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New airline aims to soar against odds

May 18 2011 17:09 James-Brent Styan

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OVER THE PAST 20 years no less than 10 private airline companies were started in South Africa. Only two of those – 1Time Holdings [JSE:1TM] and Kulula – are still flying.

The rest – including SunAir, Nationwide and Interlink – had their wings clipped. Now another new player – Velvet Sky – has entered the local market and the inevitable question to ask is what its prospects are.

Airlines in SA face two major problems: the oil price and competition. Both factors are largely beyond the control of the carriers themselves. However, their effect means airlines have to operate under enormous pressure, making it difficult for the companies to earn enough income to be sustainable.

There are currently seven established commercial airlines operating on domestic routes in SA: British Airways, kulula, 1Time, Mango, SA Express, SA Airlink and SA Airways. Three of those are state-controlled.

And now we have Velvet Sky. This airline will initially be using one Boeing 737-300 to fly the golden triangle of Durban-Johannesburg-Cape Town – the busiest routes in SA.

Durban businessman Cecil Reddy is chairperson of the new company and its major shareholder. Reddy says 9 000 tickets were sold on the airline’s website in its first three days and more than 1m people visited its website in its first week alone.

He says Velvet Sky is currently acquiring two more Boeings, although it’s uncertain when they'll be operational.

Reddy says there's a great demand for affordable air transport in SA and the time is right for a new player to enter the market. So now is the perfect time to launch a new airline, he says. "After the recession there were many aircraft that could be bought cheaply – much cheaper than the amounts that many of our competitors have to spend on renting their planes. That means our cost basis is low, which makes us competitive right from the start."

Erik Venter, joint CEO of airline group Comair, admits it’s now easy to start a new airline but he says it's not that easy to stay in business.

"Business models for airlines are simple to compile and even look attractive to prospective investors. You estimate how much you’ll get for an airline ticket and if the business plan doesn't work you simply add a few rand here and there. But the reality is a bit different, with airlines in SA that just can’t afford to charge the ticket prices their business plans call for," he said.

When input costs – such as the oil price – rise, the company suddenly finds it difficult to absorb the additional costs. Venter says the ticket prices of airlines in SA usually only vary by a few rand.

"The pressure is aggravated by privately controlled airlines having to compete against state-controlled airlines, which are to a large extent protected by their shareholder."

Linden Birns, an independent aviation analyst, agrees competition in SA's airline industry is exceptionally tough. He feels it will be difficult for Velvet Sky to be successful as long as it only operates one aircraft.

"For an airline to be successful in SA it must fly high frequency – 12 to 14 hours/day – with high load factors. But with only one plane at its disposal Velvet Sky may well find it’s too difficult to achieve its targets, especially if it encounters delays."

However, Birns says Velvet Sky has a few experienced people involved in running it, people who know the industry. "At least that will help."

Venter says the impact of the oil price on running costs is as much as 30%. He says airlines can take the risk of hedging against the oil price but he feels that tactic actually adds more risk to an airline's existence.

"You win some, you lose some. Airlines aren't financial institutions. In the end, we found the best hedge against the oil price was to use the most modern – therefore the most fuel-efficient – aircraft. That means it has less impact on you when the oil price rises."

Comair uses Boeings and it recently signed a contract for eight new Boeing 737-800s. "In SA, the airline industry is like the story of the guys being chased by a lion. They're all in danger and the only thing you can do is make sure you aren’t the nearest one to the lion,” Venter says.

The problems experienced by local airlines aren't unique to SA. The International Air Transport Association (Iata) says the fluctuating oil price over the past few months will result in a 46% fall in the airline industry's combined profit this year.

Iata represents more than 230 of the world's biggest airlines, which account for close on 93% of the world’s commercial air transport.

Iata CEO Giovanni Bisignani says airlines can expect a profit margin of 1.4% this year, while last year it was at least still 2%. Bisignani says airlines expect a total net profit of $8.6bn this year. Last year the figure was $16bn. "The problem is that this profit is earned on a total turnover of $594bn. What kind of profit is $8.6bn on that level of turnover?"

* This article was first published in Finweek.

* To read more Finweek articles, click here.

 
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