This panorama at the endof the summer holidaysfocuses primarily onassessing sector risk in 14sectors of business inthree major geographicregions. What are the

main trends? North America's economyremains robust and dynamic, despitethe rough winter weather in the firstquarter of 2014. US companies have astrong capital base that enables themto keep risks at relatively low levels andto conquer new markets. The sectors inemerging Asia are enjoying steadygrowth, but the sword of Damocles -overcapacity - that is hanging over busi-ness activity in sectors like construction,chemicals or metallurgy is a risk whichCoface's economists are factoring in.Restructuring will, therefore, take time.

By Coface Group Economists in Paris

Accordingly, we are downgrading theassessments of the construction sectorto high risk and that for paper-wood tomedium risk. In Western Europe, com-panies are gradually getting their headsabove water. Without ignoring the diffi-culties associated with a recovery thathas been too stow and uneven, depend-ing on the country, we are upgradingthe assessments for the metallurgy andautomotive sectors in this region fromvery high risk to high risk.

This section is followed by a focus onthe future of Europe's airlines. Thesecompanies are entering a pivotal period,which is prompting them to change.Since the liberalisation of the Europeandomestic market in 1997, competitivepressures have been growing at a fre-netic pace, which is making things diffi-

cult for the legacy airlines. On the onehand, they have not sufficiently devel-oped their low-cost services, and on theother hand, foreign airlines from theGulf, Asia or Turkey are gaining an ever-larger share of the long-haul market.The time has come for the major Euro-pean players, which have now becomethe least profitable airlines in the world,to change. Changes on the US domesticmarket, where liberalisation took placein 1978, show the advantages and dis-advantages of ever-greater concentra-tion. What is the scenario for the singleEuropean sky? Will the Communityinstitutions push for more openness inthis very particular market or will we seethe emergence of «mega players»?

T

PANORAMASECTORSTHE COFACE ECONOMIC PUBLICATIONS

SEPTEMBER 2014

7European airlines: constraints on change

+Air transport companies: 7liberalisation…how far?

+New demand, 11new entrants

How to adapt? 15

2Sectorialbarometer

ALL THE OTHER GROUP PANORAMAS ARE AVAILABLE ONhttp://www.coface.com/News-Publications/Publications

2

SEPTEMBER 2014

SECTOR BAROMETER BY OUR ECONOMISTS

SECTORS

Major trends :

• Improving sectorrisks in WesternEurope and NorthAmerica is stable

• Alertness on sectorrisks in Emerging Asia

buoyant and Coface is maintainingstable sector risk ratings. Finally, itremains vigilant as regards Asia,downgrading the construction andwood-paper sectors, in view of theindustrial restructuring being pursuedin order to address over-capacity.

Below you will find a sectorial riskassessment table completed by a 6sectors detailled analysis.

Despite stagnant growth in the 2nd

quarter of 2014 in the euro zone, sector risks in Western Europe areimproving, according to Coface,which has reclassified the metallurgyand automotive sectors as high risk.In North America, growth remains

PANORAMA

GROUP

Khalid AIT YAHIA Economic researchdepartment, Coface khalid.aityahia@coface.com

Guillaume BAQUEEconomic researchdepartment, Coface guillaume.baque@coface.com

Emmanuelle HIRSCHEconomic research department, Coface emmanuelle.hirsch@coface.com

SECTORIAL RISK ASSESSMENT

Sectors Emerging Asia North America Western Europe *

Agro-food � � �

Automotives � � �

Chemicals � � �

Construction � � �

Electronics, IT ** � � �

Energy � � �

Engineering � � �

Metals � � �

Paper-Wood � � �

Pharmaceuticals � � �

Retail � � �

Services � � �

Textile-clothing � � �

Transportation � � �

Sources : Datastream, Coface

* See credit risk chart page 6** Electronics, information technology and telecoms

� Moderate risk � Meduim risk � High risk � Very high risk

3SECTORSPANORAMA

GROUP

AGRO-FOOD

World production of cereals and oilseeds in 2014is forecast to reach record volumes, resulting inlower prices. This is due to favourable meteoro-logical conditions since the spring. North Amer-ica will benefit from exceptional soya productionin the United States. Europe too is expectinghigh rapeseed production, but will have to copewith the consequences of the Russian embargoon some of its companies. Meanwhile, produc-tion continues to grow in Asia, in conjunctionwith the rise of the middle class.

Western Europe Activity remained very dynamic in the secondhalf (+9.0% year on year) accompanied by a risein production volumes. Nonetheless, some mar-kets are still struggling, particularly in Italy and inFrance. In a context of abundant harvests, pricesfor food products (excluding alcohol) will con-tinue to fall in Europe, which could weaken thesector during the second half of the year. WithFrance being the country most affected, con-sumer prices entered into a spell of deflation inJuly 2014 (-0.3% year on year). On a quarterlybasis, the scale of the decline in prices at the endof July for fruit (-7.3%) and vegetables (-7.5%)was substantial in the euro zone and mostmarked in France where fruit prices fell by 11.6%.Moreover, the Russian embargo on western foodproducts poses the risk of bottlenecks in Europe.The dairy industry, with ¤1.3 billion in exports (1)

in 2013 (+10.3% compared with 2012) appears to be hardest hit. The risk remains medium butthe impact of the Russian embargo must bewatched.

Emerging Asia Growth in this market has held up (+4.3% yearon year), despite the weak start to the monsoonseason. In India, rainfall at the end of August was18% below the average for the past five years.The next few weeks will, therefore, be decisive.India, home to a quarter of all undernourishedpeople worldwide, is expanding its productioncapacity. According to the FAO, fish output has,accordingly, doubled over the last decade andthe fishing industry is now second in the worldafter China. Regionally, the sector's profita-bility (2) has stabilised since late 2012 to settleat 18.1% year on year, but is still below that ofthe other regions. This is because emergingAsia is characterised by small-scale operations,which limits their profitability. Meanwhile, thePacific region is likely to be hit by an El Niño-type weather effect. The risk rating remainsmedium.

North America The United States is heading for record outputsof soya and maize, which has driven the pricesof these foodstuffs down to their lowest levelssince September 2010. Soybean production vol-umes could reach their highest level since 1998.While sales growth weakened in Q2 2014 (+1.8%year on year), the industry is storing up massivestocks to limit the fall in profitability, which sta-bilised at 12.7% year on year at the end of June2014.

(1) Milk, dairy products, cheese, butter,

(2) EBITDA/Turnover

1

AUTOMOTIVES

Western Europe seems to be back on track, afterseveral very difficult years. North America con-tinues to recover, while emerging Asia is stillposting good results.

Western Europe At the end of June, automotive sales in West-ern Europe showed 10 successive months ofincreasing sales. German manufacturers arestill benefiting from their positioning in thepremium market, as well as their top spot forsales in China. As regards auto parts suppliers,they benefit from their access to the mostdynamic markets. In the UK, the market is nowin its second year of continuous growth, whilethe British automotive industry is a powerfulexport engine. Cash flows are up 10% over one

year (end June 2014), and profitability is up by2.2%. However, several segments are still per-forming poorly, in particular the distributors,first victim of the price war, which is erodingtheir margins. Finally, the second and third rankcomponent suppliers are suffering fromthrsevere constraints limiting the sectors majorclients. This start to the recovery improves ourcredit risk assessment so the sector has nowmoved to high risk.

Emerging Asia In China, automotive production continues at afrenetic rate. In the first 7 months of 2014, newcar sales rose by 11% compared with the sameperiod in 2013. Cash flow was up by 7.5% at theend of June 2014, year on year, while turnover

2

AGRO-FOOD

AUTOMOTIVES

4 SECTORSPANORAMA

GROUP

CHEMICALS

Growth in the sector is subdued in WesternEurope, where German industrialists are holdingthe fort while the others continue to suffer. In Emerging Asia, there is overcapacity in thesector, so there is little visibility regarding thefinancial stability of chemical companies. Finally,in North America, the short-term outlook isfavourable.

Western Europe German companies are expecting timid growthin output (+1% between 2013 et 2014) thanks totheir positioning in speciality chemicals. How-ever, the difficulties faced by the large majorityof companies in Western Europe do not givegrounds for optimism. The aggressive commer-cial approach of companies in Asia and the Mid-dle East in the basic chemicals sector is puttingdownward pressure on prices, which equallyimpacts on margins. Moreover, the fragile macro-economic climate means we are unable tochange our risk assessment, which is still ratedhigh.

Emerging Asia Risk is still high in emerging Asia, especially inChina. Difficulties in obtaining credit are makinglife difficult for SMEs in the sector. Meanwhile, stillhigh production capacity, together with thesevere downturn in the construction sector ispreventing Chinese chemicals companies fromrealising their hopes. Stocks are building up,especially stocks of ethylene derivatives. Netdebt was up 5%, year on year, as at end June2014. In the short-term, the outlook for a sectorwith clear overcapacity issues is not good.

North America North American chemicals companies have acost advantage over their European competitors,as is reflected by their profitability whichincreased by almost 12% as at end June, year onyear. This region is highly prized by chemicalsfirms from across the world, thanks to the avail-ability of cheap energy, which is also a plentifuland cheap raw material. Moreover, the health ofthe construction and, above all, the automotivesectors, provides the companies in this sectorwith outlets for their products. Risk remainsmedium, but the outlook is positive in the nearterm.

figures recorded a double-digit rise of 12%. Riskremains modest. Nevertheless, the steps takenby the authorities to reverse the environmentaldegradation experienced by China's major citiesentails a risk for automotive manufacturers, as itcould hamper the vitality of the market.

North America US automotive sales increased by a total of 4.6%at the end of July 2014 year on year. An increasedue to a sound economic environment, low inter-est rates, as well as consumers' desire for new

models to replace an ageing fleet. Some seg-ments of the market seem to be flourishing, suchas SUVs. American consumers clearly want newcars, but there is also demand from businesses,encouraged by pricing discounts. As a result,automotive plants continue to operate at fullcapacity, achieving almost 90% utilisation. Cashflow climbed 24%, year on year, as at end June.Net debt diminished by 9%, and profitability continued upward, rising by 3.7%. Risk, therefore,remains moderate.

3

CONSTRUCTION

The assessment of sectorial risk differs accordingto the region. Western Europe continues to seeactivity contract. North America is bullish aboutits expansion, with businesses profiting fromsolid growth. Emerging Asia is contending witha downturn in activity, especially in China.

Western Europe Construction in Western Europe continues tocontract, except in the United Kingdom andSpain Eurostat figures show output in the indus-try continuing to fall (-0.5% in June 2014 com-pared to June 2013). The decline is even more

4

«Aggressive commercial approach ofcompanies in Asia and the Middle Eastin the basic chemicals sector»

CHEMICALS

CONSTRUCTION

5SECTORSPANORAMA

GROUP

marked in the Eurozone (-2.3%). According toMarkit, the sector remains in contraction territoryin Germany, with no positive news regardingbuilding permits. In France, the situation is prob-lematic, the number of building permits weredown as at end July 2014 by around 15.7%. Hous-ing starts also continued to fall over the sameperiod, by 10%. Spain has done better, with fourquarters of successive growth, which, however,conceals a market in convalescence, given theseriousness of the previous crisis. Inter-companyrisk is still high.

North America Companies are benefiting from the economicmomentum. All signals are on green accordingto the Census Bureau, with a rise of8.1% in resi-dential building permits in July 2014 comparedwith July 2013. Lower unemployment and lowinterest rates make it easier for households toown property. Nonetheless, pre-crisis levels are

a long way from being achieved and companiesremain weak following a difficult winter and witha very probable rise in interest rates to come.Profitability stagnated at around 1% in late June2014, over a one-year period, as did cash-flows(+0.8%) Risk remains medium.

Emerging Asia China's property sector is beset by overcapacity.Property developers in several of the country'slarge cities are facing huge difficulties in sellingoff their stock (vacancy rate of almost 10% in themajor cities), despite price discounting. Pricesare, therefore, heading south, which is having animpact on the construction sector. This isexplained by increasingly stringent credit condi-tions, and by the fact that local authority debthas risen in recent years such that they areunable to participate in financing the acquisitionof land for construction. The images of ghosttowns, already known in Southern Europe arenow haunting investors. As a result, constructionsector companies showed a net rise in indebted-ness of around 7% at the end of June 2014, yearon year. Intercompany risk is deteriorating andhas become high.

METALS

During the first six months of 2014, world steelproduction reached 821.3 million tonnes (Mt),representing an increase of 3.1% compared withthe first six months of 2013. Growth was drivenmainly by the EU28 (+3.8%) and Asia (+2.9%). As for Ukraine, production shrank by 6% in June.Although the environment is favourable to arise in global demand, overcapacity is havinga lasting impact on the sector.

Western Europe The first half of 2014 confirmed the slightupturn which became apparent at the start ofthe year. Company sales figures began to riseagain (+3.9% over a 12-month period), andcompany debt was down, declining by 2.42%over the first quarter and hardly increasingover the second quarter. At the same time,their profitability has strongly improved. Thisis due, in particular, to the recovery of the auto-motive sector in various European countries,such as Germany, Spain, Italy and Poland.Automotives represent 18% of the steel indus-try’s outlets. Although investments are pickingup, Europe remains hampered by overcapacity(estimated by UBS at 20Mt), although restruc-turing of the Ilva site (partial closure) couldresult in moderating this overcapacity.

North America The decline in the sales figures for companies inthe sector continues (-6.4% over a 12-monthperiod), while their debt levels are rising sharply.Production in the United States remains stable,despite pressure from imports, which are 34% upon the same period in 2013, in particular in thepipe and tube sector.

Emerging Asia China has consolidated its position as the world'sleading steel manufacturer with a market shareof over 50%. In June 2014, output rose by 4.5%compared with June 2013. Despite the slowdownin construction, companies in this sector haverecorded an 8.4% increase in sales over the past12 months. The closure of some non-profitablesites has resulted in improved profitability (+13%over a 12-month period). However, Chinese over-capacity is affecting the market by driving downglobal steel prices.

5

«The images of ghost towns in China arenow haunting investors»

METALS

6 SECTORSPANORAMA

GROUP

Sectorial risk assessmentmethodology

Coface’s assessments are based on the financialdata published by over 6,000 listed companies inthree major geographic regions: Emerging Asia,North America and the European Union 15.

Our statistical credit risk indicator simultaneouslysummarises changes in four financial indicators:turnover, profitability, net indebtedness, and cashflow, completed by the claims recorded through our network.

Hierarchy sectors in Western Europe

Sectoial risk assessment

North America Driven by growth in the US construction sector,wood production is expected to grow by about5% with positive repercussions on prices and oncompanies which have seen their turnover riseby 4.2%. Nonetheless, profitability remains weak.

Emerging Asia China has overtaken the United States as far aspaper production is concerned. The growing roleof innovation in the paper industry as well as thestart up of new production plants means it isable to position itself on the «low-cost» papermarket. Companies in the sector have posted a10% increase in profits over the past twelvemonths and debt is reducing by a similar amount(-11%). However, an increase in Chinese insolven-cies in the paper sector leads us to downgradethe sector in medium risk.

PAPER/WOOD

Internationalisation, environmentally friendly,and innovation are the three terms which bestcharacterise this sector. Over the past twelvemonths, companies in the sector have seen, atworld level, both their turnover increase - by5.5% - as well as their profitability (+6.5% over a12-month period). Several factors are behind thisgrowth: the dynamism of some sub-sectors,such as hygiene products, the Chinese authori-ties' wish to close obsolete sites (3.97 milliontonnes/year of capacity are expected to vanishin 2014) in order to restructure the market. How-ever, these factors have impacted on prices.Their downward trends are weakening companymargins and are indirectly favouring the trendtowards consolidation which has been takingplace over recent years.

Western EuropeRationalisation is continuing in Europe with theclosure of non-profitable or non-strategic sites.Companies in the sector have seen turnover riseagain (+7.9% over a 12-month period), and aslight increase in cash flow (+1.7%). The difficul-ties in the construction sector in turn are affect-ing the wood sector.

6

AutomotivesMetalsConstructionChimicalsPaper-WoodPharmaceuticalsElectronics, IT

EngineeringEnergyTransportation RetailAgro-foodTextile-clothingServices

HIGH

RISK

MEDIUM

RISK

PAPER/WOOD

7SECTORSPANORAMA

GROUP

The global air passenger transport businessdeveloped after the First World War for a well-to-do or professional clientele. At that time it wascharacterised by weak demand, chiefly becauseof operational risks which amplified the costs.Generous government support was given to thewhole sector to ensure its viability. In this con-text, there was no price competition and the air-lines offered inefficient high service quality (1).

Since 1944 the Chicago convention has regulatedthe development of global air transport. Adoptedthen by 52 countries, it now has 191 members. Itgrants states full sovereignty over managing theconditions governing services and overflying oftheir air space. Moreover, it defines nine Free-doms of the Air on which the states agree (2).

DOSSIER

EUROPEAN AIRLINES: CONSTRAINTS ON CHANGE BY OUR ECONOMISTS

(1) T.H. Oum, A. Zhang, X. FU (2010), Air transport liberalization and its impact on airline competition and air passenger traffic, December(2) ICAO (2004), Manual on the Regulation of International Air Transport

Guillaume BAQUÉEconomic researchdepartment, Coface guillaume.baque@coface.com

Antoine COMPSEconomic researchdepartment, Coface antoine.comps@coface.com

because they have been unable toacquire new air traffic rights, theyhave stepped up their acquisition ofstakes in EU carriers. At a time whenit seems vital to tap into Asia'sgrowth potential, European carriershave been hit by this aggressive competition and are among the leastprofitable in the world. There is muchto be learned from the changesobserved on the US internal market,liberalised since 1978. Increase prof-

itability, tap into demand where itexists and do better than the newentrants – these are the three mainchallenges faced by Europe's major,traditional players. Are we seeing thestart of a new wave of consolidationlike that which occurred in the UnitedStates?

The single European Union (EU) mar-ket for air transport was formed onlyin 1997. Since then, the traditional airlines have had to compete withlow-cost carriers on their short andmedium-haul flights. But now, newcompetition has been developingeven more rapidly with regard tolong-haul flights: the Gulf carriers.Their traffic, capacity and profitabilityare expanding more rapidly than inany other region of the world. And,

Table n° 1

Passenger traffic by region

Source : ICAO, domestic and international

Asia and Pacific 1 008 1 1 785 1

Europe 817 2 1 556 2

North America 815 3 1 505 3

Latin America 230 4 303 5

Middle East 161 5 500 4

Africa 76 6 134 6

Total 3 103 5 782

Passengers # Passengers/ #2013 carried km

(millions) (billions)

«European carriers have been hit by aggressive competition from Middle East and Asia and, they are among the least profitable in the world»

1 AIR TRANSPORT COMPANIES: LIBERALISATION… HOW FAR?

8

Market liberalisation has played a large part inthe democratisation of air transport. Since1978, the «Airline Deregulation Act» in theUnited States has boosted the domestic mar-ket. European countries then had a strongincentive to develop bilateral agreements,leading to a doubling of traffic in the EUbetween 1982 and 1993 (3). Europe is now thesecond largest market in the world (table No1) behind Asia and Pacific, which has occupiedfirst place since 2011. The sector provided 7million jobs (1.9% of total jobs) and ¤440 bil-lion in economic benefits in 2013 (2.8% ofEuropean GDP (4)).

Trend towards economic globalisation

The liberalisation of the air transport sector is atrend in line with the globalisation of the econ-omy, leading to the emergence of new players,regardless of nationality. It is, moreover, the pri-mary catalyst for the development of air traffic,which in its turn stimulates a new demand,because liberalisation leads to lower prices. Butin an environment limited by the 1944 Chicagoconvention, the regulatory frameworks betweencountries are organised around bilateral agree-ments (5) (chart N° 1) the very existence of whichcreates obstacles to an optimal development ofthe market.

Against this backdrop, airline companies areorganised in the form of alliances in order toguarantee continuity of service to the consumerfor long-haul flights: Star Alliance (27% marketshare), SkyTeam (20%) and Oneworld (15%). Thenetworks have therefore expanded in spite of thebilateral agreements thanks to the sharing oftraffic rights between companies in the samealliance.

A single market in the European Union

While the American domestic market opened tocompetition in 1978, the EU liberated its ownmarket from 1987 to 1997. Since then all the Euro-pean airline companies have been able establishconnections between EU airports withoutrestrictions on traffic and freely fix their prices.However, domestic routes remain inaccessible toforeign companies not domiciled in the EU. Thecreation of the single market has brought newplayers onto the market, essentially at the low-cost end (text box 1, page 3). The number of aircarriers thus rose from 135 to 152 (6). This situationeven created competition on certain routesunderserved, leading to substantial price cuts.Because of this, the number of routes served bymore than two competitors increased by 415%between 1992 and 2012 to reach 479 routes.

But liberalisation has limits: the European frame-work preserves airline companies’ control andownership rules in order to guarantee the pro-tection of community interests. The acquisitionof a stake in an EU airline by a foreign share-holder (non EU) is capped at 49.9% against 25%in the United States. If the concept of restrictions

(3) N. Lenoir (2007), Is competition possible in the airline industry? September (4) Europe in the broad sense with Turkey and Russia, ATAG Economics (2014), Aviation: Benefits Beyond Borders, April (5) Air services Agreements (ASAs)(6) OAG data

SECTORSPANORAMA

GROUP

«Since 2011, Europe is the second largest market behind Asia and Pacific»

Chart n° 1

Level of air transport liberalisation in different regions of the world

Sources : Boeing Current Market Outlook 2013-2032, World Economic Forum Travel and Tourism competitiveness 2009

Level of liberalization

Regulatory LiberalTransitional

9SECTORSPANORAMA

GROUP

(7) EU-ASEAN Aviation summit, Singapore, February 2014

(8) European Commission (2012), The EU's External Aviation Policy - Addressing Future Challenges, September

(9) Paris Air Forum, July 2014, Paris

(10) CAPA (2014) Airline ownership & control. Why might Europe uphold something its officials call stupid, May

(11) Reuters (2014), Etihad says is buying stakes in Europe to compete, not control, 4 May

on ownership seems clear, the concept of controlis less so. It is in fact difficult to control the influ-ence even of a minority shareholder. For exam-ple, the Swiss airline, Darwin, now operatesunder the name of Etihad Regional following theacquisition of a 33% stake by the United ArabEmirates airline of the same name.

But some officials in the European Commissionare calling for more liberalisation, particularly theTransport Commissioner, Slim Kallas, who con-siders the capital restrictions outdated andharmful (7). Even if the airline market is by defini-tion globalised, not a single aviation company isowned by international shareholders regardlessof nationality. The European Commission is infavour of greater liberalisation of the air trans-port market - a liberalisation which it describesas «the best basis for developing internationalaviation relations (8)», while emphasising, how-ever, the importance of fair competition, basedon regulatory convergence.

Currently, numerous open skies agreementshave been adopted bilaterally with non-EU coun-tries. For this reason the European Commissionhas reminded the need to adopt a communityposition. The bilateral agreements with non-members weaken the coordination of bolder liberalisation. This uncontrolled pace of newagreements could sharpen the competitive pres-sures on the traditional European players.According to the honorary president of AirFrance-KLM, Jean-Cyril Spinetta, «23 or 24 EUcountries have already signed open skies agree-ments(9) (with the Gulf countries, editor’s note)».But France and Germany continue to hold out.

Growing competitive pressure

Competition on the long-haul market has beenprofoundly changed by new entrants from theGulf. Although the existence of unfair practiceson the part of these airlines cannot be shown,particularly because of their opacity concern-ing Etihad and Qatar Airways, their majoritypublic shareholding (chart No 2) reflects thegovernment willingness to promote theirregion across the world thanks the expansionof state-owned airlines.

Faced by acceleration in equity participationby foreign companies, particularly from theGulf, the European Commission has steppedup its investigations. In April 2014, it beganinvestigations (10) into a series of operations(table N° 2) aimed at checking the effectivecontrol linked to these transactions. In Septem-ber it will also study the acquisition of 49% ofAlitalia by the Etihad Company of the UnitedArab Emirates.

In June 2014, Air France-KLM and Lufthansatogether sent a letter asking the European Com-mission to take all suitable measures to ensure alevel playing field. These remarks were aimeddirectly at the Gulf countries. The President ofEtihad, James Hogan, moreover declared that«some legacy carriers are using the EuropeanCommission to challenge us rather than chal-lenge us through competition (11)».

Table n° 2European Commission's Investigations (April 2014)

Source : Coface

Chart n° 2Shareholding (regional average weighted by available seats kilometres)

Source : IATA

100

80

60

40

20

0NorthAmerica

Europe LatinAmerica

Africa Asia MIddleEast

Shareholder % capital Target Date

Etihad29 % Airberlin 12-2011

33 % Darwin Airlines 11-2013

Delta Air lines 49 % Virgin Atlantic 12-2012

Korean Air 44 % CSA Czech Airlines 03-2013

HNCA 35 % Cargolux 04-2014

PrivateGovernment

10 SECTORSPANORAMA

GROUP

LOW COST CARRIERS

Text box 1

Chart n° 4Market share in the EU (% of seats available)

Source : European Commission

(i) a new entrant increases supply thanks to lower prices;

(ii) legacy players lower their pricesto meet this new competition;

(iii) Demand is stimulated and revenues increase for the wholesector.

The strong growth of the low costairlines stimulates the competiti-veness of the whole aeronauticalindustry, which bring about greaterliberalisation of domestic and inter-

national markets. Within the EU themarket share of the low cost airlinesexceeded that of the legacy airlinesfor the first time in 2012 (see chartNo 4). The development of the lowcost model could be limited to shortand medium-haul carriers, particu-larly because of the limited numberof rotations on long-haul flights,which is the main source of saving.But in Europe, Lufthansa announcedin July 2014 the impending launch oflong-haul routes on the low costmodel through its new Germanwingscarrier. The first departures areplanned for the winter of 2015,favouring the tourist destinations ofSouth East Asia, while the Norwegianlow cost carrier proposes to fly to theUnited States from London since thebeginning of July.

This new competition has weighedheavily on the profitability of the tra-ditional airlines, particularly in Europeand is encouraging them to developa low cost offer in their turn. Indeed,consumer habits seem to have per-manently switched to this model forshort and medium-haul flights.

Liberalising a market leads to theemergence of new players capableto capturing market share thanks toan original positioning. Disrupting amonopolistic situation can haveconsiderable economic repercus-sions. For the air transport sectorthis phenomenon came aboutthrough the «Southwest effect (16)»,which refers to the consequencesof the entry of the Southwest Airlines company into the Americanmarket:

(12) Air France-KLM (2014), June 2014 Traffic Results (13) Lufthansa (2014), Lufthansa Group adjusts earnings forecast, June (14) SESAR, http://www.sesarju.eu(15) Single European Sky Air traffic management Research(16) DOT (1993), The Airline Degregulation Evolution Continues: The Southwest Effect, May

The whole European sector seems lastinglyweakened by this new competition. Their earn-ings have been reduced to make it one of theleast profitable regions in the world (chart N° 3).In 2014, the situation does not seem to beimproving, as, in early July, Air France issued aprofit warning, linked to overcapacity on someof its routes in North America and Asia (12).Lufthansa had reported the same problem in theprevious month citing strong competition fromthe stat-owned airlines of the Gulf (13).

Apart from these competitive pressures, theEU suffers from airport under-capacity associ-ated with a lack of investment. This saturationis expected to reduce the prospects of identi-fying potential demand and to increase oper-ating costs by 50% between now and 2050 (14).The main challenge is that of replacing the airtraffic management system, whose technologydates from the 1950’s. The deployment of theSESAR programme will take place between2015 and 2030 for a total budget of ¤2.1 billion.

Some European airlines among the least profitable in the world

Source : IATA

Chat n° 3Net post-tax profit (USD, per passenger)

2,8 0,5

-1,6 -1,60,8

-0,9

0,6 6,9 6,3

2,92,0

8,6

2012

2013

60

50

40

30

20

10

0

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Low costIncumbentOthers

11SECTORSPANORAMA

GROUP

According to the International Civil AviationOrganization (ICAO) in 2013 air transport willhave carried more than 3 billion individuals.When households are more prosperous, theirspending on travel increases. Hence 60-80% ofair travel growth is attributable to the economicgrowth (17) measured by GDP (chart 5), withlower prices or the quality of the infrastructuresalso having positive repercussions on the sec-tor’s penetration rate. Thus global passengertraffic doubles every 15 years.

Chart n° 5GDP growth and number of passengers carried by plane

Source : World Bank

(17) Boeing (2013), Current Market Outlook 2013-2032(18) CAPA (2014), Air travel rises with a country’s wealth. Law of nature, or can government policy make a difference? June (19) Number of passenger multiplied by the length traveled(20) Domestic market by passenger-kilometers, ICAO (2013), Annual Reports of the Council (21) IATA (2007), Estimating air travel demand elasticities, December

Increase in wealth is accompaniedby an increase in passenger traffic

The level of market penetration can be measuredby the passenger carrying capacity, defined asthe number of seats available per inhabitant.Countries with a high per capita income tend tohave a larger number of seats per inhabitant (18).But this market penetration varies according tothe regions of the world (chart 6). In NorthAmerica, it seems to have reached a ceiling. Inother words, beyond per capita GDP of $53,000an increase in the average wealth of a country'sinhabitants no longer stimulates the growth ofair travel (+0.5% of passengers and +3.6% in pas-senger-kilometers (19) in 2013). On this market, itis only possible to win new customers if pricesfall or if there is an increase in the number ofroutes.

With nearly 51,000 seats per million inhabitants,the European market seems to be relatively welldeveloped. The ratio between the number ofseats per million inhabitants and the GDP level is1.75 for Europe against 1.20 for North America or2.60 in the Middle East. The domestic liberalisa-tion of the EU and the multiplication of low costservice partly explain this situation. It must beemphasised that area covered also includesTurkey and Russia, which reduces average GDPper capita.

The Middle East shows excellent but unique per-formances. They are the result of a governmentstrategy aimed to stimulate the region. The Gulfcountries have invested massively in their airportinfrastructures, while the state-owned airlineshave become instruments for promoting theregion throughout the world. This means capac-ity is in fact not at all correlated with the rathersluggish internal market, which accounted foronly 5.7% of total traffic in 2013 (20) against 65%in North America. Qatar thus has 610,000 seatsfor 1 million inhabitants against fewer than150,000 in Switzerland.

However, we must note the strong potential ofIndia whose penetration rate remains weak, asthe country suffers from limited infrastructuresbut also from high taxes on petroleum products,which limit the population’s access to air travel.Since September 2012, foreign airlines can holda stake of up to 49% in a national airline. It is aGulf airline, Etihad Airways, which carried out thefirst transaction initiated in January and for-malised in November 2013, acquiring a 24% stakein the fourth biggest Indian company, Jet Air-ways (17.1% of market share (21)) for $330 million.

Chart n° 6Market penetration and maturity

Source : CAPA Centre for aviation

12,000

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Seats per million capita

2 NEW DEMAND, NEW ENTRANTS

12

(22) IATA (2007), Estimating air travel demand elasticities, December (23) H. Kharas (2010), The emerging middle class in developing countries, OECD(24) Boeing (2013), Current Market Outlook 2013-2032(25) S. Hess (2010), Evidence of passenger preferences for specific types of airports

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Tomorrow, predominantly Asian demand

The elasticity between rising personal wealthand air passenger travel seems to be muchgreater in the emerging countries. For a rise of10% of GDP, demand increases by 20% against15% for the developed countries (22). The emer-ging middle class expects to enjoy a standard of living comparable with the developedeconomies. Their demand for leisure will makethem the biggest market for air travel by 2020.

Moreover, these new middle classes, whose dailyspending will amount to between $10 and $100at purchasing power parity, will be mainly inemerging Asia (chart N° 7). To cope with thespeed of development in this region, between1992 and 2012, the number of weekly flights inrocketed from 2,184 to 52,651 (24). This shift indemand requires an effective response on thepart of Europe's legacy airlines, if they want toguarantee their competitive position becausethe Asian internal market is developing at thesame time. ASEAN is preparing to set up a liberalised single market among its membersby 2015 on the same model as that of the 28 EU members.

Towards a relocation of the hubs

Since 2007, demand in North America hasremained sluggish with a weak growth of 6%testifying to the maturity of its market.Although the situation in Europe is moreencouraging with growth of 34% (see chart 8),it results essentially from the performance ofthe low cost airlines. The traditional airlines arealso having to face the substantial develop-ment of international traffic to or from emerg-ing countries, particularly in the Middle Eastwhere traffic has more than doubled in 5 years.

The greatest growth potential is located in Asia.By making stopovers at the Middle Eastern hubs,the routes are 20 – 30% longer than a direct connection starting from an EU hub. Althoughpassengers may prefer to travel without a con-nection, the elasticity of prices depends on thecustomer segmentation. Indeed, business trav-ellers are ready to pay more to avoid a connect-ing flight. But, this behaviour is rarer for leisuretravellers whose are ready to spend four timesless (study conducted on the domestic marketin the United States (25)). In other words, the com-petitive advantage linked to the EU's proximityto Asia must be moderate and would not justifytoo great a price difference.

Turkey is on this same route. Thanks to thedevelopment of Turkish Airlines, and its 48 mil-lion passengers carried in 2013 (+24% on2012), the country aspires to a share of theEU/Asia market (text box 3, page 15). It isalready the second most popular destinationfrom the EU after the USA.

Chart n° 7Global distribution of middle classes (% of total)

Chart n° 8Regional traffic

Source : OECD (23) Source : ICAO

«Within 5 years, half of the middleclasses will be located in Asia»

100

80

60

40

20

0

North America

Asia andPacific

Latin America

Middle East

Europe

Africa

TOTAL

7% 7% 7%6%

14%

7%

66%

X5

8%

22%

10%

54%

10%

36%

18%

28%

2009 2020 2030

� Middle Eastand Africa

� Latin America

� Europe

�North America

� Asia

� Passengers/km (billions km)

� Change since 2007

6%

0% 50% 100% 150%

0 2,000 4,000 6,000

34%

35%

38%

58%

75%

123%

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Text box 2

In a little more than a decade, the Gulfairlines have succeeded in partially shift-ing Europe's main hubs to the MiddleEast. How might European playersrespond in order to preserve their marketshare on long-haul routes?

The Gulf airlines have significantlyincreased their market share on routesbetween Europe and Asia, especially inSoutheast Asia where they have morethan 25% of the market (their share inJapan and Korea rose from 4% to 15%between 2008 and 2014, in China from4% to 13%, and from 20% to 40% in Aus-tralia). All the natural growth in thesemarkets has particularly benefited theGulf airlines operating in Southeast Asia.As a result, the major European airlineshave seen their results plummet on theirroutes to Asia, whereas these had hith-erto been profitable.

Journey times to Southeast Asia arealmost the same via the Gulf hubs. Euro-pean airlines still have the edge onroutes to Northern Asia, despite thefinancial terms imposed by the Russianauthorities for flying over their territory.The competition, especially on routesbetween Europe and Asia, will sharpenconsiderably in view of the aircraftorders placed by the Gulf airlines; theseare set to total 600 by 2017.

The strategies for dealing with theexpansion of the Gulf airlines are builtaround the following elements:

• Recognition and acceptance of thecompetitive disadvantage and poten-tial withdrawal from the most loss-making routes.

• Improvement of competitiveness ofEuropean airlines, where requiredthrough sectorial programmes specificto the aviation industry, aimed atenabling them to compete with thesecarriers. The input price variance iscurrently estimated to be about 30%to 40%.

• Development of effective partnershipswith Asian airlines, in particular toreplace the traffic lost on routes toEurope with connecting flights fromAsia to the hubs of these Asian part-ners. Guaranteeing efficient connec-tions.

• Developing a high-quality service, set-ting it apart from the quality of theservice provided by the Gulf airlines.

• Controlling access to the Communitymarket (air traffic rights) while waitingfor the establishment of a regulatoryenvironment ensuring the conditionsfor fairer competition between theEuropean Union and the Gulf states.

In a joint letter addressed to the Euro-pean Commission, the European airlinespleaded for a strong joint response towhat they consider to be unfair competi-tion from the Gulf airlines. How do youthink the European Commission willrespond?

European airline companies generallysupport the development of fair compe-tition, undistorted by state subsidies. Inthis regard, the extremely rapid expan-sion of state-owned airlines, some ofwhich are based in the Persian Gulf, israising concerns. With regard to thistopic, in December 2012, the EuropeanCouncil of Ministers of Transport askedthe European Commission to enter intodialogue with the countries of the GulfCooperation Council with a view to con-sidering the conditions for developingfairer competition. This dialogue began inautumn 2013 and will continue in thecoming months.

The question of including aviation in amultilateral scheme similar to that of theWorld Trade Organisation in order to dealwith the problem of competition distor-tion resulting from state aid has, ofcourse, also been asked. The EuropeanCommission are, in particular, pushing forsuch an approach within internationalorganisations.

Finally, in 2013 the European Commissionlaunched a consultation on the opportu-nity to modernise the existing EuropeanTrade Defence Instruments, which dealtwith the problem of airlines from thirdcountries benefiting from subsidiesgranted by their State of origin (Revisionof Regulation 868/2004). Such a pro-posal is expected in the coming months.In this context, the airlines in the AirFrance KLM and Lufthansa groups haveasked the Commissioners for air transportand competition to ensure that Europe'sexisting rules reserving the majority of thecapital and effective control of carriersestablished within the European Unionfor European Union nationals are strictlyapplied when third country investmentsare concerned.

The European Commission have, in par-ticular, the ability to check that theserules are observed and, if necessary,take appropriate measures to limit thedegree of influence a non-EU investorhas in defining the strategy of a Euro-pean carrier.

Air France and KLM support strongaction by the European Commission onthese issues and are in favour of initiativeswhich could, moreover, be taken by theEuropean institutions to improve thecompetitiveness of the European airlines(similar to the guidelines adopted by theCommission in 2004 regarding the mar-itime sector authorising specific socialprotection schemes for seafarers).

Europe's airlines are among the leastprofitable in the world. Do you share theopinion of the European Transport Com-missioner, Siim Kallas, as expressed inLes Echos on 16 July 2014 «consolidationis necessary […]. It has to be said that 150airlines in Europe are far too many»?

Well, compared with the situation in theUS, the situation in Europe is completelydifferent. After the liberalisation of themarket in the 80s, the US aviation indus-try had high overcapacity and experi-enced a significant drop in yield (ofabout -25%) between 1990 and 2000.With the strong growth of low-cost car-riers, legacy airlines filing for bankruptcyprotection under chapter 11 between2002 and 2007. From 2007, the processof consolidation began with the Deltaand Northwest merger. Today, each ofthe 3 main legacy airlines holds 20% ofthe market, while the legacy airlinestogether have a total market share of74%. There has also been concentrationof the low-cost carriers; Southwest is themain operator with 18% and JetBlue isthe only other operator with a marketshare above 5%. The other ultra low-costcarriers, Spirit and Frontier have sharesbelow 2%. In total, 8 operators hold 96%of the market and only 4% is sharedamong the smallest operators.

In Europe, the legacy operators have54% market share and none has morethan 11%. The largest low-cost carriers(Ryanair and Easyjet) have 13% and 8%respectively. Of the total 150 airlines, 21represent 84% of market share.

The consolidation in the US is charac-terised by very stable capacity (-0.4%average growth a year over the past 10years), while, in Europe, growth is con-siderable (average of +5.4% a year). TheEuropean market is much more frag-mented and has a lot of small, veryactive companies! Maintaining stablecapacity has helped maintain revenuelevels (yield). This phenomenon has notyet been observed in Europe. A movetowards consolidation has, however,started with the formation of Pan Euro-pean players and is expected to lead inthe end to 2 or 4 large Pan Europeanpoint-to-point carriers and 3 regionalpoint-to-point carriers operating inniche markets.

Finally, it should be pointed out that theUS authorities have de facto and de juredriven the consolidation of their nationalairlines by strictly applying their legisla-tion limiting access to the capital of USairlines by foreign nationals, and lettingthem restructure and merge in theframework of the particularly advanta-geous provisions of the US bankruptcylaw (known as chapter 11). The situationis different in the European Union, wherestate capital of EU or non EU origin isregularly invested in airlines whose mar-ket viability is not assured.

(26) In number of seats available by kilometres travelled ICAO (2013), 2013: Air Transport Yearly Monitor

The Gulf countries - brimming with momentum

The Middle East is a unique market to the extentthat internal demand is almost non-existent. Theregion benefits from an ideal geographic posi-tion since two billion people live within a radiusof 4 to 5 hours flight from Dubai. The nationalairlines share the region’s image across theworld. Tourism now represents 30% of Dubai’sGDP in line with their strategy of diversifying revenue sources. Indeed, the Emirate will con-tinue developing airport infrastructures. Theabsence of night flight restrictions or taxes forthe national airlines also helps increase theregion’s capacity. In 2013, this capacity grew by12% (26), the best performance in the world, toreach 9% of the world capacity behind the AsiaPacific region (32%), North America (25%) andEurope (27%).

Dubai international airport is the world's seventhbusiest airport with 66 million passengers andsecond busiest of solely international passen-gers. In 2013 it hosted more passengers thanParis Charles de Gaulle Airport. At this pace it isexpected to overtake, within two years, Europe'sbusiest airport, Heathrow, with its 72 million pas-sengers in 2013. In only 5 years the two mainMiddle Eastern airports, Doha and Dubai, havebeen able to capture a large part of the increas-ing demand (Chart No 9).

But the development of the Gulf airlines beganas one-way process with the opening of the EUmarket. The ability of foreign airlines to serve theGulf airports was indeed restricted. In this con-text, legacy airlines being unable to respondeffectively to this competition, and they have losta large number of their direct routes by joiningup with a Gulf partner. For instance, the Aus-tralian Qantas formed a partnership with Emi-rates in September 2012. Since then, the majorityof its European destinations are carried via itsDubai hub by Emirates.

Emirates is the world-leader with regards tointernational passengers-kilometres with a per-formance of 16% in 2013, beating the US carrierUnited Airlines by 50% (table No 3). It has a fleetof 217 jumbo jets, or twice the fleet of Air France,which has 110. Moreover, Etihad Airways, thenational airline of the United Arab Emirates, carried some 12 million passengers in 2013 (+13%on 2012) against 18 million (+6% on 2012 and+50% since 2009) for Qatar Airways. In responseto the difficulties of penetrating the internationalmarkets, Qatar Airways joined the One Worldalliance in 2012. But the strategy of the other twocompanies is to focus on their brand image anddoes not therefore consist in seeking to join oneof the three alliances.

In this context, western airlines, claiming distor-tion of competition, have questioned thesestate-owned airlines' sources of finance, espe-cially concerning Qatar Airways and Etihad,which do not publish their financial statements,unlike Emirates. But for the least opaque of thethree, it must be emphasised that its chairman,Sheik Ahmed al-Makthoum, is also chairman of Dubai airport, Minister of Transport, and Chairman of the Noor Bank which finances,among others, the Emirates fleet.

Chart n° 9Top 25 airports by international passenger traffic

Source : ICAO

120%

100%

80%

60%

40%

20%

0%

-20%

Doha

AntalyaSeoul

Dubai

Singapore

Bangkok

CDGHeathrow

Istanbul

International passengers (millions, 2013)

Change 2013/2008

10 20 30 40 50 60 70 80

��

��

Ryanair 81 Emirates 209

EasyJet 53 United Airlines 141

Lufthansa 51 Lufthansa 139

Emirates 43 Delta Air lines 129

British Airways 34 Air France 128

Table n°3 The world’s top 5 on the international market

Source : IATA

Passengers carried Passengers - km(millions) (billions)

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(27) American Airlines (et US Airways), Delta Air Lines, Southwest Airlines and United Airlines, www.transtats.bts.gov(28) Ryanair, Lufthansa, Airfrance-KLM, Easy jet and IAG, CGSP (2013), Are Airline Companies mortal? July

The United States, world's largest domestic mar-ket, was the precursor to the liberalisation of airtransport of passengers. In October 1978 thefederal «Airline deregulation act» put an end tofederal government control over the granting oflines, the fixing of tariffs and the entry of newcompanies to the market. Whereas 11 companiescontrolled 90% of the market, 47 new entrantsappeared between 1978 and 1984. Only South-west Airlines is still operating today. This isbecause the 2000s were marked by a wave ofconsolidations and liquidations. In 2013, only 4 of the 11 legacy airlines remain, while market

concentration has increased. The top 4 Ameri-can airlines share 69% (27) of the domestic mar-ket against about 45% for the top 5 Europeancompanies (28).

The United States: a precursor?

Liberalisation shook up the organisation of airlinecompanies. It led to a move from the point-to-point to the hub-and-spoke model, in whichshort-haul flights take passengers to an hub fromwhich an airline's long-haul flights are concen-trated. Such an approach optimises profitability

Efe KALKANDELENAssociate Research at Is Investment, Turkey

THE IRRESISTIBLE RISE OF TURKISH AIRLINES Text box 3

Besides, geographically Middle Easterncities remains away from the major des-tinations compared with Istanbul.

How will the European airlines grow in the next 20 years?

Airline companies in emerging marketshave longtime examined European com-panies in order to avoid the mistakes oftheir business models. In emerging mar-kets, the most important advantage ofthe airline companies is the lower laborcosts compared with the European air-lines. In the aviation sector, the highestcost item is the fuel and the second high-est cost item is the labor cost. The controlover one of the most important cost itemgives a serious advantage to the airlinecompanies in emerging markets. This isone of the reasons why the airlines com-panies in emerging markets continue togrow while their rivals in Europe meetsome difficulties in recent years.

How do we define the strategicpositioning of Turkish Airlines?

Turkish Airlines aims to create an aviationholding. Therefore it has implemented astrategy to control costs and provide bet-ter service through its affiliates and sub-sidiaries specialized in different aspectsof the aviation business. For instanceDO&CO for catering services, TGS forground services, THY Opet for fueling air-crafts and Turkish Technic for mainte-nance. Usually Turkish Airlines owns 50percent of capital. In total, Turkish Airlineshas 12 affiliates.

What are the main growth drivers of Turkish Airlines?

The number of transit passengers isincreasing at a high speed. The fall inticket prices of domestic flights supportthe domestic demand. As Turkey haswide and mountainous lands, citizensusually prefer to fly to their final desti-nation instead of driving. The lack ofrailway infrastructure also adds to thedemand for airline transport in thecountry. The government plans to con-struct an airport close to each city. Thisalso would increase the demand.

How does Turkish Airlines face competition from Gulf airlines?

The airline companies in Gulf countrieshave the advantage of using cheaperfuel. Usually the owners of these com-panies are extremely wealthy andthese companies don’t have anyfinancing difficulties. There will alwaysbe a competition with these companiesas they want to become the world’sbiggest airlines. The fact that Turkeyattracts more tourists then these coun-tries, the strong demand for domesticflights in Turkey, the strategic geo-graphical position of Istanbul are Turk-ish Airlines’ advantages in thiscompetition. Turkish Airlines wants tobecome a 5-star airline company. If itsucceeds to become one, we will seehow this will contribute to the compe-tition.

What are the main characteristics of the Turkish aviation sector?

Turkish Airlines is the national flag car-rier airline of Turkey. Istanbul is situatedbetween Europe and Asia which givesthe city a very strategic geographicalposition concerning the transit passen-ger traffic. Passengers who travel fromEurope to Asia, from Asia to America,from Europe to Middle East and Africa,they all prefer to make transfer in Istan-bul as geographically the city allowsthem to make this transfer right in themiddle of a long flight. This gives anadvantage to Turkish Airlines as theother airlines in Europe make this kindof transfer in cities like Paris, Amster-dam or Munich which force passengersto do a short flight in the first place,then make a very long flight in the sec-ond place.

In order to increase the number of tran-sit passengers, Turkish Airlines aims toraise the flight frequency. This reducesthe waiting time between the con-nected flights. The narrow body air-crafts owned by Turkish Airlines enablesthe company to serve easily the totalityof Europe, Middle East, West Asia and80 percent of Africa at lower cost com-pared with wide body aircrafts. Thecompany is able to gather all the transitpassengers in Istanbul through thesenarrow body aircrafts, which is a veryeffective cost saving strategy and sendthem to their final destination with widebody aircrafts. This strategy gives animportant advantage to Turkish Airlines.

Interview by Seltem IYIGUN, Economist at Coface, Turkey

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3 HOW TO ADAPT?

(29) Optimisation of revenues depending on the evolution of the structure of demand thanks to price adaptation

The average price for a domestic flight contin-ued to fall until 2005 (chart N° 11) in conjunctionwith the appearance of low cost airlines in the1980s. The real cost has thus decreased by 40%since the liberalisation of the domestic market.

and the load factor. This reorganisation led to animprovement in services at the large airports butalso to a reduction of services at the less fre-quented small airports. The freedom to set pricesallowed greater diversification of tariffs. Loadfactor have steadily increased (chart N° 10). This is partly the consequence of yield manage-ment (29) invented by Delta Airlines in 1984 andgeneralised throughout the sector. These inno-vations have now become universal.

During the 1990s, companies benefitted from astrong rise in demand: domestic traffic grew by4.1% a year on average over the 1990-2000decade. This led them to excessively increasetheir capacity and therefore their fleet, whichcontributed to their later difficulties.

The effects of contemporary crises

Following the terrorist attacks of 11 September2001, demand fell sharply over two consecutiveyears (-6% in 2001 alone in kilometres flown bypassengers) for the first time in more than 30 years. The financial crisis of 2008 and therecession in 2009 led to a further drop indemand (-4.7% between 2007 and 2009) and,in spite of the recovery of demand from 2010,the 2007 levels have still not been reached.

On this background, the sector’s financial situa-tion has sharply deteriorated. The airlinesrecorded 5 consecutive years of net lossesbetween 2001 and 2005 and the accounts againwent into the red in 2008 and 2009 (chart No12). They have been forced to make substantialreductions in capacity and therefore to reducetheir fleets, which fell by 16 % between 2000 and2010 (not including regional airlines). All themajor airlines underwent a period of judicialrestructuring in the 2000’s. They were often ableto negotiate a substantial reduction in socialcosts (salaries and, above all, pensions) with staffrepresentatives by filing under chapter 11 of theAmerican bankruptcy law. Thus weakened, theairline companies regrouped to rationalise theirnetworks and better control the growth ofcapacity.

Chart n° 10Performance indicators in the United States on the domestic market

Chart n° 11Change in the real prices of domestic flights in the United States (100 = 1979)

Chart n° 12Profitability and revenues of American airline companies (domestic market)

* billions of passengers-kilometres

Source : Bureau of Transportation statistics (BTS)

Source : Airlines for America Source : Bureau of Transportation statistics (BTS)

1,500

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Net profitsAverage fare per mile flown (USD cents)

16 SECTORSPANORAMA

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(30) Average annual price, Airlines for America

(31) US GAO (2014), «The average number of competitors in markets serving the majority of passengers has changed little in recent years,

but stakeholders voice concerns about competition», June

Advantages and disadvantages of further consolidation

From 2008, the American airlines embarked ona major concentration process (chart N° 13).Delta acquired Northwest following the latter’ssuccessful filing for bankruptcy. In 2011, the lowcost airline, Southwest, acquired Airtrans (an-other low cost player), whose integration wasexpected to be completed at the end of 2014.Finally American Airways, which was undergoingbankruptcy proceedings (chapter 11), obtainedagreement from the authorities for its mergerwith US Airways in 2014. This merger wasintended to create the biggest global company,ahead of Delta, with slightly more than 100,000employees.

Finally, through successive mergers/acquisitions,the 7 major companies of the 1990s formed 3 airtransport giants (Delta, United Airlines andAmerican Airlines) alongside Southwest. Themarket share of the four biggest companies,which has reached 69% (against 55% in 2009), isat its highest level the liberalisation of the market.

This unprecedented concentration raising theprospect of an oligopoly on the air transportmarket, which would push up prices. In fact,since 2009, the real prices of domestic flightshave risen by 15% (30). Almost inexistent in theearly 2000’s, fees (Wifi, choice of seat, addi-tional baggage, priority boarding…) now rep-resent nearly 6% of the average ticket price for a domestic flight, which pushes up the finalprice (chart N° 11). This price rises are explained

by a growth in supply (measured in seat-kilome-tres offered) below that of demand. In otherwords, capacity is growing less slowly than thetraffic (chart N° 10). At the same time the merg-ers have made it possible to rationalise the majorairlines' networks, particularly through thereduction in the number of hub (chart N° 14).

Chart n° 14Variation of flights and seats offered by American-type airport* on domestic routes (between 2007 and 2012) in %

Source : United States government accountability Office (31)

* By airport size as % of total passenger numbers (>1%, 0.25% to 1%, 0.05% to 0.25%, >0.05%)

SeatsFlights

-11.1

-18.1

-15.3

-20.1

-18.5

-23.9

-7.0

-9.1

0%-10%-20%-30%

2010

Chart n° 13Main acquisitions since 2008

Source : Bureau of Transportation statistics (BTS)

* market share at the end of the operational year ** market share in May 2014

2008

16.50%**

14.88% 16.02% 12.61% 21.06%

10.16%

7.33%6.39%*

15.50%

2011 20133.36% 8.45%

10.71%*

17SECTORSPANORAMA

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(32) As number of available seats by kilometres travelled, OACI (2013), 2013 : Air Transport Yearly Monitor

(33) Les Echos (2014), Slim Kallas: «for the Commission, the reform of the French railways is going in the right direction», 17 July

Thus, the liberalisation of the American domesticpassenger transport market has undergonethree distinct phases:

Increase in passenger numbers in line withnew entrants’ deployment at the low costend and the price decline;

Concentration of the market as a result of a growing number of actors affecting the sector's profitability;

Restriction of capacity to make economiesof scale linked to the rationalisation of thenetworks;higher revenues thanks to additional charges.

In Europe: a necessary transformation

A first phase of consolidation was successfullycompleted with the mergers between Air Franceand KLM (2004), of Lufthansa and Swiss Airlines(2005) or IAG following the mergers betweenBritish Airways and Iberia (2010) then BMI(2004). But at European level, expected prof-itability remains too weak. At the same timeoccupancy rates are still below those of NorthAmerica at 80% against 83% in 2013. And totalavailable capacity in Europe grew by only 2.8%in 2013, or the second weakest performancebefore North America (32) (+2.1%).

Even if we have to consider the biggest fragmen-tation of the air transport market in the EU, thereseems to be room for manoeuvre to improve thesector’s efficiency. This occurred in the UnitedStates with the liberalisation of the market, 19years earlier than in the EU, suggesting that afuture move towards concentration (describedby the phase 2 experienced by the Americanmarket) will occur in Europe. This scenario isshared by the European Commission through itstransport commissioner, Slim Kallas, for whom«150 companies in Europe are far too many. Consolidation is necessary and should take place (33)». Such a scenario will also be accompa-nied by new problems. The consequences of anexcessive move towards consolidation will firstof all affect the consumer through a lowering ofthe quality of the service (reduction of capacityand services road) and a rise in prices.

Reduced competition is thus unfavourable toconsumers if the companies develop sufficientmarket power to impose high prices on certainroutes. On the other hand, the pressure on priceslinked to the growth of low cost companies istending to decline. They are increasingly estab-lishing themselves at big airports or improvingtheir services in order to capture a new customersegment. For this reason, Southwest has modi-fied its strategy by developing its offer aimed atattracting business customer. On the Europeanmarket, Ryanair launched its «business plus»service in August 2014.

1

2

3

The EU’s sky has been open without restrictionto member states only for 17 years. Since then,the legacy airlines have been subject to inter-nal and external pressures linked to risingimportance of the low cost and Gulf carriers.With low profitability, the EU airlines mustadapt their growth model to capture the highgrowth potential markets, chiefly in Asia.

The global liberalisation of air transport sectorseems far-off but it remains foreseeable. TheEuropean players will have to contend with thisnew foreign competition, which is alreadyundermining the entire European air transportindustry, a little more every day. These com-

petitive pressures have never been so strongfor the EU. The acceleration of foreign invest-ments in EU airlines is prompting the EuropeanCommission to react without compromisingthe viability of these airlines. The size of thesector in the economy makes it difficult to pre-dict a liberalisation of the long-haul segmentas it could lead to a massive destabilisation ofthe sector. It is also necessary to avoid theemergence of a flag of convenience, like thatwhich affects maritime trade.

The most predictable scenario is that of sectorconsolidation. The emergence of the EU superplayers will make it possible to confront theforeign competition.

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4 CONCLUSION

COFACE SA1, place Costes et Bellonte92270 Bois-ColombesFrance

www.coface.com

RESERVATION

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