20/07/2016

Can Monarch Airlines survive as a low cost carrier?

Can Monarch Airlines survive as a low cost carrier?

The two largest LLCs operating in the UK, Ryanair and easyJet, are both rumoured to be interested in acquiring Monarch Airlines which has recently made the transition from a charter to a low-cost carrier. A sale to either would represent a win for Monarch’s majority stakeholder, the private equity firm Greybull, although the carrier is also interested in airlines acquisitions itself.

However, if Monarch is not acquired then it faces the greater challenge of building a successful low-cost business model. Currently its CASK rates are 5.66 pence, which is far above its rivals.  This will have to be lowered if it is to successfully compete against other UK LCCs in the long-run.

Monarch moves off life support

Monarch returned a £44.3 million ($65 million) profit last year following a successful restructuring programme under Greybull Capital.  The private equity firm took a 90% stake in the previously family run business in October 2014, following consolidated group losses of $191.1 million.

Greybull injected £125 million ($183 million) into Monarch to save it from collapse and began an austere consolidation programme to return the carrier to health. Long-haul and charter flights were jettisoned, along with 8 aircraft and 700 jobs as a £200 million cost-cutting measure. For the remaining staff, pay has been reduced by 30%. Monarch was also able to reach a deal with the UK Pension Protection Fund which took the remaining 10% equity stake in the business.

As of October 2015, the group’s free cash had improved by £35 million ($51 million) yields were up by 9.5% and passenger revenue per available seat kilometre was up 7.2% on 2014.

Monarch’s switch to become a low cost carrier

In August 2014 Monarch announced it would begin transitioning from a charter airline into a low cost carrier. This was a good move considering the decline of the charter-based model, which its CEO says is dying, and the fall-off in demand from key charter destinations such as Egypt and Tunisia due to terrorism.

Flights to Sharm el-Sheikh in Egypt alone account for 10% of Monarch’s revenue. At the same time a reduction in the number of routes has resulted in a heavy concentration of routes to Spain, which now accounts for almost 59% of the airlines flights during the peak summer season.

Monarch is also radically moving from an all-Airbus fleet to an all-Boeing fleet. It has placed an order for 30 Boeing 737 MAX 8 and 15 options as part of its transition to a scheduled leisure airline.  Monarch has stated it will save them around 15% in fuel costs each year.  They are due for delivery from the second quarter of 2018, through to 2020. Current fleet leases on its exisiting A320 and A321 are scheduled to terminate as each new aircraft arrives.                                

Greybull looks for the exit

In early 2016, Greybull appointed Deutsche Bank to explore ‘inbound and outbound’ growth opportunities in Europe. These could include a sale to, or a merger with, another airline. EasyJet and Ryanair are said to be looking at the carrier, and China’s Hainan Airlines has confirmed interest.

easyJet is after Monarch’s highly-prized slots at London Gatwick, which also happens to be easyJet’s largest base in the UK. However, easyJet’s founder and majority stakeholder, Stelios Haji-Ioannou, has said that such deal would be destructive of shareholder value.

If no one is willing to purchase Monarch, then the airline will have to earn its bread as a standalone low cost carrier.  So far it has been aided by a weak euro and £30 million in savings from the low fuel price environment, but these are variables that could easily change.

Crucially, Monarch’s cost per available seat mile (CASK) will have to come down if it wants to compete as an LCC on price alone.  In 2015 Monarch’s CASK rose by 12% to 5.66 pence.  By contrast, EasyJet’s was 4.77 pence in 2015 while Ryanair’s was lower still at 2.90 pence.

Monarch’s CEO, Andrew Swaffield, says there are too many airlines in Europe today and that around half are challenged by a high cost base. He predicts further consolidation and a growing divide between those which have restructured their cost base and those that haven't.

The move to a Boeing fleet will likely cost Monarch in terms of training, new infrastructure and spares, although Boeing have almost certainly factored some of these considerations into a sweetened deal for the airline to agree to switch aircraft supplier.

On the other hand, Monarch is as likely to be the acquirer as the acquired. In April 2016, Swaffield said the carrier was not for sale but was alert to possible acquisitions itself.  Any acquisition would preferably have a Boeing-heavy fleet. Monarch has expressed an interest in Air Berlin, TUIfly, and Thomas Cook Airlines but only TUIfly operates an exclusively Boeing fleet.

Brexit update

Despite a strong return to profitability, Monarch announced in late June that it requires £35 million to help it through the winter period. Initially the carrier looked to capital markets, but the outcome of last month’s Brexit vote makes this unlikely according to Chief Executive Andrew Swaffield. Instead Monarch is looking to Greybull for the necessary cash.

Moreover, Monarch’s incoming B737 order is likely to be more expensive given the current depreciation of the pound. But with deliveries due from 2017, the airline has some time to allow sterling to stabilise before incurring that cost. For more insight into Brexit's effect on UK airlines see  Ishka’s report: Brexit Part II.

Brexit or not, Swaffield insists that Monarch is on course for its second most profitable year ever.

The Ishka view

The question is how Monarch will expand following its painful restructuring process. Ishka believes that the airline’s existing slots in the UK make it an attractive target for easyJet which would provide a straightforward exit for its private equity owner.  A more involved approach is for the airline to acquire other airlines to build enough scale and slots to compete as a standalone low cost carrier. This approach represents a challenge as Monarch works to drive down its own costs.

Comments: 1
Ian  Hosier
Ian Hosier , Aviation Capital Group

easyJet is much more interested in finding an acquisition target within the other EU countries, as it only has UK and Swiss AOCs. So, assuming Brexit actually happens, then it will need another AOC, otherwise it can't operate its non-UK intra-EU routes. So, acquiring Monarch (which is also moving to a Boeing fleet) doesn't seem to make much sense for the all-Airbus easyJet. Frankly, not for Ryanair either - unless they can get it for the proverbial 'song'.

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