Europe’s Airlines Face a Chilly Winter

(Bloomberg Businessweek) -- Midwinter in Iceland can be brutal, with temperatures struggling to rise much above freezing and daylight spanning barely four hours. For the North Atlantic island nation’s two main airlines, Icelandair Group Hf and Wow Air Hf, times are equally bleak. With competition from larger carriers depressing fares and fluctuating oil prices making it tougher to manage costs, mounting losses and weak balance sheets are stoking concern about the airlines’ future.

Iceland isn’t alone in feeling the chill. Six European airlines have gone bust since June, while debt-laden Norwegian Air Shuttle has been targeted for takeover, Alitalia has been in insolvency for 18 months, and Britain’s Flybe Group is seeking a buyer as it tries to preserve cash. Even once-thriving operators such as Finnair Oyj have seen their share prices plunge as investors fear profit headwinds.

That’s a far cry from the record earnings achieved by U.S. airlines since a consolidation spree handed pricing power to enlarged supercarriers American Airlines, Delta, and United Continental. Wow founder Skuli Mogensen says the difference is that the pace in Europe is still being set by discounters Ryanair, EasyJet, and Wizz Air, dragging down margins for carriers across the region.

“These are all very aggressive and still fast-growing operators, and as a result the whole [European] market becomes much more aggressive,” Mogensen says. “If you look at North America, there’s been a lot of consolidation, and as a result it has become less competitive.”

What Europe’s poorest performers have in common is a solo status that provides little insulation from a wider earnings squeeze. The region’s three big airline groups include nine former national carriers, representing formidable opposition for companies that aren’t part of that club and lack the clout of bigger independents such as Ryanair Holdings Plc.

The Nordic region is especially exposed since even its leading carriers—SAS, Finnair, and Icelandair—were left out of a merger spree that began in 2004 led by British Airways, Air France, and Lufthansa. Breakneck expansion at Norwegian Air has further weighed on its Nordic brethren’s profits—and resulted in a cash squeeze at the discounter that’s prompted bids from Deutsche Lufthansa AG and BA parent IAG SA, keen to tap into its network of low-cost trans-Atlantic routes.

Those routes are also central to the fortunes of Icelandair and Wow. The two carriers, which use smaller single-aisle jets to help keep a lid on expenses, have developed Reykjavik into a hub linking cities in Europe and North America that generally have no direct services.

For Iceland, the crisis threatens to put a damper on a growing tourism industry that’s been vital in filling a gap in the economy left by the 2008 collapse of the island’s banking system.

One Nordic carrier, Primera Air, was among the six European airlines that collapsed in the second half of 2018. The Scandinavian specialist in holiday flights followed Norwegian Air into discounted trans-Atlantic services before running out of cash. Europe’s patchwork of charter carriers and nonaligned operators accounted for the other five victims: Swiss carriers PrivatAir and Skywork Airlines, Small Planet and Azur Air of Germany, and Belgium’s VLM.

But the biggest operators, too, are struggling to boost margins as a glut in seating capacity depresses fares in even the healthiest markets. While the International Air Transport Association forecasts global airline profits will surge 10 percent in 2019, to $35.5 billion, European carriers will see their earnings slide. That’s because of competition and a delay in the effects of cheaper fuel, due to greater use of fuel hedging contracts that locked in some higher prices. North American earnings should be twice those for Europe, IATA estimates, even though traffic in both regions is similarly dominated by three main carriers.

Craig Kreeger, who ran Britain’s Virgin Atlantic Airways Ltd. until November after working more than two decades at American Airlines Group Inc., says European mergers have shown too much regard for local political sensitivities and failed to deliver the capacity cuts needed to boost profitability. “We’ve had acquisitions in Europe, but I don’t think we’ve had a lot of actual consolidation,” he says. “The difference is in the rationalization of capacity. If you look at what’s happened in the U.S., where there are no national borders, we’ve had both acquisitions and rationalization.” 

Back in Iceland, there’s a ray of light in the depths of winter. After Wow lurched toward the precipice following the failure of takeover talks with Icelandair, the discounter appears to have found a white knight in the shape of U.S. private equity firm Indigo Partners LLC, which is negotiating to take a stake. But the price of the rescue appears to be high, with the airline announcing last month that it will slash its fleet by half, fire hundreds of workers, and close a unit that provides flights from the U.S. to India that’s been running for just a few weeks. 

Mogensen says the decision to retrench has been chastening, and it was a mistake to stray from Wow’s original low-cost focus into sidelines such as the Indian venture. As for the trans-Atlantic market, he predicts that the competition will grow even more fierce, while insisting that smaller players can find their niche in the market.

“We have learned the hard way,” he says. “But it’s still up for grabs.”

To contact the editor responsible for this story: Benedikt Kammel at bkammel@bloomberg.net, James Ellis

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