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Ishka Insight Volume 2

Indispensable Analysis and Opinion

4 August 2016

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Insight

© Ishka Ltd ishkaglobal.com

4 August 2016

Ishka Insight Volume 2

Contents

Malaysia Airlines to survive Mueller’s departure 1









Sign up free today to receive independent, authoritative analysis, from our world-class editorial and advisory team, into changing market conditions and the implications for your business.

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The information used in this document has been assembled from many sources, and whilst the utmost care has been taken to ensure accuracy, the information is supplied on the understanding that no legal liability whatsoever shall attach to Ishka Limited, its subsidiaries, officers, or employees in respect of any error or omission that may have occurred.

China’s growing leasing ambitions

Will banks and lessors finance Iran aircraft orders?

Unprofitable Oman Air faces uphill task to break-even by 2017

Is there an opportunity for the smaller Egyptian airlines in times of adversity?

Avianca’s bid for new equity vital for fleet financing

Against heavy odds Aeroflot is heading for a profit in 2016

Brexit Part II: Weaker sterling impacts airline order books

Future appears bleak for Fastjet

Can Monarch Airlines survive as a low cost carrier?

Struggling LATAM gets equity boost from Qatar Airways

Kenya Airways likely to struggle to break even

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41

44

47

Contents




Insight


4 August 2016

The Team

Eddy Pieniazek Head of Analytics and Advisory

Eddy has supported thousands of aircraft transactions during his 35 years’ career, advising leaders of the world’s top aviation finance, investment and leasing companies, airlines and manufacturers. A respected and valued influencer, Eddy was one of the original pioneers of today’s aircraft valuation and appraisal industry, developing the industry’s first online valuation tool and associated analytics, fulfilling the rigour and consistency demanded by investors.

Eddy began his career at Ascend (formerly known as Airclaims) in 1982. He founded and led Ascend’s rapidly expanding data and advisory business, spearheading flourishing relationships with industry leaders which continue to this day.

Eddy is a frequent speaker on the international conference circuit and is a visiting lecturer at the Air Business Academy in Toulouse.

Dickon Harris Editor

Dickon operates at the very heart of the aviation financial community and is one of the sector’s most respected journalists. Dickon has been a financial journalist for nine years and spent four years as editor of Airfinance Journal leading the aircraft and leasing finance news and data service from Euromoney. He was also integral to the expansion of Airfinance Journal’s deals database, editorial and international events portfolio. Before his career in financial journalism, Dickon worked for the former UK MP and Energy Secretary, Ed Davey and has worked on several UK regional newspapers.

Since joining Ishka, Dickon has led the foundation and development of the editorial team and specialist reporting capabilities, delivering breaking news, exclusive features and in-depth interviews with key industry leaders.

Stuart Flaye Analytics and Advisory

Stuart has over 15 years’ experience within the aviation industry. Prior to joining Ishka, Stuart was Technical Director at Hong Kong Aviation Capital (formerly Allco Finance Group) where he was responsible for the day-to-day technical asset management of the HKAC portfolio, the drafting of technical lease documentation, co-ordinating and managing aircraft valuations and investor reporting, along with analysing trends in the aviation market. Stuart previously spent seven years as Senior Analyst at Ascend where he provided advisory services to banks, financiers and lessors.

Stuart holds an HND Engineering qualification from the University of Hertfordshire and a BEng (Hons) Aeronautical Engineering from City University, London.

Siddharth Narkhede Analyst

Siddharth has over five years’ experience in aviation research and analysis. He has a strong background in airline financial research and strategic analysis and has written many business and credit research reports on airlines and other industries alike.

Siddharth holds a MSc in Finance degree from the University of Edinburgh Business School and a Bachelors degree in Business Studies from the University of Mumbai. As part of his masters’ thesis, he had researched the impact of the US Bankruptcy Code (Chapter 11) on the financial performance of US based airlines.

Connor Lovell Analyst

Connor graduated from Kings’s College London in 2014. He worked as an academic researcher before training as a journalist and joining Ishka in 2016. He currently supports the news and analytics team, researching and analysing market trends for Ishka Insights.




China’s growing leasing ambitionsWhile there have been several established lessors in the Asian market for a good number of years,

2014 could well be looked back on and seen as a definitive page in the development of global

aviation. While ‘Western’ leasing companies have traditionally dominated the global aircraft leasing

arena since the inception of the model, Chinese-based financiers in the last few years have turned

their attention towards the international aviation leasing market; making announcements - albeit with

some false-starts - about new deals, demonstrating their growing ambitions in the aviation industry.

Friday 8 July 2016

Market InsightIndispensable Analysis and Opinion

Of course, none of this has evolved naturally, but has been rather deliberate. In 2007, policy

decisions from the State Council and action from the China Banking Regulatory Commission (CBRC)

encouraged state-owned banks to participate in the sector, resulting in all five state banks, as well as

one of the three major ‘policy’ banks, forming new aircraft leasing companies in a space of less than

18 months. In December 2013, the central government again stated its wish for Chinese lessors to

become some of the biggest in the world by 2030. Two and a half years later we have already seen

the effects.

While the historical trend has been for China-based leasing companies to focus on domestic leasing,

reflecting previous regulatory limitations and the availability of the free trade zones (Tianjin, Shanghai,

Fujian and Guangdong), Chinese lessors have now become visible in their determined quest for

assets with leases attached to foreign airlines as a means to expand their portfolios and to some

degree change the rules of the game within industry. Coupled with this, their acquisition of, and

investment into, established foreign leasing companies has provided, in some cases, direct access to

valuable management experience.

In this article, Ishka aims to provide a summary of the major players – old and new – and to anticipate

what the future may hold once the dust has settled.

We begin with Hong Kong-based Cheung Kong, which made a notable entry into the field of play in

2014, with deals totalling to the tune of around $1.89 billion. CK Hutchinson Holdings Ltd, headed by

Hong Kong billionaire, Li Ka-shing, entered into an $816 million deal with GECAS to buy 21 aircraft;

with BOC Aviation in a $492 million deal for 10 aircraft and with Jackson Square Aviation LLC with a

$584.2 million deal to buy 14 aircraft. At the time of purchase, nearly all the aircraft were on lease to

airlines for an average six to nine years. Accipiter Holdings is the Dublin-based company Cheung

Kong set up to run its leasing business. It reportedly struck a deal to buy 60 aircraft from AWAS

before being outbid by Macquarie AirFinance for the portfolio.

Stuart FlayeAnalytics and Advisoryat Ishka




Cheung Kong, along with the Li Ka Shing (Overseas) Foundation, also formed a joint venture with MC

Aviation Partners Inc. (MCAP) in November 2014, called Vermillion Aviation Services. It saw MCAP

transfer to the JV a seed portfolio of 15 aircraft to Vermillion’s Irish entity (Vermillion Aviation Holdings

Ireland Limited) and concluded a purchase and leaseback arrangement with Avianca Brasil for new

Airbus A320-200 in August 2015. CK is believed to have paid $132 million for its stake in the venture

with MCAP. Questions were raised at the time as to whether this JV effectively overlapped with

Accipter’s strategy.

Now, moving on to the ‘Big Four’ - Industrial and Commercial Bank of China Ltd., Bank of China (BOC),

Agricultural Bank of China (ABC) and China Construction Bank (CCB).

ICBC Leasing had already been on a strong – albeit largely quiet – growth path that has made it

one of the larger lessors in the world. It has held an unusually international viewpoint since it was

established in November 2007, swiftly adding overseas offices to facilitate its global reach. Its total

portfolio is stated at 452 aircraft. It has 17 domestic clients and 34 overseas clients. By 2018, it is

expected to corner over 50% of the Chinese market overall, up from 38% in 2013.

BOC Aviation Pte. Ltd was formed in December 2006 when Bank of China took over the established

international lessor Singapore Aviation Leasing Enterprise Pte. Ltd. (SALE), offering it a ready-made

global presence on a plate. The company became a wholly-owned subsidiary of Bank of China.

In May 2016, BOC was converted to a public company, changing its name subtly to BOC Aviation

Limited. As part of a spin-off and separate listing by the bank, BOC Aviation listed 27.3% of its total

share capital, or 189,724,500 shares, on the main board of the Hong Kong Stock Exchange on 1st

June 2016. Beijing Hanguang Investment Corporation holds 2.7%; while Sky Splendor, an indirect

wholly-owned subsidiary of Bank of China, holds the remaining 70% stake in BOC Aviation.

Agricultural Bank of China Financial Leasing Co., Ltd. (ABC Financial Leasing) is a wholly-owned

subsidiary of the Agricultural Bank of China. Since the late 1970s, the Bank has evolved from a

state-owned specialized bank to a wholly state-owned commercial bank and subsequently a state-

controlled commercial bank. The Bank was restructured into a joint stock limited liability company

in January 2009. It remains focused on the domestic market, and is one of a number of Chinese

leasing companies to have ordered the Comac C919.

Established in December 2007, CCB Financial Leasing Corporation Limited (CCBFL) is a wholly-

owned subsidiary of China Construction Bank. CCB Leasing International is the primary overseas

platform for CCB Leasing’s aviation leasing business and established a Dublin office in October 2015,

which is responsible for all aircraft leasing business outside of China. It currently has a portfolio of

around 35 aircraft, although the company has set its sights at having a fleet of 200 by the end of the

decade – which means they will have to be extremely active in the sale and leaseback market or

they will have to acquire an existing aircraft portfolio.

Market insight Friday 8 July 2016




CDB Leasing is arguably one of the best known of all the Chinese lessors. The company was

formerly known as Shenzhen Finance Leasing Co. Ltd. and changed its name to CDB Leasing Co. Ltd.

in May 2008 as the result of China Development Bank increasing its ownership stake to become the

controlling shareholder. The company was established in 1984 and is headquartered in Shenzhen,

operating as a subsidiary of China Development Bank Corporation, one of the China’s policy banks

which is under the direct jurisdiction of the State Council of People’s Republic of China. In 2015,

the state-owned bank announced it plans to list the leasing unit on the Hong Kong Stock Exchange

(HKSE) with the aim of raising between $759 million and $1.1 billion (deal priced at $799 million in the

end). CDB Leasing officially launched its IPO on 21st June 2016 and is expected to begin trading on

the HKSE on 11th July 2016. Its prospectus indicated that aircraft leasing accounted for 45 percent of

CDB Leasing’s total revenue in 2015.

China Aircraft Leasing Company Limited (CALC) is the largest independent aircraft operating lessor

in China, in terms of new aircraft import under lease each year. It was founded in 2006 and is

headquartered in Hong Kong. CALC was the first publicly-listed aircraft lessor in Asia, floating on the

Hong Kong Stock Exchange on 11th July 2014. It is scheduled to deliver around 17 aircraft in 2016 and

increase the fleet to at least 80 aircraft by the end of 2016. Based on the order commitments, the

fleet is forecasted to increase to 172 aircraft by the end of 2022. It has plans to expand across Asia

even though it presently relies on China for most of its business.


BOC Aviation

CASC

Astro

CDB Leasing

Minsheng

Vermillion

Accipiter

ABC

AerDragon

BoCom

CCB

AVIC

CALC

ICBC

Ping An

Shanghai 1979 50

Shanghai 2008 25

Hong Kong 2006 172

Beijing/Shannon 2006 18

Shanghai/Dublin 2007 49

Beijing/Dublin 2007 35

Beijing 2007 452

Shanghai/Dublin 2012 50

Dublin 2014 19

Dubai 2014 43

Singapore 2006 462

Beijing 2002 13

Hong Kong 2015 -

China/Ireland 2012 443

Shenzhen 1984 360

Beijing 2008 39

Name Base Date FormedApprox. Total Fleet Size

(commercial aircraft)

Bohai Leasing (Avolon et al.)





East vs. West - A comparision of the top leasing companies by fleet size

CDB Leasing

Source: Company data and Ishka estimates

BBAM

Bohai Leasing (Avolon et al.)

ICBC

BOC

SMBC

AerCap

GECAS

0 400 800 1200 1600 2000

AerDragon Aviation Partners Limited was established in 2006 and was formed as an aircraft leasing

joint venture between China Aviation Supplies Holding Company (CAS), AerCap and affiliates of

Credit Agricole Corporate & Investment Bank (CACIB). The venture comprises of AerDragon Aviation

Partners, based in Shannon, Ireland and Dragon Aviation Leasing, based in Beijing. It currently has 18

aircraft on lease to eight airlines. East Epoch Limited became a new shareholder in May 2013, while

increasing its share capital to $268 million. CAS owns a 50% stake, while AerCap, CACIB and Epoch

each own an equal remaining share in the company. As an entity, it is a relatively small player in the

market.

Established in February 2008, Minsheng Financial Leasing was founded by China Minsheng Banking

Corporation Ltd. (CMBC) and Tianjin Port Free Trade Zone Investment Co, Ltd. A now established

name in the industry, it has been looking at developing the Hong Kong market; along with Japan,

South Korea and Southeast Asia. While it is more known for leasing business aircraft, the lessor has

been active in the US market, signing up to a $300 million financing of eight Gulfstream aircraft, using

a US Ex-Im Bank guarantee and a Letter of Intent with Boeing for 30 737s (both NG and MAX).

A new aircraft leasing company to launch in 2015 was Astro Aircraft Leasing, although it has yet to

announce any deals in the public domain. It has been established by the former Global Head of

Aviation Finance and Managing Director of ICBC Leasing, Johnny Lau.




In January 2016, Avolon became a wholly-owned, indirect subsidiary of Bohai Leasing (formerly known

as Xinjiang Huitong (Group) Co., Ltd), which is a majority controlled subsidiary of the HNA Group. The

deal priced the publicly listed Irish lessor at $31 per share, representing a purchase price of about $2.6

billion. The transaction is reportedly to have a total enterprise value of approximately $7.6 billion. Avolon,

which was only established in May 2010, is now the core aircraft leasing brand for Bohai Leasing, and also

assumed management of the Hong Kong Aviation Capital (HKAC) business – an existing Bohai subsidiary.

HKAC itself was formed by the HNA Group in January 2010 following its purchase of the aviation division

of Allco Finance Group, after the Australian company went into administrative receivership in 2008. Bohai

Leasing acquired a majority shareholding in HKAC from the HNA Group in 2012.

Also sitting under the HNA umbrella is Changjiang Leasing Co. (formed in 2000), Yangtze River

International Leasing Co. Ltd. (formed in 2003) and Hong Kong International Leasing Co. (formed in 2007).

Avolon’s owned, managed and committed fleet is now in the order of 400 aircraft, which combined

together with HNA Group and Bohai’s other aircraft leasing interests, comprises of a total fleet of more

than 500 aircraft – which would now rank it as the world’s fourth largest aircraft leasing business by asset

value.

Bohai Leasing’s purchase of Avolon is not only the largest aviation deal in China so far, but is also marks

the first time a Chinese lessor has succeeded in taking over a Western one. In 2012, an ambitious attempt

by a private Chinese consortium to acquire ILFC for $4.8 billion failed to come to fruition. The US-based

lessor was later acquired by AerCap in 2014.

Also in the race to purchase Avolon was AVIC Capital Co. Ltd. - the financing arm of Aviation Industry

Corporation of China, a Chinese state-owned aerospace and defence company. It had bid, along with

and its parent China Investment Corp - the Chinese sovereign wealth fund - for a 51% bid for Avolon but

ended talks during 2014, when the parties could not come to an agreement. Avolon then progressed

with its IPO at $20 per share in December 2014. Under AVIC Capital Co. is AVIC International Leasing,

which leases out primarily Chinese-manufactured aircraft to Chinese carriers. It has also grown a portfolio

of around 50 western built aircraft, utilising export credit financing for a lot of the transactions.

Hong Kong has been very open about its intention to become more of a rival to Singapore and Ireland

and it has recently introduced withholding tax reductions aimed at establishing the city as an aircraft

leasing and financial hub. Designed to make the city more desirable and competitive, tax on Hong Kong-

PRC transactions has been reduced from 7% to 5% meaning the Hong Kong based lessors can now offer

more attractive rates to PRC airlines.

Cheng Yu-Tung is such a case in point. Hong Kong’s fourth richest man has, via Chow Tai Fook

Enterprises Ltd. and NWS Holdings Ltd. invested in start-up Goshawk Aviation, a joint venture formed in

late 2013 with Investec Bank. Having secured a $605 million non-recourse secured loan facility in July

2015, the Dublin-based lessor has recently ramped up staff numbers and will be a name to watch in 2016.

Other mainland-based smaller players worth a mention are Bank of Communications Financial Leasing

(or BoCom Leasing) – established in 2007 and headquartered in Shanghai. It has established JY Aviation

Leasing as its Dublin-based leasing subsidiary. China Aviation Supplies Holding Company (CASGC)

was established in October 2002 and is one of six holding companies of the China Civil Aviation

Administration. It offers operating lease as part of it wider business. China International Aviation Leasing

Services Limited (CALS) is a specialist aircraft leasing company headquartered in Shanghai. Established

in 2012, the company provides domestic leasing services.





There are also reports that Rongzhong International Financial Leasing formed an aviation leasing

division in March 2015. With it majority shareholding held by Goldbond Group Holdings Ltd.,

Rongzhong was established in 2008 and based in Wuhan; it was the first wholly foreign owned

finance leasing company founded in Hubei Province. Little more is known about any aviation activity

it has been involved with.

Another name to watch going forward is the Shanghai-based aviation division of Ping An International

Financial Leasing, which was formed in 2012; and is a wholly owned subsidiary of Ping An Insurance

Group – the largest non-state company in China. In addition to a sizeable order of COMAC aircraft

made in June 2015 this new entrant is due to expand its portfolio with the arrival of reportedly 30

Boeing and Airbus aircraft via sale and lease back transactions. It also established an Irish subsidiary

(Ping An Aircraft Leasing Company Ltd.) in September 2015 and is currently building up a Dublin-

based team.

Finally, at the time of writing, CIT Group is in the process of selling its aircraft-leasing business, CIT

Aerospace, having initially revealed its intention to do so in November 2015. Reports suggest that

more than a dozen entities have asked to be considered for bidding, which includes Chinese and

Japanese leasing companies, plus some global pension funds and insurers. CIT’s leasing arm owns

more than 350 aircraft with asset valued at around $11 billion, although the estimates of the final price

for the lessor range between $3 billion and $4 billion. The first round of bids was due in towards the

end of June 2016. The outcome of this contest could change the landscape again over the latter part

of 2016.


The Ishka View

Building a Chinese presence in the aircraft leasing industry is a stated long term intention. Bearing that in mind, the ‘new’ leasing companies have been making some smart strategic moves – they have bought ready-made aircraft portfolios from a variety of sources; bought whole leasing companies; formed JVs to leverage management experience and test the various ways of operating in this sector; and perhaps most importantly, they have been building relationships with the lessor community and with airlines. Whether they have bought the right assets, paid the right price, or acquired the right credits/airlines in the right proportions, will depend on how the market evolves.

It also appears that even those companies that have been successful in acquiring lessor portfolios in the market over recent times remain hungry for more. The number of potential ‘larger’ lessor portfolio’s being offered going forward is gradually diminishing, although there remain a few possible targets to satisfy the growth requirements of all the Chinese-backed institutions.

The clamour to obtain market share amongst Chinese leasing firms eager to acquire established Western lessors, following the Avolon deal, may drive up prices to beyond-premium levels, which could well return to challenge them in the future unless sufficient due-diligence has been done beforehand and realistic management is undertaken to master the potential risks, including those related to the operation of the aircraft and their condition, maintenance, registration and insurance, transition process and costs, and associated residual values.

The delivery of a large number of aircraft orders made after 2011 by Chinese lessors and airlines is due to peak by 2018. While the lessors remain in a honeymoon period as aircraft run through their primary leases, those lessors that don’t possess the necessary expertise to tackle the aforementioned issues are going to face a turbulent ride and a steep learning curve.




Wednesday 27 July 2016


Dickon HarrisEditor

[email protected]

Will banks and lessors finance Iran aircraft orders?Iran, through Iran Air, is in talks with Boeing and Airbus for up to198 new aircraft through direct orders.

At least two big issues remain in place for either of the two aircraft order deals. The first is regulatory

approval in the face of increasingly vocal US opposition in Congress towards selling aircraft to Iran

and any involvement by the US Export Import Bank.

The other related but secondary concern is whether banks and lessors are willing to finance aircraft

deals into Iran.

In addition, US EXIM still cannot approve any deals over $10 million with no quorum and Senior US

Republicans are legislating to specifically prevent the North American export credit agency from

being able to support any aircraft sales to Iran.

The Ishka view is that US political opposition to the order, while vocal, will ultimately prove pointless

and will not prevent either a sale from either Boeing or Airbus if Iran upholds its own commitments.

However, US EXIM support for aircraft deliveries for Iran Air is currently forbidden under Federal law.

Moreover it will remain politically difficult for the bank to offer support for several years at least.

Banks and lessors are waiting for permission to fund aircraft in Iran from the US Office of Foreign

Assets Control (OFAC). Ishka anticipates that competition will be slow at first among the banks and

lessors until the OFAC agreements are in place, but will quickly gain momentum due to the obvious

commercial opportunities, especially among lessors looking to expand their coverage and win new

sale/leaseback business.

Iran, through Iran Air, is in talks with many OEMs but especially with both Boeing and Airbus for up to

198 aircraft.

Iran Air has signed an agreement for 118 new aircraft with Airbus. The order agreement signed back

in January 2016 includes 73 widebodies and 45 single aisle aircraft. The order includes pilot and

maintenance training and support services.

The agreement spans Airbus’ single-aisle A320 product line – involving both current engine option

(CEO) and new engine option versions (NEO) – as well as the widebody A330ceo and A330neo, the

A350 XWB and A380. Deliveries could start as early as this year, according to Airbus. Covered in

the historic accord are: 21 A320ceo Family and 24 A320neo Family jetliners, 27 from the A330ceo

Family, 18 A330-900neo aircraft, 16 A350-1000s and 12 A380s.

Iran’s Airbus and Boeing order



mailto:dickon%40ishkaglobal.com?subject=


Boeing also has a prospective agreement in place with Iran Air for a deal which could involve up to

109 aircraft. According to Iranian officials talking to media agencies, the order is split between 80

direct aircraft sales and potentially up to 29 leased aircraft, aided by Boeing.

Iran needs new aircraft to replace it aging fleet. Its current fleet has an average age of 26.4 years

according to ATDB, but the planned scope of change is breathtaking. Iran Air has just 29 active

aircraft and there is speculation that some of the aircraft could go to other Iranian carriers and hints at

Iran’s wider ambitions to create a new aviation hub to rival Dubai.

Sales from both manufacturers are pending approval from the US before they can go ahead and

both agreements have already faced political resistance from the US. When Boeing announced its

tentative agreement with Iran it faced a quick backlash from several members of Congress uneasy

about the sale of aircraft to Iran.

Congressman Peter Roskam, one of the most vocal opponents to any aircraft sale to Iran, states that

the Iranian regime is using commercial airlines to send troops, weapons, missiles and cash to assist

Syrian dictator Bashar Assad. Roskam has succeeded in passing two amendments to the Financial

Services Appropriation Act as well as a separate free standing bill – all designed to prevent and

complicate the sale of commercial aircraft to Iran (see table below).

The Financial Services Appropriation Act, H.R. 5485, has passed the House, and includes the two

amendments from Rep. Roskam to block the licensing of the sale of aircraft and to block the financing

of aircraft sales. The Financial Services appropriation act still need to be passed by the Senate and

receive Presidential approval.

Bills H.R. 5711, H.R. 5715, and H.R. 5729 have passed through committee, and are ready for

consideration on the House floor, but have not received a vote yet and passed the House. They

would need to pass the House, then be passed by the Senate and would still need Presidential

approval

House Republicans aim to scupper Boeing sale

Market insight Wednesday 27 July 2016

Bill Summary

Blocking the Export-Import bank from financing the sale of aircraft to Iran either directly or indirectly (passed out of

committee via H.R. 5715).

Blocking OFAC from licensing the sale of aircraft to Iran (passed via amendment to Financial Services appropriation H.R.

5485, and via H.R. 5729 passed out of committee).

Blocking the licensing of the financing of aircraft sales to Iran (passed via amendment to Financial Services

appropriation H.R. 5485; and via H.R. 5711 passed out of committee)

Recent US legislative efforts to prevent an Iran Air aircraft sale

Source: National Iranian American Council





None of the recent bills designed to frustrate an aircraft sale are likely to pass Congress and become

law in the immediate future. Much of the legislation geared to prevent aircraft sales to Iran has been

confined to the House of Representatives. The Senate has the numbers to block consideration of

such legislation, and even if it were to pass the Senate, the President is very likely to sustain a veto.

Airbus also needs to win approval from the US Office of Foreign Assets Control before it can export

aircraft to Iran as several of its key aircraft components are made in the US. The European Original

Equipment Manufacturer (OEM) has been waiting since at least April 2016 for confirmation from

the Office of Foreign Assets Control (OFAC) regarding its aircraft order. Sources familiar with OFAC

explain that the usual timeline for an OFAC license application is between 3-12 months but that given

the importance of Airbus and Boeing’s sales to Iran the license approval is likely to jump the line.

However OFAC only has a few dozen licensing officers and thousands of applications pending.

Some of the anti-Iranian legislation has also taken aim at US EXIM as a secondary measure to prevent

any aircraft sales to Iran. The export finance bank is still being targeted by senior Republicans.

Senators Ted Cruz and Marco Rubio co-signed a bill which mirrored the House Bill preventing US

EXIM from participating in deal with Iran. Federal law prohibits US EXIM from financing exports to

Iran as it continues to be designated by the US as a state sponsor of terrorism. Boeing’s Senior Vice

President of Government Operations, Tim Keating in a letter to Congress has stated that it would not

seek the bank’s support for the aircraft sale.

Even if US EXIM were capable of offering support, Ishka’s view is that US EXIM would be reluctant to

be involved with any Iranian deal, unless strictly necessary, due to the controversial political nature of

such a deal and the inevitable backlash this would generate among Republicans.

One of the practical concerns is not the risk of new legislation but the ambiguity still surrounding Iran

and US sanctions. Many restrictions on doing trade with Iran still exist, not least the limitations around

Iran accessing US dollars.

Iran’s financial system has been labeled “a primary money laundering concern,” preventing any

company from funding any Iran deal that goes through the US financial system. For this reason,

financiers, and lessors, appear extremely reluctant to engage with Iran Air for a potential deal. One

financier was skeptical of claims that Airbus has several French and German banks lined up to fund

deliveries.

However, rumors continue to circulate around the number of banks looking to finance a deal. Ishka

understands that several Asian lessors and a few European boutique lessors have made enquires

about the possibility of arranging an Iran deal.

Impact of legislation

US EXIM still in the target sights

Ambiguity continues around US dollars to Iran





The recent US Republican attempts to block an Airbus or Boeing commercial aircraft sale to Iran are

destined to fail as they are highly unlikely to pass Congress. Even if they did, it could still be easily

vetoed by President Obama. The only real risk to a sale would be a significant Republican win in the

November elections combined with Donald Trump winning the Presidential election. Even then it is

not clear whether a President Trump, who has previously stated he was open to selling aircraft to Iran,

would support a bill blocking a sale to Iran.

The Ishka view is that most aircraft investors are still very wary about potentially funding aircraft into

Iran, especially until OFAC gives the go ahead, and even then they will seek counsel’s considered

opinions on the security of doing such deals. There appears to be some confusion among the

aviation finance community as to which sanctions are still in place with regards to Iran. That being

said there appears to be more interest, for now, among lessors contemplating Iranian deals

compared to aviation banks.

In the long-term, competition among lessors for sale/leasebacks seems inevitable given the value

of the equipment potentially available. However, competition will only really materialise after the first

deals are announced and after leasing companies and banks become more comfortable that they

will not be breaking sanctions by funding these orders, and will have determined the mechanisms for

aircraft recovery in the case of defaults.

The Ishka View

Source: ATDB

B.747

A300

B.747

A310

A330

A320

MD-80

A300

A320

ATR-72

A380

A300

B.747

A300

A350

A310

A320

A330

A320

Fokker

Total

A380-800

A300B2 1

12 -

36.3 year

B.747-200c

A300B4(F)

A350-1000

A310-300

A320neo

A330ceo

A330ceo (CFM)

Fokker 100

1

2

2

3

4

24

16

24

27

139

27.8 year

34.8 year

-

26.0 year

-

-

20.5 year

24.6 year

26.4 year

B.747-200B

A300B4

B.747SP

A310-300

A330-900neo

A320ceo

MD-80

A330-600

A320ceo (IAE)

ATR-72-600

2

1

2

3

3

2

1

18

21

20

-

32.3 year

39.2 year

26.0 year

-

-

26.3 year

22.4 year

19.2 year

-

Sub-TypeModel Current Active Planned Average age of active fleet

Iran Air’s current and historic fleet




Unprofitable Oman Air faces uphill task to break-even by 2017Oman Air made pre-tax losses of $209.18 million in 2015, adding to total accumulated losses of $1.7

billion, and although the airline has had some success in limiting its losses last year, its financial

performance remains unsustainable.

The strategy is to break even by YE2017 and prepare the ground for a possible privatisation, but on

current trends the Ishka view is that more needs to be done to make this happen.

Friday 8 July 2016

Company InsightIndispensable Analysis and Opinion

Oman Air was confident of a good year in 2015, but its gains were overwhelmingly the result of lower

fuel prices. Cheaper fuel prices and higher revenues on the back of increased passenger numbers

helped reduce losses by 21.2%.

But expenditure rose by 5% due to capacity and fleet expansion. This, combined with stiff regional

competition from Emirates, Etihad and Qatar airlines (the ME3), pulled yields down by 14%.

The airline’s cost cutting programme ‘Shape and Size’ has helped to trim expenditure by $259.7

million and has allowed the airline to reduce its dependence on government cash injections. The

carrier has maintained a recruitment freeze in place from the beginning of 2016 and has also

temporarily stopped operating from the recently developed Sohar Airport, citing poor results.

Unit costs fell from around $8.62 in 2014 to $6.70 in 2015. CEO Paul Gregorowitsch is determined

that Oman Air will stand on its own feet as a business. But the carrier faces an uphill struggle to break

even.

Connor LovellAnalyst at Ishka

A loss-making enterprise




Company insight Friday 8 July 2016

Cash as % of total revenues

CASK (Unit Cost)

No. of months unrestricted cash to cover EBITDAR

Passenger Revenue per RPK (Pax Yield)

Adjusted net debt/EBITDAR

Revenue per Passenger

EBITDAR margin

Breakewen load factor

Revenues

Fuel Cost/ASK

Net profit margin

Load Factor

RASK-CASK Margin

Adjusted net debt/Equity

RASK (Unit Revenues)

382

1.1307

408

1.0634

466

0.5960

1.1x

3.3780

1.3x

3.6142

1.1x

3.1699

-29.7%

75.8%

0.1402

-26.8%

74.3%

0.2932

-18.5%

71.4%

0.5853

-11.9%

95.8%

-9.2%

91.9%

1.7%

81.5%

3.4%

3.2377

0.34 months

3.3780

4.8%

3.3209

0.50 months

3.6142

2.3%

2.5846

0.26 months

3.1699

-12.7x

76.34

-18.2x

80.08

93.6x

72.81

Oman Air Financial Data 2013-15(in Omani rials)

31-Dec-1331-Dec-1431-Dec-14

Source: Oman Air and Ishka calculations

The collapse in world oil prices has put pressure on the Omani government which now runs the

largest budget deficit in the Middle East at around 55% of GDP. As part of its response to IMF

pressure to retrench, the government plans to end subsidies to the airline by the end of 2018.

Direct equity injections by the government have already been reduced from $194.8 million in 2014, to

$140.2 million in 2015. Subsidies began following the financial crisis in 2008, when the government

increased its shareholding stake from around 85% to its current level of 99.9%, and expanded the

size of the subsidy every year to 2013.

An end to government subsidies





0

50

100

150

200

250

194.8

2011

194.8

2010

220.8

2012

Mill

ion

s U

SD

Year

220.8

2013

194.8

2014

140.2

2015

181.8

2009

Government subsidies to Oman Air 2009-15

Oman Air pushes for increased bilateral traffic rights in India

Will the government have the discipline to keep the purse strings tight? As the national flag carrier,

the airline would certainly not be allowed to fail, but the government clearly has a good incentive to

let the airline stand on its own feet.

On current projections, the IMF estimates that the government requires an oil price of $110 per barrel

in order to clear its deficit. With prices hovering around $50 p/b at the time of writing, this is very

unlikely in the short term at least.

Moreover, it is a stated aim of the airline to break-even by YE2017. If that is achieved and maintained

through 2018 then Oman Air will be ready for full privatisation says Gregorowitsch, which could in turn

prove lucrative for the Omani treasury.

Currently the government is only divesting from nationalised companies that make a profit. So Oman

Air will have to start behaving less like a state-owned-enterprise and more like a commercial concern.

However, if the airline is incapable of increasing its revenues and cutting costs, then a complete

withdrawal of government support would prompt a liquidity crisis. Oman Air has dwindling cash

reserves. Last year cash as a percentage of total reserves fell 2.5% to 2.3%.

The Ishka view is that government cash will continue to prop up the carrier for some time.

India is the world’s fastest growing economy and Indians account for 20% of the Omani population,

so it is unsurprising that the carrier has identified the country as a key market and a way of competing

directly with the ME3 carriers. Oman Air has increased capacity there by 30% and has an average

seat occupancy of 80%.





With the recent liberalisation of foreign-ownership rules in India, the airline has also indicated that it is

open to taking equity stakes in Indian airlines.

Oman Air operates 126 flights a week to 11 destinations in India. The ambition is to add a further 50

routes. However, this is constrained by the current bilateral traffic rights of 21,147 seats a week which

leaves it unable to operate wide body aircraft to India, says Gregorowitsch. Greater traffic rights

that could support wide body aircraft [it has 8 B787s on order] would allow the carrier to increase

revenues and its market share. In late 2015, Oman negotiated an increase of 5,131 seats a week but

Gregorowitsch believes 29,000 seats a week are needed by 2018.

The airline is pushing for more seats, better infrastructure, and even an open-skies agreement as

a condition of any investment it makes in an Indian carrier. It hopes to follow the success of Etihad.

Three years ago Etihad had its flying rights increased from 13,000 per week to 50,000, only hours

after taking a 24% stake in India’s Jet Airways.

Unlike many of its neighbours, Oman has good relations with Iran. The airline plans to exploit the

opportunities presented by the weakening of US sanctions and fleet renewal programmes by Iranian

carriers by training Iranian pilots at its facilities in Muscat.

Oman Air has also doubled flights to Tehran and has also begun a new B737-operated route to

Iran’s second city, Mashhad. Since there are no incumbents on the route, and some firect flights from

Saudi Arabia and Bahrain have been cancelled, the airline wants to cater to demand for some of the

20 million pilgrims who visit the Islamic shrines in Mashhad each year. The carrier expects 85,000

passengers on the route in 2017.

In tandem with its network expansion plans, Oman Air has 27 B737 MAX-8s on order, 20 direct from

Boeing and seven from lessors, together with four B787-8s, four B787-9s and three B737-800s.

Oman Air currently has a 57-aircraft fleet and it is expected to grow to 70 by 2020.

At the end of 2015 the airline leased 64% of its fleet and owned 36%. As subsidies dwindle and the

financial position of the airline becomes more challenging, it is possible that past commercial lenders

such as Citibank and Standard Chartered may be less willing to increase their exposure and finance

the incoming orders. One banking source that Ishka spoke to said that the cost of financing for all

the ME carriers is set to increase due to government fiscal pressure in a low oil price environment.

On the other hand, local lenders, many of which have the Omani state as its largest shareholder, may

be in higher demand. In early 2015, Oman Air’s second B787 order was financed by Meethaq Bank

in Oman’s first Sharia-based Islamic financing.

Iranian opportunities

Fleet expansion plans





B737-800

B 787-8

B 737 Max-8

B7B7-9

7

4

4

3

Aircraft on Order (by Type) Number of Aircraft

Source: Oman Air

In tandem with its network expansion plans, Oman Air has 27 B737 MAX-8s on order, 20 direct from

Boeing and seven from lessors, together with four B787-8s, four B787-9s and three B737-800s.

Oman Air currently has a 57-aircraft fleet and it is expected to grow to 70 by 2020.

At the end of 2015 the airline leased 64% of its fleet and owned 36%. As subsidies dwindle and the

financial position of the airline becomes more challenging, it is possible that past commercial lenders

such as Citibank and Standard Chartered may be less willing to increase their exposure and finance

the incoming orders. One banking source that Ishka spoke to said that the cost of financing for all

the ME carriers is set to increase due to government fiscal pressure in a low oil price environment.

On the other hand, local lenders, many of which have the Omani state as its largest shareholder, may

be in higher demand. In early 2015, Oman Air’s second B787 order was financed by Meethaq Bank

in Oman’s first Sharia-based Islamic financing.

What if the airline fails to achieve break-even? As the nation’s flag carrier, the government is very

unlikely to allow the airline to fail. However, this implicit support may be the reason why lenders and

lessors continue to have confidence in the carrier. If Oman Air is unsuccessful in returning to a profit,

then the state will most probably maintain its current level of ownership for the foreseeable future.

But even if subsidies are maintained, then aircraft deferrals could be expected as the airline changes

strategy and battles a shortage of ready cash.

Scenarios

6

The Ishka ViewOman Air is currently an unprofitable airline that is expanding quickly in a bid to become profitable. While the Indian and Iranian markets are worthwhile ventures, the carrier should also continue to focus on aggressively reducing costs. The government may well consider reducing its equity stake regardless of whether the company breaks-even. This could assist in attracting private capital, relieving the burden on the treasury and gaining the confidence of commercial lenders.




Is there an opportunity for the smaller Egyptian airlines in times of adversity?International tourism to Egypt has suffered markedly as a result of the socio-political unrests and

terrorism related incidents since 2011. The number of passenger arrivals into the country fell by

a compounded annual rate of 9% between 2011 and 2014. However, during the same period, the

number of passenger departures have risen by a compounded annual rate of 7.6%. While the

downturn in tourism, especially from Europe, is clearly having a negative effect on international air

travel into Egypt, the growth in outbound travel remains a potential area of growth for the smaller

Egyptian airlines (those operating with 10 aircraft or less on short-haul routes)



Siddharth NarkhedeAnalyst

International tourists’ numbers into Egypt are tumbling

20102008 2012

Number of arrivals Egypt 2005-2016

2014 2016 2015

800

600

400

200

1000

1200

1400

1600

2006

Source: Tradingeconomics.com and Central Bank of Egypt




Market insight 6 July 2016

As per figures from the World Bank and Trading Economics, the number of arrivals into Egypt has fallen by a compounded

annual rate of 9% between 2011 and 2014, recovering marginally in 2015 only to collapse further in 2016 in the wake of

the Metrojet and EgyptAir disasters. Following recent terrorism related incidents, many countries issued travel warnings

to some cities in Egypt. Not surprisingly, most of the international airlines flying into Egypt have substantially reduced

their capacity and this has had a significant impact on the tourism industry in the country. As the chart above shows, the

recovery in inbound traffic from each shock to the Egyptian tourist market is steadily getting weaker, and a long way from

returning to the growth pattern of 2006-2010

In difficult times for the tourism industry, there are, however, some more positive signs. The number of departures from

Egypt saw an impressive compounded annual growth rate of 7.6% between 2011 and 2014. A continuation of this trend

would lead us to take a more optimistic view on the medium to long-term prospects of the smaller Egyptian airlines.

Egypt has around seven airlines operating with less than 10 aircraft. They generally provide scheduled air transport

and limited charter service. For the purpose of this report we have consciously decided not to cover EgyptAir, EgyptAir

Express and Air Cairo as these three airlines are more likely to receive government support either directly or indirectly

(they are part of EgyptAir Holding which is a state-owned holding company).

The seven airlines we have considered collectively operate a fleet of around 21 aircraft.

Potential opportunity

0

1

2

3

4

5

6

FlyEgyptAir ArabiaEgypt

AlMasriaUniversalAirlines

A320-200

Smaller Egyptain carriers - Number of aircraft by fleet model

Source: CH-Aviation / ATDB

Source: World Bank Data

8737-800 A321-200 ATR72-200 A319-100 8737-500

AMCAirlines

Nile Air NesmaAirlines

NesmaAirlines

AlMasriaUniversalAirlines

AviatorNile Air NesmaAirlines

1,000

6,0%

4,0%

2,0%

0

2010 2011 2012 2013 2014

0,0%

2,000

8,0%3,000

10,0%4,00012,0%

5,00014,0%

6,000 16,0%

7,000 18,0%

Deparatures - Egypt

Deparatures Y-o-Y increase




Nile Air is the largest of the smaller airlines in Egypt. It is a privately owned full-service carrier (FSC) focused on the Saudi

Arabian market. The airline operates scheduled air services to various cities in Saudi Arabia in addition to covering one

city each in Kuwait, Iraq and Sudan. Nesma Airlines, part of Saudi Arabia’s Nesma Group is also a FSC connecting the

Egyptian cities of Cairo and Sohag to several cities in Saudi Arabia. AlMasria Universal Airlines is another FSC operating

out of Cairo and Alexandria to destinations in Saudi Arabia, Bahrain, Kuwait and some domestic routes within Egypt.

FlyEgypt started scheduled service as recently as May 2016, flying to three destinations (one each in Saudi Arabia, Kuwait

and Egypt). It is backed by the Egyptian conglomerate Talaat Moustafa Group. Air Arabia Egypt, part of the Sharjah based

Air Arabia Group, is the only low-cost carrier based in Egypt. It currently operates a single A320-200 on charter services

like those offered by AMC Airlines and Aviator to destinations in the Middle East.

The Ishka view is that these airlines have very limited exposure to traffic inbound from European markets, consequently

they would not be impacted significantly by the drop in European visitors. We see the 7.6% average annual growth in

outbound departures from Egypt as a positive sign for these airlines. Secondly, these seven airlines primarily operate on

routes between Egypt and the Gulf countries, Saudi Arabia in particular. The number of tourists from Saudi to Egypt rose

by an impressive 14% during 2015 compared to 2014 as per arabnews.com. Some airlines already seem to be optimistic of

this trend - Nile Air more than doubled its fleet in 2015, which is an indication of how favorably the airline views the market

between Egypt and Saudi Arabia. In addition, the airline announced in April 2016 that it would now be taking delivery of

the larger A321s instead of the A320s that it had ordered originally. AMC Airlines also has one B737-800 on order which

is due for delivery in 2016.


0

1

2

3

4

5

6

A319-100ATR72-200A320-200

Nille Air

Number of aircraft by airline


Nesma Airlines AirMasria UniversalAirlines

FlyEgyptAMC

AirlinesAir Arabia

EgyptAviator

A321-200 B737-800 A320-200B737-800A320-200 B737-500A320-200 A321-200

0

1

2

3

4

5

6

7

8

9 Lessor/Investor exposure to smaller Egyptian airlines


BBAM AircraftLeasing &

Management

GECAS BOC AviationDAE CapitalAerCap

Nile Air Nesma AirlinesAlMasria Universal AirlinesFlyEgypt AMC Airlines Air Arabia Egypt

Avolon/HKAC SMBC AviationCapital

ACGAcquisitions




We believe that since these airlines already operate with a limited fleet and have no plans to further

expand capacity in the short-term (Nile Air’s two A321s are scheduled to arrive in 2018), they should

be able to withstand the current markets challenges in the short-term – all else being equal. In

addition, some of these airlines have the backing of stronger parent companies and in the event of

any financial difficulties could seek support from the parent.

In terms of macroeconomic indicators, Egypt seems to have recorded a reasonable performance

despite the difficult few years following the political unrest of 2011. According to the IMF, between

2011 and 2015, Egypt’s GDP rose by a compounded annual rate of 7.5% compared to 2.1% recorded

by the entire MENA region during the same period. Considering the nature of the political difficulties

the country has witnessed since 2011 and other terrorism related incidents, an average annual growth

rate of over 7% is quite an achievement. The IMF forecasts that the GDP will continue to grow at an

average rate of around 5% between 2016 to 2021. While Ishka views this as a favorable prospect

for the country’s smaller airlines, there are still considerable challenges in the short-term that could

impact the economic recovery.

In May 2016 S&P cut Egypt’s outlook from stable to negative on the back of its fiscal and currency

vulnerabilities. The rating agency has also warned that it could downgrade Egypt’s sovereign credit

rating in 2017 on the back of the impending fiscal challenges for the country. The rating agency takes

a dim view on the pace of reforms undertaken by the Egyptian government. The combination of

these factors along with challenges from the fall in tourism could dampen the pace of recovery seen

between 2012-2015. However, the agency also highlights some optimistic areas that could contribute

towards a faster economic recovery. The discovery of an offshore natural gas field is viewed

favorably by S&P. Secondly, while the pace of reform has been slow, the government has actually

undertaken some bold and politically sensitive decisions such as raising electricity prices, aiming

to phasing out fuel subsidies by 2020, and undertaking several tax reforms. These reforms are

expected to improve Egypt’s fiscal situation and could help in the economic recovery in the medium

to long-term.


0 0

50 500

100 1,000

150 1,500

200 2,000

250 2,500

300 3,000

350 3,500

2014 20142013 20132012 2012

Egypt GDP

Source: International Monetary Fund, World Economic Outlook Database, April 2016 and World Bank Data

GDP figures are in current US$

MENA – Middle East North Africa includes 20 countries including Algeria, Bahrain, Djibouti, Egypt, Iran, Iraq, Jordan, Kuwait, Lebanon, Libya, Mauritania, Morocco, Oman, Qatar, Saudi Arabia, Sudan, Syria, Tunisia, United Arab Emirates, and Yemen.

MENA GDP

US

$ B

illio

ns

US

$ B

illio

ns

2015 20152010 20102011 2011




What if the Gulf states substantially reduce their financial assistance to Egypt?


Egypt’s current government, led by President Abdel-Fattah El-Sisi, has relied substantially on financial

assistance from Saudi Arabia, UAE and Kuwait. Since all these economies are highly dependent

on oil, the fall in oil prices has impacted their revenues significantly. In such a scenario, if they

substantially reduce the level of funding it could lead to severe foreign exchange shortages in Egypt.

This could have potentially negative consequences on imports as the country would not have the

required foreign exchange to pay for the imports. The lack of funding could also impact investment in

new projects. This would force the Egyptian government to rely on other sources of funding, further

worsening the fiscal situation. And, with lower economic activity emanating from the Gulf countries

into Egypt, the level of air traffic from & to these countries could also fall – this could have adverse

consequences on the smaller airlines in Egypt that rely on traffic to the Gulf in particular.

The Ishka View

Despite the major socio-political and terrorism related challenges facing the country, Egypt has posted a positive macroeconomic performance. There are, however, short-term fiscal and external challenges that could hamper the economic recovery and delay any growth. In addition, international tourism in the country continues to be impacted following the terrorism related incidents and subsequent travel warnings issued by some European countries. However, there are areas of opportunity as well. The strong growth in outbound travel could augur well for the smaller private airlines that have limited exposure to Europe. Due to their limited fleet size, the risk for financiers and investors is manageable. In addition, some of the smaller airlines have the backing of powerful business groups which could prove useful in the event of any further market deterioration.

Gdp recovering better than MENA region

Smaller airlines focused on regional traffic within the Gulf

region thereby limiting their exposure to the fall in international

tourists especially from Europe

Optimistic traffic trends between Egypt and Gulf

Positive steps taken by the government and the discovery of

natural gas field could help economic recovery

International travel to Egypt has fallen substantially

and would continue to remain affected in

foreseeable future

Egypt has been reliant on investments form the Gulf

countries and absence/reduction of support from

these countries could create furher challenges in

economic recovery

Short-term fiscal challenges

With each of the smaller airlines being primarily

focused on Gulf and Saudi Arabia, any disruption

could lead to excess capacity in this segment which

could put pressure on yields of these airlines

Positives/Opportunities Negatives/Challenges




Avianca’s bid for new equity vital for fleet financingAvianca is set to receive 149 aircraft between 2016 and 2024, but the airline is struggling to bring

its costs down and tackle an unsustainable level of debt. The carrier’s gross adjusted leverage – as

measured by total adjusted debt EBITDAR – is 7.4x.

Avianca have already agreed one waiver from its lenders after breaching its debt covenants. The

airline is currently being advised by an investment bank on potential long-term strategic partnerships

and is seeking a $500 million capital injection in order to implement its fleet renewal strategy.

United, Continental, and Delta Airlines are reported to be interested in possible equity stakes. The

airline has ruled out a full sale but if the carrier fails to secure an equity injection it may struggle to

fund its incoming fleet.

Friday 1 July 2016



Cost cutting measures chase yield declines The airline has been buffeted by harsh macro-economic conditions in Latin America that is also

affecting its competitors. Avianca made net losses of $139.5 million in 2015 due to decreased

revenue and a 2.1% drop in yield. The company also made foreign exchange losses of $177.5 million

owing to the depreciation of the Columbian peso against the US dollar and a lack of cash repatriation

from crisis-stricken Venezuela.

However, the EBITDAR margin increased by 1.1% to 17.6% in 2015. Cost cutting measures include

training pilots in Columbia rather than sending them to Miami, and bringing aircraft maintenance in-

house.

Capacity and passenger growth were both up by 8.4% and 7.9% respectively. However, breakeven

load factor continues to rise and yield continues to fall, showing that, while growth is continuing, it is

not sufficient to offset these headwinds.






CASK (Unit Cost)

No. of months unrestricted cash to cover EBITDAR expenses and aircraft rental



Revenue per Passenger

EBITDAR margin


Revenues

Fuel Cost/ASK

Net profit margin

Load Factor

RASK-CASK Margin


RASK (Unit Revenues)

4,270

3.5720

4,6104,704

3.42033.2782

4,361

2.2618

4.6x

14.6865

3.1x4.0x

14.781014.4272

4.0x

12.2931

0.9%

79.6%

3.7718

5.4%2.7%

80.5%79.4%

3.88203.6504

-3.2%

79.7%

2.9868

15.4%

74.3%

18.0%16.5%

73.7%74.7%

17.6%

75.7%

9,4%

10.9146

1.25 months

12.2130

16.0%13.6%

10.899010.7768

2.18 months1.82 months

12.420311.8481

11.0%

9.3063

1.47 months

9.7469

5.3x

153.75

4.5x6.3x

156.85147.26

7.2x

122.23

Avianca Financial Date 2012-15 31-Dec-1331-Dec-1431-Dec-1431-Dec-15

Source: SEC Filling and Ishka calculations

But debt leverage remains stubbornly highAvianca’s debt leverage position has deteriorated in recent years and is now a major brake on the

airline’s ability to secure future financing. Avianca’s outstanding on-balance-sheet debt totalled $3.47

billion as of December 2015. This represents gross adjusted leverage of 7.4x, up from 5x and 6.8x in

2013 and 2014 respectively.

The carrier also has off-balance-sheet obligations of $981 million, mainly related to aircraft operating

leases. As operating performance has declined so has the airline’s credit rating. Fitch downgraded it

from BB- to B in March 2016.

Existing covenants with bondholders, ECA-backed lenders, and even some lessors are restricting the

carrier’s ability to invest unless it’s EBITDAR debt to service ratio improves. They include restrictions

on increasing debt, minimum cash levels and capitalisation ratios. The airline has already breached

covenant conditions necessitating a waiver from exposed lenders, however this may not be

forthcoming in future if the company’s debt position worsens.





0

100

200

300

400

500

600

700

CFCCalyonBNPParibas

Avianca Fleet Financing Debt by Financial institution

Source: SEC Filling

Citibank JPMorgan

TextronAviation

HSBCNatixisKFWPEFOO OtherInvestors

Bardays BINDES

ECA Guaranteed Loans Ex-Im Bank Guanteed Loans BNDES Guaranteed Loans Commercial Loans

The airline’s plan is to reduce debt leverage to no more than 5.0x by YE2016. Some progress is

already under way. At the end of 1Q 2016 the company’s adjusted net debt to EBITDAR was slightly

healthier at 6.6x as a result of the company’s cost cutting measures.

But progress is stalling because of economic headwinds in Latin American markets.

Avianca has entered into agreements for 141 Airbus and eight Boeing aircraft to be delivered

between 2016 and 2024 as part of its growth and modernisation strategy.

This includes an order for 100 A320neos. However, in April 2016 Avianca negotiated a significant

reduction in deliveries prior to 2019. This has resulted in a projected capex reduction of

approximately $1.4 billion over a period of 30 months. The question is whether it will be able to

finance the incoming A320neos. The airline mostly relies on commercial ECA-backed lending and

lessors. Although last year the carrier purchased six A320s and two B787s using an innovative

Enhanced Aviation Investment Vehicle (EAIV) private EETC.

Fleet Renewal Strategy goes on hold

Avianca Fleet Composition: December 2015

Commercial loans with ECA cover

39%

Private placement4%

owned outright 7%

Commercial loanwithout ECA cover 15%

Operating lease35%





However, Avianca’s management intend to rely on internally-generated cash and debt financing

in domestic and international bond markets to fund its growth strategy. This may reflect an

unwillingness on the part of banks to lend and a paucity in ECA cover presently available. But a

failure to bring debt levels down will close these financing options to Avianca and increase its

reliance on an external capital injection which may not be forthcoming.

What if Avianca does not manage to deleverage? A failure to deleverage would make it harder to

attract the capital needed to unlock the fuel saving and low maintenance benefits associated with the

fleet renewal plan. If lenders are not satisfied that Avianca is creditworthy then future financing terms

for everything from capex to working capital and lessors will become more expensive. The average

rate for ECA-backed aircraft financing was a very favourable 3.1% 2015. If the cost of financing

becomes penal, then cash flow will be reduced as interest payments swell (up 26.4% to $169.4

million in 2015) and may necessitate a refinancing of existing debt, and even the spectre of default if

debt covenant conditions are broken again. This would reduce the ability of the airline to deal with

external shocks, such as the existing currency convertibility losses, and make it far less competitive.

Scenarios

Avianca is making good progress on reducing costs, even as they continue to be outpaced by a drop in yields. If the airline is successful in attracting the $500 million it needs, it will help the carrier to finance a new fuel-efficient fleet and weather Latin America’s current economic slow down. Given Avianca’s strong positon in the region, US airlines are likely to pursue the option of making a bid for the carrier.

The Ishka View




Thursday 14 July 2016



Against heavy odds Aeroflot is heading for a profit in 2016Following a challenging 2014 which saw losses of RUB 17.1 billion ($267 million), Aeroflot has

managed to stem the tide in 2015 and is on track to make a profit in 2016.

Aeroflot continues to benefit where its competitors fail. Despite tough economic conditions in Russia,

the carrier increased its market share last year by 5.6%, mostly by acquiring its failed competitor

Transaero.

Unwinding fuel hedge positions will bring Aeroflot back into profitLosses in 2015 were reduced to RUB 6.5 billion ($101 million). Revenues increased 23%, however fuel

hedging losses of RUB 23.7 billion ($369 million) – up 97% on 2014 – pushed the carrier back into the

red.

Aeroflot has also been saddled with RUB 1.5 billion ($23.6 million) in obligations relating to its now

bankrupt competitor, Transaero. Under government tutelage, Aeroflot bought Transero for one

rouble and acquired most of its assets and obligations.

As the airlines hedging positions are allowed to unwind, Aeroflot’s CEO, Vitaly Savelyev, is confident

that the carrier will match last year’s operating profit of RUB 44 billion ($685 million).



EBITDAR margin

Revenues

Net profit margin


247,719290,956319,771415,173

2.9x2.7x-13.9x-10.9x

2.0%2.5%-5.4%-1.6%

15.6%18.1%16.3%24.0%

6.1%6.4%8.3%7.4%

3.7x2.8x3.6x3.9x





CASK (Unit Cost RUB)


Passenger Revenue per RPK (Pax Yield in RUB)

Revenue per Passenger (RUB)


Fuel Cost/ASK

Load Factor

RASK-CASK Margin in RUB

RASK (Unit Revenues RUB)

0.72840.72530.75300.7569

3.32063.41103.54914.2538

78.0%

0.8680

78.2%77.8%

0.95350.9272

78.3%

1.2615

73.9%72.0%73.9%70.3%

2.4526

0.80 months

2.9047

2.45752.6219


3.01933.0783

2.9923

1.02 months

3.6804

7,879.728,202.107,992.919,116.88


Source: Aeroflot and Ishka calculations

However, yields remain under pressure. In dollar terms, they fell 25% in 2015, reflecting the steep fall

in the value of the rouble. Liquidity also remains tight. Cash as a percentage of total revenues fell by

0.9%, although this is most likely a short-term pressure due to Transaero obligations.

A further weakness is that only 35.8% of revenue in 2015 was in the form of hard currency. By

contrast, 50% of its operating costs are in dollars and euros. Fortunately, Aeroflot’s acquisition of 56

international routes from Transero will help to reduce this currency mismatch.

The Russian aviation market is remarkably buoyant despite turbulent economic conditions. The

rouble depreciated by 60% against the dollar in 2015, while GDP contracted by 3.7% and traffic fell by

4.1%. Yet Aeroflot increased its revenue and market share by 5.6%. It seems that, aside from failing

to exploit a drop in oil prices, Aeroflot is capitalising on the exogenous shocks that are disrupting its

competitors.

While other Russian airlines collectively reduced capacity by 27.5 billion available seat kilometres

in 2015, Aeroflot’s ASK jumped by 8.9 billion, or 7.2%, mostly as a result of acquiring routes

from Transaero. Furthermore, as Western carriers such as easyJet, Lufthansa, Finnair, Delta, and

Scandinavian Airlines stopped serving Russian routes in 2016, the opportunities appeared for

Aeroflot to fill the gap.

In 2015, 40% of Aeroflot’s growth came from international markets and 60% from domestic demand.

Strong international growth helps to lower foreign exchange exposure, while strong domestic

demand is remarkable, given that real wages fell by 9.5% in Russia last year.

Aeroflot makes gains where others fall

Company insight Thursday 14 July 2016




Aeroflot is looking considerably more bankable than it was a year ago. In March 2016, Fitch removed

its negative outlook warning for Aeroflot, and the carrier is now positioned to expand its fleet over the

next few years. Of the 258 aircraft in the Group’s current fleet, 201 are on operating lease and 57 are

on finance lease.

The airline, together with its subsidiaries Rossiya, Aurora, Orenair, Podeba and Donavia, is expecting

a net increase of 38 aircraft to its fleet by the end of 2016. While 24 aircraft will be phased out, there

are 62 scheduled deliveries for this year.

Aeroflot also intends to acquire 34 of Transaero’s fleet, including 10 B737s and six A321s from their

order-book. Other aircraft that were already in operation with Transaero will join Aeroflot’s subsidiary,

Rossiya. Consequently, Aeroflot and the Aeroflot Group airlines no longer needs all of the aircraft it

has on order. The group is reviewing an order for 22 A350s from Airbus, and has reached terms with

Boeing for an equal number of B787s.

Fleet expansion offers opportunities for lessors and investors


Aeroflot’s delivery schedule

B-777

A-321

A-319

An-148

A-330

A-350

Narrow body (regional)

Widebody (long-haul)

B-747

B-737

B-767

A-320

Narrow body (medium-haul)

SSJ-100

39 21 1 52 1 1

0

45

14

9

0

19

0

12

0

8

0

4

0

1

1

70

1

9

0

11

0

10

1

6

0

7

0

15

181

24

31

6

38

10

26

10

19

0

17

0

27

0

22 0 0 00 0 0

0

38

0

9

0

10

0

10

0

3

0

1

0

1

16

26

7

13

1

8

0

4

1

3

1

0

1

4

40

6

1

0

0

0

0

0

2

0

6

0

7

0

Type of Aircraft CurrentFleet

Delivery

2016AEROFLOT DELIVERY SHEDULE 2017 2018

Delivery DeliveryPhase

outPhase

outPhase

out




DHC-6

DHC-8

Total

6 3 0 03 1 1

258 62 49 4124 19 29

2 0 0 00 0 0

Type of Aircraft CurrentFleet

Delivery Delivery DeliveryPhase

outPhase

outPhase

out

Source: Aeroflot

Regardless, Aeroflot still has 80 new aircraft due for delivery in the next three years and its financing

demands are likely to remain high, bearing in mind its whole fleet at the end of 2015 was either on

operating or finance lease.

Aeroflot is 51.2% state owned and can sometimes come under pressure to make decisions based on

government policy, rather than commercial logic.

In 2015, Aeroflot’s board was strongly encouraged to take over its ailing, and heavily indebted

competitor Transaero, but successfully resisted taking on its debts after the carrier folded. While the

government would certainly like the airline to fly more Russian-made aircraft, its fleet of mostly Boeing

and Airbus types have made the carrier efficient and competitive.

Moreover, Aeroflot receives no formal guarantees from the government, or cross default provisions.

Fitch, the rating agency, takes the view that the credit position of the company would actually

improve if the state was more forthcoming with cash and financial support. However, this is unlikely

to happen while the Russian economy continues to be impacted by sanctions, low commodity prices

and a devalued rouble.

Instead, the government has touted Aeroflot as a possible candidate for its privatisation programme.

The Kremlin is looking to raise RUB 1 trillion ($12.8 billion) through such sales. On current trends, the

carrier may have a promising future as a privatised company.

Arkady Rotenberg, a billionaire friend of President Putin, is said to be interested in acquiring a 25%

stake in the business. But Aeroflot’s CEO, Savelyev has cautioned against a sale, arguing the fall

in the rouble has left the carrier’s share price undervalued. Regardless, the government is under

increasing pressure to reduce its budget deficit, currently running at 4.3%, so Aeroflot could make it

onto the government’s privatisation shortlist for 2017.

What if consolidation in the Russian airline industry continues?

Following the collapse of Transaero, Aeroflot is closing in on a monopoly position in the domestic

Russian market, with 36.7% of sales. As this number is set to rise along with the fleet expansion,

Aeroflot may soon be a position where it could dictate matters and push prices up which could also

affect demand.

Government intervention is actually lighter than often assumed

Scenarios





In July 2016, the Armenian authorities complained that Aeroflot had doubled ticket prices after a mud

slide blocked the land crossing into Russia on the Georgian border.

As recently as 2011, 150 companies held air operating certificates in Russia. If the process of

consolidation continues, then within five years there may only be two or three full-service carriers and

a handful of discount operators left, several of which are Aeroflot subsidiaries themselves.

Moreover, while Aeroflot’s multi-brand approach provides the airline with diversified income streams,

one of its subsidiaries, Pobeda, is now Russia’s only LCC and the world’s fastest growing airline.

Aware of the criticism, Savelyev says that Pobeda is not expanding as quickly as it could and says

fears of a monopoly are “greatly over exaggerated.”

Aeroflot’s performance during Russia’s recession and currency devaluation has been impressive

and it is very likely that the carrier will return to profit this year. It has successfully exploited the

weaknesses of competitors in a volatile business environment. Aeroflot’s fleet expansion plans have

been complicated to some extent by the acquisition of Transaero’s fleet and order book, but the

airlines’ growth still offers prime opportunities for lessors and investors.

Although the airline is majority state owned, this has not been a major obstacle to strong commercial

performance. In time Aeroflot is expected to be a convincing candidate for privatisation. However,

Aeroflot’s dominant and expanding position in the Russian market may assume the characteristics of

a monopoly if it is allowed to go unchecked by the government.


The Ishka View







Brexit Part II: Weaker sterling impacts airline order booksLast week we analysed the impact of Brexit from a macro perspective, this week we look at its impact

on UK airline order books. The most visible and immediate impact of Brexit so far has been the

devaluation of sterling. As of 7th July, 2016, GBP was down 14% against the US$, reaching a 31-year

low of 1.2798. The pound has suffered a similar fate against the euro. While the currency devaluation

is expected to negatively impact outbound traffic as well as positively affect inbound traffic, a weaker

pound also means that airlines would theoretically require to spend more sterling on their aircraft

purchases. Our analysis suggests that among the airlines operating out of the UK, Jet2 appears to

be more vulnerable to the impact of the weaker pound and if outbound traffic is weakened, could

defer some of its planned deliveries. The other major airlines operating out of UK should be able to

manage their fleet deliveries without any major deferrals or cancellations, however, subject to their

revenue sources, they could also take a hit as a result of the increased cost of aircraft.

EasyJet

B787-10

A320neo

B787-8

B737-800

A32-200

A321neo

Ryanair

A320neo

B787-9

B737 MAX 2000

A350-1000

British Airways

B777-300ER

20 32 39 23160 55 30 4

1116 1918 33018 18 18 12

3 6 2 11

11 10025 30 30 4

12 3 183 3 3 3

5 18 22 8020 12 7 3

2 2

20 32 22 13149 30

5 01 00 60 0 0 0

4 103 3

5 1117 1918 13618 18 18 12

1 123 4 4

12 2511 2

1 1

2016 20232017 20242018 Total2019 2020 2021 2022

Aircraft on order (UK major airlines as of July 2016)




B737-800

B787-9

Virgin Atlantic

B737-MAX8

Q400

Thomson AW

Monarch

Flybe

A350-1000

Jet2

A380

ERJ-175

B787-9

30

14

128 4

30

3 63

44

1 1 2

3 306 8 10 3

10* 10

2

8 10 12 30

2 2 4

2 5 103

2016 20232017 20242018 Total2019 2020 2021 2022

Market insight Brexit part 11

Source: ATDB and Ishka Research

* tables exclude the 12 A350s ordered by Virgin Atlantic this week at the Farnborough Airshow.

The following table shows the estimated additional cash burden airlines might have to face on their

aircraft purchases as a result of sterling’s devaluation. These values are computed using indicative

delivery values in 2016 US$ terms. The analysis does not take into account the fact that PDPs have

probably already been made on a significant proportion of the order backlog, or that airlines with

high levels of revenue in US Dollars are to some extent shielded from the devaluation of Sterling,

however it does provide a guide towards the overall quantum of impact that Brexit may create.

*Flybe stated in its 2015/16 annual report “Flybe has entered into a contract with Nordic Aviation Capital (NAC) to

cancel obligations to lease nine used Bombardier Q400 turboprop aircraft, while taking ownership of 10 Q400 aircraft

it was under contract to lease, for a cash consideration of c£86.0m, with delivery and consideration to take place over

the next 12 months. The contract has a number of conditions that still remain to be satisfied as at 8th June 2016. This

will leave 10 Q400 aircraft to be delivered in 2016/17”

British Airways

Virgin Atlantic

Jet2

Annual total

Ryanair

easyJet

Monarch

Thomson

54 84 166 665159 94 94 13

13

9

3351

9

5754

9

406

94

18

54

19

54

25

54

31

3

36

9

53

22

151

10

43

72

17

27

262 57

107

58

32

426

530

116

81

131

103

41

376

85

258

69

248

31

89

2016 20232017 20242018 Total2019 2020 2021 2022

Indicative additional cash burden in GBP million




Jet2 faces forex challenge IAG’s CEO, Willie Walsh, in an interview post Brexit said that the principal impact of the UK leaving the

European Union will be on currencies. As per the USD/GBP exchange rate post Brexit, the major UK

airlines are collectively looking at an additional cash outflow of nearly GBP1.3 billion (USD1.7 billion)

compared to a no-Brexit scenario (ignoring other factors impacting currency valuation). However,

this figure assumes a constant devaluation ratio over an 8-10-year period. We would draw attention

to a more immediate period, where our analysis suggests that the airline most vulnerable is Jet2.

Jet2 has around 18 737-800s scheduled for delivery during the remainder of 2016 and 2017. Based

on indicative delivery values, it could potentially face an additional cash outflow of around GBP50

million (USD65 million) on these aircraft purchases. Jet2 is a low-cost airline serving the British leisure

market. Weaker sterling could discourage UK holidaymakers and may lead to the postponement of

holidays which has the potential to negatively affect Jet2’s traffic. This situation is likely to continue

for at least a year so long as sterling remains weak. The combination of falling traffic and potentially

higher outflows for aircraft purchases could force Jet2 to re-schedule their orders. In the event it

decides to take deliveries as scheduled, it would mean the bottom-line taking a hit.

Ishka anticipates Flybe may also feel the impact of the weakened sterling. The airline, which is

focused on serving regional destinations within Europe using its fleet of Q400s, E175s, E195s and

ATR72s has been restructuring since 2013. It only managed to post its first pre-tax profit in 6 years

in FY 2015/16 on the back of restructuring efforts. As part of its restructuring, the airline entered

into a deal with Embraer and the US based Republic Airlines (Republic) under which it cancelled its

obligation to take delivery of 20 ERJ-175s and instead agreed to sublease 24 Q400s from Republic,

10 of which are scheduled for delivery in FY 2016/17. Separately, Flybe also entered into a deal to

take ownership of 10 Q400s which are under lease from Nordic Aviation Capital (NAC) for a cash

consideration of around £86 million. As of June 2016, the contract between NAC and Flybe was yet

to be finalised and therefore it remains to be seen whether the cost of the acquisition is affected.

It is also possible that the airline could tweak some of its deliveries from Republic considering the

increase in lease costs in sterling terms.

While the bottom-line of other major airlines operating out of the UK is also estimated to be impacted,

we do not see these airlines altering their fleet plans substantially. In reality, most of the major airlines

should already have some currency hedging plans and that should help them to reduce the impact

of a weaker sterling in addition to their strong fundamentals and/or significant dollar based revenues.

Both British Airways’ and Virgin Atlantic’s fleet expansion in the next year or two is focused on long-

haul traffic and since Brexit is expected to primarily impact outbound short-haul traffic from the UK,

demand for long-haul travel and therefore aircraft should remain more or less unchanged compared

to a no-Brexit scenario. Ryanair and easyJet are truly pan-European airlines which should allow

them to adjust capacity across Europe depending on the market conditions. Even though Ryanair is

not based in the UK, the country constitutes a substantial portion of its operations. However, since

Ryanair reports its accounts in euros it has a natural hedge against sterling.

Monarch has recently undergone a successful transformation which saw it return to profit. As

Monarch’s objective for fleet overhaul is more strategic rather than operational, it is unlikely to alter

its fleet plans. Monarch’s deliveries start after 2017, which should give it sufficient time to reconsider

its network plans, provided it is not acquired by either easyJet or Ryanair who could tweak Monarch’s

order book to conform with their own.





While these are still early stages to pinpoint the effects of Brexit on UK’s aviation industry, the impact

of currency devaluation following Brexit is more certain. Since aircraft purchases are all in US$,

airlines based in the UK now have to pay more in sterling to buy aircraft. The Ishka view is that

while increased aircraft prices will impact the bottom-line of all major airlines, Jet2 appears to be

more vulnerable than others. To make matters more challenging, the airline is dependent on leisure

travellers as its customer base and as result its outbound UK traffic could also be affected as a result

of the weaker pound. This might require the airline to adjust its fleet plans for the next two years. The

strength of fundamentals at BA, easyJet and Ryanair and their business models should help them

manage the additional cost burden.

The Ishka View





Tuesday 19 July 2016



Future appears bleak for FastjetFastjet recently announced that it would be seeking another round of funding from the capital

markets to raise money for working capital needs. Since the airline started operations in late 2012

it has struggled to breakeven, having already recorded a cumulative net loss of US$205 million on

revenues of US$168 million in the four years of its existence. The Ishka view is that the airline faces

an uncertain future until it implements some drastic changes to its operations and overhauls its

network and fleet. In the absence of a strong restructuring program, the carrier could be staring at

bankruptcy in the near future.



EBITDAR margin

Revenues (USDm)

Net profit margin


21265565

6.1x-8.5x-1.9x12.8x

-265.6%-211.2%-130.0%-33.7%

-114.3%-104.9%-52.9%-46.6%

35.5%29.0%12.1%45.9%

-1.9x-2.1x-2.6x-1.4x


CASK (Unit Cost) (US$ cents)


Passenger Revenue per RPK (Pax Yield) (US$ cents)

Revenue per Passenger (USD)


Fuel Cost/ASK (US$ cents)

Load Factor

RASK-CASK Margin (US$ cents)

RASK (Unit Revenues) (US$ cents)

--3.34002.1900

-7.72008.19616.7916

-

-

72.5%73.3%

-9.9636-6.0092

66.7%

-4.0476

-166.1%127.0%106.5%

-

1.87 months

-

17.683614.2053


10.648311.1815

10.8392

3.49 months

10.1823

-719383

Weak fundamentals

Source: Ishka Calculations and fastjet Annual Reports (Accounts for 2012 are for 18 months ended 31 Dec 12) (Traffic

data is not available for 2012)




Company insight Tuesday 19 July 2016

As can be seen from the table above, Fastjet’s fundamentals are particularly weak and the airline

is clearly not running a sustainable business. With net loss margins consistently above 100% and

negative operating cash flows in each year since it started flying, it is not surprising that the LCC has

had to rely on regular equity infusions from shareholders - even for working capital needs. Fastjet

has issued new shares every year since 2012 in order to raise money. Despite lower than average

load factors for an LCC, the airline has continued to add capacity, which has further contributed to its

already unsustainable operations. Fastjet’s cost base is at such a level that even if it could manage

load factors of close to 100%, the airline would still be unable to breakeven.

The airline, which is listed on the FTSE AIM, has seen its share price decline by nearly 76% between

June 2015 and July 2016. Even the airline’s auditors have consistently raised concerns on the airline’s

ability to remain a going concern. During their review of the 2015 annual accounts, the auditors

commented, “In forming our opinion on the financial statements, which is not further qualified in

respect of this matter, we have considered the adequacy of the disclosure made in Note 1 to the

financial statements concerning uncertainties as to the Group’s and the parent company’s ability

to continue as a going concern; in particular the substantial achievement of forecasts including

higher load factors, yields and fuel prices, the successful reduction of the current cost base, any

negative cash flow implications of the liquidation of fastjet Aviation Limited, and the availability of

such additional equity funding as may be needed if those forecasts are not substantially met. These

matters along with the other matters explained in Note 1 to the financial statements, indicate the

existence of a material uncertainty which may cast significant doubt on the Group’s and the parent

company’s ability to continue as a going concern.”

Fastjet’s share price in GBP

60

40

20

0

80

100

120

140

3-4-15

3-5-15

3-6-15

3-7-15

Source: Yahoo Finance

3-8-15

3-9-15

3-10-15

3-11-15

3-12-15

3-1-16

3-2-16

3-3-16

3-4-16

3-5-16

3-6-16

3-7-16





Legacy issues

Macro issues also contributed to fastjet’s woes

Some positive steps

Fastjet’s problems started even before the airline began flying. Before entering the aviation business,

Fastjet, or Rubicon Diversified Investments (Rubicon), as it was called then, was an investment

holding company based in London. Rubicon then had an investment in a software services firm which

it decided to sell in 2011 following a string of poor performances. Based on a renewed investment

strategy, Rubicon decided to exit the software business and enter into the aviation business. As part

of that strategy, Rubicon acquired the entire issued share capital of Lonrho Aviation Limited (Lonrho

Aviation), which was the holding company for a Pan-African airline, Fly540. This acquisition saved

Rubicon from the regulatory and administrative efforts of starting a new airline from scratch. During

the same period, Rubicon also entered into an agreement with Sir Stelios Haji-Ioannou’s easyGroup

to license the Fastjet brand from easyGroup, in return giving easyGroup a stake in the airline.

Subsequently, Rubicon changed its name to Fastjet Plc in August 2012. Initially, the Fastjet group

comprised of Fly 540’s businesses in Tanzania, Kenya, Angola and Ghana. While Fly 540 Tanzania

was replaced by fastjet Tanzania in 2012, the remaining businesses continued to operate under

the Fly 540 brand. This is where Fastjet’s troubles began; Fly 540 as a whole struggled throughout

its existence under Fastjet and this has had adverse negative impact on Fastjet’s fundamentals.

Ultimately, fastjet decided to put all the three businesses of Fly 540 under restructuring and

suspended their operations. Fastjet has since disposed of Fly 540 Kenya, while its Ghana and Angola

operations are being held for sale. It remains to be seen though how positively this would impact

fastjet’s fundamentals.

The airline also had to face several external challenges that further aggravated its losses.

Macroeconomic and socio-political challenges in Tanzania led to falling demand for air traffic that

resulted in lower than expected load factors. While the African aviation market has potential, it is

not the easiest market to operate in. The continent doesn’t yet have an open skies agreement,

which creates several regulatory hurdles for airlines wanting to fly across countries in Africa. It is not

surprising that Africa remains the weakest region for aviation among all the continents. According

to IATA, African airlines collectively posted a net loss during 2014 and 2015 at a time when all other

regions experienced record breaking profitability. And, even 2016 is expected to be a challenging

year for the African aviation market. Ishka believes that the challenging macroeconomic environment

makes it even more difficult for Fastjet to improve its top line.

The airline has recently taken some positive steps. The incoming CEO, Nico Bezuidenhout, who will

join the airline on 1st August, 2016 has previously led South African Airways’ LCC unit, Mango since its

inception in 2006. Mango is among the select few LCCs in Africa that have recorded profits.

Both, the incoming CEO and Chairman, Colin Child, have already identified areas of restructuring and

will be reviewing the network and fleet to align them more with market demand.

Fleet and lessors (As of July 2016, fastjet operated 5 A319s).




The incoming CEO has also rightly identified that its fleet of A319s is unsuitable for the market it

operates in and that the airline is open to migrating to a smaller regional fleet type. We see this as a

welcome step towards cutting costs. Smaller aircraft would definitely be cheaper to lease and would

also optimise the airline’s capacity in-line with the actual demand. This could invariably lead to better

fleet utilisation and therefore greater efficiency. Separately, the management is also considering

shifting its headquarters from the UK to an African base which would also help in reducing

operational costs.

Fastjet’s future depends a lot on its ability to raise funds from its shareholders. In the absence of

funding from shareholders, the airline would struggle to pay for its day to day expenses and would

eventually have to shut shop. The airline would also find it difficult to borrow money as financiers

would not be keen on lending to a company with such weak fundamentals. Even if it manages to get

a working capital loan, the cost of financing would be extremely expensive adding further pressure

on the airline’s already weak bottom line. Separately, fastjet will also struggle if it fails to find lessors

for the smaller fleet type. Lessors might be wary of leasing to an airline that is struggling to generate

any positive cash flow and where the chance of default is high. Under current demand scenario, the

A319s would remain under-utilized and this would also make it difficult for the airline to lower its cost

base.

0

1

2

Nu

mb

er

of a

ircr

aft

Source: ATDB

Fastjet’s current lessors

Industrial and Commercial Bank of

China (ICBC)

NBB Robin Co Ltd SMBC Aviation CapitalSkyWorks Holding LLC

What if Fastjet fails to raise the required funds from its shareholders?

There is significant potential for low-cost travel in Africa, however, it is a difficult market to operate

in. The lack of an open-skies agreement between African countries and regulatory hurdles creates

an additional level of challenge for the airline. While Fastjet was correct in identifying and targeting

the opportunity, the airline has failed to control its cost base - the most critical element of a low-

cost air travel business. In addition, being based in the UK while all its operations are in Africa, not

only created operational challenges for the management and staff, but also contributed to higher

operational costs. And, macroeconomic and other socio-political challenges further dented the

airline’s top-line. We strongly believe that unless fastjet takes immediate steps to reduce its operating

costs and to restructure its network and fleet, the airline will struggle to maintain its existence.

The Ishka View








Can Monarch Airlines survive as a low cost carrier?The two largest LLCs operating in the UK, Ryanair and easyJet, are both rumoured to be interested in

acquiring Monarch Airlines which has recently made the transition from a charter to a low-cost carrier.

A sale to either would represent a win for Monarch’s majority stakeholder, the private equity firm

Greybull, although the carrier is also interested in airlines acquisitions itself.

However, if Monarch is not acquired then it faces the greater challenge of building a successful low-

cost business model. Currently its CASK rates are 5.66 pence, which is far above its rivals. This will

have to be lowered if it is to successfully compete against other UK LCCs in the long-run.

Monarch returned a £44.3 million ($65 million) profit last year following a successful restructuring

programme under Greybull Capital. The private equity firm took a 90% stake in the previously family

run business in October 2014, following consolidated group losses of $191.1 million.

Greybull injected £125 million ($183 million) into Monarch to save it from collapse and began an

austere consolidation programme to return the carrier to health. Long-haul and charter flights

were jettisoned, along with 8 aircraft and 700 jobs as a £200 million cost-cutting measure. For the

remaining staff, pay has been reduced by 30%. Monarch was also able to reach a deal with the UK

Pension Protection Fund which took the remaining 10% equity stake in the business.

Monarch moves off life support

EBIT - pre exceptional (£m)

EBITDAR - pre exceptional (£m)

Load factor (%)

Total capacity in term of passangers (‘000)

Gross Revenue (£m)

Total booked passangers (‘000)

Average number of aircraft

(14.2%)764.4655.5

(9.3%)38.935.3

(17.1%)7,2105,975

(17.6%)8,7307,196

139.7%

6690%

(113.3)

(2.1)

45.0

138.4

0.4%82.6%83.0%

Full Year Financial Results 2014/15 % Change20142015

EBITDA - pre exceptional (£m) 178.7%(87.1)68.3

Source: Monarch Airlines




As of October 2015, the group’s free cash had improved by £35 million ($51 million) yields were up by

9.5% and passenger revenue per available seat kilometre was up 7.2% on 2014.

In August 2014 Monarch announced it would begin transitioning from a charter airline into a low cost

carrier. This was a good move considering the decline of the charter-based model, which its CEO

says is dying, and the fall-off in demand from key charter destinations such as Egypt and Tunisia due

to terrorism.

Flights to Sharm el-Sheikh in Egypt alone account for 10% of Monarch’s revenue. At the same time

a reduction in the number of routes has resulted in a heavy concentration of routes to Spain, which

now accounts for almost 59% of the airlines flights during the peak summer season.

Monarch is also radically moving from an all-Airbus fleet to an all-Boeing fleet. It has placed an

order for 30 Boeing 737 MAX 8 and 15 options as part of its transition to a scheduled leisure airline.

Monarch has stated it will save them around 15% in fuel costs each year. They are due for delivery

from the second quarter of 2018, through to 2020. Current fleet leases on its exisiting A320 and A321

are scheduled to terminate as each new aircraft arrives.

In early 2016, Greybull appointed Deutsche Bank to explore ‘inbound and outbound’ growth

opportunities in Europe. These could include a sale to, or a merger with, another airline. EasyJet and

Ryanair are said to be looking at the carrier, and China’s Hainan Airlines has confirmed interest.

easyJet is after Monarch’s highly-prized slots at London Gatwick, which also happens to be easyJet’s

largest base in the UK. However, easyJet’s founder and majority stakeholder, Stelios Haji-Ioannou,

has said that such deal would be destructive of shareholder value.

If no one is willing to purchase Monarch, then the airline will have to earn its bread as a standalone

low cost carrier. So far it has been aided by a weak euro and £30 million in savings from the low fuel

price environment, but these are variables that could easily change.

Crucially, Monarch’s cost per available seat mile (CASK) will have to come down if it wants to

compete as an LCC on price alone. In 2015 Monarch’s CASK rose by 12% to 5.66 pence. By contrast,

EasyJet’s was 4.77 pence in 2015 while Ryanair’s was lower still at 2.90 pence.

Monarch’s CEO, Andrew Swaffield, says there are too many airlines in Europe today and that around

half are challenged by a high cost base. He predicts further consolidation and a growing divide

between those which have restructured their cost base and those that haven’t.

The move to a Boeing fleet will likely cost Monarch in terms of training, new infrastructure and spares,

although Boeing have almost certainly factored some of these considerations into a sweetened deal

for the airline to agree to switch aircraft supplier.

On the other hand, Monarch is as likely to be the acquirer as the acquired. In April 2016, Swaffield

said the carrier was not for sale but was alert to possible acquisitions itself. Any acquisition would

preferably have a Boeing-heavy fleet. Monarch has expressed an interest in Air Berlin, TUIfly, and

Thomas Cook Airlines but only TUIfly operates an exclusively Boeing fleet.

Monarch’s switch to become a low cost carrier

Greybull looks for the exit

Company insight Wednesday 20 July 2016




Despite a strong return to profitability, Monarch announced in late June that it requires £35 million

to help it through the winter period. Initially the carrier looked to capital markets, but the outcome of

last month’s Brexit vote makes this unlikely according to Chief Executive Andrew Swaffield. Instead

Monarch is looking to Greybull for the necessary cash.

Moreover, Monarch’s incoming B737 order is likely to be more expensive given the current

depreciation of the pound. But with deliveries due from 2017, the airline has some time to allow

sterling to stabilise before incurring that cost. For more insight into Brexit’s effect on UK airlines see

Ishka’s report: Brexit Part II.

Brexit or not, Swaffield insists that Monarch is on course for its second most profitable year ever.

The question is how Monarch will expand following its painful restructuring process. Ishka believes

that the airline’s existing slots in the UK make it an attractive target for easyJet which would provide a

straightforward exit for its private equity owner. A more involved approach is for the airline to acquire

other airlines to build enough scale and slots to compete as a standalone low cost carrier. This

approach represents a challenge as Monarch works to drive down its own costs.

Brexit update

The Ishka view

Company insight Wednesday 20 July 2016







Struggling LATAM gets equity boost from Qatar AirwaysQatar Airways has agreed to take a 10% stake in LATAM in a move that should bolster liquidity at the

struggling Latin American carrier.

The $613 million equity stake is a welcome injection for the airline as it battles a recession in its

domestic markets. The carrier, which has not turned a profit since 2011, has reduced the level of its

capacity growth to accommodate a slowing market. The Ishka view is that thanks to its network,

LATAM will be able to withstand a downturn in traffic in its domestic market. But the additional equity

will help the carrier weather a difficult operating period.

In 2015 LATAM made a loss of $219.3 million, almost doubling their $109.8 million losses in 2014. In

response the airline made cost reductions of around 5%, or $350 million, and has been helped by a

36.3% reduction in fuel costs.

However, the underlining issue remains weak revenues in the Latin American market. Revenues for

2015 slumped 19.5% compared to the previous year and are likely to continue their downward trend

in 2016. On the other hand, debt ratios remain high but stable.

Weak domestic revenues continue to hold LATAM back



Net profit/loss for the year (millions USD)

Revenues (millions USD)



9,71012,92512,0949,740

6.5%148.8%7.9%7.4%

7.2x4.9x5.5x5.8x

-5.6-263.8-2.272-178.7

0.10670.10390.09560.0754

3.3x3.2x3.5x5.2x

LATAM Financial Data 2012-15 31-Dec-1231-Dec-1331-Dec-1431-Dec-15

Fuel Cost/ASK (in cents) 0.05120.03350.03200.0197




RASK-CASK Margin

RASK (Unit Revenues in cents)

Load Factor

Revenue per Passenger (in USD)

CASK (Unit Cost in cents) 0.08180.07630.07390.0569

119.84165.85153.02123.99

78.6%80.4%83.4%83.0%

0.00360.00770.00580.0057

0.08540.08400.07970.0626

LATAM Financial Data 2012-15 31-Dec-1231-Dec-1331-Dec-1431-Dec-15


Exchange losses as a result of currency depreciation in Latin American economies increased by

72.2% last year, from $130.2 million in 2014 to $467.9 million in 2015. However, 57% of revenues are

in dollars which is a healthy metric.

Source: LATAM ans Ishka calculations

Although the decision will not be ratified by shareholders until 4Q2016, the immediate effect of the

investment, once agreed, will be to boost LATAM’s liquidity.

“In addition to strengthening our financial position, it will allow us to explore new opportunities for

connectivity with Asia and the Middle East,” says LATAM’s CEO, Enrique Cueto talking to Ishka in July.

In the long run, Cueto tells Ishka, the carrier is open to a higher stake.

Despite the downturn, the Latin American market is expected to be a good source of growth. IATA

predicts passenger growth of 6% per year over the next two decades. As the largest airline in Latin

America, LATAM is perhaps the only carrier that has a strong regional presence and can compete

at a global level. Last year LATAM carried 68 million passengers and increased its international

capacity by 6.4%. The airline is a natural partner for cash-rich Qatar Airways who want to drive more

traffic through its hub in Doha, through a possible codeshare agreement, and are likely to make few

demands as a stakeholder.

“This was an offer from them, not a request from us,” says Cueto, “They believe in our long term

project. We will bounce back.”

Qatar’s investment is a bet on LATAM’s leading position

Fleet trimming and capacity management have been crucial to LATAM’s attempts to shore up its

bottom line. “We are going to be very careful about how we grow in the Pacific region and will

continue to reduce capacity in Brazil if necessary,” adds Cueto.

Last year LATAM reduced domestic capacity in Brazil by around 5% and will cut another 10% in 2016.

It has moved 10 aircraft to its operations in Brazil, Peru, Chile and Argentina. Thanks to its structure,

LATAM can move aircraft around its subsidiaries. “It’s one of the advantages of this group. Not

everyone can do that,” says Cueto.

Brexit update




LATAM forecasts $4.8 billion in fleet spending commitments for the 2017-18 period, down from the

$7.7 billion predicted last year. But Ishka understands that the airline expects to cut another $2 billion

to $3 billion in excess of the amounts already announced. The carrier already has financing arranged

for the $2 billion worth of orders it is taking delivery of in 2016.

LATAM has existing relationships with 20 different lessors for their fleet, though Ishka understands

that the airline would ideally like to reduce this number. On terminating leases early, Cueto said the

lessors have been very sensitive to their needs given reduced traffic in the region, particularly Brazil.


$ 324m

$ 456m

$ 1170m

Fleet Financing Distribution 2016

Comercial Loans EETCSale Leaseback and Operating Leases

Source: LATAM

What if air traffic in Latin America remains depressed/underperforms for the next five years?

Although the continent has a large and growing middle class, should the downturn turn into a

depression LATAMs domestic revenue weakness will increase as will cargo revenue. Consolidated

cargo revenues are already down 6.6% since 2013 and could fall further still. LATAM has $9.3 billion

in debt, $4.3 billion of which is due to mature in 2020. Though the pressure on LATAM’s bottom

line would be great, the airline would most probably respond by expanding its international capacity

further as a way of protecting its hard currency revenues. In addition, if the carrier’s market continues

to be depressed the carrier could request deferrals from the manufacturers from its incoming order

stream.

Scenarios

LATAM maintains a strategically important position in the Latin American market which will help the

carrier through a turbulent few years in the Latin American market. The carrier has been aggressive in

reducing its capacity and moving aircraft around its network. At the same time, it has been in regular

talks with its leasing partners to off-load additional aircraft if necessary. A focus on international

operations will increase dollar revenues and is a natural hedge against weak demand at home.

The Ishka view







Kenya Airways likely to struggle to break evenKenya Airways (KQ), once one of Africa’s most profitable airlines, has broken its own record for the

worst ever corporate losses in Kenya for the second year running.

The carrier reported losses of $254.2 million for the fiscal year ending 31 March 2016, up from $249.5

million the previous year. Operation Pride, the carrier’s turnaround plan, has brought down costs but

the carrier still faces a difficult foreign exchange environment, a depressed tourism market due to

terrorism and a poor hedging strategy.

Kenya Airways has managed to cut $194 million of costs through its current restructuring programme.

In order to break even the carrier will need to cut a further $200 million of costs. The Ishka view is

that the planned $200 million in cost saving is too ambitious. The airline’s management will face

pressure from its pilots against pay cuts and could hurt its own revenues if it sells or sub-leases too

many of its fleet.

This is the fourth consecutive year that Kenya Airways has run at a loss. However, overall losses

should not obscure the fact that the airline has reduced its operating losses by around 75% from KES

16.33 billion ($158.3 million) in fiscal year 2015, to KES 4.1 billion ($39.7 million) in 2016.

The main issue relates to a series of one-off charges that have hit the airline in the last 12 months.

This includes a KES 4.1 billion ($39.7 million) loss on fuel hedges, and KES 9.7 billion ($94 million)

foreign exchange losses due to a 12.9% increase in the strength of the US dollar which was

aggravated by capital controls in Nigeria, Angola and South Sudan as their currencies devalued

rapidly The carrier’s finance costs have almost doubled on last year which resulted in an additional

KES 2.3 billion ($22.3 million) in interest expenses.

If these one-off impacts are excluded from consideration, then the airline broke even on an operating

cost basis. However, another serious concern is that the airline remains technically insolvent. As of

31 March 2016, its total liabilities of KES 229.7 billion ($2.2 billion) including equity, exceeded its assets

of KES 158.4 billion ($1.5 billion).

If the carrier can wind down its remaining fuel hedge positions and continue to stem operating

losses, then it may well break even next year. But much will depend on its cost cutting measures. “In

order to come back to roughly 5% profit after tax, we need to add about $200 million dollars to the

bottom-line because of our cumulative losses,” says CEO Mbuvi Ngunze.

Operating losses are down but one-off charges are up






CASK (Unit Cost KES)

Operating margin

RASK (Unit Revenues in KES)

Profit/Loss after tax (millions KES)

Load Factor

Revenues (millions of Kenyan Shillings KES)


Revenue per Passenger (KES)

Net profit margin

98,860106,009110,161116,158

-8.00%-3.20%-23.40%-22.60%

14.50%

23,000

10.60%

24,378

3.00%

21,523

4.20%

22,458

7,864

68.70%

-3,382

65.60%

-25,743

63.40%

-26,225

68.30%

2.9x

7.628

4.3x

7.665

31.6x

8.211

5.4x

8.156

-9.10%

7.093

-2.60%

7.473

-14.80%

7.15

-3.50%

7.878

Kenya Airways FinancialData 2013-16 31-Dec-1331-Dec-1431-Dec-1531-Dec-16

Passenger Revenue per RPK (Pax Yield in KES)

RASK-CASK Margin

10.119

0.535

10.799

0.182

9.85

1.061

n/a

0.278

Source: Kenya Airways and Ishka calculations

However, Kenya Airways’ poor performance is also being linked to allegations of corruption at the

carrier. Deloitte were commissioned to provide a forensic audit of company accounts in February.

The audit is still ongoing.

In the meantime, transport secretary James Macharia says the government is conducting “major

surgery” on the airline’s top management. Since October 2015, the airline has lost a number of senior

managers including: chief operating officer, Yves Guibert; chief financial officer, Alex Mbugua; fleet

director, Rick Sine and commercial director, Gerard Clarke.

In the meantime, the government has committed to a KES 10 billion ($98.8 million) bridging loan

while the carrier is mulling a debt to equity scheme in a bid to ease the pressure on its finances.

The Kenyan government and KLM Royal Dutch Airlines are currently the largest shareholders with

respective stakes of 30% and 27%.

The two-fold plan aims to reap KES 20 billion ($194 million) in savings. Half will come from cost saving

measures and half from increased revenue.

Early indications appear promising. Operating costs are down by 4.9% to from KES 126.5 billion

($1.226 billion) to KES 120.25 billion ($1.165 billion) and the strategy has received a boost from lower

fuel prices.

Capacity has been trimmed by 4.29% from 15.4 billion available seat kilometres (ASK) in 2015, to 14.7

billion this year. Ngunze is keen to point out that the airline is still growing – passenger numbers

increased by 300,000 in the past year to total 2.3 million.

Operation Pride is making steady progress





Under a debt restructuring plan drawn up by McKinsey, around 600 staff will be made redundant.

This is expected to save the airline KES 1.3 billion ($12.6 million) a year, although there have only been

80 layoffs to date. Moreover, the well-unionised pilots are likely to be exempted. In April, they staged

a strike calling for the resignation of the CEO. They were unsuccessful in this respect, but as part of

a compromise the human resource director and flight operations manager both agreed to step down.

As a consequence, the carrier may struggle to reach its target of 600 redundancies.

The airline also received a $24 million boost from sale of its valuable Heathrow slots, but this is

a one-off windfall that will not help it again next year. KQ will benefit from a new is a government

decree which requires all state employees to fly with the national flag carrier when travelling for

business.

In order to raise cash, Kenya Airlines has sold two Boeing 777-200ER aircraft to Omni in the US

and no longer operates the 777. It has also sub-leased its three B777-300ERs for between four and

five years to Turkish Airlines. In March, the carrier also agreed to lease two of its nine B737-800s

to Oman Airlines for a three-year period, and the Embraer 170s have also left the fleet. The recent

moves are expected to reduce monthly leasing costs by more than $7 million and improve the

carrier’s overall liquidity position.

KQ leases out its own fleet to reduce costs and improve liquidity

E190

B737-700

B777-300ER (leased out)

B787-8

B737-800

B737-300F

7

2

8

3

15

4

Kenya Airways Fleet Composition

Total 54 Source: Kenya Airways

Will KQ continue to bring costs down?

It is hard to see how much more the airline can cut costs without undermining revenue. Aircraft are

assets that need to be sweated and put to work. Sub-leasing them out will improve cash flow in the

short term, but if the sub-lease rates are below what they are paying lessors as a head lease they

will still incur an overall loss. Moreover, there are factors still to be quantified that will affect whether

the carrier has a chance of returning to profit. The airline has not released the exact savings from low

fuel prices. This would give an indication of how much of the reduction in operating costs are down

to Operation Pride, as opposed to a lighter fuel bill. One the other hand, if the airline has relied too

heavily on cheaper fuel then a rise in prices will hit the company’s fragile finances hard. Likewise, the

full role of corruption in the company will not become clear until Deloitte have finished their audit.

Other headwinds that have hampered KQ’s recovery, such as currency volatility, are not likely to

disappear while commodity producing neighbours struggle with capital flight and devaluations.

Scenarios





The performance of Kenya Airways has been disappointing, especially compared to a nearby

competitor, Ethiopian Airlines. According to data from the International Air Transport Association

(IATA), Ethiopian Airlines recently recorded a full-year profit that was more than all other African

carriers combined. There are few reasons why another majority state-owned carrier such as Kenya

Airways, should not perform better in the African market.

If the cost cutting measures continue to bear fruit, then the airline may break even next year.

However, it remains an uphill battle as many of the variables that dragged the company into a loss

last year, including foreign exchange volatility and a rising cost of capital, are outside of KQ’s control.

The Ishka View




Insight


8 July 2016

Ishkaglobal.com

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