Plenty of people have been saying the airline market is too fragmented for a while now, but a series of deals in recent weeks have pushed a renewed desire to shrink the pool.

Alitalia’s ongoing bankruptcy looks like it is creating an opportunity for one of the larger carriers to take a substantial slice of the Italian market. And Air France-KLM Group has taken a 31 percent stake in Virgin Atlantic as part of a wider reshuffle of its relationships with partners Delta Air Lines and China Eastern.

Consolidation in Europe hasn’t happened nearly as quickly as it has in the U.S., where over the past decade nine large airlines have been reduced to four.

Mergers and acquisitions in Europe have reduced the number, with arguably five big companies – Ryanair, Lufthansa Group, International Airlines Group, Air France-KLM, and Easyjet – at the top. But there are still plenty of mid-sized carriers carrying millions of passengers each year.

The reasons for their continued existence are part circumstantial and part structural. Cheap fuel has meant that even the most inefficient airlines have been able to keep flying. When this era ends, its likely they’ll go bankrupt or be snapped up by one of the big groups. Legacy issues such as leases and labor contracts — something that U.S. chapter 11 bankruptcy helps mitigate — also make some independent carriers unattractive targets for acquisition.

What Airline Executives Are Saying

In recent earnings calls, talk among European airline executives once again turned toward consolidations.

Jean-Marc Janaillac, CEO of Air France-KLM, is certainly bullish about his company’s new venture.

“The global agreement with Delta and Virgin Atlantic on one side and with China Eastern on the other side is unprecedented in the airline industry. It will allow Air France-KLM to be the European pillar of the most powerful commercial and equity partnership,” he said on an earnings call after releasing the company’s second-quarter results.

The deal certainly brings all the airlines closer together and will likely be the consolidation of two separate joint ventures into one.

“If we look to then what is next, we do have a couple of drivers for change really. Today, there’s two joint ventures. One is the joint venture between Delta and Virgin between US and London. And on the other-hand side, there’s the European joint venture with Air France-KLM, Alitalia and Delta,” said Pieter Elbers, CEO of KLM. “In fact, we have two joint ventures next to each other. So, there’s nothing more [logical] really than combining these two joint ventures into one and making sure that we give all the synergies and benefits to our customers.”

While any new grouping won’t necessarily vastly improve the offering, it does help clean things up, according to aviation consultant John Grant.

“It is unlikely that Virgin will develop services from either Paris or Amsterdam as a result of the development,” he said. “We might see further Virgin services replacing existing Delta Air Lines services from Heathrow, but that wouldn’t be a surprise since it is already happening on markets such as Atlanta, Detroit, and Seattle. So in essence, nothing significant is likely to happen.”

Rivals’ Views

Interestingly, both of Air France-KLM’s big rivals – International Airlines Group (IAG) and Lufthansa – welcomed the tie-up.

“I think, in general, all consolidation is good,” said Ulrik Svensson, Lufthansa’s chief financial officer, on the company’s earnings call. “The European market is very fragmented. The airline industry, in general, is very fragmented. And looking at what has happened in the U.S., I think that helped the industry quite dramatically. So I think this is a positive sign.”

IAG Chief Executive Willie Walsh had a pretty similar response on IAG’s earning call, albeit one that was a little less effusive.

While he said the public change in ownership in Virgin Atlantic was mostly meaningless “because it is effectively controlled by Delta,” Walsh, like Lufthansa’s Svensson, sees the benefits in consolidation.

“I’d have to say generally it’s a positive, because it does move the consolidation agenda forward,” Walsh said.

Low-Cost Moves

All three of the big airline groups have invested in low-cost operations to varying degrees. Air France-KLM has two budget carriers (Transavia and Hop), which will soon be joined by Joon. Lufthansa has Eurowings and IAG has Vueling and newcomer Level.

Joon was launched in July and raised eyebrows by revealing that it would be aimed at millennial travelers. So far, only routes from Paris to Berlin, Lisbon, Porto, and Barcelona, which will begin later this year, have been announced. Long-haul destinations will follow in 2018.

IAG’s Level started flying in June, and Walsh said he was “surprised” by how strong bookings had been with special reference to the routes between Barcelona and Buenos Aires and Los Angeles. Walsh also expects a dedicated management team for the unit will be in place by the company’s first quarter (end of March, 2018).

Lufthansa’s Eurowings has increased in size this year thanks to a deal to take control of sister carrier Brussels Airlines. Eurowings also gained 33 aircraft as part of a wet-lease deal between Lufthansa and struggling Air Berlin, and Lufthansa’s Svensson hinted that the number may be increased.

“We are looking at quite a number of different scenarios when it comes to Air Berlin. And we will be indeed interested to take on more wet leases if that opportunity would show itself,” he said.

These low-cost units not only ape the likes of Ryanair and EasyJet, but also routes offered by Norwegian Air. Norwegian is the poster child of the low-cost, long-haul revolution but recently it has run into troubles of its own.

The Brexit Effect

IAG, Air France-KLM, and Lufthansa have all fallen behind Ryanair, which is now the biggest airline in Europe.

For Chief Executive Michael O’Leary, the biggest issue for his airline is Brexit and he has been almost relentless with his constant warnings about the damaging impact it will have if not managed properly.

Should the UK leave the European Union without a deal on aviation, it will have no established rules to fall back on and O’Leary has raised the prospect of flights being grounded.

Ryanair along with IAG (through British Airways) and now Air France-KLM, thanks to the Virgin Atlantic deal, all have skin in the game and will be hoping a sector-specific deal is thrashed out.

“We will be trying to keep this issue front and center in the UK,” said O’Leary. “I don’t think anybody should get panicked, but you know until the UK begins to realize the weakness of their negotiating position particularly in this sector, there’s a real risk of a disruption to flights from April 2019 onwards.”

O’Leary believes IAG itself might be under threat because of European Union rules on ownership (although Walsh believes this is misplaced). An airline operating in the European Union must be at least 50.1 percent owned by EU nationals, and when the UK leaves, UK shareholders will no longer count towards this number.

The impact on Germany-based Lufthansa will likely be minimal, and it may even benefit from some of the problems at its rivals.

“There are so many different loose elements” that could affect the airline industry in general and Lufthansa specifically, said Svensson, the Lufthansa CFO. “Of course, you could say that with Brexit, as such, Frankfurt is probably a winner of the cities, and that helps us being based in Frankfurt.”

The Bottom Line

If you only had the most recent set of results to go on, you’d get the impression that European airlines were in great shape and therefore a sound investment case. But dig a little deeper and things are far less clear cut.

In a note to investors entitled “European Airlines: Beware the short-term sugar rush,” analysts from Liberum wrote: “Earnings momentum for the European network airlines is undoubtedly positive for now, led by better than expected unit revenue trends. Inbound long haul demand is recovering and fuel prices remain benign. A stronger euro could extend the short-term boost a little longer. However, we believe positive short-term earnings trends mask underlying challenges at many airlines.”

Of the big three — Lufthansa, Air France-KLM and IAG — only the latter is awarded a “buy” rating and when the markets conditions become tougher, all of them are likely to face much bigger challenges.

Photo Credit: Aircraft at Heathrow's Terminal 5. The big airline groups are keen on further consolidation. Heathrow Airport