Russia’s Air Traffic Growing, But Adding Jets Could Prove Risky

 - May 9, 2017, 9:55 AM

Despite last year’s period of stabilization in the Russian airline industry following two years of losses, financial experts continue to warn against inclinations toward fleet growth as market fundamentals show little promise of improvement in the overall condition of Russia’s economy. But even while economic indicators show little more than 1- to 1.5 percent GDP growth into the foreseeable future, airline traffic has seen a boost since last October thanks to a recovering tourism industry. In April alone, airline traffic jumped 20 percent. Still, financiers remain cautious, warning major airlines against embarking on the potentially risky policy of luring passengers with low fares in hopes that an improving economy will eventually compensate for the resulting losses.

“Not everything can be explained by the economics; there are also social factors,” said one Russian analyst during the recent Russia & CIS Aircraft Finance and Lease conference in Moscow. “After an initial shock and a period of austerity, middle class people are returning to a normal way of comfort life; they want to travel for holidays…and follow other modern standards of living.” A steadily strengthening national currency has supported the trend: the ruble’s value against U.S. dollar has risen by 30 percent after a sharp fall in 2014 and high volatility in 2015.

Experts agree on “good performance” of Aeroflot and S7 Airlines, both of which continue to “eat out [defunct] Transaero’s inheritance” in a profitable way. Since the then second largest national carrier collapsed in 2015, its primary rivals have accommodated most of its customers. Subsequently, Aeroflot’s share of Russian airline traffic rose from 20 percent in 2006 to 40 percent in 2014 and, now, to some 55 percent. Today, the three largest airline groups in Russia, including S7 and UTair, control 75 percent of all traffic.

Transaero’s collapse intensified changes in the Russian fleet, which saw a reduction from 1,212 to 1,032 of all aircraft types, mostly foreign-made airplanes. In 2015 the number of jets carrying more than 50 seats declined by 80, and now total 551 aircraft, all the while Russian passenger traffic stayed steady at 88.7 percent. However, Russian airlines took 20 jets recently and expect 60 more this year. Since major airlines do not coordinate on fleet expansion plans, the ongoing expansion holds risks for the entire industry, say experts.

Manufacturers take another view, and point out that prominent airlines follow “far more sober strategies now” centering on fleet “right-sizing." Composite load factor has increased to 81 percent, compared with 79.5 percent in 2013, while imported commercial jets’ average monthly utilization rate remains at 250 to 270 flight hours, compared with 242 in 2013 and 272 in 2016.  

Boeing forecasts a 20-year demand for 1,170 new aircraft (190 regional jets, 810 narrowbodies and 170 widebodies) worth $140 billion in the former Soviet Union, including 800 in Russia. Bombardier predicts demand for 150 airplanes in the 60- to 100-seat category and 350 in 100- to 150-seat range over the same period. For the next five years Boeing sees demand for 240 narrowbodies, while Irkut cites a figure of 180, including 130 Western jets already under contract and the rest MC-21s.

Today, Russian carriers lease 98 percent of their foreign-made narrowbodies and 82 percent of their widebodies. Direct purchases have proved problematic because the cost of capital for a Russian airline typically runs 8- to 9 percent annually, compared with 3- to 4 percent for lessors. Following “negative experiences” with KrasAir and Transaero, and the chill in relations between the West and Moscow, Western lessors have increased “risk margins” for Russian clients, which results in a rise in rentals. “We feel some prejudice towards Russian airlines from the side of Western lessors,” said Eugeny Klyucharev, CEO of Red Wings, which seeks to add Airbus A321s to its Tupolev-204 fleet.

Meanwhile, Chinese financiers have recently won “many competitions in Russia” due to “lesser political risks.” Gecas regional manager for the Middle East, Africa and Russia/CIS Todd Freeman acknowledged that “Chinese lessors and banks are very active in Russia” and often challenge Western lessors in competitions run by such premium customers as Aeroflot.