Air turbulence: The airline industry continues to face a number of challenges

The aviation sector remains a crucial driver of growth, contributing R50.9bn ($6.2bn) or 2.1% to GDP. When catalytic benefits, such as tourism spending, are included, this rises to R74.3bn ($9.1bn) or 3.1% of GDP, according to a 2011 report by Oxford Economics. This comes on the back of solid performance by local airports, which saw total departures from facilities owned by the Airports Company South Africa (ACSA) – owner of the nine main airports – rise by 3% to 17.9m for the 2012 financial year. Meanwhile, aircraft landings declined by 1% to 272,320.

Traffic

International airline passenger traffic increased 2% for the year, while domestic passenger numbers, which make up 70% of total traffic, were up 3% and regional traffic rose 6%. All of this was good news for the airport operator. A combination of these trends and tariff increases saw ACSA revenue from air services increase by some 38% to R920m ($112.15m) for the year.

After rising traffic in 2012 that saw more than 30m passengers pass through the three largest airports, the 2012/13 fiscal year is likely to be more difficult. Year-to-date figures for the first 11 months of 2012/13 show that passenger traffic declined by 1.8% and 7.7% at airports in Cape Town and Durban. Although these drops could hurt profitability, ACSA revenues are likely to be protected to some extent by recent tariff increases levied at its airports.

Indeed, tough times over the last 12 months is likely to hit the airlines harder than the operator. This is indicative of a number of factors hampering the industry, including domestic regulatory factors, a difficult global environment for leisure and business travel and a depressed local economy. As with other segments of the sector, a key concern for the airline industry has become how to mitigate the impact of the cost of upgrades on business and end-users.

Raising Tariffs

There have been substantial tariff increases in the past two years, which have been intended to cover the previous development and expansion programme at the country’s airports up to 2010. In the three years leading up to the 2010 FIFA World Cup, ACSA spent R17bn ($2.07bn) on upgrades, according to its 2010 annual report. Consequently, tariffs were raised by 70% in October 2011 and by a further 8% in October 2012. Including the 2011 hike, airport tariffs are set to increase by 160% by 2015 under ACSA’s operating plan.

The ability of ACSA to levy fee increases remains critical given that its founding act mandates that any deficit on its balance sheet must be met through tariff revenue. However, while such a model has allowed the company to remain solvent, it has led to significant disquiet from within the tourism and aviation industries. In May 2012 Marthinus van Schalkwyk, the minister of tourism, told local press that South Africa’s landing fees, ranked as the third-most-expensive globally, were “unreasonable and unjustified”, and said that the cost of getting to South Africa had overtaken security concerns as a key consideration for those looking to visit (see Tourism chapter).

This has also affected the business operations of the airlines that serve the country. Simon NewtonSmith, the country manager for South Africa Virgin Atlantic Airways, said, “Government taxes and fees can amount to 20-25% of a round-trip economy class ticket between South Africa and the UK. In a world of razor-thin margins, this has a significant negative impact on passenger demand and profitability. The trend toward above-inflation increases by governments and airport operators appears to have no regard for the long-term viability of the industry and its critical role in enabling a thriving economy.”

Closing Down

In late 2011, low-cost carrier 1Time said that it would be scrapping its flights to Maputo, Mozambique as a result of several increases in airport tax. However, by March 2012 the operator was in discussion with its creditors over the repayment of R320m ($39m) in short-term debt. By November 2012 the company had announced that it was filing for liquidation. 1Time had struggled to compete with Mango, a low-cost subsidiary of state-owned South African Airways (SAA) that was founded in 2006. The many subsidies offered to Mango and SAA have become as substantial a challenge as airport tariffs for private operators. Natasha Michael, a Democratic Alliance member in Parliament, told the local press in light of the liquidation, “Does every privately funded domestic airline have to shut down before the government admits that the funding model for the national carrier is killing the aviation industry?” Out of 11 private airlines launched in the country since deregulation in 1991, 10 have closed down.

Finding A Niche

Just what sort of role SAA should play remains under discussion. The latest controversy occurred in third-quarter 2012 when members of its board and its former CEO, Siza Mzimela, resigned over disagreements with the government about the way forward for the operator. At the same time, it was announced that the government had granted SAA a R5bn ($610m) guarantee for two years beginning in September 2012. This will allow SAA to borrow from the markets so that it can continue operations and purchase new short-and long-haul planes. The guarantee was conditional upon the firm’s board developing a strategy for turning around the fortunes of the airline, with the plan subject to the approval of the minister of public enterprises and the minister of finance. While this will allow the firm to maintain operations and retain its position as the flagship carrier, competing airlines have complained about the distortion this creates in the market. Erik Venter, the CEO of Comair, which runs the British Airways brand and the low-cost carrier Kulula in South Africa and had previously threatened to sell some of its fleet in anticipation of tariff increases, told the local press that his company would challenge the government guarantee. “The losses incurred by SAA and Mango in the domestic market could not be sustained by a private airline. SAA’s latest request for government funding for new planes is largely a result of SAA and Mango fighting their domestic competitors for market share at the expense of generating sufficient profits for sustainability,” he said.

Paul Hurst, the managing director of Solenta Aviation, told OBG, “Airlines serve as an important part of a country’s economic value chain and it is understandable that governments intervene to keep them afloat. However, for some countries, especially in Africa, it is simply not viable for national carriers to compete as global carriers – they could be encouraged to act as feeder airlines.”

The national carrier has been experiencing a bumpy ride in the past decade. SAA reported a R1.3bn ($158.5m) operating loss for fiscal year 2012. While revenues rose to R23.8bn ($2.9bn) from R22.6bn ($2.8bn) in 2011, operating costs increased more, by R3.6bn ($439m), to reach R25.2bn ($3.1bn). In the past 10 years, SAA has made total losses of R14.7bn ($1.8bn). Mango, its low-cost domestic brand, incurred losses in 2011/12 as a result of a tough local economy and competition from other low-cost carriers. Internationally, passenger numbers were down 2% in the fiscal year 2011/12, as the firm suffered as a result of high price competitiveness from state-owned Middle Eastern carriers.

Making Changes

SAA has begun adjusting its network accordingly. In August 2012 the airline dropped its Cape Town-London route, which had been running for 20 years. Instead, it will focus on emerging global cities such as Mumbai and Beijing, as well as regional routes, supported by its SA Express brand. The key to SAA’s success moving forward could well be its ability to rejuvenate its ailing fleet. The airline has seen its operating costs spiral as its older aircraft have been particularly expensive to run due to rising oil prices. In 2011/12, fuel accounted for 33% of its operating costs, up from 28% a year earlier. The firm will use the state guarantee to buy new aircraft, receiving delivery of the first of 20 new Airbus A320 aircraft in 2013, with the rest due to arrive by 2017.