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2012 Airline Themes www.pwc.com/uk Battling the Headwinds
2012 Airline Themes
www.pwc.com/uk
Battling the Headwinds
2012 Airline Themes 1
Contents
2012 - Demise of the squeezed middle? 2
European debt crisis and implications for state owned airlines 3
How can the industry convince governments there is an economic case for supporting growth? 4
M&A continues but legislation needs to catch up 5
High fuel prices are here to stay. How does the industry respond? 6
Is bio fuel still too expensive as an alternative? 7
Further cost base reduction is required - how much deeper can cuts be made? 8
Imperative for improved yields to offset continual cost pressure 9
EU-ETS - 2012 is year 1. Will there be a year 2? 10
New Aircraft orders and their implications for older generation aircraft and residual values 12
Aircraft financing - More constrained and more expensive 14
PwC2
2012 - Demise of the squeezed middle?
For a number of years now industry commentators have been predicting the shakeout of the European aviation market and the rise of the big four / five. Given the economic headwinds facing Europe, combined with high oil prices, 2012 could be the year when we start to see this become a reality.
As the industry entered 2012 signs of distress were already evident within the sector. In Europe Malev and Spanair have been the most high profile victims but there have been others (Cirrus, Czech Connect, Air Alpes). With the imminent IAG acquisition of BMI we are witnessing the squeeze out of another mid-tier, mid-market operator.
From our perspective the common theme for these airlines seems to be the lack of clear differentiation in their home markets, combined with rising competition and pressure on profitability.
In Europe there are a number of airlines that are facing similar pressures whether on short haul from continued growth of low cost carriers or on long haul from increasing competition from well invested carriers, including those from the
Middle East and, to a lesser extent, China.
As we have seen in Hungary and Spain competitors are waiting to fill the void, often with available spare capacity of their own. It is informative to note that neither Malev nor Spanair have as yet been resurrected in any meaningful way.
European penetration is increasingly seen as an opportunity for Middle Eastern airlines (for example Etihad’s investment in Air Berlin) and the growth prospects for these carriers suggest that this penetration will only increase. Is this something which European carriers should fear or can they gain mutually beneficial partnerships with the Middle Eastern carriers.
We may yet see the stratification of the European market, with short haul dominated by low cost specialists and passengers choosing to self connect to long haul flights at a limited number of dominant hub airports. This would have the benefit of focussed business models, optimised for short haul or long haul and a clear choice given to the consumer.
SASSweden
Virgin AtlanticUK
Air BalticLatvia
Aer LingusIreland
TAPPortugal
Aegean AirlinesOlympic AirGreece
Czech AirlinesCzech Republic
LOT Poland
TaromRomania
Cyprus Airways Cyprus
JAT Airways Serbia
Air MoldovaMoldova
Adria AirwaysSlovenia
State owned airlines
European Airlines seeking investment
2012 Airline Themes 3
European debt crisis and implications for state owned airlines
The ongoing financial challenge for European nations, both within and outwith the Eurozone is well documented. The EU’s fiscal compact prescribes that member states should have debt to GDP ratios at a maximum of 60%. Those that do not will have to adjust at a prescribed rate. This places restrictions on short-term borrowing and longer-term debt reduction for those countries exceeding 60%, whilst also putting pressure on those countries whose current spending levels would drive their ratio towards 60%. These actions also raise levels of risk associated with Government debt and mean that running a large deficit is becoming an increasingly less viable option, particularly in a slower growth environment.
Against this backdrop there are a number of airlines in Europe that are currently wholly / partially State owned. The majority of these have recently signalled that they are investigating options for privatisation or are searching for strategic investors.
The challenge for the management of these airlines and their shareholders is how to redefine their market position and create a longer term differentiated (and profitable!) offer that will have real strategic value for new investors. If this can be achieved then we might see another barrier to cross-border European mergers finally put to bed and the emergence of multi-national carriers with hubs
in Western and Eastern Europe offering a compelling route network to passengers.
Whilst potential investors have been linked with these investment opportunities there has not yet been any material investment forthcoming. In part this is because these state owned airlines have an uncertain strategic future. They are not particularly differentiated and as such struggle to compete with both the LCC’s that are pushing into their airspace and the full service offer from better invested carriers. In addition they typically have not addressed their cost base and are generating losses in the current high fuel, weak yield environment. At the same time European legislation prohibiting state subsidies means that it is becoming increasingly difficult for these States to continue to fund ongoing losses (the demise of Malev was in part due to the need to repay illegal state support following an EU ruling in 2011).
Even if Governments can find a way to support their airlines, sovereign funding constraints are such that continuing to support loss-making, capital intensive airlines is fiscally and politically unpalatable. But if this sees the end to the support of un-economic and loss-making airlines then the landscape will be a much more level one.SAS
Sweden
Virgin AtlanticUK
Air BalticLatvia
Aer LingusIreland
TAPPortugal
Aegean AirlinesOlympic AirGreece
Czech AirlinesCzech Republic
LOT Poland
TaromRomania
Cyprus Airways Cyprus
JAT Airways Serbia
Air MoldovaMoldova
Adria AirwaysSlovenia
State owned airlines
European Airlines seeking investment
PwC4
How can the industry convince governments there is an economic case for supporting growth?
The airline industry has come a long way from the Government owned national carriers of the past, supported by the public purse. The airline industry has matured with once local or regional markets opened to global competitive pressures. Emerging markets are supporting airlines and see aviation infrastructure as vital to achieve future economic growth. However, many Governments and regulatory bodies in mature markets are at the same time imposing restrictions and operational and tax burdens at a local level, ignoring the wider pressures on airlines, and implications of local policy on global competitiveness.
In the context of unstable demand, rising fuel costs and increased competition, the additional burden placed on the industry by Government and regulatory bodies’ disadvantages affected regions in what is an increasingly global marketplace.
The EU Emissions Trading • Scheme (ETS) will impact the cost base of European carriers disproportionately vs. non EU carriers. Indeed, should the carbon price rise, there may be an incentive for transfer passengers to avoid Europe altogether, if carbon charges outweigh additional fuel use, or inconvenience.
A number of local aviation taxes • on tickets have been levied by European Governments, the highest being in the UK (£13-£184) and Germany (€7.50-
€42.18). These taxes are seen as a sustainable revenue stream for Governments. Annual UK airport passenger duty receipts have nearly doubled in the last 10 years to an estimated £2.7bn in 2011/12 and will continue to rise. This compares with countries such as the Netherlands, where taxes introduced in 2008 were subsequently withdrawn after analysis showed a significant reduction in air traffic.
Competitiveness of airport hubs • has been further constrained by lack of support for infrastructure investment. The economic arguments for additional runways in the South East of England has until recently been falling on deaf ears, whilst operators at Frankfurt airport continue to battle with restrictive night flight limitations. When compared with Government sponsored investment in new hubs in the Middle East and Asia, the future competitiveness of Europe is in doubt.
Whilst consolidation and • cooperation would strengthen airlines’ ability to compete in such a challenging landscape, foreign ownership restrictions in Europe and the US have limited the emergence of ‘global’ rather than ‘multi-domestic’ airlines. The need for local Air Operating Certificates and retention of national brands has restricted the scope for synergies obtainable from the mergers which have happened and resulted in a landscape which is much more fragmented than it ought to be.
The Aviation industry has been vocal about these issues for many years. However, some efforts have been viewed as PR focussed exercises, and lobbying has not managed to engage with Governments on their own terms. As cost pressures continue to mount, we can expect the debate to continue well past 2012.
2012 Airline Themes 5
M&A continues but legislation needs to catch up
There were a number of high profile M&A transactions in the sector in 2011 including BA / Iberia, Flybe’s acquisition of Finncomm, Hainan’s acquisition of Turkish based ACT airlines, LAN / TAM, Air Berlin taking full control of Fly Niki and latterly IAG’s acquisition of BMI. This reflects the push for consolidation and drive for scale which remains the ultimate vehicle for top tier global carriers to:
access growing markets / achieve • a step change in mature markets;
become a long term winner in the • market;
achieve cost reductions; and•
deliver sustainable profitability, • with an appropriate return on capital.
However, considerable legal and regulatory barriers to full merger remain in place, including limits to foreign ownership, and ongoing government shareholding. This is further heightened by the role which flag carriers are seen to have in delivering in the national interest. Notwithstanding the legal
and regulatory hurdles a number of carriers are now seeing benefit in strategic investments including Etihad taking a 29% stake in Air Berlin, Air Asia taking a 20% stake in Malaysian Airlines and Qatar taking a 35% stake in Cargolux.
For both full mergers and strategic investments the synergy benefits are driven as much by revenue improvements as they are by cost reduction. Typically revenue benefits account for between 40% and 55% of the full synergy benefits. Compared to transactions in other industries this is a much higher percentage (where between zero and 25% of total synergies is typical). This is driven by the constraints of inter territory investment within the airlines sector which limit the level of cost base optimisation.
Arguably, Government regulation has not kept pace with the commercial realities of operating a global airline and the need to generate a consistent return on capital. We are starting to see some signalling of change, notably in India which is finally considering allowing foreign airlines to own up to 49%. However, it remains the case that there are few highly capital intensive global industries, which remain as fragmented as the airline industry.
Alliances and code shares are also attractive in enabling airlines to satisfy customer demands for global connectivity, often in tandem with joint sales and shared aircraft. We expect to see further participation in alliances and joint business arrangements in 2012 and beyond and further competition amongst the big 3 alliances for new members. Whilst cost synergies from such agreements remain limited they provide airlines with the opportunity to “get to know each other better”, potentially as a precursor to merger / acquisition / investment as and when the legislative and regulatory landscape changes.
Minority investment Acquisition / Merger
January BA / Iberia*
February
March
April
May
Qatar / Carlgolux June
July Flybe / Finncomm**Hainan / ACT**
Air Asia / Malaysian August
September
October
November
Etihad / Air Berlin** December LAN/ TAM***IAG / BMI **
Airline M&A activity in 2011
* month completed** month announced*** month approved
PwC6
High fuel prices are here to stay. How does the industry respond?
Fuel now accounts for over 30% of the industry’s collective cost base and fuel price volatility is currently the key determinant of industry profitability.
The anniversary of oil at $100+ has passed and we have now had 14 consecutive months of oil trading above $100 per barrel. The average price for the period Feb’11 to Feb’12 was $113 with fluctuations between a high of $126 and a low of $100. With increasing tension in the Middle East region and tentative signs of recovery in the US economy there is further upward pressure likely on the oil price in 2012.
For European airline operators the current oil price aligned with the stronger USD means that in GBP and Euro terms, oil prices at the end of February 2012 were at an effective all time high (£78.60 and €92.40 per barrel respectively).
Furthermore, with many airlines having a hedging policy of between 12-18 months forward, the benefits of hedging that provided some relief in 2011, are now expiring and current hedging positions are now much closer to spot. This means that airlines are currently experiencing typical increases of between 20-30% in fuel costs in 2012 vs. 2011.
Airlines also need to be mindful of the cost of refining oil into jet fuel. In the last three years there has been a step down in refinery cost as large new refineries have been brought on line and brought oversupply to the market. Over the longer term we anticipate that a number of smaller oil refineries will exit the European market (Petroplas in the UK is an obvious example). As the demand / supply equation improves we expect that refineries will seek to improve margins and that will add further upward pressure to Jet fuel pricing.
Given the above and the potential volatility of fuel prices, with ongoing tensions in the Middle East it is vital that airlines have planned, well thought through scenarios for how they will proactively respond to further potential fuel price increases. Scenario planning for revenue enhancement initiatives, fuel saving measures in operating practices, revisions to business models and route structures, supported by more efficient air traffic management should all be areas for discussion for aviation executives to deliver a profitable business and sufficient return on capital for investment in more fuel efficient aircraft.
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Jet Fuel prices per metric tonne ($, £, €)
Average jet fuel spot price (MT USD) Average jet fuel spot price (MT GBP) Average jet fuel spot price (MT EUR)
2012 Airline Themes 7
in biofuel costs that far exceed the cost of conventional jet fuel. Recently, Alaska Airlines paid $16 per gallon of biofuel using feedstock derived from used cooking oil and meat production by-products compared to $3.15 per gallon of Jet A. Furthermore, the low carbon credentials associated with biofuels are being strongly contested, with a call by Friends of the Earth Europe for a halt on all biofuel trials in the aviation sector. It is argued that biofuel crop production can result in indirect land use change impacts such as deforestation and the displacement of food production leading to rising food prices, hunger and poverty.
Airlines considering biofuel need to consider:
The net financial and strategic • return on the options they are assessing;
How biofuels fit into their wider • CSR agenda, particularly given the potential impact on indirect land use change;
How they participate in the • market (sponsor, JV etc.) and secure supply; and
At what point is it optimal for • them to participate (early adopter vs. market follower).
Over the longer term the ongoing investment into biofuels needs to be considered. Best case industry estimates forecast 50-70% of jet fuel could be replaced by bio fuels by 2035 and even worst case estimates put biofuel use in aviation as high as 40% by 2035. Fuel price volatility, regulation of air traffic greenhouse gases through EU ETS and the IATA industry wide goal to reduce net carbon emissions by 50% by 2050, have prompted a number of biofuel trial flights in recent years. These have explored the use biofuel feedstock options including algae, jatropha and camelina.
Based on successful trials and advances in aviation biofuel certification, airline carriers such as Lufthansa, United Airlines and Alaska Airlines have taken the next step by scheduling passenger flights fuelled by biofuel blends. Recently, Lufthansa has declared a carbon emissions reduction of 1,471 tonnes by operating 1,187 biofuel flights between Hamburg and Frankfurt (Germany) under the burnFAIR project .
However, the widespread use of biofuels remains inhibited by the lack of available biofuel feedstock and production infrastructure resulting
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31/05/2004 31/05/2005 31/05/2006 31/05/2007 31/05/2008 31/05/2009 31/05/2010 31/05/2011
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Development of Jet fuel crack spread over time
Average crack spread ($bl) Crack as a% of crude
Is bio fuel still too expensive as an alternative?
PwC8
Further cost base reduction is required - how much deeper can cuts be made?
The downturn in demand in 2009 and significant increases in fuel prices since then has been the catalyst for cost reduction programmes and restructuring activities across the sector aimed at tackling the non-fuel cost base. A lot of these programmes have been presented as transformational, with significant savings numbers being communicated to the market e.g. BA announced a savings plan of £220m of underlying non–fuel saving costs in 2009/10. However, digging deeper into the specific plans shows that some programmes are more tactical than transformational – high volume of low value initiatives and one-off cost cuts e.g. cutting marketing spend, reducing rates with existing suppliers and releasing provisions, as opposed to implementing longer term transformational change. Where this is the case, it is likely that value will have been left on the table as the business will have tweaked around the edges of functional cost bases, rather than challenging the operating model of the business and its major functions.
If a business has gone through a major cost reduction programme based on its current operating model then it’s likely that a lot of the low hanging fruit will already have been picked. This will make driving
further cost out of the business more difficult, the airline will have to drive efficiency from existing processes and encourage behavioural change in a large, often highly unionised workforce.
Airlines continue to announce new change programmes that are aiming to improve profitability and cash flow over the coming years. Two such examples are the Transform 2015 programme announced by Air France / KLM, which aims to generate an additional €1bn of free cash flow by 2015 and the SCORE programme announced by Lufthansa that aims to deliver €1.5bn in improved earnings for the Group by 2015. The Air France programme includes sustainable changes relating to people productivity, but also temporary measures such as pay and hiring freezes for the next couple of years. The latter makes the overall savings number potentially unsustainable over the longer term.
Further opportunities to reduce costs should exist, but it is likely that following the current round of cost reductions implemented by some of the major carriers (see graph opposite) that any future improvements could be harder to realise. In order to achieve further improvements in the cost base the industry will need to:
Be more creative in the way it • looks at developing cost reduction initiatives;
Ensure that an appropriate • delivery structure and governance is in place to realise the full range of benefits identified; and
Allocate sufficient resource and • focus to delivery throughout the organisation.
The airline industry could also benefit from gaining insights from other capital intensive industries (e.g. automotive) on how they have managed to achieve long term sustainable changes to their cost bases and operating models.
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Luf thansa FY11
Air France / KLM FY11
Air Berlin FY12
Aer Lingus FY12
Easyjet FY12
€in
mill
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Summary of historical profit improvement plans
Staff Non-staff Process and productivity
Procurement Distribution Fleet
Other / not categorisedSource: Company websites & PwC analysis
2012 Airline Themes 9
Imperative for improved yields to offset continual cost pressure
This highlights the importance of focusing on yield improvement in order to deliver improved profitability, rather than the irrational use of low price to chase volume. Capacity constraint is starting to provide the right environment for yield improvement and most airlines have revenue and yield improvement as key building blocks of recently announced restructuring plans. We are also seeing yield development becoming an ever increasing focus for the low cost carriers. easyJet is targeting the business travel market in part to drive improved yield (+7.7% in Q1 FY12) whilst Ryanair’s winter capacity reduction was firmly driven by the need to ensure the airline focused on profitable flying over the winter season and maximised yield (+14% winter 11/12 est.).
For context we need to look back to 2010 when the industry saw a better than expected bounce back in the yield environment. That momentum was maintained into early 2011.
With the sharp increase in the oil price over the period Nov ’10 – Feb’ 11 many airlines took the opportunity to pass through an element of price increase either through underlying
fare increases or an increase in fuel surcharges. However, the increases passed through were not sufficient to fully offset the increase in fuel price. It seems many airlines were anticipating only a temporary spike in fuel prices due to the Arab Spring which they felt could be managed through their hedging programmes. However, the problem for the airlines is that oil prices have remained between $100-$126 per barrel and therefore the public catalyst for further increase pricing on the back of rising oil prices is simply not available.
Ongoing cost pressure on the aviation industry most noticeably from fuel but also from increases in taxes, airport charges, flight charges and underlying inflationary pressure continues to heavily squeeze operating margins which were already dangerously low.
The yield environment for most operators remains challenging, particularly in Europe where rising tax burdens, declining social security payments and the squeeze on household incomes are depressing leisure spend. This in turn is putting pressure on economy class fares and LCC ticket pricing. At the same time there has been a continued increase in market capacity which has added to the challenges faced in trying to improve yield.
Notwithstanding the initiatives described above yields have not been increasing at the same rate as costs and in an industry which is struggling to repair its profitability and recoup significant losses that needs to change.
In short the average passenger is not paying a sufficient fare to cover the cost of flying and deliver a reasonable economic return to the airlines and their stakeholders. Whilst higher fares are not palatable in the current economic environment they are necessary to secure the long term future of the industry. Airlines need to take the brave decisions to support yield increases.
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FY07-08 FY08-09 FY09-10 FY10-11
% Change in Yield vs % change in Fuel Price
Fuel Price Yield (average of European carriers)
The Indian market in 2011 delivered a salutary lesson in the perils of chasing volume. For the majority of 2011 Air India, the national carrier, pursued a volume-based strategy driven by aggressive yield discounting. This destroyed yields in the market in a period when oil prices were significantly increasing and the rupee was depreciating against the US$. The net result is that the market in India is forecast to deliver a loss of $2.5bn in 2011, in large part driven by a decline in yield.
2 year lag
Source: PwC analysis
PwC10
EU-ETS - 2012 is year 1. Will there be a year 2?
The EU Emissions Trading System went live for all airlines with a flight departing or arriving within the EU from 1 January 2012. Payment for the first year of emissions is due on 30 April 2013.
There is lot of uncertainty surrounding the future of the scheme, with questions being asked more broadly than just in relation to the airline industry.
Within the airline sector the scheme has caused much discontent with 26 nations (including the USA, China, India and Russia) forming what has been called the “Coalition of the unwilling”. This coalition has implied that there may be an array of retaliatory measures that could be brought against the EU for breaching what they see as the sovereign rights of each nation. Measures that are being discussed include barring national airlines from participating, ceasing talks with European airlines on new routes, halting European
aircraft orders or imposing retaliatory levies on EU airlines.
At the same time EU carriers complain about the surcharge which adds costs during a period of rising cost and weak demand. They fear both the cost advantage for non EU airlines should they decide not to pay as well as the structural cost advantage that the scheme provides a number of non EU-based airlines who use their hubs to connect long haul routes from Europe.
A number of countries including China and USA are about to pass acts which would prohibit national airlines from participating in the EU ETS. This could lead to a breach of national law if Chinese / US airlines are to comply with their financing documentation, which may include ETS provisions and representations. Finance institutions need to consider what their response might be to such a technical breach.
The “Coalition of the unwilling” met formally in February 2012 in Moscow
2012 Airline Themes 11
and are due to meet again in Saudi Arabia in Summer 2012. Members of the coalition have repeatedly stated that any emissions scheme should be global and administered by the ICAO. This view has also been supported by a number of European airlines.
Given the meeting in Saudi Arabia it is likely that this issue will be further debated and reviewed in Q3 /Q4 2012. That debate is likely to take place at the highest political levels and it is clear that the EU will continue to come under enormous political pressure.
In our view, there are three likely outcomes. The first is that ICAO accelerates its global ETS development, with implementation beginning hopefully around 2015, allowing a smooth transition from the EU ETS to a global scheme. The second is that ICAO faces obstacles in global ETS development and the EU ETS includes aviation through the whole of Phase 3 (to 2020). The
third is that overwhelming political pressure forces a climb-down by the EU and the withdrawal of aviation from the EU ETS.
Given recent announcements by the bloc’s climate chief that the EU is standing firm in the face of opposition, and the likely delay in reversing EU legislation once passed, a climb-down is currently unlikely. An ICAO-led solution would be preferable politically as it allows both the EC and other national governments to save face. This is unlikely to be implemented within the next two years though.
What is desirable to maintain business and investor certainty is action by the EU and ICAO to specify a route forward; intermediate milestones, agreement on free allowances, offset eligibility etc.
Whilst uncertainty remains and is not helpful for business planning airlines should consider the fact that with either the first or second outcome,
they will be subject to a regime which will require them to pay for and/or trade in emission. Appropriate business planning rather than reliance on a political stand-down would be the least risky strategy. We believe:
The ability to monitor and verify • carbon emissions, understand and quantify key abatement technologies such as navigation systems and biofuels will be crucial for minimising compliance costs;
Larger emitters might benefit • from early engagement with the market, understanding key drivers of the EUA(A) price, futures markets and options for hedging volatility; and
Offset markets, which produce • carbon credits eligible for at least 4.5% of the EU ETS carbon liability, are a potential source of cheap credits for those willing to finance or invest in projects.
PwC12
New Aircraft orders and their implications for older generation aircraft and residual values
for in excess of 1,400 aircraft from just seven carriers in the last twelve months.
The challenge for both manufacturers and aircraft owners is that this record level of demand for future aircraft types (which, save for the A380, have not yet come to the market in any scale) will have implications for the residual pricing of current technology aircraft, both those currently in service and those yet to be delivered.
New aircraft variants have a history of delays in production (Boeing’s first 787 was three years late in delivery) and teething troubles as the first fleet emerges (the recent issues with cracks on the wings on the A380 highlights the snagging issues that arise). These programme delays and issues create challenges for aircraft owners and operators who are seeking to replace ageing airframes as soon as possible. In a number of cases they default to existing, rather than new technology aircraft to plug their delivery schedule gaps.
As a result production volumes for existing technology aircraft are high and increasing in order to supply the large level of backorders. As the industry starts to cycle through this technological replacement period the expectation amongst a number of industry players is that the value of existing technology aircraft will decline at a quicker rate and that value may be lost. This clearly has implications for both aircraft owners (those who hold equity in the aircraft) and finance providers.
We have started to see some of the larger aircraft owners taking write downs on asset values of aircraft (ILFC’s $1.5bn writedown in Q4 2011 for example). The question is whether the increase in production volumes of existing technology aircraft, particularly for short haul aircraft will exacerbate this value write down.
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March 2012 Boeing & Airbus backlog order book (Volume and list price value)
# of aircraft List price value $bn
Technological innovation and the increase in fuel prices have driven order books for new, fuel efficient aircraft to record highs. New aircraft programmes such as the A380, A350, A320 neo, B747-800, B787 and B737 MAX all offer the opportunity to replace ageing, less efficient aircraft with significantly more fuel efficient variants. The operating cost benefits of these aircraft are amplified as oil prices continue to rise. The current estimate of the value of the aircraft order book for Boeing and Airbus is $1.2 trillion at list price (contracted value is more akin to $600bn reflecting the significant discounts to list offered by the OEM’s).
The order books have benefited from what appear to be longer term more “speculative” mega orders, predominantly from lower cost operators. These have accounted
* 737 MAX, A320 Neo** 787, 747-800, A380, A350
Source: Boeing and Airbus websites and PwC analysis
2012 Airline Themes 13
We are also seeing a trend towards a shortening in the average life of an aircraft from the traditionally accepted 25 years. Another trend is for younger aircraft to be sold for spares as this provides greater value than as an aircraft in operation.
Airlines need to consider:
Not only the aircraft type and • overall fleet mix when placing new orders, but also which ownership structure to utilise in order to best balance the needs of lowest unit cost per ASK, financing availability, ongoing level of fleet flexibility and optimisation of the tax position.
The implications for residual • values of current aircraft assets given the likely downward pressure being brought to bear by both the next generation fleets and the increase in supply of existing technology aircraft
Whether their depreciation • policies remain appropriate given both the potential weakening in residual values and the shortening of useful economic lives that are beginning to be seen in the industry.
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A320 Neo
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Length of delay from initial estimated service date to actual scheduled service date
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737MAX
Source: PwC analysis
Source: Various websites and PwC analysis
Source: Boeing and Airbus websites and PwC analysis
PwC14
Aircraft financing
The record order books of Boeing and Airbus reflect a period of strong orders buoyed by both new aircraft types and strong growth in air travel demand in the high growth markets of Asia, South America and the Middle East. However, there are a number of headwinds in the aircraft finance markets which will make these orders more difficult to finance, and more expensive.
The European Sovereign debt crisis, ongoing uncertainty in the financial markets and in particular the retreat of the French banks (who have historically played a dominant role in the European aviation financing market) are causing ongoing tensions in the funding market. These tensions, which have been heightened by the implications for the banking system of Basel III requiring improvement in capital ratios and tightening of credit conditions, will result in more expensive debt where it is available.
European banks are also facing difficulties in accessing US dollar funding and are therefore less competitive in US dollar denominated aircraft financing. The downgrading of several European banks has made refinancing more expensive and aircraft financing less profitable (due to reduced margins to remain competitive).
A saviour of aircraft financing over the last few years has been Export Credit Agency (ECA) financing. Traditionally a backstop, this became the funding source of choice for many airlines. However, going forward the new Aircraft Sector Understanding (ASU) which governs pricing of ECA financing will come into force in 2013 and will result in considerable premium increases for this financing stream.
Airlines will need to be prepared for increased costs for new fleet acquisition (or even situations in which banks may claim increased costs for existing financings).
With the overall supply of financing
reduced, airlines will have to compete in the global market place for funds. They will need to be mindful that in this area their competitors will not be the usual airlines that they compete with on a route basis.
Going forward we expect that:
US banks and non-European • banks with access to US dollars will strengthen their market share;
For non-US airlines, alternative • funding sources will become more important, e.g. capital market structures (bonds, EETC, etc.). However, these will only really be accessible by those operators with the best credit ratings;
ECA financing will again play • a major role in global aircraft transactions despite the change in the ASU’s. However, since ECAs are still ultimately accessing the same funding pool as the airlines themselves they may be forced to adjust their instruments to new funding sources;
Aircraft lessors will become even • more important as their more stable business models, diversified portfolios and comparatively higher ratings ease their access to the capital markets; and that
The argument for pricing aircraft • in EUR (for Airbus) may again emerge.
With liquidity scarce, airlines need to continually review their fleet management policy and actively manage their future financing. Sale-and-Leaseback alternatives for a given period may enable bridging of any current financing shortfalls. Airlines with substantial local currency income should consider local currency financings which reduces refinancing costs for local or regional banks. Executives and treasurers should be examining all possible financing forms (SLB, ECA, Bank loans, Bonds, Capital Markets, manufacturer support, etc.) in order to secure finance going forward.
More constrained and more expensive
30% 28%
28% 26%
25% 23%
14% 18%
3% 5%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2011 (Act) 2012 (Est)
% o
f fin
anci
ng
2011 vs 2012 sources of aircraft financing
Bank Debt ECA financing
Cash Sale & lease back
Capital markets Manufacturer
ECA financing cost increases
Old ASU New ASU*Per
annums spread (bps)
Up front
%
Per annums spread (bps)
Up front
%
AAA - BBB-
n/a 4.0% 149 8.4%
BB+ - B-
n/a 4.7 - 6.2% 178 -
25210.1 - 14.5%
CCC - C
n/a 7.5% 276 - 28215.9 - 16.2%
*For aircraft sale contracts agreed post 2010 and/or deliveries post 2012
2012 Airline Themes 15
For more information please contact
UK airline sector leader Roger de Peyrecave [email protected] 01727 892106
Consolidation and alliances
Airline M&A Ken Walsh [email protected] 020 721 31228
Will Inglis [email protected] 020 780 49246
Operational DD / Post merger integration
Cameron Roberts [email protected] 020 780 40133
Airline distress Steve Russell [email protected] 020 721 25334
Ian Oakley-Smith [email protected] 020 721 26023
Capacity and yield management
Strategy consulting Neil Hampson [email protected] 020 780 49405
Anna Sargeant [email protected] 020 780 44127
Traffic forecasting Michael Burns [email protected] 020 780 44438
Coping with commodity price uncertainty
Biofuel developments Jeroen Kruijd [email protected] +31 88 792 6472
John-Mark Zywko [email protected] 020 721 31755
EU-ETS monitoring, reporting and verification
Atul Patel [email protected] 020 721 26618
Carbon markets stategy Jonathan Grant [email protected] 020 780 40693
Hedging effectiveness Carl Sharman [email protected] 020 780 46421
Maximising the cost base
Business services transformation Nick Atkin [email protected] 020 780 43166
Rob Banham [email protected] 020 721 25692
Risk Assurance Helen Nixseaman [email protected] 020 780 44442
Sourcing financing and maintaining liquidity
Aircraft financing Andreas Klasen [email protected] +49 40 6378 / 2178
Stephan Cors [email protected] +49 40 6378 / 2173
Debt finance Jason Green [email protected] 020 721 2535
Tax Planning Paul Nash [email protected] 020 780 44040
This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
© 2012 PricewaterhouseCoopers. All rights reserved. “PricewaterhouseCoopers” and “PwC” refer to the network of member firms of PricewaterhouseCoopers International Limited (PwCIL). Each member firm is a separate legal entity and does not act as agent of PwCIL or any other member firm. PwCIL does not provide any services to clients. PwCIL is not responsible or liable for the acts or omissions of any of its member firms nor can it control the exercise of their professional judgement or bind them in any way. No member firm is responsible or liable for the acts or omissions of any other member firm nor can it control the exercise of another member firm’s professional judgement or bind another member firm or PwCIL in any way.
ML4-2012-03-22-14 54-AC_2012 Airlline Themes
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