Aerospace Technology & Industry

FINANCING THE CIVIL AIRLINE

BUSINESS
Dr Rachel CUNLIFFE
School of Engineering & Technology
r.cunliffe@herts.ac.uk

INTRODUCTION
Airlines have been operating on very small
margins since deregulation in the 1980s.

In spite of this, it remains a dynamic industry

which continuously attracts new airline
businesses and an array of different business
models.

Where is there information about Airline Finances?

1. Publicly owned companies are obliged to publish an annual report

giving details of their finances. (Privately owned or Government owned
companies tend to be secretive.)
2. The annual report includes data formatted according to convention: Profit & Loss Account (Income Statement) Statement of earnings
summarises revenues and expenses.
Balance Sheet Statement of financial position on a particular
date what the airlines total assets and liabilities are.
Cash Flow Statement Statement explaining changes in balance
sheet, i.e. how cash is generated for the payment of aircraft or
loans.

3. Difficult to compare companies accounts especially when they are

based in different countries.

What do you need to know to understand airline financial statements?

1. Negative values are shown in brackets and not with a minus sign in
front.
2. Tangible assets = aircraft, buildings, terminals, etc..
3. Tangible assets are assumed to depreciate. Typical: a straight line
depreciation over 15 years to a 10% residual value.
4. Intangible assets = route/traffic rights, take-off/landing slots, brand
value, staff experience and training, etc..
5. Intangible assets are written off i.e. amortised (e.g. over 40 years to a
zero residual value).
6. Gearing indicates percentage of companies worth used as leverage on
loans.
Useful abbreviations: ASK = available seats per kilometre
RPK / RPS = Revenue per kilometre / Revenue per seat

Comparison of Financial Statements from IAG and EasyJet

IAG has negotiated and

made initial payments for
future aircraft. Between
2012-13, they invested in
4 Boeing 787s,
3 Airbus A380s,
and 2 Boeing 777s.
EasyJet sold12 new Airbus
A320s, and 12 mid-life
A319s and then leased
them back.

IAG

EasyJet

431 + 282 options

217

N/A

33%

Passengers

54million

60.8million

Load factor

80.8%

89.3%

BA = 194 / Ib = 68

633

14,753million

4,258million

6.27

5.74

4,701million

1,182million

Aircraft (owned &

leased)
Percentage a/c leased

Routes
Total Revenue
RPS (pence/ASK)
Fuel Costs

EasyJet disclosed details of their hedging transactions which reduce the cost
of fuel: Market price $900 to $1,100 per tonne over the year. EasyJet
paid $980 on average. Has forward purchased 1.4 million tonnes
at $948 i.e. 72% for 2014, and 56% 2015.

How Much Revenue Do The Airlines Get?

1. Revenue comes mainly from passenger fares, but some income is

derived from cargo. (British Airways, 2013 - Passenger revenue = 93.6%,
Cargo revenue = 6.4%)
2. Attempts to increase revenue can be erratic if aircraft operating the
route are already full. Significant cost of aircraft, crew, landing/take-off
rights, etc..

3. Operating margins tend to cyclic with costs and economic performance

of the countries they operate within. Current data suggests an average
profit of $5.42 for each passenger carried (CNN, June 2014).
Step in fuel prices Slow-down in economy Slump in revenues

What are the Costs of Running an Airline?

Operating Costs for British Airways December 2013

million
Fuel, oil and emission costs
Employee costs
Handling charges, catering and other operating
costs
Landing fees and en-route charges
Depreciation, amortisation and impairment
Engineering & other aircraft costs
Accommodation, ground equipment and IT costs
Selling costs
Aircraft operating lease costs
Currency differences
Restructuring
TOTAL

2013
(3,755)
(2,387)
(1,340)

2012
(3,712)
(2,345)
(1,213)

Increment
(1.2)%
(1.8)%
(10.5)%

(790)
(722)
(643)
(576)
(439)
(85)
(28)
(5)
(10,770)

(726)
(720)
(625)
(613)
(466)
(98)
(1)
36

(8.8)%
(0.3)%
(2.9)%
6.0%
5.8%
13.3%

Fuel is by far the largest cost.

The second largest cost is cost of employees
Data calculated for the ASK (available seats per kilometre). For British Airways
fuel costs have risen in spite of drop in oil price and advances in aircraft
performance exchange rate fluctuations.

Fuel Costs Vs Financial Performance

Data for oil
prices and
airline revenue
does show high
degree of
correlation.
Recovery
period varies
from just a
couple of years
to more
protracted
periods.

Oil Prices from 1988 to 2011

160

Jun 2008

140
120
100
80

Oct 2004

60
40

Oct-Dec 2000

Oct 1990

20
0

50

100

150

200

250

300

350

ICAO Scheduled Airline Financial Results Source: Airline Finance by Peter Morrell

Fuel Costs Vs Financial Performance

The same ICAO data as

before, but separated by
region: US hardest hit by
recessions : Chapter
11, consolidation.
European airlines
faired better BUT
help from
governments
Asian airlines most
successful.
Asia Pacific
Europe
North America
ICAO Scheduled Airline Financial Results Source: Airline Finance by Peter Morrell

What are the Costs of Running an Airline? EMPLOYEE COSTS

Airlines are essentially a service industry require large

numbers of employees.
There are two ways of reducing the wage bill: 1. Hold down salaries and benefits
2. Reduce the numbers of personnel
Bankruptcy Law in US has been used to hold down wages
and renegotiate contracts.

AIRLINE BANKRUPTCIES
Competition has led to numerous airlines filing for bankruptcy (Sabena, British
Midland, Swiss Air, etc..)
In US bankruptcy laws provide for different types of protection: Chapter 7 straight bankruptcy, assets sold-off
Chapter 11 allows debtor to continue operating (Debtor in Possession
(DIP)) debtor remains in control of assets but has to negotiate with creditors.
Time is used to cut costs and submit a viable business plan.
Chapter 11 has allowed many US airlines to continue operating.
Downside is devastating effect on
employees.
Up to 2004 144 airlines had filed for
Chapter 11 bankruptcy, and 14 for
Chapter 7 bankruptcy.

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Statistical Data for Number of UK Airline Employees Worldwide

100,000

Number of People Employed Worldwide

90,000

TOTAL

80,000
70,000
60,000

50,000
40,000

Cabin Attendants
30,000

Other Personnel

20,000

Pilots and Co-Pilots

10,000

Other Cockpit Personnel

0
2000

2002

2004

Maintenance
2006

Tickets and Sales

2008

2010

2012

Year

12

What are the Costs of Running an Airline? Landing Fees &

Accommodation
Great variation of landing fees and building rates for Legacy Carriers and Low
Cost Carriers
High congestion / high demand produces higher costs
SLOTS not tradable commodities - but in fact airlines do. (Airports or governments
tend to claim ownership.)
Slots allocated according to
grandfather rights BUT
need a landing slot for
every take-off slot hence
carefully coordinated by
IATA (International Airline
Trade Association).

What are the Costs of Running an Airline? LEASES

Advantages of leasing aircraft: 1. The airline doesnt tie up valuable capital purchasing its own aircraft
2. Airlines trying out new routes can reduce their risks
3. Airlines can lease aircraft to accommodate short-term peaks in demand
(summertime)
4. Aircraft are available quickly, even if the manufacturers have full order books
5. Airlines may choose to sell all or part of their fleet to a lessor
6. Airlines that go out of business can hand the aircraft back
7. The lessor stands the risk of a slump in the second hand value of the aircraft
Leasing Companies = airlines with no passengers
Agreement can be for just a few months, or up to 15 years.
Of more advantage to smaller airlines. For British Airways = 0.008% of costs.
Wet Lease includes crew and engineering team.

What are the Costs of Running an Airline? LEGISLATION

Airlines have to ensure that their aircraft are compliant with

legislation for: Noise Abatement
CO2 Emissions
Non-compliant aircraft are not allowed to fly.
New legislation planned for CO2 emissions for aircraft.
Lower noise standards due to come into force for large aircraft 2017
(2020 for smaller aircraft): 10dB less than current standard
New Airbus A320 family and A350XWB are already
compliant.
Long range A350XWB will be able to achieve 16dB below
current standard.

LOW COST CARRIERS HAVE TAKEN A SIGNIFICANT

SHARE OF THE MARKET
LCC Share(%) of Total Seats (2001 2012)

Growth in UK market share of LCC between 2001 to 2012: -

Current data suggests

LCC have seized 36% of
European market and
56% of UK market.
Source: OAG

AIR SERVICE LICENCES 5 Freedoms of the Air

Air service licences are given by governments within a framework of 5 freedom
traffic rights of the air: 1. The right to fly over a country without landing
2. The right to land in a country (for refuelling) without picking up any
passengers or cargo
3. The right to carry passengers or cargo FROM your country to another
4. The right to carry passengers or cargo TO another country from your own
5. The right to carry passengers or cargo from your country to another, and then
on to a third country
If two airlines merge, they risk losing their licence to fly passengers and cargo.

Alliances bypass the licencing legislation by

sharing infrastructure.
Code-sharing and Interlining agreements
with other airlines without formally merging.

ALLIANCES & MERGERS

Since 1992, the US has been pursuing a policy of Open Skies i.e.
unlimited exchange of third, fourth and fifth freedom traffic rights.
BUT restrictions remain e.g.
US refuses to trade domestic flight licences (more to lose than gain)
airline given a licence to operate from a country must be
substantially owned and effectively controlled by nationals from
that country. (Many countries specify limits on foreign ownership).

International Airlines
Group

Traffic rights and restrictions on

foreign ownership have reduced
the number of mergers. Mergers
tend to be between members of
a global alliance.

RECENT FINANCIAL PROBLEMS FACED BY AIRLINES & AIRCRAFT MANUFACTURERS

Shortage of credit from banks meant that airlines turned to government
agencies to supply credit for expansion / new stock.
Since 2008 60% more aircraft purchased using government loans.
1986 Large Aircraft Sector Understanding framework regulating the terms by which loans were
given to purchasers of civil aircraft
2007 Aircraft Sector Understanding
3 categories of aircraft, category 2 aircraft given more favourable terms
Home-Country rule seen as giving unfair advantage to competitors
2011 Aircraft Sector Understanding
Abolition of separate categories of aircraft
Brings government financial arrangements into line with market conditions
High risk buyers only given 80% funding
Maximum repayment of 12 years across the board
Sukhoi SuperJet
BUT no agreement on Home-Country rule

Bombardier C-Series

HIGHLIGHTING PROBLEM WITH HOME-COUNTRY RULE

January 2012 Airline Business published by NEXUS UK

Air Transport Association of America has asked to block Exim Bank giving
credit guarantees to Air India.
Example: Delta Airlines operated New York to Mumbai non-stop until
2008, after which time they were forced off the route by Air India.
Exim Bank had given $3.3billion for aircraft purchases to Air India
between 2006 and 2009, who then flooded US-India market with extra
capacity. Delta forced to cut 64 pilots.
ARGUMENTS AND COUNTER-ARGUMENTS
Airlines employ more Americans than the aircraft
manufacturers, so US finance should back airlines not
Boeing.

BUT
If Boeing didnt sell to India then Airbus would, and US
routes would be flooded with additional capacity
anyway.

So How Much Profit do the Airlines Make?

Return on invested capital - 2004
30

Average Annual Return

25

20

Averaged over past 4 decades, net profit margin

of the worlds airlines is 0.1%!
One of the most profitable activities is Computer
Reservation System (CRS).
Airlines hope to restore profitability by charging
for extras.
Source: Nexus UK

15

10

A NEW FACET OF THE AEROSPACE INDUSTRY IS BORN: -

Aircraft Leasing

Resulting from the downturn in the Global Banking System

Currently 32% of global fleet is leased from Investment Companies
Perversely banks seem happier to lend to lessors than airlines
Business model provides a 5% yield on investment

Recently, Royal Bank of Scotland forced to

dispose of its Aircraft Leasing business
Sold for $7.3billion to Japanese consortium
206 aircraft
Reflection of nature of the business?

TIMELINE
Virgin Galactic at Farnborough
Airshow, 2012

1918

THE
FUTURE?

Questions ?