30/06/2016

SAS needs to continue reforms to counter losses

SAS needs to continue reforms to counter losses

Ignoring the non-recurring revenue and cost items, SAS posted losses in both the quarters of the first half of FY 2015/16. The Scandinavia based airline needs to boost its capacity utilization in H2 2015/16, especially on its intercontinental routes, in-order to post a profit in FY 2015/16. SAS completed its 4XNG restructuring program in 2015 – significantly cutting its cost base (by SEK4 billion (USD477 million) as per SAS) and overhauling its fleet composition and network structure. While its previous restructuring efforts should help the airline better face competition especially the low-cost carriers, the airline needs to continue to undertake further restructuring and reforms in-order to achieve sustainability in profits. In addition, to achieve growth in the medium to long-term it also needs to capture a larger share of the frequent flyer market.

 

Losses despite a strong recovery

 

After posting a positive performance during FY 2014/15, SAS recorded a loss before tax and non-recurring items of around SEK1 billion (USD119 million) during H1 2015/16. The positive non-recurring items helped to reduce the extent of the net loss, however, the subdued financial performance is particularly concerning at a time when airlines globally were enjoying record breaking profitability and the fuel prices were at a record low.

Increasing competition from the low-cost rivals and recent increases in capacity have put downward pressure on yields which in-turn has substantially hampered revenue growth. The growth in SAS’ capacity has not been accompanied by an equivalent increase in traffic. In addition, currency exchange losses and higher maintenance charges than usual all contributed to the weak H1 2015/16 results. While the restructuring program has helped to lower SAS’ unit costs, its yields have also been under pressure due to reasons mentioned earlier. However, the Ishka view is that SAS’ net results are likely to improve in the second half of the year as traffic is usually stronger over the summer months. SAS had a tough first half in FY 2014/15 as well; they posted an almost identical loss of SEK1.2 billion (USD143 million) compared to SEK1 billion (USD119 million) in H1 2015/16, but still managed to end the year with a profit before tax of SEK1.2 billion (USD142 million) before accounting for exceptional items. However, it remains to be seen how much of an impact Brexit will have on the summer traffic in Europe in the second half of FY 2015/16.

 

Fundamentals improving gradually

 

It is important to note that SAS has achieved commendable improvement across its bottom-line between 2013 and 2015. While the margins, liquidity position and leverage are still modest, Ishka views the trend of improvement as a positive sign considering the challenges faced by other network carriers in Europe from the low-cost carriers.

 

The Ishka view is that SAS’ restructuring plan has targeted the right areas and has achieved credible progress. The carrier has overhauled its fleet - reducing the number of fleet types as well as adapting its network based on the market need. SAS has also cut the numbers of employees and centralized some of its shared services, and outsourced its non-core activities. It has also sold stakes in struggling airlines like Blue1 and Widerøe. SAS has restructured from being an elaborate airline conglomerate operating in various segments of the airline value chain to a leaner and more efficient airline focusing primarily on passenger and cargo transportation. The table above clearly demonstrates the changes in the business model and company structure. The carrier has improved its bottom line and is in a better position now than it was 5 years ago to compete against low-cost carriers. However, the carrier still needs to increase the pace of its reforms especially with regards to labor costs, supplier contracts, and its IT systems.

 

Targeting frequent flyers

 

One of the challenges SAS faces, is how to increase the number of frequent flyers within the Scandinavian market. As part of its restructuring, SAS increased its focus on frequent flyers within the Scandinavian market.  As per the airline, nearly 11% of the 20 million people in Scandinavia take five or more return flights every year and SAS, as of 2015, served around 74% of this market at least once.

SAS upgraded its frequent flyer program and improved its customer service in a bid to build more loyalty from its customers, however, its efforts have not yet yielded substantial positive results. In addition to its overhauled fleet, the airline also upgraded its inflight entertainment systems and waiting lounges. These steps are in the right direction and should help SAS to capture a higher market share. However, competition from the LCCs has not gone away.

 

Short-term challenges and areas of further reform

 

As mentioned earlier, SAS needs further reforms in-order to achieve consistent profitability. The CEO, Rickard Gustafson, has already identified labor as the next area of restructuring. SAS’ labor agreements are covered under Scandinavian terms and as a result employee expenses are its largest expense category, contrary to most airlines. SAS has already finalized new collective agreements with its pilots, however, the airline could face challenges from other unions who would resist attempts at reforming their terms. In addition, with further capacity increase already planned for the remainder of FY 2015/16, yields and unit revenues would continue to remain under pressure.

 

What if SAS’ strategy of targeting the frequent flyers fails to deliver the expected results?

 

SAS has bet significantly on capturing more of the frequent flyer market, as it has plans to expand capacity. Failure to do so would require another re-think in strategy. It could force the airline to undertake further restructuring cuts and bring down its costs further in order to allow it to charge lower fares. In the face of competition from the LCCs, it would be imperative for SAS to re-work its strategy to better compete with the LCCs. SAS has 30 A320s on order and therefore will continue to have significant exposure to the short-haul European market that is dominated by the LCCs.

 

The Ishka View

 

 

Having reorganized its complex organization structure and trimmed its cost structure by several notches, SAS is now better positioned to face competition especially from the LCCs. SAS has the advantage of being the only network carrier out of Scandinavia and there is potential to build a fairly successful and sustainable model connecting the frequent flyers within Scandinavia to long-haul destinations across the Americas and Asia.  With a lower cost structure and improved product offerings including its fleet overhaul, in the medium to long-term, SAS should be able to attract a bigger share of the frequent flyers by providing good quality service at attractive pricing. The carrier still needs to increase the pace of its reforms especially with regards to labor costs, supplier contracts, and its IT systems. Competition from LCCs remains a concern and with rivals like Norwegian offering low-cost travel options across the Atlantic and within Europe from Scandinavia, SAS will have its work cut out.
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