Despite confusing government signals, Russia's airline industry is slowly beginning to consolidate
Aeroflot, Russia's great airline bear, has its eye on regaining at least some of its former glory. Prior to the collapse of the Soviet Union in 1991, this monolithic carrier flew a staggering 120 million passengers a year on a fleet of several thousand aircraft.
During the 1990s Russia's industry fractured into some 400 carriers. This number has since fallen to around 185 airlines carrying between them less than 40 million passengers in 2006.
And more change is in the air. Aeroflot still dominates the country's airline scene, and its role could become even more prominent if consolidation moves, promoted by state intervention, come to pass.
Aeroflot chief executive Valery Okulov says the flag carrier can be "the leading force" in this long-overdue process of consolidation. "It would be beneficial not only for our business, but for the national airline industry as a whole, at a time when international competition is increasing in the Russian market."
More than half of all traffic in Russia is flown by just six airlines - Aeroflot, AirUnion (Domodedovo Airlines, KrasAir, Omskavia, Samara Airlines and Sibaviatrans), Rossiya (including Pulkovo Aviation), S7 Airlines (formerly Sibir), Transaero and UTair. Only these six transport more than a million passengers a year, and only Aeroflot has revenues that top a billion dollars.
The government view on air transport reform oscillates between liberalisation and tightening its grip. Some see the recent suggestion of divesting the remaining state holdings in 61 joint-stock companies and 57 wholly owned smaller carriers to Aeroflot as a massive backward step, reflecting the perceived political shift towards increased central control and worryingly echoing the old Soviet days.
"Consolidation would be beneficial not only for us, but for the national airline industry as a whole"
Okulov is frustrated by the lack of clear direction from the government. "The government's assets are now dispersed throughout the industry and badly managed," he says. "A clear-cut position on this would be really helpful. Unfortunately, there is still no unanimity at the top. There are several concepts on how to proceed, but the final decision has yet to be made."
In the meantime, Aeroflot has itself been a catalyst for strategic market consolidation. It has created Aeroflot-Don at Rostov in the south by taking over Donavia, acquiring full control in December 2006, and then setting up Aeroflot-Nord in the north by acquiring the assets of Arkhangelsk Airlines.
Early last year, it opened a branch at St Petersburg and at a board meeting in October decided to move into isolated Magadan. This is a port city on the Sea of Okhotsk in Russia's Far East, where it has taken over the assets, including some staff, of the defunct Mavial Magadan Airlines.
The Magadan base forms one of the central planks of a major Aeroflot-led project to create a subsidiary by grouping its activities in the sparsely populated Far-Eastern Federal District, which covers more than one-third of Russia's landmass, with those of local carriers Dalavia and Sakhalin Airlines. "The purpose of this consolidation is to better organise and provide much needed reliable air communications on both local and long-haul routes," says Okulov. Yamal Airlines, based at Khanty-Mansiysk, will be another Siberian airline to come under Aeroflot's wing.
This latest Far East venture will go some way towards Okulov's ambition to boost the airline's share of the domestic market to 30% by 2010. After the break-up of the Soviet Union, he says, Aeroflot lost its market position almost entirely, but has since worked hard on balancing its network. According to Innovata schedule data for March, its capacity share has risen by nearly five points to over 18%. Its nearest rival, and its principal competitor in the Far East, is S7.
Aeroflot's international expansion will focus on consolidating its European network, increasing its presence in China and aiming to become the leading carrier offering the shortest routes between Europe and Asia. By 2012, Okulov says, Aeroflot plans to buy up to 120 aircraft, including 45 Airbus A320s, 30-40 Sukhoi Superjet 100 regional aircraft, and 40-45 widebodied long-range Airbus A350s and Boeing 787s.
The concern about the government's real agenda has not been lessened by the forced merger between St Petersburg-based Pulkovo Aviation and state-owned Rossiya under the latter's name. Pulkovo resisted the move but its objections were ultimately futile. The Presidential Decree in 2004 ordering the merger was aimed at creating a competitive state enterprise as part of a strategy to reorganise the aviation industry. The merger was fully implemented in October, creating the third-largest state-owned airline in Russia with strong hubs at Moscow Vnukovo and St Petersburg Pulkovo. Rossiya general director Sergei Mikhalchenko says the airline is considering joining a global airline alliance and has received representations from all three. The only Russian carrier currently an alliance member is Aeroflot. It joined SkyTeam in April 2006.
The new Rossiya Airlines is planning to modernise its fleet with the addition of 20 new aircraft by 2010, with the Superjet 100 and Embraer E-jets for domestic and regional services. According to first deputy director Gennady Boldyrev, it will lease of four Bombardier CRJ200s until the Superjet 100 is available. In addition it has six A319/A320s due for delivery this year and has selected the Boeing 767-300 for its long-haul operations. Three aircraft will join the fleet during 2008.
Family-owned Transaero Airlines is another with big ambitions. It saw 47% traffic growth last year and revenues soared to $504 million. The Moscow-based airline, which also operates a strong St Petersburg hub, has ambitious plans for expansion, which it hopes to fund through a sale of a substantial stake in the business.
Husband and wife team Alexander Pleshakov and Olga Pleshakova, chairman and general director respectively, and the Pleshakov family collectively own 44.25% of the airline and are believed to be in the process of acquiring another 32%. This would give them a majority holding before a public offering of 20% of shares on stock exchanges in Russia and Kazakhstan is made, probably in 2008, which could net $100 million. Meanwhile, 10% of its shares are to be sold through a private placement.
Further expansion is planned from its Moscow Domodedovo and St Petersburg hubs. It has signed a memorandum of understanding with Airbus for eight A330-200s for delivery over a three-year period from 2009, and is also negotiating for 10 A320s. Transaero has further committed to buy 10 Tupolev Tu-214s to boost a fleet that currently comprises six 747s, seven 767s and seven 737s.
Krasnoyarsk Airlines (KrasAir) pre-empted the government's fluid time-table for consolidation by establishing the AirUnion alliance in 2005, which now includes partially owned Domodedovo Airlines, Omskavia, Samara Airlines and Sibaviatrans. The five carriers are well on the way to integrating their largely complementary networks, which cover a large area from Krasnoyarsk in the far east to the European part of Russia in the west.
The alliance has placed a $400 million firm order with Sukhoi for 15 Superjet 100s, plus 15 options, with deliveries due to start in 2009. KrasAir chief Boris Abramovich plans to transform AirUnion into an alliance run as a single business unit, but needs to gain control of its government members. When signing the deal with Sukhoi, he said: "Our prime goal is to consolidate ownership and increase shareholding [within AirUnion]. We have reached an understanding on that score and have all the blueprints agreed with the government." A bond issue may be initiated this year, with an initial public offering planned for 2008.
KrasAir is attacking the market on other fronts, having been involved in the creation of Russia's first low-cost airline, SkyExpress, and being part of the group that has successfully bid for a controlling stake in Hungarian flag carrier Malév. Based at Moscow Vnukovo, SkyExpress has taken delivery of two leased 737-200s and operated its inaugural flight at the end of January. Initial services will link Moscow with the Black Sea resort of Sochi and Rostov-on-Don.
General director Maria Bukalova has big plans for the airline and is targeting for it to breakeven in 18 months and to be carrying 7 million passengers within four years. It will serve cities in the European region of Russia and destinations in neighbouring countries are planned. Another six aircraft could be added this summer.
It has taken the new Aeroflot 15 years to carry this number of passengers. Okulov says that while he recognises the efficiency of this business model, there are many obstacles for low-cost carriers. He cites the lack of cheap and efficient Russian aircraft, the availability of discounted handling services at secondary airports, and the absence of e-ticketing due to legislative restrictions. "But it does not mean we are ready to write off low-cost carriers as serious competitors," he says. "Eventually they will play a more important role in the Russian market, because the problems I have outlined can and must be solved."
Having occupied the number two slot behind Aeroflot on the domestic front, S7 Airlines now faces stiff competition from the new and enlarged Rossiya, especially at Moscow, where both operate strong hubs. The government plans to divest its 25.5% shareholding in S7. The federal property fund has set a low starting price of Rb289 billion ($100 million), but the fact that the airline's head Natalya Fileva holds title to the collective shares of minority stakeholders, making up 63.3%, may scare off investors. However, according to local reports, the airline is planning to sell a majority stake to trading and investment group Nafta-Moskva.
S7 reporting revenues of $900 million for 2006, a massive 30% jump over 2005, generated by a 14% increase in traffic following an equally impressive hike in 2004. However, profits were still elusive, with S7 slipping to a loss of $38.9 million in 2005. The carrier's financial result for 2006 will be released by mid-year.
The carrier has a partnership agreement with small regional operator Perm Airlines and intends to develop domestic and international services from Perm, one of Russia's most populous cities. In exchange for operating rights, S7 will set up a local subsidiary based on Perm Airlines and invest in its home airport of Bolshoye Savino. A codeshare arrangement was established last November with Interavia for flights between Moscow Domodedovo and Magadan.
Among the world's largest helicopter operators servicing the Siberian oil and gas market and UN humanitarian relief contracts, UTair Aviation also operates a growing network of scheduled passenger services within Russia from its bases at Khanty Mansiysk, Surgut and Tyumen. This accounts for only 8% of the total domestic market, but puts the airline at number three, after Aeroflot and S7.
UTair's general director Andrey Martirosov has his eye on a 10% market share and projects a 45% boost in revenues to $865 million and a net profit of $25 million this year. The increased revenues will be generated from 31 new routes within Russia and nearly 3.5 million passengers. In December, the airline also set up UTair Express from the reorganisation of Komiinteravia, which has been controlled since 2004. Its six ageing Antonov An-24s will be replaced by up to 20 ATR 42s.
The heavy hand of government may slow the development of Russia's air transport sector, but two other limiting factors also have to be addressed. One is the modernisation of infrastructure, especially airports, which, outside Moscow, have been neglected under government ownership.
The other, probably even more critical, is a desperate need for modern, fuel-efficient and environmentally acceptable aircraft. It is thought that 90% of around 2,000 active passenger and cargo aircraft were built more than 20 years ago and are being forced off international routes because they do not comply with ICAO's strict standards. Highly publicised accidents involving old ex-Soviet aircraft continue to leave the perception of an unsafe operational and legislative environment.
While protecting its local manufacturing industry by trying to force airlines to buy Russian, the government has at the same time failed to support promising aircraft projects. Last year's decision to consolidate its manufacturing industry under the United Aircraft (OAK) banner may have come too late.
The unavailability of suitable local aircraft at competitive leasing rates and the imposition of high import taxes have pushed Russian airlines into acquiring mostly ageing secondhand aircraft, and these are increasingly taking over mainline fleets.
Since the Soviet era ended, the role of the state has been at best ambivalent. Although it has been trying to promote air transport, high taxes have put the price of a ticket beyond the means of the average Russian. It has also paid lip service to competition, while favouring some airlines, and has hampered the introduction of modern Western aircraft through the imposition of high import levies, now at 42%.
All these issues, in concert with restructuring, need to be addressed urgently if the industry is to put itself on a stable footing and fend off competition from foreign airlines.
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