Airline profits: Demand dampens oil threat

Improving yields and better balanced capacity keeps profits hopes despite price surge

This year's strong start is helping ally fears over oil price rises, leaving airlines remarkably bullish even with the prospect of higher costs this year. IATA has left its industry profits forecast for 2011 almost unchanged despite hiking its fuel price expectations for the year by $12 per barrel.

Rising fuel costs was always one of the big obstacles to building on last year's recovery and the creep in oil price turned into a surge as unrest and political turmoil spread in North Africa and the Middle East. Brent Crude oil reached a high of $118 per barrel in March amid escalating tensions in Libya, compared with $90 only three months ago.

Small wonder IATA upped its projections for the 2011 average oil price to $96 per barrel, compared to the $84 it conceded was a conservative estimate in December. Against this backdrop IATA scaled back its full-year profits forecast for 2011 from $9.1 billion to $8.6 billion.

While this is a further reduction on the revised $16 billion profit the industry made last year, it is a relatively small adjustment given IATA estimates each dollar increase in the oil price adds $1.6 billion to the industry cost. Even allowing for hedging mitigating the impact, IATA still sees an addition $10 billion added to airline costs from fuel.

So why no pronounced fall in the profits forecast given the sharp rise in fuel costs? The answer lies in the improved economic environment. IATA had expected only fractional growth in yields for 2011. But off the back of improving economic growth, it now sees yields growing 1.5%.

"GDP forecasts in December were for 2.6% growth. That has risen to 3.1%. So we have revised our growth forecasts upwards to 5.6% growth in the passenger business and 6.1% growth on the cargo side," explains IATA chief executive Giovanni Bisignani.

Strong demand also helps the revenue environment as it narrows the gap between demand and likely supply this year. "The capacity has remained the same, but the GDP is pushing business traffic in a more positive way," says Bisignani. IATA now predicts just a 0.3 point gap between demand and capacity. "Tight supply and demand environment will give the airlines some pricing power," he says.

Airports are also reporting a strong traffic start to the year. Passenger traffic was up 7.1% in January, above the 12-month rolling average growth rate. "Emerging markets are buoyant, and we also now see that mature markets are returning to real growth compared to the pre-crisis levels," says ACI World director general Angela Gittens.

European traffic grew strongly, notably in international markets. "The indications for January and February are extremely good," says ACI Europe director general Olivier Jankovec. Concerns remain in Europe - notably from the sovereign debt crisis and low consumer confidence - but Jankovec adds: "We see, and are hearing the same from North America, the recovery is more pronounced in the business travel segment."

In the USA there was bullish talk from US Airways president Scott Kirby after unit revenue per passenger seat mile grew 10% in February. "The demand environment during February was exceptionally strong," he said early in March, believing the growth in unit revenues seen through to the end of February would be sufficient to fully offset the increase in fuel prices seen in February.

IATA left its North American forecast unchanged at $3.2 billion and raised its projection for Europe slightly to $500 million.

And despite local unrest, it also lifted its profits expectations for the Middle East as a whole to a $700 million profit. While noting political instability will take its toll in Egypt, Tunisia and Libya - which account for about one-fifth of the region's international passenger traffic - it sees this balanced by the Gulf area, which benefits from economic activity related to high oil prices and whose hubs continue to win long-haul market share.

It is Asia where IATA has scaled back its expectations the most for this year. While still set to be the most profitable region, IATA shaved nearly $1 billion off its previous profit forecast for Asia to $3.7 billion, citing the region as being more exposed to higher fuel prices, due to relatively low hedging on average. Similarly, it has also scaled back projections for Latin American carriers, halving its profits projection to $300 million.

But while IATA still expects profits for this year, Bisignani warns of possible risks ahead. "The oil price rise is based on political fears with the Middle East unrest. If the price rises to levels that stall economic growth, the impact will be severe."

He also spells out fears over the limited buffer the industry has to absorb further shocks after a torrid decade.

"In order to survive the industry had to increase total debt levels by $30 billion. We now have an industry with around $210 billion debt," he says. "When we see margins of 2.5% in 2010 and 1.4% this year, you understand the fragility."

Source: Airline Business