ANALYSIS: Overcapacity overshadows Atlantic alliance shifts

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The ever-popular transatlantic market is booming again this year, with industry capacity up more than 8% for the IATA summer season.

New routes and frequencies have appeared all over the map. Austrian Airlines launched a new Vienna-Newark service, Delta Air Lines and Air France-KLM jointly added additional daily frequencies on the Atlanta-Amsterdam and Atlanta-Paris routes, and low-cost “disrupter” – in the words of one analyst – Norwegian has launched 14 new routes in the past year alone.

Even the long-standing shift towards more hub-to-hub flying – with an emphasis on joint venture alliance partner markets – was set aside in the frenzy. Craig Jenks, president of Airline/Airport Projects – who has analysed transatlantic capacity trends for years – says more new daily transatlantic flights were hub-to-spoke routes, rather than hub-to-hub ones, for the first time in five years in 2014.

“Fragmentation at the route level is alive and well,” he says, citing six new hub-to-spoke routes operated on Boeing 757-200s. These include flights between Charlotte and both the Portuguese capital Lisbon and Manchester in the UK on US Airways, and Washington Dulles and Madrid on United Airlines.

Flightglobal’s Innovata schedules for the North Atlantic market shows total capacity running in August will be around 8% higher than the same month in 2013.

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However, the capacity growth is proving to be too much of a good thing.

“With international capacity growth steadily moving higher through summer – not a surprise – we suspect overcapacity is playing its regular and expected role,” says David Fintzen, an analyst at Barclays Capital. Carriers last reported overcapacity in the market during the downturn that began in 2009.

Air France-KLM, American Airlines, Delta Air Lines, Lufthansa and United Airlines all acknowledge that transatlantic capacity has grown at unsustainable levels during the 2014 summer season – although only the two European carriers have lowered their profit guidance as a result.

“I see some softness in the market, but in the overall transatlantic market we’re less susceptible to that because of our combined network with [British Airways], Iberia and Finnair,” says John Boettcher, managing director of the Atlantic joint business at American. Strong premium demand into London Heathrow buffers the carrier from some of the market overcapacity, he adds.

Passenger unit revenue rose by 2.7% on a 7% increase in capacity across the Atlantic at American in the second quarter. This performance is not expected to last, however.

The airline will cut Atlantic capacity by about 3% in the second half of the year, with marginal routes being the first to go, resulting in just 2% growth in the market for 2014, says American Airlines president Scott Kirby. American has not disclosed where the cuts will be made, but many hub-to-spoke opportunities likely exist with the shift of its US Airways subsidiary to Oneworld and the joint business from Star Alliance in March.

“We know the capacity situation in the transatlantic has been a concern for investors,” says Ed Bastian, president of Delta Air Lines. The Atlanta-based carrier’s unit revenues will be “somewhat impacted” by capacity growth in the market, but he says “revenue generation” will be strong, with an expected 5-6% increase through the third quarter.

Delta, along with its joint venture partners Air France, Alitalia, KLM and Virgin Atlantic Airways, will tighten capacity growth to just 1-3% for the IATA winter season he says.

Atlantic passenger unit revenue increased by 7.2% – beating a system-wide increase of just 5.7% – on a 1.6% cut in capacity at Delta in the second quarter.

“Lufthansa’s issue was company-specific: they added too much capacity in their markets, and without US Airways in the Star Alliance, they were not seeing the transfer of passengers they had seen in prior years,” says Helane Becker, an analyst at Cowen, when asked about the German carrier’s profit warning. The airline cited overcapacity in transatlantic markets for yield weakness as one of the factors for warning in June that full year profits would only be about €1 billion ($1.35 billion), instead of €1.3 billion-1.5 billion.

She cites the Frankfurt-based carrier’s decision to continue to operate Airbus A340s on its Frankfurt-Philadelphia flights – and serve Charlotte from both Frankfurt and Munich – despite losing US Airways, which maintains large hubs at both US airports, as a codeshare partner in March.

Andy Buchanan, managing director of international planning at United, says the carrier sees improving demand despite the capacity trends across the Atlantic. However, the airline is closely managing capacity and plans to maintain relatively flat capacity through the IATA winter season.

Passenger unit revenue at the Chicago-based carrier rose by 2.5% on a 0.3% increase in capacity in the Atlantic during the second quarter.

PARTNER SPLITS

Membership in an immunised joint venture appears to have a negligible impact on an airline’s fortunes flying across the Atlantic.

United’s Buchanan offers a cautiously optimistic outlook, while its partner Lufthansa is arguably one of the more negatively impacted airlines. Bastian at Delta, however, emphasises continuing revenue growth, even as Air France-KLM issues profit warnings.

All three immunised joint ventures are not created equal, explains Shakeel Adam, managing partner of Aviado Partners. While they all co-ordinate schedules and fares, revenue sharing models vary and only one includes profit sharing, he says.

This means that for an airline like Lufthansa, which carries a lot of transfer traffic from central Asia, India and the Middle East to North America over its European hubs, revenue is negatively impacted as competition in those markets increase. However, this does not impact United to the same degree, as its revenues are only derived from the transatlantic portion of passenger itineraries.

Gulf carriers including Emirates, Etihad Airways and Qatar Airways are growing dramatically on routes to North America. Capacity between Qatar and the UAE and the USA is up nearly one-third to 9.2 billion available seat kilometres in the third quarter, Innovata data shows. The airlines compete with Lufthansa and other European carriers for flow traffic from the same regions to North America.

Recent new non-stops include flights to Boston and Chicago O’Hare from Dubai on Emirates, Los Angeles from Abu Dhabi on Etihad and Miami and Philadelphia from Doha on Qatar.

US carriers are also “insulated” somewhat from Atlantic – and other international – capacity increases, due to their sizeable domestic businesses, says Fintzen at Barclays. He estimates about 70% of American, Delta and United’s revenues are generated within the USA.

“I think that domestic dynamic is why you are seeing four to five [percentage] point increases in US operating margins in the second quarter, despite what was pretty substantial international capacity growth through the entire quarter that very much limited international RASM,” he says.

JOINT CHANGES

Transatlantic allegiances changed dramatically in 2014 – a fact that has been overshadowed by the capacity issues. Delta and Virgin Atlantic launched their immunised alliance in January, and Finnair and US Airways joined American, BA and Iberia in their joint business in April.

These mark the single largest shift in the transatlantic landscape since American, BA and Iberia launched their joint venture in 2010.

Capacity is split roughly equally between the three joint businesses. Oneworld partners American, BA, Finnair, Iberia and US Airways have about 23% of the market. SkyTeam partners Air France, Alitalia, Delta and KLM, along with Virgin Atlantic – which remains outside the global alliance – have about 28%, while Star partners Air Canada, Lufthansa and United have about 25%, Innovata data shows.

“The market is moving pretty nicely for us,” says Chris Rossi, senior vice-president of North America at Virgin Atlantic, on performance of the joint venture to date. “We’re really pleased.”

Virgin Atlantic has co-ordinated its schedules with Delta on the London Heathrow-New York JFK route, co-located some Delta flights to terminal 3 at Heathrow, and will begin swapping equipment on select London-Atlanta and London-Los Angeles flights from October.

“We are seeing some success in the corporate market with customers in those areas, especially in the major gateway areas of New York and Los Angeles,” Rossi adds.

American – which with BA dominates the London-New York route – has yet to see an impact from the Delta-Virgin tie-up, says American’s Boettcher.

“We look at them as competition, and they’ve gotten together so it’s more competition, but on the whole we’ve got the advantage,” he says, citing additional frequencies and lie-flat seats. “We welcome the competition.”

Boettcher says the addition of Finnair and US Airways to the joint business has broadened their network, although he adds it is still too early for the combination to translate into increased corporate sales or other revenue benefits.

United has not noticed an impact from the new Delta-Virgin Atlantic partnership or the additions to American’s joint business, Buchanan says.