The planned merger of Air Nostrum and CityJet, in combining two of Europe’s small regional airlines, is a reminder of how scale is once again of critical importance in the competitive European sector at a time of rising fuel prices and excess capacity.

The new airline group, comprising the Spanish and the Irish regional carriers, would carry more than 6m passengers a year and have annual revenues of almost EUR 700m, plus an array of wet-leasing contracts—providing aircraft, crew and services—to bigger European carriers such as Iberia and Air France.

Scope Ratings predicted earlier this year that the European sector has entered another turbulent phase in which it might be difficult for all but the biggest players to survive (Europe’s airlines brace for more consolidation, June 2018 and Growing Need for Consolidation?, Sep 2017), hence pressure on smaller carriers to bulk up or seek the embrace of larger companies.

Scope analyst Sebastian Zank puts the Air Nostrum-CityJet deal in the broader industry context.

To what extent is the Air Nostrum-CityJet agreement part of a broad consolidation trend?
The Air Nostrum and CityJet strategy of teaming team up with larger airlines such as Iberia and Air France by shuttling passengers to/from larger European hubs was the right thing for the past few years. However, trading conditions have become more testing in recent months, particularly for smaller carriers without economies of scale. A few years of comparatively low oil and jet fuel prices worked to the advantage of healthy carriers and allowed time for many weaker airlines to get in better shape. Today, fuel prices have rebounded with a price increase of 48% from July 2017 according to the IATA Jet Fuel Price Monitor. There is also relentless competition from low-cost carriers and non-European airlines. Overcapacity and the ambition of the larger airline group to expand market share make it hard to pass on extra costs quickly through higher fares.

After much consolidation over the years, is it a surprise that there is room for more?
Steady passenger growth and cheap finance continue to lure new entrants and capacity expansion from the healthier European carriers. One result is an increasingly saturated market with large overlapping route networks among carriers. A marginalisation of smaller airlines and more consolidation appears inevitable.

What impact is this having on airline finances?
As many airlines have expanded their fleets backed by comparatively cheap debt, increased leverage and weaker debt protection measures could haunt them when rising costs squeeze margins and operating cash flows. A small-airline merger like Air Nostrum-CityJet looks smart to sustain or even improve margins through economies of scale or synergies from maintaining of a larger, compatible fleet including Bombardier CRJ 900 and CRJ 1000 aircraft.

Are there factors particular to the smaller regional airline sector?
Besides the lack of economies of scale, another aspect is the consolidation among aircraft makers, with Airbus buying Bombardier’s jet business and Boeing looking to tie up with Embraer. Airlines without the negotiating power of larger bulk orders for new aircraft may find it tougher to negotiate with the remaining aircraft makers when it comes to buying newer, more efficient planes they need.