Even before the headlines and immediate outlook in Europe came to be dominated by the fallout from the UK's June referendum vote to leave the European Union, there were concerns around whether airline profits in the region would continue to advance at their current pace amid pressured yields.
European carriers enjoyed their best year since the economic recession in 2015. FlightGlobal’s World Airline Rankings show the vast majority of European carriers were profitable in 2015: the leading European carriers increased collective operating profits to $11.5 billion. Against a backdrop of fuel savings, as hedged carriers began to enjoy the benefits of the lower oil price, most projected higher profits for 2016.
But the UK vote to leave the EU added uncertainty to a region that had already faced its share of anxiety during the current economic cycle. European airlines – particularly those based in, or with a high portion of their activity in, the UK – were quick to stress the long-term picture would not be affected. That was set against the not-unreasonable expectation that the UK – a country which had already embraced open skies – would retain an open aviation deal with the EU once it left the grouping.
"The fundamentals of the business have not changed. There is some short-term turbulence, but ultimately things will settle down," said IAG chief executive Willie Walsh in late June, echoing the views of other European airline bosses.
That turbulence was clear amid profit warnings from IAG and EasyJet immediately after the referendum result, both citing the volatility following the Brexit vote. But both pointed to other factors.
EasyJet warned that "economic and consumer uncertainty" following the referendum was likely to contribute to a weaker second-half performance. But it also cited the impact of strikes, weather disruption and the EgyptAir Airbus A320 crash as contributing a £28 million ($37 million) hit on third-quarter profits.
British Airways parent IAG – which also operates Ireland's Aer Lingus and Spanish carriers Iberia and Vueling – noted that in the run-up to June's UK referendum it experienced a "weaker than expected" trading environment. It added that following the outcome of the referendum and "given current operating profit" it no longer expected to generate an absolute operating profit increase similar to 2015’s.
The impact of weakening yields had already been apparent during the results season for the first quarter of the calendar year.
After profits surged by 40% last year, Irish carrier Ryanair is projecting a more modest rise of 13% for the year ending March 2017, as it sees average fares falling 7% this year. This is caused partly by "a lot of capacity this winter", including that added by Ryanair itself, says the carrier's chief executive Michael O'Leary. Of other airlines, he notes: "As their oil hedges decline, they will want to stand and fight on price."
In June, SAS disclosed its second-quarter revenues were down 5%, which, combined with long-haul capacity, led unit revenue to fall by more than 10% during the first half. SAS Group chief executive Rickard Gustafson cited greater pricing pressure and negative currency-exchange effects, as well as maintenance costs, for the poor performance. SAS, however, still expects to deliver a "positive" pre-tax profit, before nonrecurring items, for the full year.
HOLDING GAINS
Unveiling IATA's latest industry outlook at the start of June, the association's chief economist Brian Pearce said: "Europe has picked up but is still fairly weak." While IATA raised its overall industry outlook, it scaled back its earlier projections for European profits for this year – which it now sees roughly unchanged on 2015.
"There is still intense competition in European markets as well and that is clearly a factor in limiting the improvement," he says, while also noting the dampening effect from terrorism events. "Europe is probably more of a mixed region, but some airlines are delivering the sorts of returns on capital that US airlines are," he says.
The World Airline Rankings show the vast majority of European carriers were profitable in 2015. But, comparatively speaking, strong profits are spread relatively thinly.
Out of 26 leading European carriers only two carriers recorded an operating loss in 2015 – though this does not include loss-making Alitalia or Russian carrier Transaero, which collapsed under the weight of its troubles. For many though, profitability remains marginal. Only five of the 35 carriers with double-digit operating margin were from Europe, while eight of Europe's profitable carriers failed to muster operating margins above 5%.
"You have this issue where you can have an efficient airline, but they can end up losing money because of the market environment they are operating in, the growth rates that are occurring and the deals they've got with their staff," notes Peter Morris, chief economist at Flight Ascend Consultancy, regarding the challenges facing many European carriers. "All of this can be quite reasonable, but you are locked into it and business can change either on the supply or the cost side, and you are unable to pull any levers to make something happen.
"I think the European carriers have definitely been helped by a significant degree by the fuel price reduction. One way or the other, if you are running a tight ship, you are almost certainly making money at the moment, even the ones that are a bit leaky. All the boats have gone up together, but the ones that make the best returns still appear to be the major low-cost airlines."
EasyJet and Ryanair have both enjoyed the fruits of their move upmarket – the latter making up for lost ground with a dramatic increase over the last two years – and figure among the most profitable in the region.
Morris, however, notes the difference in performance between Europe's big-three network operators and their counterparts across the Atlantic. "The interesting thing about the USA is the big three are all making money, in slightly different ways with different networks, but one way or the other they are all making money. While in Europe you've got a hierarchy of IAG, Lufthansa and Air France-KLM – in terms of a one, two and three of profitability. Other things being equal, why doesn’t that apply to Lufthansa and Air France?"
While IAG is bullish enough to set a new higher level of profit for the next cycle, Air France-KLM and Lufthansa continue the painful process of tackling their structural issues. Lufthansa, plagued by strike action over the past 18 months, still seeks costs savings. Air France-KLM will be hoping a change of leader can bring the elusive breakthrough in labour costs. But at the same time, competitors continue to heap the pressure on.
Several of Europe's struggling network carriers have at least secured new investors. However, the profit levels of many of these carriers remain thin, with a number only scraping back profit. Lower fuel costs should ensure another improvement for the year ahead, almost regardless of economic development. But these airlines will need the environment to stay kind – or their strategic value to remain high to their new investors – if they are to build foundations for the long term.
Morris says: "In terms of profitability, there are some dark clouds over UK aviation post referendum, and that will affect all carriers operating to and from UK. With the rest of the EU hopefully likely to be showing 1%-plus GDP growth, that's going to generate some additional traffic. Whatever the negative talk about immigration – increased mobility in Europe generates substantial economic and travel growth for business and tourism. The UK referendum effect on GDP growth and prices is a negative factor that won't easily go away, particularly for UK-based airlines.
"Fuel prices and terrorism are ongoing concerns, although on the fuel price front at present futures prices seem to be reasonably benign to 2020."
SECURITY MATTERS
Security challenges are increasingly evident, with aviation caught in the middle following the attacks at Brussels National and Istanbul Ataturk airports this year.
While the attacks have caused disruption to air travel services and demand in Belgium and France, it is the fast growing markets of Russia and Turkey that have been hit the hardest by geopolitical and security issues.
"Declining passenger traffic in Russia and Turkey is now weighing down on the overall performance of European airports – here we clearly see the impact of increasing geopolitical and terrorist risks," noted ACI Europe director general Olivier Jankovec earlier this month. May traffic from ACI showed non-EU airport traffic down 2.5% – the first time it had dropped collectively at these airports since 2009.
Turkish operators Pegasus Airlines and Turkish Airlines had already reported challenging conditions during the first quarter, even before the blast at Ataturk airport and the fresh political uncertainty following the recent attempted coup in the country.
Challenges for the Russian sector, meanwhile, which increased as sanctions following the annexation of Crimea compounded an economy and currency already struggling with falling energy prices, toppled the country's second biggest operator Transaero – by a distance the biggest European carrier to collapse in recent years.
Source: Cirium Dashboard
