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Analysis & Opinion
22.04.10 Winged Desires
By Tai Adelaja

After a debilitating slump that saw many airlines grounded for good, the Russian airline industry is reveling in a first-quarter upswing in passenger traffic, the clearest indication yet that the air travel market is slowly healing as the economy improves. However, it appears that Russia’s air travel market is still underdeveloped, and even after the financial crisis has dealt out its blows there are too many airlines competing for too few passengers. This, unfortunately, hardly translates into lower ticket prices. So is it time for some Russian airlines to wave goodbye?
Russian airlines transported 17.2 million passengers in January and February of this year, a 36 percent increase over the same period in 2009, Russia's Federal Air Transport Agency (RosAviatsya) reported. International passenger traffic grew by 40 percent, while domestic flights shot up by 31 percent, as passengers took advantage of cheaper airfares to shift from railways to air transport. The country's 35 largest airlines, which account for 97 percent of the nation's passenger traffic, gained from the sudden growth, including the nine biggest airlines which together showed more than a 50 percent increase in passenger traffic compared to 2009.

The latest figures from RosAviatsya could not have come at a better time for an industry left badly pinched by Russians' newfound frugality. It was gloom and doom at the same time last year, when all the airlines transported five million fewer passengers as the price of aviation fuel skyrocketed, pushing up the cost of air tickets. Domestic airlines transported 45.11 million passengers last year, which is 9.4 percent or about five million passengers less than in 2008, FATA data shows. Carriers specializing in international air travel were most affected, as passenger traffic dipped 9.9 percent to 21.3 million passengers compared to the previous year. Airlines operating on domestic routes carried 23.8 million people, or nine percent less than in 2008.

Of the five largest Russian airlines, which account for more than 55 percent of all passenger traffic, S7 or Sibir, which has a robust charter business, was worst affected. The volume of the company’s passenger traffic slumped 22.3 percent to 4.5 million passengers, prompting the company to withdraw all its fuel-guzzling Soviet-made planes, including the Tu-154 and IL-86, from operation in November 2008. Elena Kolesnikova, the spokeswoman for the company, said that the S7 Airline’s fleet is being gradually replaced by a fuel-efficient fleet of Airbus and Boeing aircrafts. The move, analysts say, underscores a peculiar problem for the domestic airline industry: the prevalence of locally built, fuel-guzzling aircraft, which have aggravated the impact of the downturn by making it hard to achieve profitable operations even with a high load factor.

Aeroflot, the nation’s largest carrier, transported 8.8 million passengers last year, 5.6 percent fewer than the previous year, while GTK Rossiya, the country’s fourth largest airline, carried 15.4 percent fewer passengers than in 2008.
Only Transaero and UtAir showed an increase in the volume of passenger traffic, registering 3.6 and 9.3 percent growth respectively. Transaero, the country’s third-largest airline and its biggest charter operator, increased its market share from 16.8 percent in January to 21.5 percent in March, company spokesman Konstantin Tyurkin said.

Over the same period, the volume of passengers carried by the airline grew by 72.7 percent compared to the same period last year, Tyurkin said. UTair, which carried 3.5 million passengers last year, is the nation’s fifth largest airline company and also operates a helicopter transport business, which greatly helped the company’s financials through the downturn. The company expanded its regional routes by as much as 81.5 percent after the bankruptcy of Air Union and other competitors, Konstantin Yuminov, an analyst at Rye, Man and Gor (RMG) Securities said.

While the overall decline in passenger transport last year was less than projected, the downturn nonetheless dealt a painful blow to many Russian air carriers. At the height of the crisis, many airlines went into voluntary liquidation. AiRUnion, an alliance of five airlines including Samara, KrasAir and Domodedovo Airline suspended flights and then went bankrupt in the fall of 2008. The privately owned carrier, KD Avia based in Kaliningrad on the Baltic coast, went bust in September of 2009, after chronic shortfalls in patronage. Overall, more than 20 airlines dissolved during the crisis, according to RosAviatsya.

Analysts and industry executives said that one of the reasons the crisis had such a disastrous impact on airlines is that the country’s aviation industry is still quite fragmented, with about 170 airlines competing for 45 million passengers. The country’s five biggest airlines - Aeroflot, Sibir Airlines, Transaero, UTair and GTK Rossiya – carried more than 60 percent of passengers last year. Other players are small regional companies with Soviet-made planes, few routes and very low margins, and some of them with no more than five jets each.

“There should be more closures and more bankruptcies before the country’s aviation industry assumes an optimal number of airlines,” Elena Sakhnova, a transport analyst at VTB Capital, said. “There are about 130 airlines operating in the country at present, which is far too many for a passenger traffic volume of 45 million. Some of these lack strong financials, a good safety record and a good aircraft fleet.” Sakhnova added that the country needs only about five or seven big airlines, including giants like Aeroflot, Sibir, Transaero UtAir and perhaps some small regional airlines. The rest, she said, should gradually leave the market through further consolidation and mergers and acquisition deals in the aviation industry. In her opinion, fewer airlines would not impact competition by pushing up ticket prices. “On the international routes, Russian airlines would continue to compete, which is a recipe for low ticket prices. Domestically, airlines will face competition from other means of transport, especially the Russian Railways.”

Yuminov said the combination of an old, inefficient fleet and rising fuel prices could lead to a new wave of bankruptcies among small regional players in 2010. “This will create expansion opportunities for the biggest airlines, as the crisis continues to speed up concentration,” he said. “Overall, we expect the number of Russian airlines to decline significantly in the mid-term. The big players (and other survivors) will use the opportunity to increase their market share, and their operating results will improve substantially as the Russian economy recovers and per capita passenger numbers increase.”

Oleg Panteleyev, a senior researcher at Aviaport, said that while further consolidation of airlines is inevitable, it would be more beneficial for the Russian aviation market if separate airlines specialized in separate areas rather than merge their operations. “Each airline should find a market niche in a particular area or region and focus efforts toward achieving predominance,” Panteleyev said. “For a big country like Russia, being a dominant charter, cargo or helicopter operator in any particular region is an attractive business. This is very evident in the operation of Vladivostok Avia, a big player in the Far East that carries passengers as far afield as China, Japan and South Korea.”

As passengers trickle back, some airlines, including Aeroflot and Sibir, are positioning themselves to benefit from an anticipated boom in air travel. Earlier this month, Aeroflot announced plans to launch a subsidiary budget airline, which could help the airline to consolidate its grip on the domestic market. Aeroflot CEO Vitaly Savelyev told journalists that the carrier could become one of Europe’s ten largest airlines, with 20 million passengers annually, once six regional airlines come under its control next year. Aeroflot has been in talks with RosAvia to take over control of some regional airlines, which include Vladivostok Avia, Saravia, Sakhalin Airlines, Rossiya, Orenair and Kavminvodyavia, from state-owned conglomerate Russian Technologies next year, and hopes to integrate their operations with its own.

Russia already has two discount operators – AviaNova and Sky Express – that carry low-budget passengers from Moscow and St. Petersburg to destinations like Samara, Smolensk, Ufa and Perm in the South. AviaNova started operations on August 27, 2009, by offering cheap-ticket flights to Sochi. Sky Express, the other low-cost carrier, said it carried 81,700 people in March 2010 alone, a 40 percent increase over the same period last year.

Marina Irkly, a transport analyst with Veles-Capital, a brokerage, said that Aeroflot’s market share could increase by as much as 35 percent if the company successfully consolidates the assets from RosAvia. "Aeroflot now carries about 11 million passengers annually, but this could increase to 16 million passengers after successful integration," Irkly said.

Panteleyev said that Aeroflot’s creating a budget airline could change the country’s aviation landscape, as the company controls large resources and could attract huge investment to expand its aviation park. “The company also has good opportunities to receive commercial flight rights over large territories,” Panteleyev said.

But with Russia’s annualized air travel per capita at about 0.5, the same as that of Slovakia, compared to two for France and Germany and 3.7 for the UK, some analysts have pointed out that conditions are ripe for the creation of discount airlines. “The main advantage of discount airlines – the ability to carry many passengers – is lacking, as the annual volume of passenger traffic is a mere 45 million,” Sakhnova said. “The second problem is that discount airlines usually fly to second-tier local airports, which are few and far between in Russia. In addition, budget airlines have to operate on the principle of efficient park pricing, whereas in Russia there is a 20 percent purchase tax levied on new aircraft.” Yuminov said the situation is made worse by refueling monopolies at many regional airports, adding that only airlines which refuel in Moscow and St. Petersburg or abroad can be sure of obtaining fair prices for fuel. Panteleyev agreed with this assessment, adding that the electronic ticket system is weakly developed, seriously limiting cost-cutting potential.

By wiping out the airlines' profits, the downturn appears to have dampened their appetite for an aggressive growth strategy. Despite benefiting from a diverse route network and a new fleet, Aeroflot’s main competitor, S7 (Sibir) Airlines said that it has no plans to create budget airlines or enter into any M&A transactions, even after having pulled through the crisis. "Our post-crisis task is to adhere to the strategy of moderate growth, with emphasis on maintenance of an efficient and profitable operation of the airline,” Kolesnikova said. “S7 Airlines is content to have secured a position as the largest airline on domestic routes in Russia.” Transaero's spokesman Tyurkin also said that the company has no plans to launch a budget airline, adding that expansion of its domestic route network remains the company’s top priority.
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