European Airlines Fare Wars
Despite a series of bankruptcies, 2017 has been a good year for the European airlines industry. While this might seem counterintuitive, declining capacity (number of seats available) is a sign of strength, not weakness. The market’s persistent excess capacity – a side effect of sustained low fuel prices – resulted in fare wars for short-hauls. The dominance of low-cost carriers (LCCs) made this segment highly competitive and pushed some players to give up.
Three established airlines went bust over the past eight months. Italia’s flagship carrier Alitalia applied for bankruptcy in May. Germany’s second largest carrier Air Berlin followed in August when UAE-based airline Etihad, its main shareholder, cut funding. Finally, Monarch, a British leisure carrier, filed for insolvency early October and left the UK government arranging the return of 110 000 tourists.
With these weaker carriers exiting the market, capacity has decreased significantly on some slots at large hubs over the year (in London and Berlin in particular). This allowed remaining competitors to generate better yields and limit declines in unit revenue (average revenue per seat), and display better passenger load factors. Flag carriers are the main benefiters (namely IAG and Lufthansa) and LCCs to some extent (mainly easyJet). Some of them seized the opportunity to bid on exiting carriers’ assets (aircraft, slots...). While recent developments should allow for capacity levels to be more aligned to passenger demand – a potential end to fare wars – airlines’ capacity guidance for 2018 point to an acceleration.
Nonetheless, 2018 should be a good year for European airlines in our view. Earnings point to double-digit growth, driven by passenger demand (expected to outpace capacity growth), the European economic recovery and cost control in a context of rising fuel prices and higher labour costs. The International Air Transport Association (IATA) anticipates a 17% surge in European airlines earnings in 2018. This would place Europe as the largest contributor to global growth while it generates ‘only’ 30% of the total estimated amount of earnings (USD 38.4 bn). On the other hand, North America, which represents more than 40%, should grow only by 5%. M&A activity seems also likely (attractive valuation, improving prospects). On the other hand, failure of a Brexit deal is a key risk (implications on flying rights).
Overall, we have a preference for LCCs. We believe they offer more upside potential in a highly competitive environment. Our top pick is Ryanair, the largest LCC and the 1st European airline by number of passengers.
Data & recommendations as of 11 December, 2017 close
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