State of the Airline Industry. Vaughn Cordle, CFA / AirlineForecasts

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1 State of the Airline Industry Vaughn Cordle, CFA / AirlineForecasts

2 Airlines Destroy Economic Wealth Global Commercial Airlines - System-wide In $Billions E 2010F 2011F REVENUES $307 $306 $322 $379 $413 $465 $510 $564 $483 $560 $591 Fuel $43 $40 $44 $65 $91 $107 $134 $189 $113 $137 $145 OPERATING PROFIT ($12) ($5) ($1) $3 $4 $15 $20 ($9) ($1) $21 $15 % margin NET PROFIT ($13) ($11) ($8) ($6) ($4) $4 $13 ($16) ($10) $9 $5 % margin % Net Margin $15 $15 $16 $19 $21 $23 $26 $28 $24 $28 $30 Proft Deficit $28 $27 $24 $25 $25 $20 $13 $44 $34 $19 $24 Deficit as % of Revenue 9% 9% 7% 6% 6% 4% 2% 8% 7% 3% 4% Excess Capacity 6% 5% 4% 4% 4% 3% 1% 5% 4% 2% 2% Crude oil price, Brent, $/b $25 $25 $29 $38 $55 $65 $73 $99 $62 $79 $79 World economic growth, % Barrels of Jet fuel (billions) Source: IATA Economics & AirlineForecasts Updated 9/20/10 Next Update 12/20/10 2

3 Jet Fuel: Key Cost Input 2011 Oil Price Estimates & Industry Impact Futures* IATA** DOE*** Oil Price Estmate $/barrel $90 $79 $85 Industry Cost ($billions) $162 $142 $153 Variation from IATA's ($billions) $20 $0 $11 *Global Airlines' Net Profit ($billion) ($3) $5 $4 Net Profit Margins -0.5% 1.6% 0.7% *Futures Curve on 12/05/10 **IATA's 9/20/10 Estimate ***DOE's 11/07/10 Estimate *AirlineForecasts' Estmates 5% Profit margin : $30 billion 3

4 $8.9 Billion Swing in Net Profits 3Q Net Profits: Year-Over-Year # of 3Q Q 2010 Change Airlines $millions $millions $millions 17 North America ,332 2, Asia-Pacific -1 3,428 3, Europe 689 2,308 1,619 4 Latin America Other 251 1, Total 854 9,746 8,892 Source: IATA 4

5 The Middle East has the Fastest Growth RPK Rank IATA Traffic Results 10 Months to Oct09 verus 10 months to Oct10 RPK Growth ASK Growth PLF FT K Growth 1 Middle East 19% 13% 76% 30% 2 Africa 13% 9% 69% 31% 3 Asia/Pacific 10% 3% 78% 28% 4 Latin America 10% 4% 77% 35% 5 North America 7% 3% 83% 26% 6 Europe 5% 2% 80% 12% Industry 9% 4% 79% 24% 5

6 Bad Industry Fundamentals The airline industry is very volatile, both from a demand side and from a fuel side. The industry has excess capacity because airlines must grow if they are to remain viable and attract investor support. Unfortunately, what s rational [in terms of growth] for the individual airline is irrational at the industry level. History has shown that because of the cyclical nature of the industry, and its tendency to supply too much capacity, airlines are not fit for long-term investment. Older airlines cannot compete effectively with younger and faster growing airlines, and overleveraged balance sheets prevent adequate investment in competitive resources human and physical. Labor has a history of extracting more value when airlines are profitable and fuel costs will increase as economies improve and if carbon taxes are imposed upon the industry. Higher fuel costs impact consumer demand for air travel in addition to increasing unit costs. 6

7 Bad Industry Fundamentals Earnings and Excess Capacity: 10-yrs ending 2009 Net Net required revenue 10-yr avg. Excess Required Millions & 2009$ Earnings Margins earnings deficit Load Factor Capacity Load factor Continental (693) -0.6% 6, % 78% 3% 81% US Airways* (6,206) -5.2% 12, % 76% 6% 82% American* (12,534) -5.6% 23, % 76% 6% 82% United (15,408) -7.5% 24, % 78% 8% 86% Northwest (10,679) -9.0% 16, % 81% 8% 89% Delta (24,884) -14.4% 33, % 77% 12% 89% total/average (70,404) -7.6% 118, % 78% 7.8% 85% Industry (68,707) -5.5% 128, % 76% 6.4% 82% *American includes TWA and US Airways includes America West. Source: AirlineForecasts 7

8 U.S. Domestic Revenue per Passenger 8

9 U.S. Network Airlines Labor Bubble Popped Labor Bubble 9

10 U.S. Network Airlines: 1,000 Fewer Aircraft 10

11 U.S. Industry Composition 11

12 U.S. Industry Composition 12

13 The Middle East: Open to the World Passenger traffic currently at 95 million, targeting 400 million by 2020 Recorded 10% consistent passenger traffic growth in the last 6 years Internatıonal growth of 11% ın The Middle East has a 10.7% share of the international passenger market. Government ınvestments spur tourısm and trade- 48 US bıllıon over three decades. Over half the populatıon ıs under 25 bodes wıll for future growth. New generatıon long-range aırcraft can reach any poınt ın the world from the Mıddle East. An ıdeal connectıng poınt between Europe, Indıa, Afrıca, and Asıa. Use of sıxth freedom to provıde alternatıve travel to nonstops offered by European and Asıan aırlınes. 13

14 The Middle East: Open to the World Mıddle East Aırlınes: 68% share between Mıddle East and Europe, 64% share to South Asıa, 77% share to Southest Asıa, and an 80% share to Afrıca. UAE airlines are expected to grow the three airports into mega-connector airports that in 10 years are expected to handle 200 million passengers. These aırlınes represent a threat to other ınternatıonal aırlınes and each of the gobal allıances. The government is pro-aviation so as to spur economic growth via financial services, trade, and tourism. The government has a highly liberal open skies policy, and streamlined immigration and visa policies making easier to pass through or stay. 14

15 North American & European Protectionism Canada and South Korea have already said no to more landing slots for Emirates. The carrier is involved in a dispute with the Germans over fare setting as the Gulf carriers seek to undercut prices by legacy network carriers in the European Union (EU). And the French are said to be limiting access to Paris and secondary cities like Lyon. Wolfgang Mayrhuber, CEO, Lufthansa, said, It s a miracle that Emirates already has more intercontinental seats than Air France and British Airways combined." He added, "It took us 40 years to get s in the air in one of the biggest global economies, so one must assume that this is an investment for the world. The geographic position allows one-stop service to and between every world region. Yes, we still have an outdated bilateral regime present as Emirates tries to negotiate Pro-aviation policies that embrace the airline industry s role as an economic facilitator cannot be overemphasized and should serve as a lesson to all governments that want to tax their respective carriers into oblivion. Wıllıam Sweblabar 15

16 North American & European Protectionism Air Canada says that the UAE carriers' expansion plans would harm the country s airports and airlines, previously warning that Emirates wanted to flood Canadian airspace with seats to take more travelers and divert them through Dubai. Emirates is the clear market leader, with a 21.0% share of capacity on Middle East-Europe routes. Qatar Airways is the second largest, with 8.7%, while Lufthansa, British Airways and Air France have just 5.6%, 3.5% and 2.7% shares, respectively Another concern for European airlines is that the bulk of long-haul premium travelers connecting via Europe are traveling to the Far East and to the Middle East, with much of this occurring on Middle Eastern carriers. 16

17 UAE Airlines: Global Super Stars UAE Carriers' Aircraft Orders and Fleet Size Current Fleet on Fleet Order Total % chg Emirates % Qatar % Saudia % Etihad % Gulf Air % Total % Source: The Gulf Region's air transport networks (2010) 17

18 Emirates: One of the Best in the World Voted the second best First Class by Skytrax Ranked amongst the top 10 carriers worldwide Largest airline in the Middle East Reported a 351% rise in net profit of USD925 million for the first six months of the financial year to 30-Sep Achieved record average load factors of 81.2% over the six-month period. Load factors in premium cabins rose by 2.6 percentage points, reflecting an encouraging change in the global economic outlook. Overall passenger traffic (RPKs) increased 19.4%, on a 13.4% increase in capacity (RPMs). Dubai is planning a stake sale in Emirates to reduce the emirate s debt 18

19 Turkish Airlines: The Best ın the Mıddle East Europe's 3rd largest, fastest growing and Southern Europe's largest airline. It received the Awards of World s Best Business Class 2010, World's Best Catering in Business Class 2010 and Best Airline in the Middle East 2010 As of 30 October 2010, the Turkish Airlines fleet consists of 151 passenger aircraft with an average age of 6.0 years, as well as 5 cargo aircraft:. It has plans to purchase 105 aircrafts by 2023 Turkish Airlines narrow body fleet could be used to serve new markets from Atatürk that Emirates and Etihad struggle to operate. In Europe, Turkish operates thinner European markets such as Warsaw and Budapest, not operated by the Middle East carriers. The narrow-bodies could also be used to tackle routes in the Middle East that its biggest competitor (Emirates) does not have the right (narrow body) equipment to serve. 19

20 Key Trends Joint Venture (JV) revenue represents increasing international operational revenue share Branded Global Alliances manage supply and demand, and lower costs, ıncrease servıce offereıngs, but may not be stable over time Metal Neutral Partner Growth will continue Issues such as currency, fuel and labor affect partners asymmetrically 20

21 Branded Global Alliance Partners Are Not Equal All three BGAs have Metal Neutral partners All Metal Neutral partners have ATI Not all BGA partners with ATI belong to the Metal Neutral JV Not all BGA Partners have ATI BGA Hierarchy Metal Neutral Partners ATI Partners Non-ATI Partners Non BGA Relationships 21

22 Metal Neutral Networks Reduced double marginalization enables lower fares on more itineraries between Closely coordinated schedules, inventory and fare combinability Volume discounting results in more high yield traffic Accelerated introduction of new routes Additional flights on existing routes More efficient utilization of capacity Improved schedules, Reduced travel and connection times 22

23 Integration: Key Network Ingredient Reduced costs and increased revenue through integration Shared sales Marketing Distribution Procurement Fleet assignment, and Frequent-flyer program management Long-term operational changes Product enhancements Investment in infrastructure 23

24 Final Thoughts World GPD growth higher than expected Oil and fuel costs higher Higher growth in seat capacity Big increases in labor costs Higher government-imposed taxes and fees More mergers and consolidation Political barriers to domestic markets Balance sheet repair dominates Europe & US represent the weakest regions N. American & European network airlines will shrink over time 24

25 Money Follows Earnings & Growth 2010 Market Value to Enterprise Value EV Market Cap Mkt Cap ROI Aircraft # of $US millions (gross) US$ % of EV 2010e Avg. Age Airlines 4 Latin 28,829 18,513 64% 20% Asia/Middle East 161,856 75,721 47% 13% Europe 78,160 32,121 41% 10% N. America 103,042 34,939 34% 10% 8.9 Source: AirlineForecasts Note: Estimates based on Oct 2010 estimates 25

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