Aviation: Low-costs under pressure?

The European low-cost airline sector didn't have it all its own way during 2018. The largest, third and forth largest carriers in the sector - Ryanair Norwegian and Wizz Air - all cut forecasts and announced reduced profits. So what's going on in the world of low-cost airlines - why are some of them struggling?

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Background

Over the last three decades budget airlines such as Southwest in the USA, Ryanair and easyJet in Europe, and Air Asia in the Far East, have transformed the way we travel. In doing so they swept away the era of high fares, replacing them with a la carte pricing.

Some low-costs are struggling while others are thriving.

In the early days, low costs took market share from the legacy airlines that continued to include all the extras in ticket prices. More recently however, the budget airlines have moved into new airports and regions that the majors didn't touch. These services were predicated on low fares as much as latent demand. However, the airline business is notoriously challenging and the law of the jungle - the survival of the fittest - usually prevails. The onslaught of low-fares forced the established legacy carriers to adapt by cutting both prices and amenities, as well as forming alliances. For the most part the big players have since become stronger while the smaller and weaker new entrants - especially those lacking a niche market or USP - have perished.

Set backs

Early 2019 signaled two noteworthy developments in Europe. Primera had already gone and WOW Air was on its last legs - at least while awaiting a potential suitor. On January 19 Ryanair issued its second profit warning for the year, revealing that its results were likely to be between €1.0bn and €1.1bn, rather than the previously forecast €1.1bn-€1.2bn. The Irish carrier blamed a need to cut fares by up to 7% to maintain load factors, against its previous expectation that only a 2% drop would be necessary. Just two weeks later it announced its first quarterly loss since 2014.

Two days earlier Norwegian Air, Europe's third largest budget airline, announced it would close three crew bases in Spain, one in Italy, and another two in the USA. The firm is also cutting frequency on some routes within Europe. But that wasn't all.

Norwegian has announced a rights issue to shore up its balance sheet. (Butz.2013)

On January 29 Norwegian announced a NOK 3.0bn rights issue aimed at shoring up its balance sheet, while also revealing it planned to dispose of some aircraft in its fleet and defer deliveries of others. At the same time IAG said it had abandoned attempts to take over the low-cost carrier which is struggling with a lack of profitability and a mountain of debt. Ryanair and Norwegian aren't alone. The quarter to December 31, 2018 saw Wizz Air's profits and margin reduce considerably with costs soaring, particularly for fuel and staff.

Meanwhile Iceland's WOW Air got itself into a parlous state while smaller players such as Primera Air and Cobalt Air disappeared altogether. Only this week Germania admitted its January payroll would be delayed while it continues to secure additional funding. It wasn't all bad news for the sector though. Mid-month easyJet unveiled growing revenue and increased profitability, although its share price is down nearly a third on the spring of 2018.

Challenging times

Firstly, during the last few years some budget airlines have prioritised growth over profitability. There is only so much growth a mature market like Europe can stand, and with the opportunities to open lucrative new routes diminishing some airline bosses decided to get in early rather than see a competitor move first. Newcomers have entered some markets and the extra capacity put downward pressure on fares. As competition intensified, the fare cuts became more prevalent - or at least it became more difficult to raise prices. The low-cost sector is notoriously flighty when it comes to maintaining unprofitable operations but even accounting for the aid that some airports have been prepared to offer, start-up costs are incurred while routes develop. Its only when a route is firmly established that fares can start to be carefully raised. But the constant stream of new aircraft being delivered hasn't helped constrain capacity.

There is a lot of capacity in the European low-cost market, and it isn't all provided by the big four. (ERIC SALARD)

The secret is to keep revenue coming - and to do that load factors (the percentage of seats that are occupied) have to be robust. Ryanair has led the way, filling more than 95% of its seats while easyJet and Wizz Air are not far behind. Norwegian's latest figures point are in the mid-80s%.

To maintain occupancy rates fares have been cut - Ryanair expects the average to be 7% lower this winter. But there's simply too much capacity in the European system right now and load factors and ticket prices aren't where they need to be to support all of the weaker players. Compounding the problems, would be customers that do not travel for business rarely visit an obscure destination more than once and the average traveller will only take a limited number of weekend trips away. All of the core routes in western Europe are being operated regularly and the market is largely saturated. What revenue growth there is, is coming mainly incrementally rather than from opening new markets, so load factors and fares have come under pressure. And budget carriers have been forced to look elsewhere to keep their growing fleets busy.

Long haul - no easy solution

Eastern Europe and north Africa were the new first regions explored, primarily because they could be accessed with existing narrow-bodied fleets. They represented a fruitful if more dispersed hunting ground, but one or two budget carriers like Norwegian looked further afield. Sir Freddie Laker was the first to try it in the 1970s, although he came unstuck in part due to predatory action from the established legacy airlines of the era.

The real challenge with low-cost long haul is keeping the aircraft in the air. After an eleven hour flight from Europe to the US west coast, an aircraft can't be turned around and sent back quickly. And some return trips can't be completed in 24 hours if sufficient leeway is built into the timetable to allow for ground handling and the delays that inevitably crop up from time to time. So airlines needed to find shorter flights for their widebodies fir between the longer trips. A London - Los Angeles - London - New York - London operation over two usually works. And if - like Norwegian - the airline is using narrow-bodies on long haul they don't have the range to reach the west coast so the mix has to include some European flying between trips across the Atlantic. It all adds complexity - and risk when delays occurs.

Low-cost long haul is not as simple as short haul. (Juraj Patekar)

Long haul services are also more expensive for airlines to run. Crews can't fly out and back in a day, so hotels and subsistence away from home come into the equation. The other problem is that passenger expectations are often greater on long haul. While many will accept going without food or drink on a one-hour intra-European flight, fewer find the same prospect appealing on an 11 hour journey. Once passengers started adding up the cost of checked bags and food, the total they had to pay suddenly got greater and closer to the fares demanded by the legacy carriers.

Norwegian's state-of-the-art Boeing 787 Dreamliners make a good impression but they have to be kept flying in order to cover their acquisition costs. Some analysts estimate the airline only makes money with them for four or five months of the year, and at other times it is forced to discount heavily to keep occupancy rates up. Any airline can fill its aircraft - the trick is to fill them at fares that are profitable (i.e. cover costs) on a continuous basis.

New fleets, more aircraft

Even now, Norwegian Air has outstanding orders for more than 120 new jets (92 Boeing 737-MAX and 30 Airbus A321) while Ryanair has 135 Boeing 737-MAX200s to be delivered and holds options on another 75 of the type. Meanwhile Hungary's Wizz Air has committed to take another 250 aircraft (against a current fleet of little more than 100) while there are more than 120 Airbus narrow-bodies easyJet in the pipeline for easyJet (current fleet just over 300). Norwegian has announced it will be disposing of some aircraft this year, and some of easyJet's and Ryanair's new jets will almost certainly replace some older aircraft currently in the fleets.

Airlines such as Wizz Air, Ryanair and easyJet have substantial numbers of aircraft on order. (Konflikty.pl)

Those new aircraft will are a step in the right direction: for example, the 737-MAX is around 16% more fuel efficient than the earlier models it will replace and carries more passengers, while Airbus claim the A320neo will burn 15% less fuel than an earlier derivative. Using 15% less fuel is great, but if that fuel costs twice what it did in 2015 then the bill is still much higher now. If the owners of all these new aircraft want to make money they still have to fill them consistently, and even more importantly the passengers need to be paying fares that cover rising costs.

Brexit, recession...

The price of jet fuel also rose steadily throughout much of 2018, but thankfully fell away again during the last two months of the year. It is currently back at 2017 levels, but still costs more than double what it did four years ago. With fuel accounting for an estimated 25% of costs, airlines remain very vulnerable to price fluctuations - especially those operating in countries where the currency has dropped as Jet A1 is bought in US Dollars. And yes, finally there is the old favourite - Brexit. It's unlikely to have a huge impact on aviation whatever the outcome, but analysts point to the lack of certainty and the Sterling's loss of value as key factors that have impacted airlines' results during 2018. The next year will be much the same, possibly more so.

The traditional 'legacy' carriers compete with the budget airlines, but most of the old-school have an advantage - they have business (and in a few cases first class) long-haul products, and these lucrative seats deliver the vast majority of the profits. This also enables the economy seats to be sold at prices near to those demanded by the budget airlines - the money is made in the premium cabins and the rest just needs to cover costs. For the most part the low-fare sector doesn't have that advantage, and even if it was introduced they would struggle to establish its credibility (the one notable exception in Europe is Norwegian's premium cabin, which the carrier is enlarging due to increasing demand).

Germania is looking for additional funding. (Kambui)

The real challenge in the low-cost sector will come when the big three or four take further knocks. A few niche players such as Volotea, Pegasus and Blue Air are doing reasonably well at the moment, but they are doing so in markets where the major players are not flying. Ryanair, easyJet and Wizz will not take on the low-fare divisions of Europe's legacy carriers (e.g. Eurowings, Transavia, Vueling), but if they face more pressure they are likely move in on the more lucrative routes the smaller airlines that have spent time and money developing. The larger airlines have the strength to take on a fare war and win, leaving the smaller carriers with no where to turn.

Rocky road ahead

The UK is preoccupied with Brexit while Germany is teetering on the edge of recession. Other European countries, particularly in the south of the region, are also not overly prosperous at present. The propensity for discretionary travel is going down in several of Europe's biggest countries. At the same time, new markets aren't being opened and are not growing at the rates the airlines expected when they placed huge aircraft orders two or three years ago. There is an excess of capacity in the market already - and there is more coming over the next two years which airlines will be challenged to utilise.

The easy growth phase is over and Europe's low-cost airlines are going to face continuing pressure through 2019 and beyond. New opportunities including long-haul are much more challenging. The major players including Ryanair, easyJet and Wizz Air will remain but will see reducing margins and slower growth. The jury is out on what happens to Norwegian. The sector will continue to provide a significant proportion of short haul capacity in Europe, but some of the weaker players have already gone and more will follow this year.

Text © The Aviation Oracle