GeeWizz - aviationstrategy.aero · Issueno.197 June2014-20 0 20 40 60 80 2009 2010 2011 2012 2013 2014 0 200 400 600 800 1,000 1,200 €m €m WizzAirfinancialdata Revenues Netprofit

Issue no. 197June 2014

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Note: YEMarch. Source: 2009-2013Wizz Air Holdings; 2014 Reuters.

Wizzair is the fi h largest LCC inEurope with traffic in 2013 of some13m passengers having grown at acompound annual rate of 10% in thepast five years. Formed in 2003by theformerCEOof the (nowdefunct)Hun-garian flag carrier Malév and basedat Hungary’s Budapest airport, it haspursued the strategy of developing aroute network connec ng the poorerCentralandEasternEuropeanna onswith the richer mainstream EU mar-kets. It has pursued the ultra-low-cost-carriermodel, targe ngdemandfrom CEE markets deemed too weakfor the likes of Ryanair and easyJet(which up to now have had more lu-cra ve targets topursue). Itwasgivena significant boost from the demiseof theHungarian flag-carrierMalév in2012.

Opera ng in a niche area it hasbeen able to build a network of 18bases in Central and Eastern Europeto secondary and ter ary airports inWestern Europe and operates to 97des na ons in 35 countries with afleet of 52 A320s (and 63 further onorder). With a prime AOC in Hun-gary, it also has an opera on in theUkraine throughWizzairUkraine (andformerly ran a subsidiary in Bulgariabefore that country’s accession intothe EU).

Published financial and trafficdata are sparse; it had been hopedthat the IPO prospectus wouldprovide some reasonable detailsof the opera ons. It is a memberof the European Low Fare AirlineAssocia on through which it reportsits passenger traffic trends on a halfyearly basis. In 2010 it establisheda UK-based, Jersey registered plcholding company – presumably asa vehicle for a future planned IPO.From the accounts at this holdingcompany it appears that revenueshave grown from €390m in the yearended March 2009 to €850m for

the year ended March 2013 – whilepress comments suggest revenuesto the end of March 2014 touched€1bn. Profits up to the year endedMarch 2011 weremarginal, but sincethen the group has started to achievereasonable returns: according to

Published by Aviation Strategy Ltd

This issue includes

Page

Wizzair op ons on abandon-ing IPO 1

Airbus: Emirates poses trickyques ons 4

Super-Connectors: The realthreat 6

Cargolux and the Chinese con-nec on 9

JetBlue:Making its unique LCCbusiness model pay off atlast? 12

Gee Wizz

T IPO of Wizzair has been long awaited, rumoured, and seem-ingly o abandoned. The announcement at the end of May thatthe Hungarian-based ULCC was planning to list on the the Lon-

don Stock Exchange therefore was not a total surprise. However, fol-lowing a handful of somewhat disappoin ng new equity flota ons inLondon,exacerbatedbyaprofitwarning fromLu hansa,Wizzhaswith-drawn its immediateplans forapublicofferingbecauseof “currentmar-ket vola lity in the airline sector”.

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This newsle er is published ten mes a yearby Avia on Strategy Limited Jan/Feb andJul/Aug usually appear as combined issues.Our editorial policy is to analyse and covercontemporary avia on issues and airlinestrategies in a clear, original and objec-ve manner. Avia on Strategy does not

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Wizz Air overlapwith Ryanair

Wizz base

Wizz destination

Ryanair base

Ryanair destination

Wizz Air overlapwith easyJet

Wizz base

Wizz destination

easyJet base

easyJet destination

2 www.aviationstrategy.aero June 2014

press reports the group achievednet profits of €89m in the year toend March 2014 reflec ng a veryrespectable EBITDARmargin of 24%.

The group’s major shareholder isIndigo Partners. Indigo is a US-basedprivate equity business with a se-rial interest in developing low costand ultra-low cost carriers round theworld. Run by Bill Franke – formerCEO of America West, and closelylinkedwithother serial investors suchas TPG’s Bonderman (chairman atRyanair) – Indigo has been involvedin the start-up and development ofSpirit, Mandala, Tiger, Avianova, andlast year acquired Republic to de-velop as a ULCC (see Avia on Strat-egy October 2013). Not all of its in-vestments can be categorised as suc-cessful but part of its strategy is tobuild up awidepor olio in the expec-ta on the some investments will dovery well. Having supported Wizzairfor thepast tenyears (as aUS investorit can only officially have a minoritystake in theEuropeanairline) Indigo isobviously looking for an exit.

What are the op ons? An IPO isout of the ques on in the short runnow. Having missed the February-June equity issue window on theLondon Stock Exchange a post-summer break introduc on a erSeptember may be possible; butgiven the tenor of the announcementto withdraw this would possiblyrequire a significant improvement inmarket sen ment towards the airlinesector. Could the group revitalisean idea of selling the opera on toanother airline in Europe?

It has been over ten years sincethe last flurry of LCC take-over in Eu-rope – EasyJet/Go and Ryanair/Buzz– so the ming may be appositeagain. Memories toomay have faded– Ryanair’s take-over of Buzz was

followed by integra on problemsand caused the Irish carrier to issuea profits warning. Go caused a majordent in easyJet’s profitability, andthere is a sound argument that, hadeasyJet just waited another year,rather than paying investment group3i £374m, Go would have run out ofcash and gone out of business.

There are threemain strategic ra-onales forM&A in the LCC sector:

( Rapidexpansion intoaneworun-der developed market (in Wizzair’scase, east and central Europe);( Removalof a compe tor fromtheoverall LCC market (or prevent an-other compe tor taking over Wiz-zair);( Cost savings and synergies, whichmakeagood investmentstoryandap-peal to the regulators, but which usu-ally prove elusive.

Ryanair?

In one sense Wizzair’s opera on isclose to that of Ryanair. It operatesrela vely low frequencies to sec-ondary and ter ary airports in orderto reduce the cost of opera on toenable it to offer the lowest farespossible. It also seems to have aunit cost of opera on not far fromRyanair’s ultra low cost base.

As themaponpage2shows thereis significant overlap between theRyanair network and that ofWizzair –with two major bases in Warsaw andBudapest where they currently flyhead-to-head. From Ryanair’s pointof view it may feel that it can pro-gressively move into Wizzair’s des-na ons without the any need to

buy out the compe on. Some yearsagoMicheal O’Leary in his pre-cuddlymode, derided the idea of buyingWizzair for any price.

In addi on Ryanair is a 737 oper-ator – although it might like to intro-

duce compe on for suppliers of air-cra . Its only interest may be piquedby the idea of another carrier acquir-ingWizz.

easyJet

The second map on page 2 showsa fairly complementary network be-tween easyJet and Wizzair. Althoughthere is a difference in philosophy to-wards des na on airport category,the two carriers both operate A320family aircra , with iden cal layout.While easyJet is dedicated to turningEurope orange, and is seemingly suc-cessfully pursuing a strategy of pro-viding a business-friendly alterna veto the legacy carrier intra-EUoffering,it may just be intrigued to acquire aseparate brand.

Legacy Interest

IAG is probably the most likely of theEuro-Majors to be interested. It hassuccessfully integrated Vueling intotheGroup, and there is nooverlapbe-tween Vueling and Wizzair (and use-fully both operate A320s). It is prob-ably the only one of the legacy carri-ers to have the imagina on to thinkof acquiring a pan-European brandseemingly in compe on with an-other of its subsidiaries. That is un-less Lu hansa decides that Wizzairis a fast track to building up its ownplanned LCC subsidiary to operatealongside Germanwings and a ackthe E had-backed airberlin.

June 2014 www.aviationstrategy.aero 3

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Airbus v Boeing Share Prices

Airbus

Boeing

T cancella on by Emirates ofits $16billionorder (list prices)for the newest version of its

A350 highlights a number of issuesfacing the manufacturer in the run-up to next month’s Farnborough airshow.

The first challenge is what todo in the wake of the Emiratescancella on. Even the ebullient chiefsalesman John Leahy had to admit attheopeningof the group’s innova ondays in Toulouse in mid-June thatthe loss of the deal for 70 A350 XWBairliners was “commercially, notgood news”. It looks as though thesuper-connector might now proceedto firm up its order for at least 150 ri-val Boeing 777Xs. Not onlywould thisbe the biggest civil aircra order ever,it would be a strong endorsementof the American company’s two-pronged approach to the long-haulwidebodymarket: the 787 family anda new 777 that can ou ly the top endof Airbus’s twin-engine models, withmore range and seats.

In reality, it is not all that bleak forAirbus. First, the cancella on mightbe a blow to pres ge, but no morethan that; the A350 development isproceeding (so far) without the de-lays and dramas that befell Boeing’s787. Second, as Fabrice Brégier, theAirbus CEO, explained, the Emiratescancella on will have no financial ef-fect since the delivery dates were forso far ahead that Airbus would havenoproblemfilling the slotswith otherorders,most certainly at be er pricesthan Emirates obtained as a launchcustomer. Third, it not en rely clearwhat is a firm cancella on any more

than what is a firm order: it has sub-sequently been reported that Airbusmay be given another chance to re-tender for the A350 order.

Airbus’s basic challenge is how tosharpen its compe on in the wide-body market. It is offering two ver-sions of the A350 (the smallest ofthree seems to be in the process ofbeing withdrawn, as customers optfor the larger two) against three ver-sions of the 787s and two of the 777.This means Boeing seems to be offer-ing a range tailored to a wider vari-ety of airline needs. From here, thechallenge breaks down into how torespond, segment by segment. LikeBoeing, Airbus is on record in recentweeks of saying that there is no de-sire to launch further whole new pro-grammes, each of which can cost up-wards of $10bn. So Airbus’s responsemust be to produce significant up-grades.

The most obvious opportunityis the A330, which could be fi edwith new engines to compete with

Boeing’s 787s. Although a re-enginedA330 could not compete on range itwould be able to fly 90% of the mis-sions the 787s will be used for. Withcompe ve fuel economy thanks tothe fi ng of more modern Rolls-Royce (or, less likely, General Electric)engines and with compe ve pricingthanks to development costs of the1993 aircra having long been writ-ten down, Airbus could hold on tomarket share. Talks have been goingonwithRolls-Royce;andAirbuswantsthe engine maker to assume someof the cost of adap ng the airframefor the newer engine. Unless it optsfor an A330 neo, Airbus risks losingthe250-300 seat segment toBoeing’s787s. Although the A330 has beenanoutstandingAirbus success,ordershave been drying up recently

The next challenge is the A350stretch. A350-800 (276 seats) ordersare regularly being switched to largermodels, with the encouragement ofthe manufacturer. But Emirates hasmade no secret of its interest in a

4 www.aviationstrategy.aero June 2014

Airbus:Emirates poses tricky questions

Airbus Backlog

Ofwhich EmiratesAircra Ordered Delivered In opera on Backlog In opera on On orderA318 79 79 68A319 1,514 1,410 1,403 104A320 6,694 3,671 3,473 3,023A321 2,060 931 927 1,129A300 561 561 273A310 255 255 126

A330-200 602 537 531 65 21 7A330-200F 38 26 26 12A330-300 702 525 518 177

A340-200/300 246 246 217 4A340-500/600 131 131 130 10

A350-800 34 34A350-900 589 589 50 (

A350-1000 189 189 20 (

A380 324 132 132 192 48 92

Total 14,018 8,504 7,824 5,514 83 169

Source: Airbus. Note:( Cancelled

twin-engined aircra carrying morethan the A350-1000’s 369 passen-gers. Their view of the world is ofstronger growth at slot-constrainedairports, thus pu ng a premium onlarger aircra . Indeed, the surpriseorder last year for 40 more A380slooks almost like a swap of the super-widebody for the larger twin. But thisonly serves to point to Airbus’s nextchallenge.

A bigger, be er A380 is nowbeing sought by Emirates. Tim Clark,Emirates President, has for someyears talked about the eventual needfor a larger aircra carrying up to 800passengers in some configura ons.Now he is calling for a re-engining ofthe plane to improve its cost per pas-senger kilometre in the light of whatthe biggest Boeing twin, the 777Xwillofferwhen it comes into use in five orso years. It is likely that Rolls-Roycewould get an exclusive deal to supplynew engines for both the A330neoand the A380neo, if they happen.This is a reinforcement of theway thecivil widebodymarket is lining up as atransatlan c duopoly: Boeing/GE onone side and Airbus/Rolls-Royce onthe other.

Below these strategic challenges,

Airbus faces tac cal decisions. For in-stance, one other op on for prolong-ing the life of the A330 (about 1,000in opera on) is the development of aso-called regional varia on aimed attheChinesemarket. Thishasde-ratedengines and a lower cer fied fuel ca-pacity (with a endant reduc ons inmaintenance and opera ng costs) tocram in up to 400 passengers in sin-gle class to fly two- to four-hour hopsbetweenChinese ci es. The larger ca-

pacity planes would counter limits toair-traffic control capacity. Airbus isalready working with China to helpthem improve air-traffic control butmay be forced into a deeper involve-ment (to add to its A320 final as-sembly line in Tianjin) to assemble oradaptA330s inChina to secure theor-der which had been expected duringthe Chinese leaders’ visit to Franceseveralmonths ago.

June 2014 www.aviationstrategy.aero 5

Wewelcome feedback from subscribers on the analysescontained in the newsle er. If youwould like to suggest acompany or a subject that youwould like to see covered,

please contact us:

Email: info@avia onstrategy.aeroor go towww.avia onstrategy.aero

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Emirates

Qatar

THY (Interna onal)

E had

T Euro-Majors are ge ngmore and more upset bythe incursion of the Super-

Connectors – Emirates, Qatar, E hadand THY – complaining loudly aboutunfair compe on and ins ga ng ECinves ga ons. Here, we a empt aquan fica on of the threat.

In roundnumbers, thefourSuper-Connectors have a combined fleet ofabout 700 aircra , with 900 jets onorder plus a further 300 or so op ons(andthentherealsoLe ersof Intent).

In total the Super-Connectorshave about $125bn of aircra onfirm order plus a further $45bn ofop ons; for comparison, the com-bined commercial backlog for Airbusand Boeing is about $845bn, so abacklog share of at least 15%. (Thesefigures are not list prices, which arenormally quoted in press releases,but es mated from actual deliveredor ordered prices, which imply a dis-count of 40-60%.) Emirates is almostcertainly Airbus’ most importantcustomer accoun ng for 7.5% of thetotal backlog value, which largelyreflects its A380 purchases.

This puts an interes ng perspec-ve on protec onist responses to the

Super-Connectors. If, for instance,Air France or Lu hansa were to blockor restrain further expansion intoFrance or the EU, what would be therepercussions for the French andEuropean aerospace industries andtheir supply chains?

In the following analysis we haveprojected seat capacity forwardusingthe carriers’ aircra annual deliveryschedules and adjus ng for replace-

ment capacity (we assume conserva-vely that widebody aircra will be

re red at 12 years and narrowbod-ies at 15 years). No deliveries fromnew addi onal orders are allocatedin the forecast period. We have alsocompared the forecast to the Super-Connectors’ owngrowth planswhereavailable. We then assume that loadfactors are constant and passengervolumes will grow at the same ratesas seat capacity growth, and comeupwith these forecasts for 2021: Emi-rates at 95mpassengers by 2021, THYat 60m interna onal (close to 100m ifdomes c is included); Qatar and E -hadat48mand37m, respec vely. Forcomparison, Lu hansa is around80mtoday.

Now to address the implica onsof the Super-Connectors’ super-growth, par cularly for the Europeancarriers.

The graph below brings togetherthe historic passenger growth ofthe four airlines and the combined

passenger forecast (based on themethodology described above).From 2008 to 2013, a period whichcoincides with the longest post-1945recession in thedevelopedworld, theSuper-Connectors grew by 15.6% pa,from 50m to 100m passengers; from2013 to 2021, their combined growthrate will probably be a li le lower –10.5% pa – but this will accumulate230mpassengers by 2021.

The next step is to compare thisforecast to the volume of passengersassociated with a “normal” growthrate; by “normal” we mean themarket growth predicted by Boeing,Airbus and other forecasters, whichfalls in the range 5% pa (average) to6.5% pa (high growth regions); this isthe traffic that the Super-Connectorswould plan for if they were growingat the same rate as the market.As the two curves diverge a gapof 59-77m passengers emerges bythe year 2021. This is the, say, 68menigma – the addi onal traffic that

6 www.aviationstrategy.aero June 2014

Super-Connectors:The real threat

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Euro-MajorsTraffic toMiddle East,Asia and Africa

Super ConnectorsTotal Traffic

somehow has to be generated by theSuper-Connectors to fill their newaircra .

Of course, the traffic forecastscould simply be wrong. The growthrates from Asia and Africa could bestronger than an cipated with theSuper-Connectors s mula ng trafficin a similar way to the LCC effecton short/medium haul markets. Orthe Super-Connectors could have,like many airlines before them,over-expanded, in which caseMiddleEastern consolida on will probablyhave to take place.

Impact on the Euro-Majors

The Euro-Majors fear increasedmarket share capture. Currently, theEuro-Majors fly about 36m passen-gers between Europe and theMiddleEast/Asia/Africa , and they might ex-pect to grow this total to say 45m by2021 if they trackedmarket forecasts,but, given the Super-Connectors’capacity plans, they face the threat ofvery low growth, maybe retrac on,in the world’s fastest growing mar-kets. This would be consistent withan analysis of historic trends. Thefollowing graph compares the Euro-pean carriers’ traffic performance onMiddle East/ Asia and Africa routesagainst the Super-Connectors over

ten years (remember that E had onlystarted opera ons in 2003).

The message is that the Super-Connectors have captured or gener-ated almost all the addi onal trafficin these fast-growing developmentalmarkets while the European carriershavemore or less stagnated.

One implica on is that the Euro-Majors become essen ally nicheplayers in these markets, focusingon the major point-to-point routeswhere they may be able to achievesubstan al yield premiums overconnec ng flows.

The Euro-Majors and their USpartners have also to be concerned

about the Super-Connectors allo-ca ng new capacity to the Atlan c,diver ng non-European origina ngtraffic and by-passing the Euro-hubs.The Super-Connectors could thenemerge as a new compe ve forceon the Atlan c which the Euro-Majors had oligopolised throughtheir immunised alliances with theUS Majors. This is probably a muchmore worrying development for theEuro-Majors than long-haul start-upslike norwegian.

Finally, the Super-Connectorsadd to the Euro-Majors’ problems intheir short-haul sectors, which aregenerally very loss-making. Havingseen their point-to-point traffic evis-cerated by the LCCs, their connec ngtraffic is now also being eroded bythe Super-Connectors.

IAG

IAG appears able to take a rela-vely sanguine view on the Super-

Connectors as the threat is limited.

( Both hubs, Heathrow andMadrid, face west. Heathrow is, andis likely to remain, the prime gatewayon the North Atlan c while Madridis the main gateway on the SouthAtlan c.

June 2014 www.aviationstrategy.aero 7

( Bri sh Airways is the dominantplayer at the hub in Europe with thebest Interna onal O&D traffic flows;it is much less reliant on connect-ing traffic than the other two Euro-Majors

( Capacity restraints at the airportmean that BA will be increasingly un-able to provide short haul feed on tolong haul services – especially fromdomes c regional points, reinforcedby UK avia on policy and taxa on.The regional feed services into LHRhave for years been under compe -on from KLM through Amsterdam,

so, for example, Emirates’ opera onsto Newcastle probably impact KLMmore than BA.

( Madrid is the main gateway onthe South Atlan c with strong O&Dtraffic to La n America and Iberia hasno exposure toAsia and limited expo-sure to theMiddle East or Africa.

( Among the Euro-Majors it has arela vely lowexposure to theFar East–butwhere it is present it has a signif-icant level of O&D point to point de-mand (such as Hong Kong or Singa-pore).

( How its passenger alliance withQatarwilldevelop isuncertainbut thecargo joint-venture looks like a goodstrategic innova on.

( Nevertheless, IAG will be sub-ject to possible diversion of trafficthrough the Super-connectors’ hubs,par cularly India-UK traffic and UK-Africa routes, which are highly ca-pacity constrained on direct services.Traffic could be lost on India/Asiato Americas, Japan-Europe and Asia-Europe (par cularly Spainconnec ngtraffic). The Kangaroo route is in dan-ger from con nued a ack (followingVirgin Atlan c’s recent withdrawal,BA is now the only European carrierserving Australia).

Air France-KLM

Air France-KLM has a high degreeof connec ng traffic and is underserious threat from the Super-Connectors. A tendency to retreatinto protec onist bilateral-think justpostpones rather than obviates thisthreat.

( Amsterdam is primarily a trans-fer hub with low levels of pure O&Ddemand, and KLM relies on success-ful short haul routes from regional (ienon-hub) European ci es to feed itslong-haul services.( KLM is par cularly exposed toincursion into European non-hubairports by the super-connectors onroutes to the Far East, Middle Eastand Africa. Air France and KLM havea rela vely high level of access intoChina which leaves them open totraffic diversion on routes to Europe,Africa andNorth and South America.( AF-KLM has chosen to ally withE had but this alliance is with thesmallest of the Super-Connectors andis greatly complicated by E had’s in-vestment spree in Europe.

Lu hansa Group

Lu hansa, probably correctly, feels it-self to beunder various a acks by theSuper-Connectors.

( The three main Lu hansa Groupairlines each have small local catch-ment areas at their main hubs andare reliant on transfer traffic. WithinGermany the biggest problem is thatthe country is for historical reasonshighly decentralised: Lu hansa mayhave its main hub in the financialcentre in Frankfurt; but each of thefederal states has a significant levelof origina ng travel demand whichgenerally will have to transfer some-where to go long haul.( Lu hansa has some regulatoryprotec on in that the UAE bilateral

currently restricts the number ofGer-man ci es that can be served by Emi-rates and E had, but Qatar is build-ing up its network to the east and, im-portantly, THY is satura ng Germany,offering intercon nental connec onsfrom small ci es.( Having failed with THY, its onlyotherallianceop on iswithEmirates,but this is out of Lu hansa’s hands,dependent on Emirates changing itsnon-alliance policy.( On all its long haul routesLu hansa appears exposed to thegrowth of the Super-Connectors.On short haul, E had’s support ofairberlin is a double-edged sword(which may even be Damoclean):it may help to keep at bay furtherincursion from the LCCs (Ryanair,easyJet, norwegian, Vueling andWizz) into Germany, but it is likelyto exacerbate the pressure on yieldsand feeder traffic as airberlin chasescash.( In addi on, the Gulf carriers inpar cular are pursuing cargo traffic;and with limita ons on night flightsat Frankfurt, Lu hansamay find itselfincreasingly under pressure in one ofits core opera onal segments.

8 www.aviationstrategy.aero June 2014

Boutique Aviation Consultancy

D D-

-

@ .

F the recent acquisi-on of a major stake in Car-

golux by a Chinese company,a new dual-hub strategy appearsto have caused division among theairline’s senior management. Whatdoes the future hold for Europe’slargest cargo-only carrier?

Cargolux was established in 1970by flag carrier Luxair and a numberof private companies, including Ice-landic Airlines and the Salen ShippingGroup. Since then, however, the air-line has had an even ul history; bothLu hansa and SAir bought and thensold minority stakes, and in 2010 theairline was fined €80m by the Eu-ropean Commission for price-fixing(which the airline is s ll appealingagainst), with Ulrich Ogiermann – theCEO at the me – given a prison sen-tence.

In September 2011QatarAirwaysbought a 35% stake in Cargolux,making it the second largest share-holder at the me a er Luxair, whichowned 43.4%. Qatar was eager tomake Cargolux one of the world’stop cargo carriers by 2015, but just ayear later Qatar announced it wouldsell its stake a er differences withother shareholders over the carrier’sstrategy.

In 2012 Qatar’s stake was sold tothe Luxembourg state for $117.5m,before in turn being sold to China-based Henan Civil Avia on Develop-ment and Investment Co. (HNCA) inApril 2014 in a deal worth $120m. To-day the other shareholders are Lux-air, with 35.1%; the Banque et Caissed’Epargne de l’Etat (BCEE), 10.9%;

the Société Na onale de Crédit etd’Inves ssement (SNCI), 10.7%; andthe Luxembourg state (8.3% – a stakebought fromLuxair inApril 2014 inor-der togive thestateanongoing role inCargolux).

At the same me as the HNCAdealwas closed, Cargolux announcedthat shareholders had approved a$175m increase in its share capital inorder tostrengthenthebalancesheetandprovide funds for freighterordersand expansion of the route network.As well as the $120m it paid for the35%stake,HNCA isproviding$15mtoCargolux’s “development fund” andup to $61.5m towards this capital in-crease. The balance sheet certainlyneeds strengthening – as at the endof2013,Cargolux’snon-current liabil-i es stood at $1.5bn, up considerablyfrom the $1.2bn level of 12 monthsearlier.

Chinese inten ons

State-owned HNCA was only es-tablished in 2011 and its remit isto “accelerate the growth of theHenan civil avia on industry”, and todevelop the Zhengzhou airport eco-nomic zone. Zhengzhou is the statecapital of Henan province, which islocated to thewest of Shanghai.

The deal is resul ng in majorchanges to Cargolux’s strategy, withthe airline now changing to a dual-hub opera on at both Luxembourgand Zhengzhou. This change ofstrategy though is known to havefaced opposi on by several seniorexecu ves at Cargolux.

The alleged unpopularity of theimpending deal and its implica ons

for strategy directly led to the resig-na on of both Peter van de Pas, COO,and Robert van de Weg, the SVP forsales andmarke ng, earlier this year.Weg had been with the airline for 14years, and both execu ves have nowstarted new posi ons at AirBridge-Cargo, Russia’s largest scheduledcargo operator (with 12 747Fs) andowned by the Volga-Dnepr Group.

And Robert Song – briefly Car-golux’s SVP, head of Asia Pacific –le the company a few weeks a er“brokering” the deal with HNCA,with unconfirmed reports implyinghe clashed with senior execu ves atCargolux. Song previously advisedHNCA and only joined Cargolux inMarch.

The Volga-Dnepr Group – whichvan de Weg and van de Pas havejoined – was one of the companiesthat had (unsuccessfully) bid to buythe state’s 35% stake in Cargolux.Other rumoured bidders includedNippon Cargo Airlines and Silk WayAirways, but sources suggest thatall other companies fell away earlyin the process, leaving HNCA as theonly serious bid le . In addi on theLuxembourg government may havebeen a racted by selling its staketo a company that would clearlyimprove trade es between Chinaand Luxembourg – rather than atrade buyer thatmademost strategicand commercial sense for Cargoluxitself.

Based at Luxembourg’s Findel air-port, Cargolux currently operates afleet of 20, comprising 11 747-400Fsand nine 747-8Fs. It was the launch

June 2014 www.aviationstrategy.aero 9

Cargoluxand the Chinese connection

Cargolux Fleet2010 2011 2012 2013 OnOrder

747-8F 2 6 9 4747-400F 13 10 9 8

747-400BCF 3 2 2747-400ERF 1

Total 13 15 17 20 4

customer for the 747-8F back in 2005and has ordered 14 of the model intotal (the latest order for another air-cra – cos ng $358m at list prices– coming in February this year). Thefirst aircra arrived in October 2011and five are s ll to be delivered. Twowill be delivered in 2014 and all willarrive by 2017; they are gradually re-placing all the ageing 747-400Fs inthe fleet. The airline’s fleet has grownsteadily but slowly over the last fewyears, and this pace is not set tochange any me soon.

In 2013 Cargolux reported a14.5% rise in revenue to US$1,989m,based on a 16.7% rise in tonnes soldto 0.8m. However, load factor fell 0.9percentage points to 67.7% in 2013,and daily aircra u lisa on alsodecreased marginally, from 15:07block hours in 2012 to 14.57 hours in2013.Cargo overcapacity

Nevertheless, Cargolux turned aS35.1m net loss in 2012 (followinga $18.3m net loss in 2011) into a$8.4m net profit in 2013, with oper-a ng profits increasing from $8m to$59.5m, though the airline said that“the airfreight industry con nued tooperate in a difficult environmentfor the most part of 2013 – capacitygrowth s ll outstripped demand,which resulted in an industry-widedecline in yields and load factors”.

Much of that capacity growthcame from the Gulf Super-Connectors, who added considerablebelly capacity as their passenger

fleets grew (see Avia on Strategy,November and December 2013, andJanuary/February 2014). Thoughother airlines took freighters out ofservice through the year this onlypar ally compensated for the greatercargo capacity of the Big Three in theGulf region.

Cargolux also competes againstthe so-called “integrators” – com-panies such as DHL, FedEx and UPS.Germany-based DHL, for example,has five avia on subsidiaries underDHL Avia on that operate more than100 aircra between themacross theworld, including 44 757-200Fs and29 A300Fs. But even DHL is ny com-pared with themight of Fedex, whichoperates 650 aircra , of which 100are Airbus models and 260 Boeingmodels.

Despite industry overcapacityCargolux increased its own capacitythrough 2013, and “successfullyincreased volumes in order to max-imize contribu on to fixed costs”.As well as extra capacity on exis ngroutes, in 2013 Cargolux added 12new des na on all over the world –to Buenos Aires, San ago de Chile,Dallas, Columbus, Tripoli, Bamako,Port Harcourt, Ouagadougou, Mus-cat, Munich, Vienna and Zaragoza– and the airline now operates toaround 100 des na ons globally.

According to IATA sta s cs oninterna onal scheduled FTKs, Car-golux’s global market share grew to3.5% in December 2013, making itthe eighth largest airline in the air

cargo airline rankings. Cargolux willkeep growing this year, although toa lesser extent than in did in 2013;at the end of April, Dirk Reich – CEOand president of Cargolux – said: “Wedon’t expect market condi ons toimprove significantly in 2014, butour priority is to expand our globalnetwork while focusing on efficiencyand performance improvements.”

Reich became CEO in March,replacing Richard Forson, who hadbeen interim CEO (as well holdingdown his regular posi on, CFO) sinceAugust 2012. Reichwas previously anEVP at Kuehne &Nagel Interna onal,a Swiss transporta on and logis cscompany, and prior to that worked atLu hansa.

However, just where Cargolux’scon nued growth will come is nowopen to ques on following the in-vestmentbyHNCA.Cargolux ini ateda five-year business plan in Febru-ary 2013, which was updated in early2014 in prepara on for the HNCAdeal, and core to the new plan goingforward is the adop on of a dual-hubstrategy.

In prac ce this means that Car-golux will operate two mes a weekbetween Luxembourg (and via Baku,Azerbaijan) to Zhengzhou ini ally, ris-ing to at least four mes, althoughthose ini al opera ons hit regulatoryclearance problems, and the launchof the route had to be pushed backfromApril to June.

HNCA has an ini al target of20,000 tonnes a year between Lux-embourg and Zhengzhou, which isat the centre of a region known forthe manufacture of technology andIT products that are exported intoEurope. The longer term plan is forCargolux to build up routes fromZhengzhou to other Asian ci es, andeven transpacific routes, although

10 www.aviationstrategy.aero June 2014

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ATKsRTKs Load Factor

what the implica ons for Cargolux’sexis ng network to China has yet tobe revealed; the carrier currently op-erates a daily service to Shanghai andother flights to Beijing and Xiamen.

Apparently Cargolux has sus-pended a route between Luxem-bourg to Taipei and Singapore inorder to free up capacity for the newZhengzhou flights, and some reportssay the plan is to base around sixto eight of Cargolux’s current fleetpermanently in Zhengzhou – thoughthis has been denied by onememberof Cargolux’smanagement.

What is known is that Cargolux iscurrently analysing the possibility ofa joint venture airline based in China,and if the ini al route to Zhengzhou issuccessful that joint venture will cer-tainly be launched, though this is notlikely un l the first quarter of 2015 atthe earliest.

It’s something that Cargolux hasdone before, as in December 2008it set up Cargolux Italia, a joint ven-turewith Italian investors (andowned40% by Cargolux). Based near MilanMalpensa airport, Cargolux Italia op-erates a single 747-400F on routesto Dubai, Hong Kong, Osaka, Almaty,São Paulo and Luxembourg. In 2013the airline carried 93,106 tonnes offreight, 29.5% higher than in 2012,

with revenue increasing by 16% year-on-year in 2013 to US$143m.

But the worry that some peo-ple have – both within and outsideCargolux – is that HNCA’s long-termaims are incompa ble with a sensi-ble strategy for Cargolux. HNCA’s ra-onale for the acquisi on and the

adop on of a dual hub strategy isclear – Zhengzhou was the fastest-growing cargo airport in China lastyear, with a 70% increase in tonnespassing through the airport thanksto being part of the government’scargo development plan – and theCargolux stake will undoubtedly ac-celerate that growth.

Veto power

Controversially, it has been reportedthan HNCA – despite having justa 35% share – has been granted aveto over all decisions at Cargolux,effec vely giving it control over thestrategic direc on of the carrier. Thishas caused concern among unions,who already have a long-runningdispute with management over jobguarantees and proposed replace-ment of exis ng work contracts –last year unions and the companyclashed over these proposed staffcost savings, with many rounds ofnego a ons breaking down several

mes.

The two unions represen ngmost of the airline’s 1,600 employeesare wary of the inten ons of theChinese shareholders and its visionfor the strategic future of Cargolux,and the Luxembourg Chamber ofEmployees has also cri cised thedeal, saying that it will divert aircrafrom profitable parts of the Cargoluxnetwork.

Unfortunately for both HNCAand Cargolux, in December 2013the Chinese cargo company Navit-rans launched a two mes a weekfreighter flight between Zhengzhouand Liège, which is just 165km awayfrom Luxembourg. 747-400Fs areoperated on Navitrans’ behalf byTNT Airways with the companysaying it is targe ng at least 20,000tonnes a year on the route, carryingequipment such as smartphonesinto Europe – which us exactly thesame market that Cargolux/HNCAis targe ng for the Zhengzhou toLuxembourg route.

Nevertheless, Cargolux will presson with its new dual-hub strategy,andwhether unions and some seniormanagement like it or not, Cargolux’sfuture is now closely ed to the de-sires and inten ons of HNCA.

June 2014 www.aviationstrategy.aero 11

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20052006

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20132014F

2015F

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JetBlue’s Financial Results

Opera ng profit

Net result

Revenues

Note: Analysts’ consensus forecasts

A years of underperform-ing its peers in terms of profitmargins and ROIC and see-

ing its share price languish, JetBlueAirways has suddenly become theho est airline stock on Wall Street.The stock surged by more than 30%in May and has con nued to inch upin June, contras ng with the declinesseen by airlines generally because ofconcerns about energy prices. Whythe change in the sen ment for NewYork’s hometown airline? Could it beMint, the a rac ve premium prod-uct JetBlue has just launched on thetranscon? The sale of LiveTV? Is therenow evidence to suggest that, havingbeen a huge success in the market-place, JetBlue can also be a financialsuccess?

Un lMay, JetBluewas essen allyout of favour onWall Street. Thiswas,first, because of its decision someyearsagotofocusongrowthat theex-penseofprofitmargins,ROICandfreecash flow (FCF).

The decision to focus on growthwasunderstandable, because JetBluehad some unique growth opportu-ni es. In 2009 it was able to takeadvantage of a sharp contrac on byAmerican and other legacy carriers inBoston and quickly build itself intoBoston Logan’s largest airline. Thanksto another gi from American, Jet-Blue was also able to grow San Juan(Puerto Rico) into a sizeable focus cityopera on.

More recently, JetBlue has takenadvantage of Fort Lauderdale’s “veryrich demographic” and enormouscost differencewithMiami bymaking

FLL a staging post for significant newexpansion to the Caribbean, CentralAmerica and northern parts of SouthAmerica.

But the benefits have been slowtomaterialise. At the end of 2013 Jet-Blue’s ROIC was s ll only 5.3%, upfrom 4.8% a year earlier. For the sec-ond year running, JetBlue fell shortof its (very modest) goal of improv-ing ROIC by one percentage pointannually. Although JetBlue expectsto make up for those shor alls in2014, to achieve a ROIC of 7%, thatwould s ll be well below the 10-15%that other large US carriers are nowachieving. Although JetBlue has con-nued to report sa sfactory operat-

ing margins (7.9% in 2013), it haslaggedbehind itspeers in termsofnetmargins.

Analysts have been tough onJetBlue because the other large UScarriers (legacies and Southwestalike) have all maintained ght ca-

pacity discipline since 2009 and areintensely focused on FCF, ROIC andreturning capital to shareholders.The spring saw a steady string ofannouncements from Alaska, South-westandDeltaaboutexpandedsharebuybacks, dividends and suchlike.Some analysts said that they feltthat JetBlue’s management was notinterested in returning capital toshareholders.

Some people have blamed Jet-Blue’s lacklustre financials on theunusual “hybrid” business model,which, among other things, hasmeant JetBlue becoming a businesstraffic-focused airline in Boston and“primarily a leisure player” in NewYork.

AndJetBluehasbeenviewedneg-a vely because in late April its pilotsvoted to unionise. The pilots electedby a margin of 74% to 26% to be rep-resented by ALPA.

But the sharp fall in JetBlue’s

12 www.aviationstrategy.aero June 2014

JetBlue: Making its unique LCC businessmodel pay off at last?

share price a er the unionisa onannouncement was a turning point.Many analysts upgraded their rec-ommenda ons on the stock, which isnow ratedmostly a “buy”.

In thefirst place, analysts realisedthat JetBlue’s stock was undervaluedrela ve to its peers, in terms of pro-jected P/E ra os and othermeasures.One analyst noted that JetBlue wasthe only major US airline stock thathad declined in January-April.

Second, there was a feeling thatthemarket had overreacted to the pi-lots’ decision to unionise. It had nomaterial impact on the earnings out-look. JetBlue already faced a $145mhike in pilot costs in the next threeyears, a er a January agreement toraise pilot pay. And, as Southwest andothers have demonstrated, unionisa-on is not necessarily associatedwith

weaker financial performance. Jet-Blue’s labour rela ons remain good,and the airline is commi ed topaying“peer compe ve” pilot salaries.

Senior management changeshave taken place. The late April an-nouncement of the departure of COORob Maruster and the assump on ofhis du es by president Robin Hayeshave been interpreted as a shi inculture that will focus more on costsand margins. Maruster oversawJetBlue’s rapid expansion phase from35 des na ons to the current 85.Hayes is more financially oriented,havingworked as JetBlue’s chief com-mercial officer un l his promo on topresident in January.

The shi in culture could be evenmore pronounced if CEODave Bargerleaves the company when his con-tract expires in February 2015. Bargerhimself has not yet disclosed whathe wants to do. JetBlue’s board is ex-pected to start discussing the ma erof post-February leadership in theau-

tumn.The long-awaited sale of LiveTV –

the in-flightentertainment subsidiarythat JetBlue spent a decade devel-oping – to French aerospace com-pany Thales was completed on June10. It was solid good news to Jet-Blue: $400m proceeds, lower operat-ing costs and capex, and maintainingfull access to the product.

There has been excitement aboutFly-Fi– thenew-genera on,superfastin-flight connec vityproduct that Jet-Blue is racing to install on its fleet thisyear. JetBlue believes that Fly-Fi willbe a “key differen ator” in long-haulmarkets.

Mid-June saw the launch ofMint,JetBlue’s spectacular new premiumproduct for the transcon market,which one analyst es mates couldbring in as much as $300m in annualincremental revenues.

And, thanks to efforts to tweak itssuccessful “EvenMore” offerings andits TrueBlue FFP, JetBlue expects togrow its ancillary revenues by10-15%in 2014.

Finally, JetBlue’s gradually im-proving earnings and modest effortsto pay down debt have been ac-knowledged by the ra ng agencies.In May S&P affirmed the airline’s ‘B’credit ra ng and revised the outlookto posi ve, saying that it now ex-pects JetBlue to maintain improvedcredit metrics through 2015, despitesubstan al capital spending.WillMint be successful?

Mint debuted on JetBlue’s first “pre-miumversion”A321ontheNewYork-LosAngeles routeonJune15. Itwillbeavailable onall JFK-LosAngeles flightsby August and on the JFK-San Fran-cisco route fromOctober 26.

The product features 16 lie-flatfirst-class seats, including four pri-vate suites; tapas-style dining (choice

fromfivemenus), anupgradedLiveTVexperience (15-inch flat screens with100-plus channels each of TV andsatellite radio), among other extras.The seats are supposedly the widestand theflat-beds the longest in theUSdomes c market. No other US airlineoffers private suites in regular com-mercial service.

The Mint seats are available at asignificantly lower fare thanother air-lines’ premium services: $599 one-way. Passengers who book early canget the suites at the same price.

The product has a racted ravereviews. A Time magazine journal-ist wrote that the seats “feel moreluxury car than commercial aircra ”and “can accommodate anyone upto NBA height”, though the privatesuites are “not quite the E had orEmirates cabin”. The meals are “toprate” with a “dis nctly Big Apple fo-cus”. Overall, the review called it a“well thought out, dis nc veproductwith a dash of whimsy that has beenthe airline’s trademark”.

S ll, JetBlue faces s ff compe -on for the premium traveller in the

transconmarket, where flat-beds arenow the norm, where the legacy car-riers have all been upgrading their of-ferings, andwhereVirginAmericahasbuilt a loyal followingwith its extraor-dinary product overmany years.

The Time reviewer aptly con-cluded that itwill dependonwhethertranscon business fliers will abandontheir FF-mile accruing legacy carriersfor JetBlue’s lower cket prices (thereviewer thought they very wellmight), “whether the numbers thatdo will jus fy the airline’s invest-ment”, and “how the people in theback, once JetBlue’s focus, will feelnow that they’re in effect secondclass flyers”.

But Mint is only JetBlue’s re-

June 2014 www.aviationstrategy.aero 13

sponse to the challenges in thetranscon market; it does not repre-sent a decision to becomea two-classairline. The transcon between NewYork and LAX/SFO is a uniquemarket.As CEO Barger noted, those tworoutes are among the few wherepassengers are actually willing to payfor premium, as opposed to beingupgraded to it.

JetBlue introduced Mint becauseit has underperformed its peers interms of PRASM on the transcon.Its average fare there has been only$247, compared to Virgin America’s$320. Its most loyal customers havebeen telling it for years that, eventhough they fly JetBlue to Florida andthe Caribbean, they have switchedto other airlines on the transcon be-cause JetBluedoesnotofferpremiumservice orWi-Fi.

To illustrate the limited scale ofMint, only 11 or so of JetBlue’s A321swill be in the 159-seat “premium ver-sion” configura on by the end ofMarch 2015. The rest of the A321fleet will be in the 192-seat “coreJetBlue experience” version that de-buted in December 2013. JetBlue hasordered 88 A321s, of which five hadbeen delivered as ofMarch 31.

Cowen Securi es analysts calcu-lated that if JetBlue closes the PRASMgap with Virgin America on thetranscon, it would mean $300m inannual incremental revenues. Bargerhas called that es mate “ratherlarge”. The financial benefits wouldbe realised from2015 onwards.

TheWi-Fi race

Having fast and reliable in-flightWi-Fi will be central to both theMint experience and the core Jet-Blue experience. JetBlue was thelaunch customer for Fly-Fi, the Ka-band satellite-supported solu on

developed by LiveTV and ViaSat.First introduced in December 2013,JetBlue expects to have installed theproduct on its en re Airbus fleet byyear-end, with the E190s following in2015.

JetBlue has received lots of posi-ve customer feedback to Fly-Fi. On

some long-haul flights 80% of pas-sengers are connec ng to it, some-mes more than 100 people simul-

taneously. But evidently also com-plaints about performance have con-nued,because JetBluehasextended

the free beta test period by severalmonths to the autumn, when it alsoexpects to disclose plans tomone seFly-Fi.

The key compe tor is VirginAmerica, which five years ago pi-oneered Gogo in-flight Wi-Fi andremains the only airline to offerWi-Fion every domes c flight. To retain itslead, VA is in the process of equippingits fleet with Gogo’s faster ATG-4Wi-Fi service – a process that will becompleted by the autumn.

Network and alliance plans

JetBlue con nues to gradually mod-erate its ASM growth; currently a 4-6% increase is projected for 2014,down from last year’s 6.9%. And thegrowthwill behighly focused: up17%to the Caribbean/La n America, up15% from Fort Lauderdale, and rela-vely flat elsewhere.

The newest focus of ac vity isWashington DCA, where JetBlue won12 slot pairs thanks to the AMR-USAirwaysdives tures. Itwill essen allymean realloca on of aircra fromWashingtonDulles long-haul flying tomore a rac ve underserved, high-fare shorter-haulmarkets.

JetBlue expects FLL to be itsfastest-growing focus city in 2014.A er last year’s rapid interna onal

expansion from there, which in-cluded Lima (Peru) and Medellin(Colombia), this year JetBlue isadding Cartagena (Colombia), amongother des na ons. The plan is toexpand FLL to 100 daily departuresby 2017 (about 60 at year-end 2014).

Growth in Boston has moderatedsomewhat in 2014, so JetBlue is see-ing some matura on benefits there.But JetBlue is s ll commi ed to grow-ing the Boston opera on to 150 dailydepartures.

Almost a third of JetBlue’s ca-pacity is now in the Caribbean/La nAmerica markets (compared to 25%onthetranscon).Expansion inthat re-gion is easy to jus fy, because thosemarkets mature very quickly and arenicely profitable.

On the alliance front, JetBlue re-cently suffered the blow of Americantermina ng their coopera on (be-cause a er themerger AAL no longerneeded the East Coast feed). Other-wise, JetBlue has con nued to signup new interline partners (now 30+)and evolve some of those into code-share rela onships. JetBlue says thatfrom now on the emphasis will beon deepening exis ng rela onships,rather than signing upmorepartners.

Mone sa on of LiveTV

The LiveTV story is a great exampleof how JetBlue has innovated in theairline business. JetBlue acquired thesmall Florida-based company in 2002for $41m in cash and assump on of$40m of debt, which gave it a “re-ally nicely priced” live satellite televi-sion feature, enabling it to differen-ate its product. LiveTV has always

beenoffered free-of-chargeaspart ofthe “JetBlue experience”. The man-agement describes it as “core to thebrand”.

In the mid-2000s JetBlue began

14 www.aviationstrategy.aero June 2014

7.50

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Feb Mar Apr May Jun75

80

85

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100

105

US$

Relave

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JetBlue share price performance 2014

JBLU

Rela ve

selling LiveTV products to other air-lines. Ini ally it was careful not togive direct compe tors access to theproduct, but that changed in 2008when Con nental signed a long-termcontract for its 737s and 757s. Theshi in strategy came when JetBlue’smanagement realised that LiveTV nolonger offered a dis nct compe veadvantage; rather, having a LiveTV-type product would soon be neces-sary just to keepupwith compe on.

LiveTV has not been a hugemoney-maker because of the late-2000s recession, the high cost ofinstalling the systems and the weightof the equipment. But it s ll had arespectable $72m in sales in 2013.At year-end, it had been installedon 461 aircra , with another 196 infirm orders through 2015. Customersinclude United, WestJet, Fron er,Alitalia and Azul. But some analystsbelieve that LiveTV’s sales couldreally take off now that it is no longerowned by an airline.

The $400m proceeds rep-resented five mes the originalinvestment. JetBlue execu ves havenoted that it was hard to say what agood payback was, because LiveTVhad brought such enormous benefitsto the brand at low cost, thoughJetBlue also invested a lot in R&D

for the unit (something it never fullydisclosed).

The sale enables JetBlue to sim-plify its business and reduce operat-ing costs and capex. JetBlue has notyet released revised figures for 2014,but analysts say it had earmarked$75m capex for LiveTV this year.

A crucial part of the decisionto sell was that JetBlue managedto structure long-term agreementswith LiveTV that “will preserve ouraccess to both Ka and the TV and thesatellite radio and developments tothose items therea er”.

Shi ing priori es?

When the sale of LiveTV was an-nounced in February, some in the in-vestment community thought that itmight lead to capital returns to share-holders, such as a dividend or stockbuyback. But it is clearly too early totalk about that at JetBlue.

Rather, the proceeds will be usedto prepay $200-300m of debt in 2014and to help fund aircra deliveries.JetBlue is taking nine A321s this year,and total aircra capex is es matedtobe$600m.Becauseof thedesire toreduce debt, the aim is to buy aircraand other assets with cash.

JetBlue needs the A321s not justfor profitable growth but to keep unit

costs in check. However, the airlineremains commi ed to keeping thelevel of invested capital rela vely flatas it expands margins through prof-itable growth.

Interes ngly, JetBlue isnowat thepoint where its network growth callsfor larger gauge aircra . In a fleetrestructuring move in October 2013,the airline deferred 24 E190 deliver-ies, converted 18 A320 posi ons toA321s and placed an incremental or-der for 15A321s and 20A321neos. Atthe end of March, JetBlue operated195 aircra – 130 A320s, 60 E190sand five A321s.

A combina on of slightly slowerASM growth, maturing markets, newproducts, ancillary revenue ini a vesand keeping costs in check should en-able JetBlue to improve its opera ngmargins and eventually start return-ing capital to shareholders.

Butwill it be soon enough to keepshareholders happy? It will be inter-es ng to seewhat posi on, if any, theboardwill take in the autumn. Specif-ically, is it me for JetBlue to focus oninvestor returns over customer sa s-fac on and network growth?

By Heini Nuu nenhnuu [email protected]

June 2014 www.aviationstrategy.aero 15

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