Global Airline Industry Overview

1
Global Airline Industry Overview
Ana McAhron-Schulz IFALPA Industrial
Advisor April 2005
2
Global Regional Economies
3
Global Economy Continued to See Growth in 2004

• Global economy saw robust expansion in the past
  year
• Global growth estimate is 5 for 2004 and
  forecasted at 4.3 for 2005
• Inflation appears to be a growing concern for
  some countries
• China takes measures to slow down growth for fear
  of inflation
• Despite multiple interest rate increases,
  inflation still seen as a threat
• Energy cost increases are a continuing concern
• Impacting consumer confidence

4
Fragile state of the upswing

• Reliance on the US and China for global growth
  emphasizes a need for structural reforms in many
  countries
• Labor and product market reforms needed in Europe
• Corporate and financial restructuring needed in
  Japan despite strong performance mid 2003 early
  2004
• China and emerging Asia need greater exchange
  rate flexibility
• Countries would have greater monetary control
• Facilitate emergence of more dynamic economies
• Contribute to orderly reduction of global
  imbalances

5
Fragile state of the upswing

• Unemployment still remains a concern in many
  parts of the world
• Geo-political environment still a threat to
  global growth
• Terrorist act or significant military action
  would negatively impact current positive trend in
  growth
• Significant halt in oil production could
  ultimately increase fuel cost to 80/bl

6
Robust economic expansion continues
Real GDP Growth and Forecasts
Source IMF (September 2004)
7
Industry Trends and Performance
8
World airlines see traffic and capacity recovery
coupled with financial pressure

• Global traffic recovers from impact of Iraq War
  and SARS
• Traffic for 2004 increased 8.8 over 2000 levels
  - and up 15.3 over 2003
• 5 growth attributed to recovery from impact of
  SARS
• Overall 2004 traffic higher than expected
  increase of 14
• Capacity for 2004 was 7.3 higher than 2000
  levels and 12.1 over 2003
• Airlines carried a record 1.8 billion passengers
  11 more than 2003
• Passenger growth forecast is 6 per year for 2005
  to 2008
• World carriers loss estimates for 2004 are
  4.8B-5B
• Between 2001 and 2004 the industry has lost 35B
• Initial forecasts for 2004 were 3B profit, prior
  to increase in fuel costs

9
World airlines see traffic and capacity recovery
coupled with financial pressure

• Yields have dropped 30 in the last 10 years
• Business traveler has changed travel patterns
• Transparency of fares with increased use of
  internet distribution
• Industry has no pricing power
• Low cost carriers continue robust growth
• Overcapacity
• Increasing liberalization
• Some airlines continue to face significant
  financial pressure
• On-going losses
• Increased debt loads
• Difficulty in accessing capital markets
• Dwindling liquidity

10
2004 World Traffic and CapacityAll Regions Post
Double-Digit Traffic Growth
Full Year 2004 Year-Over-Year Percentage Change
Source IATA International Traffic Statistics,
1/31/05
11
Jan 2005 World Traffic and Capacity continued to
See Improvements
January 2005 YOY Percentage Change
Lower than expected due to Tsunami
12
Preliminary Feb 2005 Traffic highlights Asian
recovery from tsunami

• World traffic growth was 6.6
• Load factors remained high at 72
• Passenger traffic grew across all sectors
• Led by the Middle East and Latin America
• Asia Pacific posted an 8 increase over Feb last
  year
• Growth rates returned to normal levels
• Cargo traffic slumped 1
• Weaker economic activity
• Slight slump in Chinese imports

13
Summary of Regional Trends
Fuel Costs
Europe LCC expansion Airline Mergers High-speed
Trains
North America Airline Restructuring Yield
pressure Overcapacity LCC expansion
Asia-Pacific LCC growth Industry
expansion Increasing fuel demand Bi-lateral
agreements Strong economy
Middle East Political instability Huge traffic
growth
Latin America Poor economy in key areas
International ownership Corruption
Africa Political instability Largest carriers
expanding
Role of Government
14
Industry Impacted by the Rising Cost of Fuel
15
Rising Fuel Prices Impacting Industry

• Global Production Crisis
• Political unrest in oil producing nations
• Nigerias two oil unions threaten strike
• Iraq oil production continuously disrupted by oil
  well attacks
• Russian oil giant, Yukos, plagued with problems
• Ever increasing demand for fuel
• Largest demand increase in 24 years
• Chinas oil imports rose 35 in 2004 and forecast
  for 2005 is a 22 increase over 2004
• Fear factor now a component of the market
• Difficult to quantify but adds to the volatility
• Estimates are US/bbl attributed to fear factor
• Airlines spent 32 more on fuel in 2004 over 2003
• Resulted in 62B fuel cost for 2004

Source www.wtrg.com, Merrill Lynch report March
18, 2005, IATA speeches
16
Rising Fuel Prices Impacting Industry

• Supply concerns resulted in an oil price rally to
  highest level ever with prices reaching record
  levels of over 56/barrel
• Most airlines had forecasted fuel prices at
  28-30 a barrel for 2004 and 42-47 a barrel for
  2005
• 2005 analyst fuel forecasts are 51/bl with 2006
  at 40-45/bl
• U.S. carriers need 36/bl fuel cost to break even
• Inability to hedge given airlines financial
  condition and dwindling liquidity
• Difficult for airlines to manage a large cost
  that is so volatile
• Goldman Sachs recently said we could be entering
  a super-spike period with prices as high as
  105bbl
• Economy cannot support fuel costs exceeding
  70/barrel
• Governments will have to intervene
• Meanwhile, airlines continue to seek alternatives
  to adjust for fuel cost spike

Source www.wtrg.com, Merrill Lynch report March
18, 2005, IATA speeches
17
Fuel prices have risen dramatically this year
U.S Fuel Price is Closely Matched by Other
Countries
Fuel closed at high of 56.72 in Mar 05
55.40/bl as of Mar. 31, 2005
Reflects end of month NYMEX spot Price /bbl
Source www.eia.doe.gov and www.wtrg.com
18
Hedging fuel costs has helped some carriers

• Best hedged airlines maintain a cost advantage
  over those with no hedging position
• In Europe, Lufthansa, Iberia, Air France and
  British Airways are about 50 hedged
• Qantas is hedged for 70 at 31 until June, Thai
  Airways for 50, and SIA 45 at 41
• Southwest has 85of fuel requirements hedged at
  26, and Alaska has 50 at 29.87
• Airlines not hedged are exposed to the higher
  cost of fuel
• In North America Delta, United, US Airways,
  Continental, American
• In Europe Ryanair and Swiss hedges expired
• Many of Asias LCCs dont hedge at all
• Plan to weather the storm

Indicates percentage of fuel hedged for Full
Year 2005 unless stated otherwise
19
Hedging fuel costs has helped some carriers

• Many global airlines are just beginning to feel
  impact of fuel costs as a result of their strong
  currency vis-à-vis the US dollar
• Airlines are implementing or increasing fuel
  surcharges to off-set fuel costs
• European carriers have been able to off-set 1/3
  of fuel costs through fuel surcharges
• Cathay Pacific increased fuel surcharge in May by
  40 for international and 35 for regional, while
  Japan Airlines and ANA saw 5 increases
• U.S. airlines are added several small fare
  increases

20
Airline Performance by Geographic Region
21
European Airlines Face Fewer Challenges

• AEA airlines estimate a break-even year up to an
  operating loss of between 500M in 2004
• Much improved performance over 2003 loss of 1.5B
  and 800M in 2002
• In fact, the top European flag carriers earned a
  319M profit in 2003
• Traffic increased 9.0 in 2004
• Capacity increased 7.3 for the year
• Trunk carriers add capacity to maintain market
  share
• Yields continued to face pressure from low cost
  carrier growth and price discounting from full
  service airlines
• Pressure from North America capacity plans and
  aggressive fares
• LCCs compete against each other for market share
• Are there too many low cost carriers in Europe?
• Eastern European states admission to EU fuels
  growth
• Despite some failures, new ones are continuously
  emerging

Source Traffic Capacity data is for AEA
Note Top flag carriers include Air France
Group, British Airways, Alitalia, Iberia,
Lufthansa, SAS
22
European Operating Margins Saw Improvement Over
2003
2003 Pro forma Full year operating
margin AF/KLM, Ryanair BA 4Q04 estimates to
determine FY2004 results
Source Company Reports, includes all unusual
items
23
Asia-Pacific Industry Experiences Robust Growth

• Region estimates a 3B net profit in 2004
• Chinas airlines posted combined profits of 753M
• Air China, China Eastern China Southern
  responsible for 651M
• Traffic increased 20.5 for the year on 15.5
  capacity increase and is expected to continue
  growing
• Favorable economic conditions, increasing
  liberalization and high consumer confidence to
  continue driving growth
• Low Cost Carriers expected to play a major role
  in growth
• LCCs account for 16 of current announced orders
  
• Excludes unconfirmed orders LCC operators
  finalizing launch plans
• China to be a major market over the next two
  years
• Aviation regulation will be ease as demand for
  air travel explodes
• China begins approving applications for privately
  owned airlines
• China leads world in aircraft orders
• 1,790 planes in the next 20 years

24
Asia-Pacific Operating MarginsBenefit from
Economic Growth
Full Year data is Oct 2003 through September 2004
Source Company Reports
25
Latin American industry continues to strive for
recovery

• Latin American airlines have lost over 3B
  between 2001 and 2004
• Represent 5 of worldwide traffic but 10 of
  industry losses
• Privatized airports charge fees realizing 30-40
  returns
• Taxes represent 25.6 of airline ticket
• Region attempts to turn losing trend around
• Smaller airlines plagued by weak local economies,
  currency devaluations, and limited access to
  capital
• Do not have cross border alliances common to
  Latin Americas larger airlines
• As economy picks up, Venezuela see signs of rapid
  recovery
• Previous 40 drop in market attributed to
  political unrest, poor economy
• Brazils new bankruptcy law is a relief for
  troubled carriers
• Financially troubled airlines can renegotiate
  debts and stay out of bankruptcy
• Varig will negotiate 2.6B debt and take on new
  equity investors
• Avianca and Aerolineas Argentinas exit bankruptcy
• Chile approves new offshoot of Aerolineas
  Argentinas
• Multi-national alliances, TACA and LAN, have been
  very successful

26
North American Aviation Continues to Face
Challenges

• U.S. Major airlines post a net loss of 5.5B in
  2004
• Losses of 30B from 2001 through 2004
• Progress in cost reduction initiatives wiped out
  by increasing fuel costs
• Labor has provided approximately 75 of savings
  in bankruptcies and restructurings
• Despite an increase in revenues, yields are still
  down
• Analysts forecasting losses of 5B in 2005 and
  1.1B in 2006
• U.S. traffic increased 14.2 in 2004
• Low fares stimulate demand but weighs on yields
• Capacity was up 8.1 for the year
• US trunk carriers plan to switch capacity from
  domestic to international routes as these yields
  are improving
• LCCs expand domestic network as they venture
  into major airports
• Aloha joins US Airways, United, ATA and Hawaiian
  in bankruptcy
• Delta expects significant losses in 2005 and
  hints at bankruptcy

Source ATA Monthly Passenger Traffic Report
27
Losses Continue in North America
Full Calendar Year 2004 Operating Margins
Source Company Press Releases includes all
unusual items including restructuring costs
28
LCC Growth and Industry Impact
29
LCCs continue to grow at a phenomenal rate

• Concept remains popular and continues to grow
• While some emerging carriers do not survive, a
  large number of new carriers continue to appear
• Strong LCC growth expected for Eastern Europe
• Gol is a rising star in Latin America and
  Cintras Aerocaribe is expected to be re-launched
  in May
• Concept is beginning to take off in China and
  India
• LCCs continue to gain market share in U.S
• Top 4 carriers control 65 of LCC market share
• Firm aircraft orders to expand capacity 52
• LCC segment expected to account for 45 of both
  domestic US and intra-European passengers by 2009
• Asia is prime for LCC entry
• 26 newcomers expected in 2005

Source Airline Business Magazine, March 2005
Airwise news theaustraliannews.com
AirTran, Southwest, Frontier, JetBlue
30
Laws of Darwinism applied to airline industry

• Survival of the Fittest plays out as LCCs
  battle for market share
• Rivals Ryanair and easyjet control 75 of
  European LCC market
• Easyjet plans to increase fleet 62 over the next
  3 years
• Ryanair plans to double in size in the next 10
  years
• LCCs evolve as next phase includes plans for
  long-haul carriers
• Aer Lingus considers trans-Atlantic carrier
• Canadian carrier Zoom is running profitably after
  June 2002 launch
• SkyLink is next planning to operate from North
  America
• Hong Kong plans for Oasis Hong Kong Airlines and
  WOW Airlines
• Some LCC airlines are down but not out
• Volareweb to resume operations in April after
  ceasing operations in Nov.
• Wizz Air secures 25M assistance
• While we must wait to see if other airlines will
  be revived
• Jetsgo, Lagun Air, Air Polonia, V-Bird
• Air Polonia and V-Bird are working on rescue
  plans to secure new funding and restart services

Volare Group is resuming operations which also
contains 2 leisure carriers
31
Airlines Develop Strategies to Compete with LCCs
32
Established/Trunk Airlines Are Responding

• US major airlines deal with the threat by
• Restructuring mostly through cost reductions,
  majority of savings comes from labor
• Setting up own low cost operation
• Shifting capacity to more profitable
  international routes
• Better yields due to the lack of LCC competition
• Fuel costs have eroded much of the progress
• Legacy carriers in Asia-Pacific arena take LCC
  threat seriously as they branch out with their
  own budget airlines
• Budget airlines in the Southeast Asian region
  could easily grab 30 of the market in just a few
  years, as Virgin Blue did in Australia
• ANA creates LCC entrant, Air Next launching June
  1
• APAA suggests that members prepare for LCC
  competition

33
Established/Trunk Airlines Are Responding

• European traditional carriers have few choices in
  response to LCCs
• Approximately 65 LCCs are operating in Europe
• As profitable operation becomes more challenging,
  Chapter 11 protection from creditors is not an
  option
• Airlines forced to solve problems, merge or go
  under
• EUs One time, last time rule allow countries
  to bail out their carriers only once
• Latin America has emerging LCCs with Gol gaining
  strength
• Airline restructuring in the region has been the
  result of growing economies and increasing demand
• Need for defensive strategies against LCCs not
  yet addressed

34
Industry pressure impacting LCCs

• Some restructuring may succeed as LCCs appear not
  to be indestructible
• Ryanair reports its first quarter loss in 13
  years of operation
• JetBlue sees profit margin dipping
• Southwest offers all employees a severance
  package option
• Would have posted past losses if not for
  aggressive hedging policy
• Easyjet files formal complaint against Air
  France/KLM merger
• European trunk carriers protest LCCs receiving
  government incentives to attract low-cost
  business to their regions
• Estimated aid worth 10 - 17 per ticket
• A few European LCCs have failed, could more be
  on the way?
• Competition for market share anticipates blood
  shed

35
How is LCC Growth Affecting Industry?

• LCC growth undermines attempts to maintain
  capacity discipline
• Rapid growth results in overcapacity - too many
  choices
• Keeping fares depressed
• Results in challenges for higher cost,
  established trunk carriers
• Given differences in structure established trunk
  carriers can not become LCCs
• Network and fleet differences
• Seniority of work force
• Full service vs. no frills
• Who will survive?
• Will depend on competition, capitalization and
  ability to sustain a positive business plan
• Survival of the fittest
• Consolidation
• Elimination of capacity

36
What Else Can Airlines Do?
37
Airlines Work on Programs that Strive for
Profitability

• Consolidation
• Mergers
• Alliances
• Low Cost Divisions or Subsidiaries
• Comprehensive Restructuring Programs
• Court Assisted Restructuring
• Fleet Revitalization Programs

38
Airlines Recognize Efficiencies through
Consolidation

• Europe
• AF and KLM
• Partnership is recognizing cost savings ahead of
  schedule
• Lufthansas acquisition of Swiss approved by
  shareholders
• Mirror the AF/KLM merger where each maintains
  existing brand identity
• BA and Iberia evaluating a similar deal
• British Airways currently owns 9
• SN Brussels and Virgin Express
• Transaction planned to be complete in 1Q05
• Will consist of a joint holding company based in
  Brussels
• SN receives majority stake 70.1 and Virgin takes
  remaining 29.9
• Continue to operate separate brands for up to 2
  years
• SAS plans to eventually acquire 100 of airBaltic
  and Estonian Air
• Take advantage of low operational costs are
  competitive with established low cost carriers
• Currently holds 49 of Estonian and 47.2 of
  airBaltic

39
Airlines Recognize Efficiencies through
Consolidation

• Latin America
• LAN to acquire state owned LAFSA as well as the
  brand and route of a carrier in Argentina
• LAN will form a new holding company, Lan
  Argentina
• LAN has been in talks to acquire or form an
  extensive alliance with Argentinas Southern
  Winds which is in bankruptcy
• Talks broke off in June with small Argentina
  airline American Falcon
• Already successful with LanPeru
• AeroRepublica and COPA to develop an equity
  alliance
• Jointly develop common strategies and policies in
  all phases of operations, finance and marketing
• Operate independently under their own managements
  and brands

40
Airlines Recognize Efficiencies through
Consolidation

• Asia-Pacific
• Cathay Pacific/ Air China/ Dragonair cooperation
• Exploring opportunities to develop closer
  cooperation in various business and operational
  areas
• Japan Air Lines and Japan Air System
• Started the mergers in Asia
• Nothing in the U.S. yet
• ATA
• Will carriers consolidation follow trend of
  international peers?

41
Global Alliances Continue to be a source of
additional Cost Savings and new Revenue
Opportunities
World Share of Scheduled Traffic
Unaligned share was 28.5 last year

SkyTeam
Unaligned Increased since last year due to
tremendous traffic growth in Asia-Pacific
Middle East markets
Oneworld
Star Alliance
Alliances battle to gain members in Asia-Pacific
and Middle East as traffic in those regions are
growing faster than anyplace else and almost all
carriers are not formally attached to a specific
alliance
Source Airline Business, July 2004
42
Trunk Carriers look to Low Cost subsidiaries for
profitability

• Just to name a few
• United Airlines Ted
• Delta Air Lines Song
• Volare Group Volareweb
• Air Canada Tango
• Zip
• Singapore Airlines Tiger
• LOT Polish Centralwings
• Bmi british midland bmibaby
• Lufthansa Eurowings Germanwings
• Japan Air Lines JALways
• Qantas Australian Airlines
• JetConnect
• JetStar Asia

43
Several European Airlines Have Multi-year
Restructuring Programs

• Iberia has established strategies/goals for
  market growth and profitability
• Maintain leadership position in the Europe-Latin
  American market
• Develop competitive service and prices in
  Domestic and European point-to-point routes
• Improve competitive cost base
• Manage the portfolio of airline related
  businesses efficiently
• Lufthansas D-Check program was launched in
  Spring 2001 and focuses on 4 main areas
• External providers
• Internal providers
• Production framework processes
• Staff cost reduction through increased
  productivity
• British Airways plan emphasizes the need to
  Simplify the Business
• Develop a high performing organization
• Deliver a competitive cost base
• Maintain the best UK based network and schedule

44
Several European Airlines Have Multi-year
Restructuring Programs

• Austrian Airlines began its Break Even
  Turnaround Program 2001
• Network expansion - Focus East
• Successful cost and capital management
• Implementation of various strategic initiatives
• Alitalia develops new 2005-2008 Business Plan
  Recover market share
• Close CASK gap
• Realign load factor performance
• Financial turnaround
• SAS Turnaround Program
• Structural cost savings
• Revenue stabilization
• Capacity cost adjustments
• AF/KLM virtual merger allows for efficiencies in
  revenue and cost management

45
North American Airlines forced to use bankruptcy
court to reorganize costs

• Several airlines have filed for Chapter 11
  bankruptcy United, US Airways (twice in as many
  years), Air Canada, ATA, Hawaiian, Aloha
• Goal is to eliminate or reduce debt
• Vendors and lenders negotiate new agreements with
  airlines
• Process allows airlines to disregard contractual
  labor agreements
• Labor groups agree to deep cuts for fear of the
  wages and work rules airlines would enforce
  through the court
• Airlines walking away from Employees Defined
  Retirement Plans
• PBGC takes over payments offering a fraction of
  anticipated payments
• Major restructuring continuing
• More focus on cost reductions than anywhere else

46
Industry Outlook
47
Industry hopes for a profitable 2005 dwindling
due to high fuel prices

• World airline industry was hoping for a profit in
  2005
• Previous profit forecast of 1-2B now doubtful
  due to fuel costs
• Expecting revenues of 350B up from 316B in 2003
• International traffic forecasted to grow 7.2 in
  2005 and 6 in 2006
• Recovery in Europe and the US will not be as
  robust as the rest of the world
• Near-breakeven results elevated by the strongly
  profitable low-cost carrier segment
• Asia Pacific region continues to be bright spot
• LCCs are moving into Asia-Pacific but increased
  demand can withstand the near term capacity growth

Source IATA, www.wtrg.com
48
International Traffic Expected to Continue to
Rebound
Scheduled International Passenger Traffic Growth
and Forecasts
Measured in PKPs (Passenger Kilometers Performed)
Source IATA Passenger Forecast 2004-2008,
November 2004
49
Demand returns but challenge remains in yields
and financial condition

• Capacity and traffic balance is key
• Carriers are adding capacity for fear of losing
  market share
• LCC expansion to continue
• Overcapacity will keep yields down
• Deteriorating balance sheets will take a long
  time to improve
• Fuel prices continue to have a significant
  negative impact on bottom line
• Significant overall recovery not expected before
  2006
• 2005 and 2006 will see continued major structural
  changes around the world
• U.S. not expected to see any recovery until 2007

50
What will airlines do to survive?

• Revenue enhancement strategies
• Few alternatives in this low fare, low yield
  environment
• Too much competition
• Increased use of internet is a deterrent
• Increased code-sharing and reliance on alliances
• Cost Reductions
• Labor will continue to be a target
• Fuel price volatility will affect timing of
  strategies
• Consolidation

51
Impact of Industry Restructuring on Collective
Bargaining
52
Restructuring will continue to focus on labor
costs

• Cost factor over which airlines have most control
• Business plans around the world all focus on
  cost reductions or efficiencies
• Managements continue to be very aggressive in
  their strategy to reduce labor costs
• Wage reductions are higher
• Productivity is a key goal especially in
  competing with emerging low cost carriers
• Nothing is sacred anymore
• Pension costs are key target in North America and
  Europe

53
Management attitude toward labor is negative

• Goal is to reduce wages, working conditions and
  benefits to lowest common denominator
• Even for those airlines that are profitable
• Use of expectation of deterioration in market
  share and performance to target reductions
• If it doesnt work the first time, theyll come
  back with full expectation that labor will give
  more
• Threat level increases
• Collaborative process less common

54
What can we do to protect our interests?

• Stay informed
• Be prepared
• Three step approach analysis, direction,
  negotiation
• Financially
• Challenge management to do their job
• Business plans will not succeed if their sole
  focus is cost reductions
• Pilot costs average 8-12 of total operating
  expenses
• Comprehensive restructuring is necessary
• Challenge government

55
The Missing Link - Labor

• A balanced approach to collective bargaining
• Pension reform
• Consolidation and labor protective provisions
• Consistent government policies

56
Thank You
57
INTERNATIONAL FEDERATION OF AIRLINE PILOTS
ASSOCIATIONS ANNUAL CONFERENCE
Arabella Sheraton Hotel Cape Town, South Africa
Airline Development Current and Future
Challenges Chief Executive John T. Morrison

Airlines Association of Southern Africa