Could Air Malta prove a challenge for AerCap?

It is rare for an airline the size of Air Malta to lease all its aircraft from one lessor – by the same token, relatively few lessors will plan for such a level of exposure to a single carrier. In Air Malta’s case, all eight of its aircraft are leased from AerCap, which is its largest creditor. The struggling State Island national carrier is under considerable pressure to remain an entity in the market. Unable to secure further public funding due to EU regulations the carrier has few options left. Securing an ownership deal with a strategic partner seems to be the only way forward as its cost cutting measures have been insufficient. The Ishka view is that only a deeply restructured Air Malta can survive under the umbrella of a bigger carrier. However, the question is whether there are airlines willing to invest in Air Malta, a small airline with high costs and a niche network on the periphery of Europe.

Air Malta’s fleet and network

Air Malta’s fleet has been reduced from ten to eight aircraft in the last year. The carrier only operates A319s and A320s. All of the aircraft are in high density configuration with 141 seats on the A319 fleet and up to 180 on the A320 and all of the aircraft are leased from AerCap. The fleet is 10-years old on average.

The carrier has a network covering 27 short and medium-haul destinations in some 20 different countries in Europe and the Mediterranean plus some seasonal destinations. The carrier has recently suspended operations to Libya and Tunisia while also reducing capacity on the Moscow route. Air Malta’s biggest destinations are Italy, Germany and the United Kingdom - due to financial and historical links and geographical location. Germany and the UK are the country’s main trade partners while Italy is the closest country to the island. The carrier’s network is well connected to the financial centres of Europe and Air Malta has actively pursued codeshares on the Frankfurt, Paris and Amsterdam routes to fence off direct competition from mainline carriers. In terms of leisure traffic the airline is faced with heavy competition from low-cost carriers. Ryanair has been particularly aggressive at Malta Airport where it has based three aircraft for the 2016 summer schedule and operates to 36 destinations. The share of passenger traffic in 2015 can be seen below.

Malta Airport Passenger Traffic Share

The London market is, by a good margin, the main generator of traffic with 800,000 passengers travelling to the Island in 2015. Frankfurt and Rome generated around a quarter of a million passengers each in 2015.

Financial position

In June 2012 the European Commission approved a four-year restructuring plan. This plan was implemented after the company registered losses of EUR78 million ($87.5 million) in 2011. With a target to reach break-even point in fiscal year 2015 and turn a small margin in 2016, the policies implemented by the company so far have failed to bring the airline back to profitability. According to the airline, losses are projected to be EUR4million ($4.4 million) at the end of March 2016 after losses of EUR16.4 million ($18.4 million) in 2015 and EUR17.5 million ($19.6 million) in 2014. The company has a high cost structure with fuel, flight costs and employee benefits making up its largest expenses.

Despite the restructuring program the company achieved total cost reductions of only 2% in the fiscal year 2014-2015. Revenues decreased by 6.8% in the same period whereas costs as a percentage of revenue increased by 5.5%.

Largely because of this high cost structure the company has accumulated debts that have driven it into negative equity reported to be above EUR60 million ($67.3 million) in July 2016. In November 2014 the Air Malta group sold property to the Government of Malta for EUR68 million. This and part of a loan facility of EUR52 million ($58.3 million) have been converted into equity on top of the EUR78 million ($87.5 million) capital injection authorised under the terms of the restructuring plan.

Management measures

In order to tackle these issues, the company has engaged with a series of cost-cutting measures across the whole business as well as signing additional credit facilities. The company has reduced some of its fleet. Volotea airlines has taken two of the company’s A319s this year and Air Malta has renegotiated leases on the remaining two A319 aircraft, the company expects to realize EUR 9 million ($10.1 million) in savings from fleet disposal.

Air Malta has also renegotiated contracts with some of its IT and catering suppliers saving EUR5 million ($5.6 million). Some of the company’s subsidiaries have been sold and some non-core businesses have been identified for future sale including real estate and properties.

The company has saved nearly $16 million through cost cutting but the measures fall short of the expected cost cutting actions needed by the company. Costs associated with employee benefits are still increasing. Similarly, the partnership with Lufthansa Technik to undertake maintenance for the carrier’s fleet has failed to deliver any savings, in fact maintenance costs increased by 35.9% for the fiscal year 2014-2015. New acting CEO Joseph Galea is to take over the legacy of Phillip Micallef who has steered the company for the last two years. This move may bring a new wave of leadership to revamp the company’s structure but action is urgent.

Labour relations

Critical to the current situation of the company is the role played by the pilots’ union ALPA. Both sides have failed to reach an agreement in the long term. A labour agreement is vital for the company and it is unlikely that an investor will be found unless this issue is addressed. The fleet has been reduced but the pilot force has remained the same. This, and a more efficient use of the company assets, are key elements to any successful restructuring and revised ownership of the carrier.

Long term viability

Malta is predominantly a service-oriented economy. With a small population of less than half a million the nation has also succeeded in the manufacturing sector with emphasis in high value-added products like electronics and pharmaceuticals. The tourism industry has traditionally been a large contributor to the Island’s economy with around 4.5 million visitors in 2015. Despite the positive indicators the economy is small in size compared to the rest of Europe.

Demand for business travel to the Island exists but it does not guarantee the traffic density and yields enjoyed by the largest financial centres in Europe. As a hub and traffic point Malta has lost importance mainly because travel from North Africa has been severely diminished in the last few years. This has left Malta as a focal route with demand coming from O&D markets across mainland Europe.

It is noteworthy that this type of traffic can be better served though a low-cost business model. It is not clear if the country’s economy can support a legacy carrier model like Air Malta. Alitalia is looked upon as a ‘natural’ candidate to invest in Air Malta given the close geographic location of the island, but any such deal would have to consider a repositioned and streamlined company. As it stands today, Air Malta is an inefficient company. As illustrated above Ryanair handles 26% of the traffic to the island with a much smaller fleet. The value and service propositions offered by Air Malta are not clear differentiators. Its European network, despite being extensive, does not offer high enough frequencies for business markets or a low enough cost to compete for leisure and local traffic. The company is still the largest player in its home market but low-cost carriers have gained share consistently in the last five years. For a carrier the size of Air Malta, achieving the economies of scale of mainline carriers will always be difficult, but relaunching as a low-cost operation could prove to be as difficult a proposition, considering the current stance of the pilots in respect of restructuring. Carriers like Vueling have successfully entered the market offering a value proposition appealing both to leisure and business traffic. A similar strategy change at Air Malta appears to be only possible under new management and ownership.

What if Alitalia acquired a controlling stake in Air Malta?

Alitalia has been the most active player in pursuing a share in Air Malta. Alitalia would be able to funnel traffic more effectively through its hubs in Rome and Milan if it entered into an ownership deal with Air Malta. However, a deal would only make sense if the costs of acquiring Air Malta are in line with Alitalia’s own cost base. Etihad has a 49% ownership share in Alitalia and has managed to reposition the airline as a competitive carrier. If Alitalia took control of Air Malta it would have to be able to ensure the carrier achieved the same type of efficiencies and cost reduction.

The Ishka view

Air Malta’s management has not succeeded in reorganizing the finances and structure of the company sufficiently to make it an investable carrier. Since 2012 little progress has been made in critical areas including cost control, fleet rationalisation and employee benefits. Outsourcing has not made a significant impact on the bottom line and neither has the sale of assets, which have not effectively plugged the airline’s deficit. Any potential buyer will have to consider making further investment to turn the company around, but if the market served by Air Malta is seen to be attractive enough, an investor may also consider starting an operation from scratch.

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