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June 27, 2016: Aerospace and airline analysts are reacting to Thursday’s vote in Britain to leave the European Union. Below is a synopsis of some of the analyst notes we receive.
We are forwarding the analysis our European Transports team put out this morning on Brexit and have a few observations as it relates to US Airlines.
- GBP Exposure: For the US network carriers (UAL, DAL, AAL), GBP exposure averages ~2-3% of total revenues with overall UK exposed revenues ranging 4-6%.
- Impact to High Yield Transatlantic Traffic Primary Concern: For US network carriers, we see the primary concerns post-Brexit on the demand implications on the Transatlantic. Last week IAG issued a profit warning which worries us on corporate demand weakness. Given scheduled seat growth in the Transatlantic continues to outpace demand (H2 seat growth US-EU scheduled at 8.6%), capacity cuts are needed to stabilize pricing particularly since UK GDP is likely to slow even further. We look to Q2 earnings calls next month for additional color from carriers.
- AAL Viewed Most at Risk Given Partnership with IAG, but Our Team Believes IAG is Least at Risk [among EU airlines] from Future UK-EU Air Service Negotiations: Our European analyst believes IAG’s airlines would see limited effect from the UK exiting the EU Open Skies agreement as long as renegotiated UK-EU bilaterals do not limit service levels. This suggests that AAL’s relative underperformance was overdone on Friday; however, we expect Brexit-related uncertainty to continue to weigh on network carriers, and reiterate our confidence in domestic carriers (Outperform on LUV & SAVE).
ECAA seems the most likely route for the UK
We make the following points with respect to the UK’s impending exit from EU OpenSkies:
- The EU Third Package of air transport liberalisation measures was introduced in 1996, creating EU Open Skies and following on from an increasingly liberal position on air services within the EU.
- The European Common Aviation Area (ECAA) was created in 2006 with a view to opening up markets between Europe and its neighbours. It includes Norway, Iceland and the Balkan states.
- Henrik Hololei, European Commission Directorate-General for Mobility and Transport, at an International Aviation Club address on 13 June 2016, implored the US to consider further air service liberalisation measures including cabotage (domestic ops) and the relaxation of foreign ownership caps. Additionally the EC is currently reviewing foreign ownership caps and EU-level opposition to UK carriers flying intra-EU routes would represent a significant shift in positioning.
- EU US Open Skies, agreed in 2007 and implemented from 2008, came with a promise of a phase two of further liberalisation measures which has not materialised yet. The original agreement was heavily influenced by the opening up of Heathrow to unlimited competition (subject to slot procurement), removing the cap of two US airlines operating to the airport. In our view, it is in the US’s interest for the EU to agree a new open skies agreement with the UK such as the UK joining the ECAA.
- The UK will have 2+ years to renegotiate pre-existing bilateral air service agreements with EU nations or join the ECAA. This may be done at an EU level in the spirit of the EU Open Skies agreement.
Given the aforementioned points, we consider it likely that the UK will join the ECAA or agree a different, but liberalised, air service agreement with the EU. However, we acknowledge a high level of uncertainty over the potential for the EU to take a more restrictive approach to air service levels with UK airlines, and contemplate scenarios as follows:
- Were easyJet prevented from operating intra-EU services, this would impact near to half of EZJ routes, accordingly posing the risk of a significant reduction in the size of its business. Absent a satisfactory UK-EU agreement, EZJ would be required to obtain an air operator certificate (AOC) in an EU country to preserve its existing intra-EU footprint – however this may be politically difficult given, in essence, such a move would be designed to over-ride EU-UK agreements.
- Were Ryanair prevented from operating UK-EU services, this would impact broadly one quarter of its routes.
- Beyond BA’s Open Skies airline, which operates a couple of aircraft between Paris and New York / Newark, IAG airlines would see limited effect from the UK exiting EU Open Skies as long as renegotiated UK-EU bilaterals do not limit service levels.
In summary, the starkest scenario of an end to intra-EU services for UK airlines suggests most risk to easyJet and is likely to weigh most on its multiple. Ryanair’s regulatory risk is also high given its reliance on UK-EU operations. However, IAG is least at risk from future UK-EU air service agreement negotiations.
The surprise vote by the UK to leave the European Union in the long-term should have minimal impact on the global Aerospace and Defense sector. Near term, there is risk around just how the UK will start to unwind it relationship with the European Union, and what will the impact be on financial markets, currencies, trade arrangements and the global economy. We do not expect the vote to push the US or other major economies into a recession, but we will be very focused on the impact on passenger travel, which has been one of the key pillars of strength for the commercial aerospace cycle.
For the commercial aerospace cycle, remember that the UK and Europe represent relatively smaller markets in terms of aircraft orders and deliveries, especially as the growth has been concentrated largely in emerging markets. For example, in 2000, Europe (including the UK) accounted for 20% of the commercial backlog and 36% of the annual deliveries, while during 2015 represented 22% of the backlog but only 18% of deliveries. Europe accounts for about 26% of total air traffic, with the UK accounting for less than 5%.
Cowen and Co.
We had numerous questions about the financial impact on the airlines with the UK decision to exit the EU. While nothing happens this week, American Airlines has the largest direct exposure to the UK with 6% of their trailing 12 month capacity as of June in the market (according to Diio Mi), while United is at 5% and Delta is ~3%. Air Canada also has exposure to the UK with ~9% of their capacity in the market. The exposures are amplified when taking alliances into account. It will take time for this to play out, but we suspect the UK will need to renegotiate bilateral agreements with the EU. We expect airlines to reduce capacity to the UK as UK outbound traffic is likely to decline by as much as 5%, according to IATA.
While not an aerospace analyst, IATA—the International Air Transport Assn.—published a six page report about its assessment of the impact of Brexit on the UK. The report may be accessed here.