTV helicopters. The remaining 21 aircraft are in long-term storage. 2013 will be a testing year for Tajik Air while it continues to face increasing pressure from not only Somon Air and foreign carriers, but potentially from start-up Asian Express Airline. This new start-up's plans to enter the domestic market and later into regional international services will further aggravate Tajik Air’s current financial difficulties. Tajik Air’s future will depend on whether it can trim its fleet and focus on its most profitable services in order to effectively compete against growing competition in the market. It may also depend on whether it will continue to receive financial support from its main shareholder, the Tajikistani Government. Meanwhile Somon Air expects to continue to expand and take advantage of the growing air transportation market in Central Asia. The next few years could see the airline grow to become a significant player in the region.

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