“Imagine a beautiful world, less sad than it is now,” declares El Al Airlines in ads touting its new Boeing 787 Dreamliner. Flight attendants carrying miniature suns stroll down the aisles as stars cascade down on smiling passengers. An elderly passenger is covered in a blanket by a stewardess for a night of sweet dreams.
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If that doesn’t quite remind you of what it’s like to fly Israel’s flagship carrier right now, the experience will certainly be changing for the better – after the airline bought seven of Boeing’s state-of-the-art Dreamliners for its fleet, at a cost of $1.025 billion, with plans to lease nine more.
There may also be a bright future ahead for investors, but not for the short term.
Five years ago, El Al was in the midst of a crisis. The airline was weighed down by $575 million of debt and the Borovich family, which controlled it, was desperate for a buyer. The FIMI private equity fund looked, but demurred over concerns about El Al’s troubled labor relations. Avi Gabbay, who now heads the Labor Party, mulled an offer but also decided against it.
As it turns out, both erred big time: In the five years that followed, El Al shares climbed nearly 660%.
Without any outside help, the airline recovered. Cash flow more than doubled – to $329 million in 2015, up from $151 million three years earlier – thanks to plummeting oil prices. Every one-cent drop in a gallon of jet fuel cuts the airline’s costs by about $2.5 million annually. Thus, a 58% drop in oil prices over recent years to just $130 a gallon saved El Al as much as $442 million annually.
Another factor contributing to the recovery was the revival of Israeli tourism after a sharp drop in 2014 due to the summer war in Gaza. Tourist arrivals grew 22% over the next two years and soared another 15.7% in the first nine months of this year, to a record high.
Cost-cutting from the sale of more tickets online and the shuttering of nonprofitable routes also gave the airline a boost.
El Al also had a key strategic success in recent years with the launch of its Fly Card credit card. It boasts 238,000 holders who spend a combined 21 billion shekels ($6 billion) on them, making it a major revenue earner for the airline.
The airline also has more direct connections from Ben Gurion Airport than any of its rivals, and is still regarded as tops for security.
But not everything has been rosy.
Since the Open Skies accord – the aviation deal Israel signed with the European Union in 2013 – travel to and from Israel has risen, as more competition led to lower airfares and new routes.
The problem is that El Al wasn’t ready for the new era and hasn’t been able to make the most of all the growth that occurred.
A small capital base and heavy debt prevented it from adding capacity – especially for the most profitable, top end of the market. Those fliers wanted the newest and most spacious planes, and El Al just didn’t have them.
The airline also didn’t have enough pilots, since it is prohibited from hiring foreigners for the job. El Al’s market share was down to 24.4% last month, from 26.2% two years before – which means it’s no longer entitled to discounts on the Ben Gurion Airport fees it used to get.
In addition, falling airfares meant the return the carrier earned from each seat filled over each kilometer flown (a standard industry measure) was dropping. El Al’s passenger count in the years 2012 to 2016 rose 22%, but revenues rose just 1.1%.
Furthermore, El Al has some severe drawbacks compared to the competition – among them high airfares and a poor record for on-time arrivals (in 2016, 56% of all arrivals were late). It also lacks alliances with other airlines, which would enable it to effectively fly to more destinations; has an aging fleet of jets with an average age of 12.1 years; and high labor costs, which are going up under the latest collective labor agreements.
The fleet of Dreamliners will go a long way toward solving many of these problems – but they will come at a cost.
The seven 787s that El Al is buying outright are being financed by a three-year loan that will saddle the airline with added costs. It is also committed to leasing five jets for 12 years and four more for a minimum of 10 years, and those costs alone will cut its cash flow by $62 million annually.
The Dreamliners use as much as 30% less fuel than older jets and have much less downtime for maintenance. But their lower costs and other steps El Al is taking won’t be able to offset the imminent hit, especially as deprecation costs will rise from the currently low level of about $95 million annually.
The airline aims to mitigate that cost impact by introducing its Dreamliners gradually – two this year, five in 2018, five in 2019 and four in 2020. But that means the improved service El Al is promising to flyers will only come gradually, too. It won’t be until 2019 that it will be able to promise business class passengers they can enjoy the comforts of a Dreamliner on the flight to New York and back.
Given the challenges the airline faces, it’s no surprise that the El Al share rally petered out a year ago. Since then, the price has fallen about 40%. On Sunday El Al shares closed down 3.9% at 2.13 shekels.
The ratio of its enterprise value to earnings before interest, taxes, depreciation and amortization is just 2.43, compared with 5.4 for Delta Airlines, 4.85 for Lufthansa and 9.1 for Turkish Airlines. Low-cost airlines, meanwhile, have an EV/EBITDA of 9 or more.