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Rationalization in Europe

As the industry continues to suffer worldwide, it seems the challenges facing European airlines continue to increase. There is overcapacity and yields are down (partly because of that overcapacity). Currency issues, uncertainty over the European economies, weakness in China and throughout Europe as well as currency devaluations are creating a difficult situation.

Fuel prices hide many sins

Low fuel prices are a godsend for many European airlines. They help offset currency losses and dropping demand. But they're not enough. All low fuel prices do is delay the pain. European airlines continue to add caapcity in an effort to lower unit costs. But demand is falling, so the prospect of lower unit costs through more capacity is a fallacy.

Rationalization is needed

The reality which the European airline sector doesn't seem to want to acknowledge is the need for rationalization. Sure there have been mergers and acquisitions, but there has been little true rationalization. All the M&A has done is primarily create larger groupings of airlines. With demand falling and traffic shifting away from European hubs to Istanbul and the Gulf and back to point to point services as a result of efficency new aircraft, it is clear that Europe has too much network carrier capacity.

The reality is that at least the equivalent of one large network carrier should disappear from the market. This could mean a large scale contraction by each carrier or the wholesale failure of a single carrier. But realistically, neither of these will happen anytime soon.

Smaller carriers will fall first

In the absence of rational behaviour, the large carriers continue to add capacity - although they announce a reduction in planned fleets, the actual fleets have grown and the average number of seats per aircraft has risen, thus increasing caapcity. This irrational capacity growth means that the larger carriers will be forced to stimulate demand for their services. As a mature market, the larger carriers have limited scope for stimulation. This leaves cannibalization.

Cannibalization from where? From each other through origin and destination revenue management gone out of control, as well as cannibalization from smaller carriers, particularly those from smaller home markets to the South and East of Europe.

Regulatory environment

One of the key elements of Europe is the scrutiny of state-aid by the European Commission. A necessity to ensure fair competition, the state-aid rules mean the market in Europe is theoretically more rational and there exists a mechansim to ensure such rationalization, as compared to other regions. There are a number of airlines under the close and watchful eye of the European Competition regulators. One of these, airBaltic, seems to be doing well and we expect will clear all the hurdles exiting its restructuring plan this fall on the path to a healthy recovery. In contrast, there are other Northern, Southern, Central and Eastern European airlines which are facing serious difficulty complying with their European Commission approved restructuring plans, which means they have accepted approved state-aid under the condition they will break even within a prescribed period of time, but they are unable to break-even without taking more state-aid, exceeding the amount approved by the European Commission. And there are others which are not under an EC restructuring plan, but which are in serious stress and on the verge of distress that they risk needing state-aid.

The verdict

Aviado Partners predicts three to five airlines in Eastern Europe/CIS and Southern Europe, along with at least one airline in Northern Europe will likely be seriously distressed or force to shut down operations by the end of the year, if not by spring 2016 at the latest. This is not counting the stress that Russian carriers are under with likely at least one or two of them going bust over the coming 6 months if the oil sector and the Russian market do not recover.

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