aviation strategy issue #216, may 2016

Issue no. 216May 2016

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THY: HISTORIC AND PROJECTEDGROWTH

Pax

Growth Rate

THYs first quarter results werepoor, the worst quarterly perfor-mance since the airline embarkedon its dynamic expansion ten yearsago. Foreign arrivals in Turkey havebeen in decline since the middleof 2015, with THY no ng extensivegroup cancella ons from Europe,Russia, Japan and China. Neverthe-less, con nuing capacity expansionand strong growth in connec ngpassengers pushed traffic numbersup by 10% and ASKs by 19% betweenthe first quarter of 2016 and thesame period in 2015. Load factor fellto 74.0% from 76.9%. RASK slumpedby 16.6% (11.7% if the effect of thedeprecia ng Lira is excluded). CASKdisturbingly went in the oppositedirec on — the reported unit costdid fall by 8.1% but, if currency ef-fects and fuel decrease impact are,factored in, CASKwould have risen by8.3%.

In summary, total revenue fell by1% to $2.19bn and the net opera ngresult was a loss of $280m comparedto a loss of just $35m in Q1 2015. Netincomewas a loss of $421m against aprofit of $153m in 2015. THY appearsto regard this quarter as an outlierrather than reflec ng a fundamental

change in its fortunes, poin ng outthat, aswell as the tourismdisrup onimpact, maintenance costs were ex-cep onally high in the early part of2016.

This year THY might benefit froma side-effect of the Middle East wars.An agreement between the EU andTurkey, which hadn’t been finalisedby late May, would extend visa-freetravel, for up to one year, for all Turk-ish ci zens to, from and within theSchengen area, in return for Turkeystemming the flowof refugees acrossits borders. The EU is also asking for

a series of reforms to civil rights inTurkey to reverse what it sees as amove towards authoritarianism un-der President Erdogan, and it this is-sue which is holding up the conclu-sion of the travel agreement.

There is no chance in the foresee-able future that Turkey, although itis an official candidate for member-

Published by Aviation Strategy Ltd

This issue includes

Page

THY Consolida ng growth 1

Air Traffic Control: Chances ofReform? 5

Cebu Pacific: Hi ng growthconstraints atManila 11

WestJet: Pioneering a newmodel in transatlan cflying 16

THY: Superconnectingand geopolitical risk

T of European avia on gravity has been moving east-wards to Istanbul where THY Turkish Airlines has a clear mission— to establish itself as a leading global superconnector, deploy-

ing a unique narrowbody-focused connec ng strategy, bypassing Eu-rope’s major flag carriers in the process (see Avia on Strategy, March2014). Although economic condi ons remain resilient, with 4.5% realGDP growth expected for this year, the country and the airline are be-ing directly impacted by what THY describes as “geopoli cal risks andsecurity concerns”.

Aviation StrategyISSN 2041-4021 (Online)

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

shy away from cri cal analysis, and takes aglobal perspec ve — with balanced cover-age of the European, American and Asianmarkets.

Publisher:KeithMcMullanJames Halstead

Editorial TeamKeithMcMullankgm@avia onstrategy.aero

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The opinions expressed in this publica ondonotnecessarily reflect theopinionsof theeditors, publisher or contributors. Every ef-fort is made to ensure that the informa oncontained in this publica on is accurate, butno legal reponsibility is accepted for any er-rors or omissions. The contents of this pub-lica on, either in whole or in part, may notbe copied, stored or reproduced in any for-mat, printed or electronic form,without thewri en consent of the publisher.

THY: ISTANBUL’S NATURAL ADVANTAGE

ATL

BKK

BOG

BOS

CANCCS

CGK

CPT

DPS

DUR

EZE

GRU

HAV

HKG

HKT

IAD

IAH

ICNJFK

JNB

KIX

KUL

LAX

MEX

MIA

MNL

MPM

MRU

NRT

ORD

PEK PVG

SFO

SGN

SIN

TNR

TPE

YUL

YVR

YYZ

Istanbul

Wide body range

Narrow body range

Wide Body Destinations

Current

Future

ship, will become an EU state, but theEU proposed last December that, aspart of an overall convergence pro-gramme, Turkey and the EU shouldmove rapidly to a “wide ranging avia-onagreement”, ieopenskies.Turkey

is, a er the US, the most impor-tant avia on market for the EU, withabout 40mpassengers a year.

The proposed agreement wouldreplace the current system of hori-zontal EU bilaterals, which permit EUcarriers to fly to/from any EU state toTurkey, but which excludes EU carri-ers from the substan al Turkish do-mes cmarket (54mpassengers). Thecombina on of the new visa regimeand open skies would boost THY’score business, but the poten al ex-

pansion of European LCCs into theTurkish market also poses a threatto THY. Perhaps the greater threatwould be Pegasus Airlines (see Avia-on Strategy, November 2015)—the

LCC explains its recent high but un-profitable expansion partly as a strat-egy to establish greater market pres-ence before the likes of Ryanair andeasyJet arrive on a large scale.

2016will see THY increase its seatcapacity by a net 16%, with the de-livery of 11 widebodies , A330-300sand 777-300ERs, and 30 narowbod-ies, 737-800s and A321s. The airlineprojectsan increaseof18% inpassen-gers to 72.4m this year.

Revenues for the year are pre-dicted by THY to grow by 16% to

2 www.aviationstrategy.aero May 2016

mailto:[email protected]



https://www.aviationstrategy.aero/newsletter/?issue=211

https://www.aviationstrategy.aero/newsletter/?issue=211

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THY FLEET PLAN

year end 2015 2016 2017 2018 2019 2020 2021 2022

Wideb

odies A330-200 20 20 18 18 16 13 13 8

A330-300 26 31 31 31 31 31 31 31A340 4 4 4 4 4 4 4 4

777-300ER 23 32 35 35 34 32 32 32

Total 73 87 88 88 85 80 80 75

Narrowbo

dies

737-900ER 15 15 15 15 15 15 15 15737-9MAX 5 10 10 10737-800 92 112 110 99 96 88 86 82737-700 4 1 1 1 1

737-8MAX 20 30 55 65 65A321 neo 14 39 61 86 92

A319 14 14 11 9 8 6 6 6A320 29 29 22 19 12 12 12 12A321 56 66 68 68 68 66 64 64E195 6 3

Total 216 240 227 245 274 313 344 346

Cargo A330F 6 8 9 9 9 9 9 9

Wet Lease 4 4

Total 10 12 9 9 9 9 9 9

TOTAL 299 339 324 342 368 402 433 430

$12.2bn. which seems a li le op -mis c given the recent downwardtrend in unit revenues. Concernedalso by unit cost trends, the Istanbul-based airline analyst at HSBC is fore-cas ngan8%rise in 2016 revenues to$11.36bn, a fall in opera ng profit of8% to $95m and a 30% reduc on innet profit to $745m.

THY is con nuing to expand be-yond its uniquenarrowbody connect-ing market (see map on the facingpage) into itswidebodymarketwhichfrom its Istanbul hub covers most ofthe planet. The Americas is the mainfocus, with new routes star ng orplanned to Vancouver, Atlanta, Mex-ico City, Havana, Bogota and Caracas.The risk is more direct compe onwith the threeMiddle East supercon-nectors.

On the other hand, THY is a grow-ing threat to the European networkcarriers, especially Lu hansa, siphon-

ing off intercon nental connec ngtraffic to its lower cost hub opera-on and also a acking local feed traf-

fic to the Euro-hubs by its innova ve737 connec ng strategy, bringing in-tercon nental service to myriad sec-ondary city pairs.

Even with a planned sharp re-duc on in growth post-2016 THY ison target to meet two psychologi-cally significant targets — surpassingLu hansa Passenger Airline in termsof traffic in 2019 and reaching 100mpassengers by around 2021.

This, however, depends on thenew Istanbul airport opening in early2018, as currently scheduled. Ini allytheairport, yet tobenamed,will havethree runways and a terminal capac-ityof 90mpassengers. By2028capac-ity will have been extended to 150mpassengers. The government has an-nounced that commercial opera onswillberundownandclosedatAtatürk

airport, although the ming is un-clear.

THY’s fleet plan (see table onthe current page) reveals a markedchange in growth strategy. For thefive years from 2016 THY’s seat ca-pacity growthwill be around 5%pa incontrast to15%pa for the tenyears to2016. The airline officially is not plan-ning for any increase in its widebodyfleet. This makes THY an en cingtarget for both Boeing and Airbusbut, based on past ordering policy,THY, if or rather when it decides onlong-haul expansion, is likely to selectboth 787s andA350s. There is regularspecula onabout THYop ng for newor second-hand A380s, but it is verydifficult to see how this type could fitinto its network.

The narrowbody fleet is plannedto grow by a net 20-30 units a yeara er 2017, with 737MAXs andA321neos systema cally replacing

May 2016 www.aviationstrategy.aero 3


5.0

6.0

7.0

8.0

9.0

10.0

2013 2014 2015 2016

₺(lo

gscale)

THY SHARE PRICE PERFORMANCE

the conven onal types in THY’s fleet.Again this is fairly modest growth byhistoric standards.

THY, although growing at roughlytwice the rate of the Euro-majors, isentering a period of rela ve consoli-da on. It is focusing on a number ofKPIs with the aim of at least main-taining its current cost advantage —with a slightly lower average stage

length, THY es mates its unit coststo be about 30% below those of theEuro-majors and 10%below the aver-age of the superconnectors but at amuch shorter stage length.

( With fixed costs represen ng29% of total costs, increasing air-cra u lisa on by 10%, roughly theefficiency gain it achieved during

2010-15, will reduce CASK by 3%.( There is significant poten al forpushing up load factors. On shorthaul, THY’s load factor in 2015 was83.5%, up from 76.7% in 2010, buts ll some points below the LCC stan-dard.On longhaul the load factorwas77.1%, again below the levels beinga ainedbyEuropeanandUSnetworkcarriers.( RASK is about 8.1 US¢ at presentcompared to11¢ for theEuro-majors;THY sees the poten al of increas-ing its unit revenue to 9¢. Winningmore business class passengers —currentlyonlyabout4%of the total—is the challenge.

Finally, there is the perennialques on of a deep alliance withLu hansa, the last a empt at whichended a bit acrimoniously in 2013.THY may feel that it doesn’t needLu hansa on purely commercialra onale but there is now a widergeopoli cal considera on.


The Principals and Associates of Avia on Strategy apply a problem-solving, crea veand pragma c approach to commercial avia on projects. Our exper se is in strategicand financial consul ng in Europe, the Americas, Asia, Africa and theMiddle East

� Start-up business plans� Due diligence� An trust inves ga ons� Credit analysis� IPO prospectuses

� Turnaround strategies� Priva sa on projects� Merger/takeover proposals� Corporate strategy reviews� An trust inves ga ons

� State aid applica ons� Asset valua ons� Compe tor analyses� Market analyses� Traffic/revenue forecasts

For further informa on please contact:James Halstead or KeithMcMullan,

Avia on Strategy Ltde-mail: info@avia onstrategy.aero



8,000

9,000

10,000

11,000

12,000

13,000

2000 2005 2010 2015 2020

EUROPE: IFR FLIGHT FORECAST

Base

High

Low

Source: Eurocontrol STATFOR Feb 2016

This is the first of a two-part ex-amina on of air traffic control re-form around theworld.

Part2will feature in thenext issueof Avia on Strategy.

A , airports and air traf-fic control companies wereonce overwhelmingly owned

and centrally controlled by govern-ments. Airlines (and increasingly air-ports) have long sincemovedon,withthe majority now in private owner-ship, having experienced both dereg-ula on, substan al cost cu ng andefficiency improvements. For air traf-fic management, on the other hand,while there have been technologi-cal advances, the changes in own-ership structures and the increasein compe ve pressures have beenfar more modest. Is this about tochange? Don’t hold your breath.

Before considering the globaltrends behind this statement, it isimportant to differen ate betweenthe two sub-sectors of the ATMindustry: towers and en-route. O en,though not always, they are providedby the same company, and theydiffer in par cular in that there doesseem to be at least some movementtowards more compe on in towerservices. In the UK, for example, themarket is deregulatedandwhilemostairports employ NATS, some use analterna ve supplier or provide theirown ATM. The second largest towercontract in the UK, that for GatwickAirport, was recently transferredfromNATS to DFS of Germany.

Similarly, faced with extremelyhigh salary levels and inefficiencies,together with the country’s generaleconomic situa on, Spain contractedout the provision of tower services atseveralof it secondaryairports. Tenofthe contracts were awarded to a con-sor umofNATSandtheSpanishcom-

pany Ferrovial. The UK outsourcingcompany Serco won the remainingthree contracts. In Germany the Aus-trian ANSP Austro Control handlesair traffic services at several smallerairports. Even in the United Statesthe FAA has outsourced a significantnumber of smaller tower opera ons,apparently with li le if any opposi-on from other stakeholders. (This

contrasts markedly with the reac onof some to reform of the FAA’s en-route services).

This trend for more contrac ngout, and therefore increased compe-

on, in the provision of tower ser-vices is likely to con nue, probablyaidedby thedevelopmentof “virtual”towers at smaller, more remote air-ports.

En-route ATM, however, is quitea different ma er. A very small num-ber of countries have brought in ex-ternal exper se to run their air trafficcontrol, o en those faced with rapid

increases in demand and very limitedlocal ATC exper se, such as the GulfStates. But overwhelmingly govern-ments guard the sovereignty of theirairspace ferociously, with the resultthat the vast majority of countries,no ma er how small, retain controloverATMprovision. It is certainly truethat the separa on of ATM compa-nies from direct ministerial control isnow common, but the companies in-volved s ll tend to be State enter-prises.

The monopoly posi ons andpublic sector employment prac ces(including pensions) of ATM com-panies make achieving efficiencies


Air Traffic Control:Chances of Reform?


NATS FINANCIAL RESULTS

Year endingMarch (£m) 2015 2014

NATS Airspace 716 720NATS Airports 177 170

NATS Engineering 17 13Other 13 14

Total Revenues 922 918

Salaries 404 419Deprecia on 110 108

Other 156 151

Costs 670 677

Opera ng profit 253 240

Net finance costs 28 28Fair value adjustments 2 18

Pretax profit 227 230

Tax 45 38

Net profit 181 193

and mee ng customer needs all themore challenging. Cost pass-throughprac ces reduce the pressure toreform and o en mean ATC pricesincrease significantly when air ser-vices demand is weakest, such as in2001/02 and 2008/09, just when theprofitability of their airline customersis under par cular pressure. It is notdifficult to seewhy rela ons betweenairlines and ATC companies are o enstrained, even without the controllerstrikes that have become all toocommon in Europe.

NATS

Two countries in par cular havebroken out of this rigid model, theUK (NATS) and Canada (Nav Canada).Their objec ves were similar, but thesolu ons they came up with differedin several important respects. Inthe UK, the Labour party stronglyopposed priva sa on of NATS inany form when in opposi on. (“Ourskies are not for sale”.) However,when elected to form a governmentin 1997, Labour quickly proceededto sell off 51% of the company by

means of a so-called Public PrivatePartnership (PPP) ini a ve. It chose acomplex governance structure withthe objec ve of at least reducing theopposi on to the sale from variousinterests, not least theunionsand thele wing of the Labour Party, whileat the same me maximising thefinancial proceeds for the Treasury.

5% of NATS’ shares were givento the staff at no charge, with 46%made available to the private sector.However, this 46% brought with itthe role of “Strategic Partner”, effec-vely giving theminority shareholder

control of the company, subject onlyto certain powers reserved for theState. Three serious bidders were inthe running, Serco, Lockheed Mar nand a consor umof sevenUK airlinesknown as The Airline Group. It wasTheAirlineGroup, poli cally the leastconten ous bidder, which emergedas thewinner.

The fact that seven airlines putaside their intense compe ve in-s ncts to co-operate in this way is in-dica ve of how cri cal air traffic con-trol is for their opera ons. Consider-able a en on is o en paid to ATCcharges, which are certainly a signifi-cant cost item for airlines, but in factthe avoidance of delays and reduc-on in flight mes which flows from

anefficientATC system is farmore im-portant for most carriers. At the meof the priva sa on, NATS, like almostall ATC companies, had a poor repu-ta on for mee ng customers’ needs,with airlines experiencing major de-lays to their flights on a regular basisand investment projects failing to bedelivered on me and budget.

This and the feeling that theother bidders were less likely toaddress the company’s fundamentalproblems in a way that would sa sfyairlines’ needs, led to the crea on ofThe Airline Group and eventually to

the successful bid. It was a reflec onof the group’s priori es, and of theexpecta on that the investmentwould not produce early profits, thatthe bid was promoted as “not forcommercial return”, subsequentlyo en misquoted as “not for profit”,which was not the objec ve. Profitswould (hopefully) come, but themain challenge was to turn NATS intoan efficient ATC provider mee ngits customers’ requirements. To thisend, several airline employees wereseconded for a period to the ANSP.

The Airline Group bid, which washigher than its two compe tors, in-volved a highly geared investment.It may well have worked, with NATS’borrowing being reduced graduallyas the effects of the new investmentprogramme worked through, exceptfor one event — 9/11. The drama creduc on in traffic, especially acrossthe Atlan c, put considerable pres-sure on NATS’ finances shortly a erthe comple on of the PPP in 2001.It proved necessary to refinance thecompany. The Government providedaddi onal finance and a new investorwas introduced, the airport opera-tor BAA (now Heathrow Airport Ltd)with a 4% stake. The Airline Group’sshareholding was reduced from 46%to 42%, but its Strategic Partnershiprole, and accompanying governancepowers, were largely unaffected.

So, apart from the ini al financialproblems, which arguably could nothave been foreseen, has the priva -sa on been a success? The answer isalmost certainly a yes. Despite claimsto the contrary at the me, safety hasnot been impaired; indeed it has im-proved. Flight delays have been re-duced substan ally and project de-livery standards raised to those com-mon in the private sector. Industrialrela ons have been good and finan-cial performance excellent.



NAV CANADAFINANCIAL RESULTS

Year ending August (C$m) 2015 2014

Enroute 679 641Terminal 476 464

Daily/annual/quarterly 78 75North Atlan c 47 46

Other 52 46

Total revenues 1,332 1,272

Salaries 858 817Deprecia on 136 137

Other 238 226

Costs 1,232 1,180

Opera ng profit 100 92

Net finance costs 102 104Rate stabilisa on 2 12

Pretax profit – –

Tax – –

Net profit – –

The main nega ve aspect isprobably the fact that NATS re-mains, largely as a result of highemployment costs, one of the mostexpensive ATC companies in Europe,despite quinquennial price reviewsby the Civil Avia on Authority. Morerecent regulatory interven on bythe European Commission, however,is likely to increase the pressure toreduce costs.

Although the sevenairlineswhichformed The Airline Group were ini-ally focussedprimarily on improving

the service provided by NATS ratherthan financial returns, a er a fewyears their investment in fact provedto be quite profitable, probablymoreso than running airlines. However,reorganisa on among the group,such as bmi’s shares being acquiredby Lu hansa and ownership changesand mergers with respect to ThomasCook and Tui, eventually led to fourof the founding carriers (Tui, ThomasCook, Lu hansa and Virgin Atlan c)deciding to sellmostof their shares to

USS, a pension fund. This le Bri shAirways, easyJet and the MonarchAirlines Pension Fund (which hadacquired the airline’s stake in TheAirline Group some me previously),together with the four selling carrierswhich retained small stakes, owning51% of the company. The AirlineGroup’s 42% ownership of NATSand its Strategic Partnership roleremained unaffected.

In 2015, the Government an-nounced its inten on to sell its 49%shareholding in NATS, but it remainsto be seen whether this will in factprove to be feasible. A previousa empt to sell down the stake gotnowhere. The complexity of thegovernance procedures introducedat the me of the ini al PPP havecreated difficul es which, whilenot insurmountable, are certainly achallenge.

Nav Canada

NATS was not the first ATC companyto be priva sed. That honour goes toNav Canada, established as a privatecompany in May 1995, and formallytaking responsibility for the provisionof ATC services on 31 October 1996.It controls an enormous airspacestretching fromthePacificWest coastof Canada to the East coast of New-foundland and on to the centre ofthe North Atlan c. It describes itselfas represen ng “a unique consensusamong the company’s four foundinggroups: commercial air carriers, theGovernment of Canada, business andgeneral avia on, and our employees,representedby their unions.”ABoardof 15 Directors, all Canadian ci zens,consists of four elected by the air-lines, one elected by the CanadianBusiness Avia on Associa on, threeappointed by the Government, tworepresen ng the unions and fourindependent Directors elected by

the other 10 members, plus a ChiefExecu ve Officer appointed by theBoard.

This governance structure of theBoard is important because it is de-signed to minimise the opportunityfor any one stakeholder group to ex-ert excessive influence. In addi on,Board members are not permi edto be ac ve employees of airlines,unions or government. There is, how-ever, a 20-member Advisory Commit-tee of avia on professionals whichanalysesandreviews issues facing thecompany and makes recommenda-ons to the Board. It is perhaps an in-

dica onof thestakeholderconsensusapproach adopted from the begin-ning in establishing the governanceprinciples for Nav Canada that its firstChief Execu ve, John Crichton, whowent on to serve for 20 years, camefrom the Air Transport Associa on ofCanada.

Clearly Nav Canada is not a nor-mal commercial company. It was es-tablished by an Act of Parliament asa “non-share capital corpora on”, fi-nanced by means of publicly-tradeddebt, currently amoun ng to someC$2bn (US$1.5bn/£1bn). The Cana-dian Government ini ally receivedC$1.5bn as compensa on for the as-sets transferred to the new company.By law Nav Canada is not allowed toset its service charges “at a level ex-ceeding what is required to meet thecost of providing civil air naviga onservices.” The previous cket tax ap-proach to funding was replaced bycharges levied directly on the usersof ATC services, with airline rates de-pending on the weight of aircra anddistance travelled as is the case inmost countries and general avia onoperators paying a fixed annual fee.

The reasons for establishing NavCanada were similar in a number ofways to those behind the UK Gov-



ernment’s decision to priva se NATS.It had a good safety record and re-spected opera onal staff. But its in-frastructurewas in desperate need ofmodernisa on and flight delays andcosts were seen as far too high. Gov-ernment investment restric ons andwage freezes were affec ng the com-pany’s ability to reformandmove for-ward. There was also concern abouthaving the service provider and regu-latoraspartof thesameorganisa on,contrary to the trend found in manyother countries.

Airlines were par cularly vocal intheir demands that something had tobe done. As the current Nav CanadaChief Execu ve,NeilWilson, has said:“We had general dissa sfac on fromeverybody.Wehad a safe system, butit was not a system that was deliver-ing all that it could.” The op on even-tually chosen by the Canadian Gov-ernment was certainly radical, andpresumably not without its risks. Inthe event it has proved to be a greatsuccess.

John Crichton has cited six crit-ical achievements which have con-tributed to that success:

( Safety, especially halving the lossof separa on rate .( World-leading technology,reflec ng a C$2bn investment inmodernisa on.( People, with a construc ve andproduc ve labour rela ons climate.( Fiscal strength, inpar cularmain-taining an AA credit ra ng( Focus on customer service,mainly as a result of reduced delaysand lower charges.( Space-based ADS-B, a new jointventure with Iridium Communi-ca ons, ENAV, the Irish ANSP andNavair to be introduced into servicein 2018, designed to maintain NavCanada’s leading technical posi on.

As we will see later, this successhas o en been compared with theFAA’s record in the United States.Wri ng in Forbes.com in Februaryof this year, Dan Reed highlightedthe differences, and didn’t mince hiswords: “By removing the air trafficcontrol func on from the clutchesof government budget restraintsand poli cally-driven appropriators,Nav Canada has been able to rapidlyupgrade its technologies and prac-ces and to implement those with

considerable success. Meanwhile,the FAA has become the laughing-stock of the global air transporta onmanagement world for its chronicfalse starts, delays, missed deadlines,and misunderstandings of what’sactually needed or possible in termsof air traffic control modernisa on.”Another journalist, Sco McCartney,wri ng in theWall Street Journal, hasdescribed flying over the US-Canadaborder as like me travel for pilots.“Going north to south, you leave amodern air traffic control system runby a company and enter one run bythe government struggling to catchup.”

Rest of theWorld

When the UK Government partlypriva sed NATS in 2001, many in-volved expected the new companyto act as a model for other countries,just as the UK’s early priva sa onof other State industries had beenfollowed, to a greater or lesser ex-tent, by many other governments.This has not, however, proved to bethe case. The only excep on, andeven this is far from certain, is theproposed sale of ENAV in Italy. Simi-larly, while Nav Canada has a ractedconsiderable interest in the US, sofar there has been no duplica on.There are a number of explana onsfor this lack of ac on. Pressure to

“do something” is certainly buildingup throughout the world, but theobstacles to progress should not beunderes mated.

This is par cularly the case in theFar East, for example. Depending onhow Asia/Pacific is defined, there areover 40 ANSPs in the region, almostall na onally based. KhawBoonWan,Singapore Infrastructure and Trans-port Minister, has commented thatthe poten al of the ASEAN Single Avi-a on Market, which came into ef-fect early in 2015, is being s fled bypoor co-ordina on between air navi-ga on service providers in South EastAsia. “We need our airspace to bebe er integrated so air traffic can bemore efficiently managed and safetyenhanced.” He went on to call for“one market, one seamless airspace”among ASEAN countries. “Govern-ments are the key players in airspaceintegra on.”

Therein lies the problem, ofcourse. As Tom Ballantyne has com-mented, if there is one issue thatmore than anything unites airlines,ANSPs and airports in Asia/Pacificit is the belief that the region’sgovernments are not moving fastenough to address the damage theincreasingly crowded skies is doing totheir businesses. But the fact remainsthat integra on and consolida on,to be effec ve, to save costs and toimprove efficiency, almost inevitablymean closing ATC centres. Not sur-prisingly governments shy away fromannouncing that high skilled, wellpaid jobs are to be abolished andthe work handled by employees offoreign ANSPs, especially since thereare likely to be fewactual cost savingsfor the governments themselvesapart from probably modest ini alsale proceeds. This is despite the factthat there are very real economicbenefits from ATC reform for the



SINGLE EUROPEAN SKIES: PROPOSED FABs

countries involved which have beenrepeatedly iden fied.

In the Middle East, for example,airspace is similarly highly frag-mented, made worse by the impactof regional conflicts which result intraffic disrup on from airspace clo-sure. According to a report producedby Oxford Economics and commis-sioned by the UK’s NATS, if nothingis done the Gulf Co-Opera on Coun-cil States (Bahrain, Kuwait, Oman,Qatar, Saudi Arabia and the UnitedArab Emirates) together with Iraqand Iran will lose some $16bn ineconomic benefits by 2025 as a resultof increased delays to passengersand airlines.

Speaking last October at the IATAMiddle East Avia on Day conferencein Abu Dhabi, IATA’s Director Generaland Chief Execu ve Tony Tyler noted:“The enormous success that avia onhas enjoyed inmuchof the regionhascreated challenges that will requireco-opera on and visionary planningto overcome. In some ways the re-gion is in danger of becoming a vic-mof its ownsuccess…The challenge

is to increase the overall efficiency oftheATMsystemof the region throughimproved airspace design and organ-isa on… The need for ac on is ur-gent and strong poli cal will is re-quired.”Co-opera on,visionaryplan-ningand strongpoli calwillhave, un-fortunately, all been notable by theirabsence so far in the ATM field, espe-cially among governments.

Europe is just as complicated,with a highly fragmented, expensiveand poli cally dominated airspace.The Internal Avia on Market mayhave existed for several decades,but there is very li le sign of con-solida on among European ANSPs.A study recently published by IATAhighlights what is at stake. EuropeanATM modernisa on/reform would,

it is claimed, result in the crea on ofonemillion addi onal jobs and boostthe European economy by some$245bn by 2035. Currently averageflights in Europe are nearly 50 kmslonger than they need be and delaysaverage some tenminutes per flight.

Single European Skies

To address this problem Eu-rope has an ambi ous techni-cal/organisa onal solu on, theSingle European Skies ini a ve,including the Single European SkyATM Research project, or SESAR,with the objec ve of deliveringa threefold increase in capacity,improved safety by a factor of ten,reduced environmental impact of10% per flight and 50% lower costs.Unfortunately, as Tony Tyler haspointed out, these goals are notbeing achieved. “Despite a strong

European Commission vision andpush for SES, na onal interests haveprevailed.” The ambi ous SESARtechnical ini a ve is running waybehind scheduleandoverbudget andfaces major challenges. As Michielvan Dorst, KLM’s EVP Flight Oper-a ons and Deputy COO, has said:“There has been a lot of talking andnot much ac on. We have becomea bit cynical and disappointed aboutthe progress of SES.”

The introduc on of Func onalAirspace Blocks, or FABS, is a starttowards consolida on, but a verytenta ve one with limited objec-ves. Nine have been proposed, but

only two (UK-Ireland and Denmark-Sweden) have been implemented(see map on this page). In fact somebelieve FABs may even be a stepbackwards in certain respects. Forexample, Mark Deacon of Monarch



Airlines and a long-serving repre-senta ve of the Interna onal AirCarrier Associa on on ATC ma ershas argued that they have “actuallyincreased fragmenta on of the net-work by protec ng States and ANSPswithin another line of defence. Forthose of us longing for a Single Euro-pean Sky, the FAB empires appear tobe the biggest blocker of all.”

JanKlas andLubosHinovskyofAirNaviga on Services of the Czech Re-public similarly ques on the value ofFABs, no ng that there is no doubtthat their current development can-not meet the high expecta ons ofbothairspaceusers and theEuropeanins tu ons, although they argue thatit would be a mistake to abandonthe concept altogether. They go onto comment: “Unfortunately thereis a hopeless lack of shared visionin the European air traffic manage-ment industry... [The] consequencesare a poorly communicated poli -cal vision; inconsistent stakeholderrequirements; contradictory regula-ons; inefficient and inaccurate busi-

ness planning across the ATM indus-try; outcomes opposite to expecta-ons of the airline users; and a rigid

environmentpreven ngbe eruseofstate of the art technology.” Presum-ably apart from that, everything elseis rosy!

The industrial rela ons problemsexperienced by several ATC providersin Europe illustrate the scale of theunderlying issues. The one-day strikeby French controllers in late-Maywasthe sixth in five months, the 47th insevenyears. (More strikes arealreadyin the pipeline, so by the me youread this these numbers will almostcertainly have been exceeded.) Andthis is not just a French problem. Sim-ilar strikes have occurred recently inGreece, Italy, Belgium and Iceland.It is perhaps hardly surprising that a

growing number of airlines, led bythe new lobbying group Airlines forEurope, are calling for such strikesto be banned, or at least for waysto be found to mi gate their effects,such as allowing other ANSPs to takeover strikebound airspace. The finan-cial impact on airlines from groundedaircra and longer flying mes is con-siderable, now exacerbated by theneed to compensate passengers fordelays under EU Regula on 261. AllEuropean ANSPs are protected frombeing sued by airlines or passengersfor delays caused by strikes.

Perhaps the nadir of EuropeanATM industrial rela ons came withthe strike by Belgian controllers inApril, shortly a er the Brussels Air-port terrorist a ack. For once pu ngdiploma c language to one side, andreflec ng the anger increasingly feltby ANSPs’ customers, IATA called theac on “a kick in the teeth for all theairlines and airport staff who haveworked so hard to reconnect Brusselsto the world a er the appalling ter-rorist a ack just threeweeks ago. It isthe height of irresponsibility … If wecannot count on simple human de-cency from such highly-compensatedprofessionals then it’s me for gov-ernments to find ways to guaranteethe availability of air traffic controlservices.”

The job of an air traffic controlleris certainly challenging, requiring ahigh level of technical competenceand several years of training. How-ever, as IATA points out, controllersare almost invariably highly compen-sated and it is difficult to believetheir working condi ons are such asto jus fy the level of disrup on seenrecently in Europe. The underlyingproblems are more likely to be struc-tural, and therefore unfortunately allthe more difficult to solve given theirpoli cal dimension.

Some among the European ATMleadersdohaveavisionof a reformedfuture. Klaus-Dieter Scheurle, CEOand Chairman of DFS, the GermanANSP, and former State Secretaryat the German Federal Ministryof Transport, Building and UrbanDevelopment, recently wrote, forexample: “My vision is that, withinthe regulatory framework, the airnaviga on services sectorwill be con-solidated and free-market condi onswill determine success .... ANSPs willco-operate and at the same meoffer and purchase services fromeach other as required. Only a few ofthe priva sed enterpriseswill be ableto provide the complete value chainof air naviga on services. Na onalborders will no longer determine theroute network or service provisionthroughout Europe.” That may beHerr Scheurle’s vision, but unfortu-nately so far there is precious li lesign of it being implemented.

Dr Barry HumphreysAvia on consultant.

Dr Humphreyswas a Director of

Virgin Atlan c Airways, served

two terms as Chairman of the

Bri sh Air Transport

Associa on, the trade body for

UK airlines, and spent several

years as a Director of NATS.



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₱m

CEBU PACIFIC FINANCIAL RESULTS

Opera ng profit

Net profit

Revenues

P LCC Cebu Pacific Airsaw profits rise fourfold in2015, but it ambi ons for

growth on both short- and long-haulare facing a major problem — lackof capacity at Manila’s Ninoy Aquinoairport.

Cebu Pacific Air was establishedas a legal en ty back in 1988, butdidn’t launch opera ons un l 1996, ayear a er it was bought by JG Sum-mit Holdings, a giant Filipino con-glomerate that has interests in every-thing from banks and hotels to prop-ertyandu li es. Its founderwas JohnGokongwei — of Filipino-Chinese ex-tract and one of the wealthiest en-trepreneurs in Asia — and today hisonlysonLance ispresidentandCEOofCebu.

Based at Ninoy Aquino airportin Manila, Cebu was a pioneer ofthe standard LCC business model inAsia, though today it has mul pleaircra models and an FFP calledGetGo. It was launched ini ally as adomes c-only carrier before expand-ing onto interna onal routes from2001, and now operates almost 100routes to 64 des na ons, of which34 are domes c, 24 are short-hauland six long-haul. They are flown byCebu’s 57-strong fleet that comprisessevenA319s, 36A320s, six A330s andeight ATR 72-500s — which have anaverage age of less than five years.

In 2015 Cebu recorded an8.7% rise in revenue to ₱56.5bn(US$1.2bn), based on an 8.9% in-crease in passengers carried to18.4m. Passenger revenue was up6.2% to ₱42.7bn ($938m), withancillary revenue rising 19.6% to

₱10.4bn ($228m) and cargo revenueup 10% to ₱3.5bn ($76m). In 2015EBIT more than doubled, to ₱9.7bn($213m), while net profit increasedby 414% compared with 2014, to₱4.4bn ($96m).

Larger aircra

On order are two A320ceos, 30A321neos and 16 ATR 72-600s, allof which will arrive by 2022. Thesix-hour flying radius of the 240-seatA321neo will allow Cebu to operateto new markets in Australia and theIndian subcon nent, although theywill also replace older Airbusmodels.All the A319s will be sold by 2018;in May Cebu announced a deal forthe sale of four of the type to LasVegas-basedAllegiant Air in 2017 and2018. Seven A320s will also leave by2019 as their leases expire.

All Cebu’s ATR 72-500s (operatedunder theCebgobrand)will departby2018, being replaced by the arriving

16 ATR 72-600s from the third quar-ter of 2016 that were ordered in June2015 (along with op ons for another10 aircra ) in a deal worth aboutUS$200mfor thefirmorders at actualprices. The 72-600s will be equippedwith high-density Armonia cabins —with78so-called“slim-line”seatsandwider overhead bins — and will beused to expand Cebu’s network re-gionally and for increased inter-islandservices in the Philippines.

Cebu’s fleet only grew by threeaircra in 2015 (to 55 at the endof the calendar year), and future ex-pansion will con nue to be gradual,with the fleet expected to reach 69by 2018, when it will comprise 36A320s, 15 A321s, six A330s and 12ATR 72s. As can be seen in the charton the next page, in terms of ASKsCebu has grown gradually over thelast 24 months, maintaining a focuson improving its load factor, whichhas climbed impressively over thepe-


Cebu Pacific:Hitting growth constraints at Manila


0

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2014 2015 201650

55

60

65

70

75

80

85

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CEBU IS SLOWLY IMPROVING LOAD FACTOR

ASK

RPK

PLF

CEBU PACIFIC FLEET PLAN

at year end

In service Orders 2016 2017 2018

A319 7 4 3A320 36 (2) 36 38 36

A321neo (30) 3 15A330 6 6 6 6ATR72 8 (16) 10 11 12

Total 57 (48) 56 61 69

riod and is now close to its medium-term target of 85%.

That strategy is partly of itsown choosing, but partly because ithas li le alterna ve given capacityconstraints at Ninoy Aquino. Ninoy islocated centrally in theMetroManilaconglomera on (popula on around12m), with the alterna ve, lowercost airport being Clark Interna onal,which is 70km from the centre.Owned by the state, Ninoy Aquino’sthroughput was 36.7m passengersin 2015, of which 19.5m were do-mes c.. The airport’s growth rate hasbeen substan al — it has more thandoubled passenger numbers since2006 (when it had a throughput of17.7m).

Cebu operates out of Terminal3, which opened par ally in 2008(a er several years of delay) andthen launched fully in August 2014,with a capacity of 13m passengersa year. Cebu was the first carrierto move into the facility, but manyothers have joined since, includingPAL subsidiaries Air Philippines andPAL Express, as well as Delta, SIA,Cathay Pacific and KLM.

The government has plans for afi h terminal at the airport, to bebuilt next to Terminal 3 and to whichCebu and the other LCCs at T3 willmove across to, leaving T3 exclusively

for full-service carriers opera ng in-terna onally. But the terminal is cur-rently in the design stage, and in-evitably it will be many years beforeit becomes opera onal. But overallthe airport is almost at full capacityand expansion is desperately neededas passengers are forecast to grow to51.4m a year by 2037.

The situa on is complicated bythe fact that theconstruc onof a sec-ond airport in Manila — no furtherthan 20km from the city’s businesscentre — is also a possibility. Earlierthisyear thePhilippinetransportmin-istry said the loca on of a second air-port would be unveiled soon, with a

target for it to become opera onal inthe next 10 to 15 years, ini ally withtwo runways but then expanding tofour.

The new airport is likely to befunded by the government, withthe commercial sector awardedcontracts for its opera on andmaintenance. The government isalso pondering the ques on as towhether this will exist separately toNinoy, or whether it will become thesole airport for Manila, with Ninoyeventually closing down.

While Cebu waits for the gov-ernment to announce its plans, all itcan do is grow marginally at Ninoyby increasing the average size of itsaircra and squeezing more capac-ity onto exis ng routes (hence theswitch from ATR72-500s to -600s andfrom A320ceos to A321neos), andbuild up routes connec ng key Asiandes na ons with secondary airportsin the Philippines.

Segment strength

According to Cebu’s own es mates, itachieved a 60% share of the domes-c Philippines market in 2015, com-

pared with 29% for the PAL Group



CEBU PACIFIC ROUTENETWORK

Kota Kinabalu

Bangkok

Bandar Seri Begawan

Guangzhou

Cebu

Jakarta

Clark

Dammam

Doha

Denpasar Bali

Davao

Dubai

Fukuoka

Guam

Hanoi Hong Kong

Phuket

Seoul

Iloilo

Osaka

Kalibo

Kuala Lumpur

Kuwait

Macau

Manila

NagoyaTokyo

Beijing

Busan

Shanghai

Siem Reap

Riyadh

Ho Chi Minh City

Singapore

Sydney

TaipeiXiamen

and 11% for Air Asia; that was Cebu’shighest-ever market share. The do-mes c network is based on six hubs— Manila, Cebu, Clark, Kalibo, Iloiloand Davao.

On short- and medium-haul, thethree most important markets forCebu are to Hong Kong, Singaporeand China, where its share of seat ca-pacity on routes to/from the Philip-pines in the first quarter of 2016 was30%, 33% and 20% respec vely, ac-cording to CAPA data.

Other des na ons include SouthKorea and Japan, and in December2015 three new routes (all usingA320s) were added — Manila toFukuoka (Cebu’s fourth des na on inJapan a er Osaka, Tokyo Narita andNagoya); Cebu to Taipei; and Davaoto Singapore. And in March this yearCebu launched a service betweenManila and Guam (where 30% of thepopula on are Filipino), with fourA320 flights a week, so becomingthe first LCC to operate on the route.

Cebuwouldalso like to launch furtherflights tootherUS territories a er theFAA granted the airline a Category 1safety ra ng in 2014.

Long-haul opera ons are basedon the 400-seat (all economy) A330,the first of which was leased in 2013.Today Cebu operates to Sydney,Kuwait, Dubai, Riyadh and Doha,with the airline taking respec ve seatcapacity shares on those routes of39%, 76%, 31%, 19% and 15% in thefirst quarter of 2016.



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1.10

1.15

1.20

1.25

1.30

2012 2013 2014 2015

PHP

CEBU’S UNIT COSTS EX-FUEL TRENDINGDOWN

Unit Costs per ASK

Trendline

0

100

200

300

400

500

600

AfricaHong Kong

JapanTaiwan

Other East Asia

Malaysia

Singapore

Other SE Asia

Kuwait

QatarSaudi Arabla

UAEOtherMiddle East

Australia

Europe

Americas

000s

2.32m FILIPINOMIGRANTWORKERS

Male

Female

Source: Phillippine Sta s cs Authority 2014 Survey onOverseas Filipinos

Clearly Cebu faces more compe-on on some routes than others,

but where it faces well-entrenchedincumbents it appears to be estab-lishing a bridgehead. For example, ithas seen passengers carried on itsManila-Sydney route increase 58%from 2014 to 2015; it has now be-come the largest carrier opera ng onthe route, with seat share rising from14.2% to almost 40% in 12 monthsagainst the incumbentsofQantasandPAL (andwithQantas taking seats outof the route).

Cebu’s long-haul strategy is al-most en rely based on the VFR andbusinessmarkets between the Philip-pines and countries with significantFilipino communi es. ThePhilippinesitself has a young popula on of 104min total (35% of which are under theage of 15 years), but a significant in-terna onal disapora and some 2.3m(or around 4% of the popula on ofworking age) employed overseas andremi ng funds home (see chart onthis page).

In July Cebu will add a thirdweekly A330 service betweenManilaand Doha, where it’s the only Philip-pine carrier serving the two ci es

non-stop. Qatar has the third-largestFilipino popula on in theMiddle Easta er Saudi Arabia and theUAE.

Though the airline has analysedthe poten al of A350-900 XWB, largeorders are not imminent. If added,new capacity is likely to come fromone or two extra A330s.

The future

In the first quarter of 2016 Cebureported a 13.4% rise in revenue to₱16.1bn ($341m), with opera ngprofit rising 49% to ₱4.2bn ($89m)

and net profit up 81.4% to ₱4.0bn($85m).

Given the constraints at Ninoy,growth will come largely from routesto/from secondary ci es, thoughlarger aircra over the next few yearswill provide some capacity growthoutofManila. Cebuexecu ves candonothing about the airport situa onin the capital, but it must be a sourceof frustra on to them that they can’tfully exploit the significant growth inthe Philippine economy over the lastfew years, where annual GDP growthhas averaged more than 6% since2010. Cebu hopes that economicgrowth in the Philippines as a wholewill translate into demand for airtravel to/from secondary ci es,which it canmore easily exploit.

The airport capacity constraintwill also limit the benefits to Cebu ofthe open skies agreement of the As-socia on of Southeast Asian Na ons(ASEAN), which took effect across theregion in December 2015. Frustrat-ingly the Philippineswas the only oneof the 10members of ASEAN that hadnot ra fied theopen skies agreementat that date.

Though the Civil Aeronau csBoard wanted to ra fy the agree-



40

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70

80

90

100

110

120

130

140

2011 2012 2013 2014 2015 2016

CEBU PACIFIC SHARE PRICE PERFORMANCE

ment that allows designated airlinesto operate unlimited flights be-tween Asean capital airports, thegovernment — under the leadershipof President Aquino — was reluc-tant, partly due to pressure fromflag carrier PAL. It agreed ini allyonly to open up secondary airportsto ASEAN carriers, including Clark,Cebu and Davao, but in Februarythe agreement was finally ra fied byPresident Aquino. As a result, Cebuexpects to add more services to keyci es in ASEAN, though ini ally onlyfrom secondary Filipino airports.

Cebu expects to see some growththanks to a strategic partnershipsigned with Tiger Airways last year,which extended the exis ng interlineagreement between the two through

closer coordina on on schedules,sales and other areas.

The deal also included the re-naming of Tigerair Philippines as Ce-bgo. Tigerair Philippines was previ-ously known as SEAir un l 2013, butCebu ini ally bought a 40% stake inthe turboprop operator and then fullcontrol in 2014 as Tiger sold its stakeaspart of its strategy toexit from loss-making subsidiaries.

In May Cebu also announced thelaunch of an Asian LCC associa oncalled “the Value Alliance” (theother members are Jeju Air, Nok Air,NokScoot, Scoot, Tigerair Singapore,Tigerair Australia and Vanilla Air),which will essen ally offer interlinebenefits to passengers.

For the moment Cebu has ruled

out the possibility of launching sub-sidiaries elsewhere in Asia, and isinstead concentra ng on buildingup routes to secondary ci es inthe Philippines, increasing averagecapacity out of Ninoy through newaircra , and keeping a lid on costs.The LCC gives rela vely fewdetails onthe cost breakdown between short-and long-haul, but as can be seenin the chart on the preceding page,unit cost excluding fuel had beentrending downwards for some me—although it has started to rise againin the last 12months.

Altogether Cebu is targe ngmore than 20m passengers carriedthis year, thanks largely to expansionof domes c and regional routes outof Filipino airports other than Ninoy,and in the first three months of 2016Cebu saw 13% rise in passengerscarried year-on-year, to 4.8m.

Cebu came to the marketsthrough an IPO on the Manila stockexchange in October 2010, whenit floated 30.4% of equity. A er asubstan al decline though to the be-ginning of 2014, the share price hassteadily recovered since (see charton this page). Shareholders (and JGSummit s ll controls amajority of theshares) will probably remain pa entgiven the current profitability, but areas frustrated as Cebu is that growthopportuni es are beingmissed.


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

please contact us:

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WESTJET’S FINANCIAL RESULTS (C$m)

Opera ng ResultAdj Net Result

Revenues

Source: Company Reports

W J , Canada’s JetBlue-style LCC, has embarkedon a significant new

phase of its interna onal expan-sion: nonstop flights to Londonfrom six Canadian ci es with itsown 767-300ERs. How exactly doesWestJet plan to make money in thecompe ve transatlan c marketwhere it does not havemuchof a costadvantage?

The Calgary-based carrierlaunched its first widebody transat-lan c flights at the beginning of Mayand plans to operate as many as 56weekly flights to and from LondonGatwick this summer. Toronto andSt. John’s have daily service, whileVancouver, Edmonton, Calgary andWinnipeg have 1-6 flights a week.Calgary and Toronto will be operatedyear-round, the others seasonally.The St. John’s-London route uses737NGs; the others are flown with767-600ERs.

With introductory one-way faresas low as £177 (C$238) and C$20add-on fares available to/from otherpoints inCanada, theremustbemanyhappy people in Canada and the UKwho will now be visi ng their friendsand rela ves across the Atlan c thissummer.

At Gatwick, WestJet’s passengerscan connect to flights operated bycodeshare partners BA and Emirates,as well as various LCCs’ services, soperhaps the new transatlan c ser-vices will also be a viable op on fortravel betweenCanadaand con nen-tal Europe and further afield.

Transatlan c expansion is just thelatest ofmanynewstrategiesWestJet

has adopted in the past three years.Most notably, the carrier has movedaggressively to capture business traf-fic in Canada, launched regional sub-sidiary WestJet Encore and enteredthe Canada-Hawaii market (ini allywithwetleased 757-200s).

The London move may seem ag-gressive,but in reality it ismore likeanevolu onary development for a car-rier that is financially very successfuland tends to grow its network cau-ously and at ameasured pace.WestJet has been tes ng the

transatlan c market since June2014, when it launched its own dailyscheduled seasonal Toronto-Dublinservices with 737s, operated viaSt. John’s (Newfoundland), a stopmandated by ETOPS rules. Thoseflights were successful, so they wereresumed in May 2015, whenWestJetalso launched its second transatlan croute, Toronto-Halifax-Glasgow.

Likewise, WestJet minimised risk

by entering its first long-haul over-water market, Alberta-Hawaii, withwetleased757-200s. The767-300ERsnow on the transatlan c were firsttested on the Hawaii routes, begin-ning in January 2016.

The four 767-300ERs in the fleetare ex-Qantas aircra acquired fromBoeing in a July 2014 agreement (de-livered between August 2015 andApril 2016). WestJet is moving veryslowly with further fleet plans, tak-ing its me to acquire more used air-cra and pick the 767’s longer-termreplacement.

Despite its low-key approach,WestJet is probably a good candidatefor network growth and diversifi-ca on. It has an impeccable profitrecord, a strong balance sheet andample cash reserves. It has consis-tently met its ROIC target. It enjoys arela vely lowcost of capital, having inearly 2014 become only the secondairline in North America to be rated


WestJet: Pioneering a new model intransatlantic flying


WESTJET ROUTENETWORK

Antigua

Aruba

Bermuda

Bridgetown

Nashville

Boston

Cayo Coco

Cancun

Curacao

Cozumel

Dallas

Dublin

Fort Lauderdale

Grand Cayman

Glasgow

Honolulu

Holguin

Huatulco

Houston

JFK

Kingston

Kona

Las VegasLos Angeles

La Guardia

London

Kauai Island

Liberia

Loreto

Montego Bay

Orlando

Miami

Merida

Myrtle Beach

Mazatlan

Nassau

Kahului

Chicago

Phoenix

Providenciales

Puerto Plata

Port Of Spain

Palm Springs

Puerto Vallarta

San Diego

San Francisco

San Jose Cabo

San Jose

San Juan

Santa Ana

Santa Clara

Sarasota

Saint Maarten

Tampa

Saint Lucia

Varadero

Brandon Deer Lake

Edmonton

Hamilton

Halifax

Fort McMurray

Ottawa

Quebec

Comox

Regina

Thunder Bay

Grande Prairie

Gander

Sydney

Montreal

Vancouver

Winnipeg

Saskatoon

Fort St. John

Prince George

Terrace

London

Whitehorse

Calgary

St. John’s

Toronto

Yellowknife

Ixtapa

Manzanillo

737/DH4757/767

investment grade (a er Southwest;Alaska became the third in June 2014and Delta the fourth in February2016).

WestJet has a unique people-focused culture, an award-winningproduct and a strong brand. It ben-efits from a non-union workforce (ararity for North American airlines). Ithas high produc vity and efficiencylevels and great cost controls.

And WestJet needs new growthareas. It does not have the oppor-tuni es that US LCCs enjoy in be-ing able to tap the huge US marketfor domes c and near-interna onalexpansion. It has already captured40% of the Canadian domes c mar-ket and entered the key transbor-der business markets. It is alreadya major player in the Canadian win-ter sunmarket to Florida/Mexico/the

Caribbean and has staked out a posi-on in the Canada-Hawaii market.Many of WestJet’s tradi onal

markets have seen adverse macroe-conomic trends over the past yearor so. Canada’s GDP grew by only1.2% in 2015 amid a slowdown inthe energy sector. WestJet is heavilyexposed to the economic weaknessin Alberta and the Prairie provinces.

The Canadian dollar’s plungeagainst the US dollar has led to asharp decline in southbound Cana-dian travel. While Canada is nowa bargain for travellers from othercountries, those coming from theUS tend to fly on US airlines. Inthe Canada-Europe market, West-Jet arguably has a be er chanceas a price discounter to captureEurope-origina ng leisure traffic.

While WestJet seems well po-

si oned to make the transatlan copera ons a success, the venturealso poses many risks. First, it is anew area of overlap with Air Canada.Compe ve clashes between thetwo have escalated significantly inthe past three years. As WestJet setup a regional subsidiary, Air Canadaadded regional turboprop opera-ons. As Air Canada launched its

low-cost unit Rouge for interna onalleisure markets (2013), WestJetbegan its seasonal transatlan cforays. As WestJet began tappingthe business segment, Air Canadaimplemented successful cost cu ng;the result of that has been a narrow-ing of the cost gap between the twoairlines.

Second, on the transatlan cWestJet is exposed to compe -on from a mul tude of airlines.



It is the sole operator only on theWinnipeg-Gatwick route. In manyof the other markets, it competeshead-on with Air Transat, anotherCanadian low-cost operator.

Third, likeotherLCCs,WestJethasless of a cost advantage on long-haulroutes.Muchof its near-termcost ad-vantage in theGatwickmarkets arisesfrom the low ownership costs asso-ciated with the used 767s. What willhappen when the me comes to re-place those aircra ?

Fourth, adding a third aircratype and a new interna onal regionincreases the complexity (and hencethe cost) of opera ons. But the largeraircra and longer stage lengths willobviously have beneficial impact onunit costs.

Fi h, even though WestJet be-lieves that the transatlan c opera-ons will be immediately accre ve to

earnings, the combina on of highercosts and super-low fares is likely tomean lower profit margins on thoseroutes. The likely impact is to keepWestJet’s system opera ng marginswell below those of US carriers.

Sixth, the new risks, nega ve unitrevenue effects and reduced operat-ing margins will keep many investorsand analysts unhappy. Some haveques oned whether WestJet has gotits capital deploymentpriori es right.The new transatlan cmodel

WestJet’s transatlan c businessmodel has two unusual components:deployment of used 767s and impo-si on of ancillary fees such as a $25checked-in bag fee.

While bag fees are now chargedby nearly all airlines within NorthAmerica (Southwest may be theonly holdout), they are not commonon the Atlan c. WestJet makes thereasonable-sounding assump onthat since it is entering the markets

with significantly lower basic faresthan incumbent operators such as AirCanada, travellers will happily pay a$25 bag fee. And, of course, there areplenty of excep ons; for example,the fee can be avoided if one bookswith aWestJet credit card or throughWestJet Vaca ons.

WestJet will also collect addi-onal revenues from its premium

class. The 767s feature a “Plus” cabinwith 24 premium seats and a maincabin with 238 regular seats. Thepremium cabin has seats in a 2-2-2configura on (the middle seat isblocked on the 737s) and offers hotmeals and other ameni es. The Plusproduct also offers priority boardingand security screening and flightchange flexibility.

When revamping the Plus prod-uct last year, the airline also launched“WestJetConnect”,anewin-flighten-tertainment system featuring wire-less internet connec vity and 450-plus films/TV programmes. As ofMay2, all four 767s and 44 737NGs hadbeen equippedwith the system.

While low fares (at least com-pared to Air Canada’s) will be thekey to ge ng the traffic on the Lon-don routes, ancillary revenues couldmeaningfully improve the viability ofthose opera ons.

WestJet also expects to be oper-a ng at very high load factors, similarto those seen on the Dublin andGlas-gow routes.

But WestJet also enjoys network,scale and other benefits that willhelp it on the transatlan c. The keyfactors include strong VFR demandin the Canada-UK market, feed fromWestJet’s sizeable Canadian routenetwork, coopera on with BA, po-ten al connec ons with other LCCsat Gatwick, and WestJet’s excep on-ally strong brand (more on thesefactors below).

WestJet execu ves said at thecarrier’s quarterly earnings callon May 3 that they had seen astrong market response to the newtransatlan c services, with advancebookings running ahead of expec-ta ons. Feed from the networkwas “as planned”, while Sterling’sstrength against the Canadian dollarhad helped boost UK-origina ngbookings. The execu ves said thatthey s ll expected the London routesto be accre ve to earnings this year.

The Atlan c is a tough market forLCCs, but WestJet has a reasonableshot atmaking it a success for the fol-lowing reasons (in nopar cular orderof importance):

( Strong historical and ethnic con-nec onsWestJet execu vesdescribed Londonas “the crown jewel of interna onaltravel to and fromCanada”. There arestrong historical and ethnic connec-ons between the two countries and

therefore significant VFR traffic andsteady demand. US LCCs’ experiencein the Caribbean/La n America hasshown that VFR traffic makes a hugedifference to the viability of low-costair services.( Scale and network benefitsIn its 20 years of opera ons, WestJethas built enough scale and cri calmass in North America to success-fully venture into long-haul markets.With its tradi onal 737 opera onsand now also smaller-market pene-tra on with Encore, it has a strongdomes c network that will feed thetransatlan c services. It promises“convenient connec ons from ci esacross Canada in both direc ons”. Itis in a much stronger posi on thanpoint-to-point compe tors withoutnetworks.There could even be some feed fromtheUS.WestJethasseena“niceflow”



WESTJET’S FLEET PLAN

Fleet Future deliveries Fleet

31Mar 2016 Q2-Q4 2016 2017 2018 2019-20 2021-23 2024-27 Total 2027

737-600 13 13737-700† 59 59737-800 43 3 2 5 48

737MAX 7‡ 6 4 15 25 25737MAX 8‡ 4 7 12 11 6 40 40767-300ER 3 1♢ 1 4

Q400§ 27 7 2 9 36Maximumfleet↑ 145 11 8 7 18 15 21 80 225

Lease expiries -3 -6 -9 -12 -14 -44 -44Minimumfleet↓ 145 8 2 -2 6 1 21 36 181

Notes: † One leased 737-700 was returned on April 1. ‡ There are op ons to purchase ten 737 MAX aircra for 2020-2021 delivery. The MAX 7andMAX 8 orders can be subs tuted for one another or for theMAX 9. ♢ The fourth 767-600ER was delivered on April 12. § There are op ons topurchase nine Q400s for 2017-2018 delivery.↑ all leases renewed.↓ all leases allowed to expire.Source:WestJet

of US point of origin traffic on theDublin and Glasgow services. But theflow could be less to London becausethere is a lot of nonstop service in theLondon-USmarket.( Dublin andGlasgowexperienceWestJet has gained useful experienceand learned much about the transat-lan cmarketwith the 737opera onsto Dublin and Glasgow. It has provedthat the markets can be significantlys mulated by low fares. It has seenextremely high load factors and “de-centmargins” on those routes.( BA, Emirates and other partner-shipsEven though WestJet operates toGatwick, where BA has a lesser pres-ence, it could benefit significantlyfrom feed from BA’s services and theFFP partnership.Earlier this year WestJet added Emi-rates as its 15th codeshare partnerand thefirst partnerwithwhom itwillexchangeMiddle East and South Asiasubcon nent traffic via Gatwick.More such deals could be on thecards, because “enhancing alliancepartnerships” is one of WestJet’s key

focus areas in 2016.( Strong brandWestJet is a high-quality LCC in theJetBlue/Southwest mould and ben-efits from an excep onally strongbrand. Canadian Business magazinehas ranked it in the top three among25 leading Canadian brands for fourconsecu ve years. It enjoys muchcustomer loyalty.

Fleet considera ons

WestJet has not yet indicated whichlong-haul des na ons could followLondon. A year ago, when launchingGlasgow, it tantalisingly said that itwould become a “truly global carrierin the years to come”.

Widebody fleet plans are alsoup in the air. WestJet has been intalkswith Boeing and Airbus for quitesome me on a next-genera onwidebody that could replace the767s from 2019 or 2020. But themanagement has also said that theywould consider good used aircra ,such as A330s or 777s, and leasingaircra . And they con nue to lookfor addi onal 767s for growth in theinterim period.

The767-300ERprogrammeexpe-rienced delays in ge ng ETOPS cer-fica on, apparently largely because

three different interna onal govern-ing bodies were involved (Australian,US and Canadian). As a result, West-Jet had to delay the type’s deploy-ment in the Hawaii market (began inJanuary).

But the 767 has also had reliabil-ity issues, as a result of which West-Jet has contracted one aircra fromits formerwetleaseproviderOmniAirInterna onal as a “hot spare” for thetransatlan c, as it did for the delayedstart of the 767 Hawaii opera on.

The ex-Qantas 767s are 22years old. The first aircra has nowachieved the same reliability levelas the 737 fleet, and WestJet saidthat it knows from talking with itscodeshare partner Delta, whichhas the world’s largest 767 fleet,that the type operates very reliably(though it must be noted that Delta’ssuccess with older aircra is partlydue to its maintenance exper se andcapabili es).

But relying on old aircra is noth-ing new at WestJet either. The man-



10

15

20

25

30

35

2012 2013 2014 2015 2016

WESTJET SHARE PRICE PERFORMANCE

agement has described the 767s asa “low-cost way of ge ng that lineof business going, not dissimilar fromhow WestJet started 20 years agowith 30-year-old 737-200s”.

Financial strength

WestJet has been profitable throughits 20-year history, except for a smallopera ng loss in 2004. It has haddouble-digit annual opera ng mar-ginssince2012,and lastyear’smarginwas a record 14.1%. It earned a pre-tax ROIC of 12.8% in the 12months toMarch 31, which was within its long-term targeted range of 13-16%.

However, a er being the mostprofitable airline in North America inthemid-to-late 2000s, in recent yearsWestJet has fallen significantly be-hind its US peers both in terms of op-era ngmargin and ROIC.

There are several reasons. First,both WestJet’s capacity and indus-try capacity in Canada have grownat a faster rate, leading to a weakdomes c pricing environment. West-Jet’s ASMs rose by 6.7% in 2014, 5.2%in 2015 and 7% inQ1 2016.

Second, Canada has been inan economic slump in the past 18months or so, mainly because of the

fall in oil prices (Canada is a net oilexporter). As a result, domes c faresin Canada are at their lowest in sixyears. In the latest quarter, WestJet’sRASMdeclined by 11%.

Third, in the past couple of yearsthe Canadian dollar has weakenedsignificantly against the US dollar,mirroring the fall in oil prices (thoughthis year has seen a slight reboundin both). It has increased WestJet’sdollar-denominated costs, such asleasing, maintenance and interestexpenses.

WestJet has taken remedial ac-on, including schedule adjustments

in the Alberta market, deferral ofthree 737 deliveries, return of someleased aircra (for the first me in itshistory) and a slight reduc on in thisyear’s planned ASM growth to 7-9%(of which about six points will be ex-pansionwith 767s).

In addi on to the growth inwide-body opera ons, longer-term strate-gies to help keep unit costs in checkinclude the substan al 737 MAX or-ders (see fleet table on the previouspage) and poten ally increasing seat-ing density following the installa onof new slimline seats on the 737s.

In addi on to growing widebody

opera ons, which has a nega ve im-pact on unit revenues, WestJet alsocon nues to develop the regional En-core opera on, which has the oppo-site effect of improvingRASM. Encorenow accounts for 5.5% of WestJet’ssystem ASMs and u lises 27 Q400s,with nine more scheduled for deliv-ery in 2016-2017. The unit recentlyadded its first transborder des na-on (Boston).In the first quarter, WestJet’s

network was nicely balanced, withdomes c opera ons accoun ng for41% and interna onal (includingtransborder) 59% of systemASMs.

The consistent earnings have en-abled WestJet to maintain a healthybalance sheet. Cash amounted toC$1.4bn in March, represen ng35% of trailing 12-month revenues.Adjusted debt-to-equity ra o was1.38. But con nued fleet spendinghas meant nega ve free cash flow,which is not likely to change any mesoon.

In early May, WestJet securedinvestment grade corporate creditra ngs (Baa2) from a second ra ngagency, Moody’s, which men onedthe carrier’s “low leverage, strongliquidity, good margins and a longrecord of opera ng success”. InMarch S&P confirmed theBBB- ra ngand stable outlook that it originallyassigned in 2014. Those ac ons prob-ably speak louder than words aboutWestJet’s prospects in new long haulmarkets. There are not many otherinvestment grade rated airlines onthe transatlan c.

ByHeini Nuu nenheini@theavia oneconomist.com



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