Nothing is Impossible: Korean Air Posts an Operating Profit, Buys Asiana

I was all set to publish a piece talking about Korean’s remarkable Q3 operating profit… and then that story was dwarfed by blockbuster news. Korean’s parent will buy nearly two-thirds of rival Asiana for KRW $1.8 trillion (~$1.6 billion) with KRW 800 billion of that coming from the government’s development fund. Korean will merge the two airlines under the Korean Air name. This will create a remarkably formidable competitor in Asia. It’s also great — or horrible — news for Delta depending upon how the regulatory authorities view this.

I thought about scrapping my original post on profitability, but instead I’ve combined them into a single, long article. We’ll start with the merger.

Korean to Acquire Asiana

Korean and Asiana are the two biggest airlines in South Korea, but just how big will the combined airline be on a global scale? Pretty darn big, based on seats.

This creates a new top-10 global carrier (when excluding domestic travel, at least). Looking through full year 2019 Cirium data, the combined airline (including low-cost carrier subsidiaries Jin Air, Air Busan, and Air Seoul) will have 56 percent of total departures from South Korea. It will have a combined fleet of 305 aircraft, or at least, that’s what it would have if it opted not to retire anything that’s already temporarily parked. There are also 135 aircraft on order with 70 options.

Specifically, if we look at the 2019 Continental US/Canada to South Korea market, the combined airline along with joint venture partner Delta would have been responsible for more than 85 percent of seats between the countries. That’s great news for Delta since it will bring Asiana into the fold… but the competition authorities may foil that plan. The argument is undoubtedly that there is plenty of competition from other North Asian hubs. But when it comes to South Korea specifically, the only real argument is that Asiana was in such bad shape there was a good chance it would have disappeared anyway. We’ll see how this goes.

It is certainly bad news for Star Alliance since Asiana was a nice presence to have on the team, but it’s certainly not a death knell. The focus for the alliance in that area is on ANA in Japan and Air China in China. Asiana didn’t have a joint venture with United, nor did it add a ton of extra value. The worse news is that as an Asian connecting hub, SkyTeam is now going to be very well-positioned.

Will the combined airline do well? I’d say so. I imagine it will depend on how much rationalization can be done between the fleet, people, related businesses… you name. But even if little work is done, any time you eliminate competition to go from a duopoly to a monopoly, the surviving carrier is going to be happy. Korean has been running its business very well lately, posting a profit as I mentioned above. And now we’ll shift to that topic.

A Look at Korean’s Q3 Financials

How is Korean making money? Of course the answer is cargo, but it’s more than just that. There are a few things that are unique about Korean here.

Let’s start with the basics comparing Q3 and Q2.

	3Q 2020	3Q 2019
Revenue	KRW1.55t (~$1.38b)	KRW3.28t (~$2.92b)
Operating Expense	KRW1.54t (~$1.37b)	KRW3.17t (~$2.82b)
Operating Income	KRW7.6b (~$6.78m)	KRW118b (~$105.28m)
Operating Margin	0.5%	3.6%

As you can see, revenue was basically cut in half while expenses dropped by a little less than that. The end result was operating income just barely squeaking into positive territory. I should note that there were several non-operating charges that dropped net income down to a negative KRW386b, or a -25 percent margin, but hey, even an operating profit is worth celebrating these days.

Cargo was a big part of this, and adding Asiana to the mix can’t hurt that. Korean is one of the few passenger airlines to still have a large, dedicated freighter fleet. Out of a total fleet of 164 aircraft, Korean has 23 freighters — 12 777s, 4 747-400s, and 8 747-8s.

Last year, cargo represented just shy of 20 percent of the airline’s revenue. This year, it was more than 65 percent. That’s a reflection both of the plunging in passenger revenue but also a huge increase in cargo. Korean saw cargo revenues increase in Q3 nearly 60 percent over last year to just over KRW1t (~$900m). So, even though passenger revenues plummeted 87 percent to KRW273b (~$245m), total revenue was down only by about half. With costs dropping nearly as much, the airline eked out that operating profit.

This might sound like the end of the story, but it’s not. The passenger fleet played an important role as well. First, Korean has something that airlines like Singapore could only dream about: a domestic market. About half of Korean’s flights (and the same goes for Asiana) are domestic, including many on one of the busiest routes in the world, Seoul to Jeju.

In Q3, Korean’s domestic revenue was responsible for about a quarter of total passenger revenue. That’s up from 6 percent normally.

In November, domestic seats are scheduled at 79 percent of last November. Two-thirds of those flights are on the airline’s 10-strong fleet of A220s. The rest are split between 737s, A330s, and 777s. (Asiana primarily uses A320 family aircraft for domestic flying.)

Outside of that, you can see that most of Korean Air’s focus has been in the North American market. North America is crucial for Korean in its long-haul world, and it has regularly been ranked as the largest Transpacific carrier. That will only grow with the Asiana acquistion. Korean’s North America revenue is still down 79 percent, but considering that every other international region is down 90+ percent, this is a victory.

How is that even possible? Remember, South Koreans can still freely enter the US. We think of the whole world as closed since most countries have blocked Americans. But the US itself has only blocked travelers from Brazil, China, Iran, and most of Europe. South Koreans may not want to come to the epicenter of COVID terribleness, but they can if they want. And considering the close familial ties in some regions, it’s not surprising to see some limited travel.

We should also remember that these flights aren’t just carrying passengers. They are carrying cargo alongside the dedicated fleet. Currently, A330s are flying to San Francisco, Seattle, and Vancouver. Those are certainly capable of carrying decent amounts of cargo, especially with a light load of passengers. Meanwhile, the 777-300ERs are flying to LA, JFK, and Chicago. That airplane is more than capable in those markets, which are most likely the primary cargo markets for the airline in the US. Lastly, the 787-9 is flying to Atlanta, Boston, Dallas/Fort Worth, Toronto, and Washington/Dulles. That can carry less, but there is less demand.

Now, Korean is pulling seats out and creating more cargo capacity on its existing fleet to accommodate the flood of demand. It is also preparing its infrastructure to be able to carry the COVID vaccine all over the world with proper temperature controls… when one is ready to go.

As passenger demand recovers, Korean can shift as needed. In the meantime, it now has a tall task ahead of it. Combining with Asiana won’t be easy, but in the long run it should pay dividends in spades.