A heady mix of lower fuel costs, economic growth and strong passenger demand, combined with greater exchange rate stability, is set to drive more record profits for airlines next year.
But such has been the relatively dire track record of airline profitability that IATA, in projecting this and next year will be the industry's most profitable by a distance, it talks only of some of its members starting to reap "normal" profits.
IATA has raised it outlook for airline in 2015 by almost $4 billion to $33 billion and sees a further uplift in industry profits to $36.3 billion next year. It puts collective industry net profit margin at 4.6% and 5.1% respectively.
"These are exceptional numbers for the airline industry, a second consecutive year of record profits," says IATA chief economist Brian Pearce. "But these shouldn't be viewed as exceptional; these should be the normality."
At the heart of the improved profits picture is the combination of a relatively benign economic environment – with most regions still in overall growth – and low fuel costs. The continued fall in the cost of oil – the barrel price of Brent Crude oil this month dipping under the $40 level taking it into territory not seen for seven years – has driven a lower fuel burden for airlines
IATA estimates the global airline fuel bill will fall around a fifth this year from $226 billion in 2014. But many of the gains of lower oil prices are still to come through for airlines, especially those with a high level of hedging in place. The unwinding of these hedges - combined with a lower oil price average for 2016 - means IATA sees global airline fuel spend falling by a quarter next year. Total fuel spend of $135 billion in 2016 would see this accounting for around a fifth of airline operating costs next year, sharply down on the more 30% it accounted for in 2014.
"There are quite a range of expectations for [oil prices in] 2016, with some coming out saying it will fall further. Certainly there is a lot of surplus oil in inventories floating around. Others still expect it to rise. Our forecast is based around the middle, but even if higher numbers come...we are still in an environment where oil costs are relatively low for airlines," explains Pearce.
But he adds: "Its not just fuel costs. There are other factors improving profitability beyond the fall in fuel price. One of those factors is the industry is using assets, aircraft, much more efficiently. Since 2010 we have seen a step change in load factors."
IATA expects industry average passenger load factor to top 80% for the first time in 2015, reaching 80.6%.
That in part was down to lower fares. "Certainly in the past year, the falling cost of travel has has stimulated travel," says Pearce.
IATA estimates passenger yields fell around 12% this year and expects this to fall by around 5% in 2016. But it also sees a repeat of strong traffic demand. Passenger travel increased 6.7% this year and IATA sees that improving again in 2016. "Air travel is accelerating with growth of 6.9% expected next year, the best since 2010 and well above the 5.5% trend of the past 20 years," IATA notes.
That demand picture is helped by the economic growth. "We are not seeing exceptional rates of economic growth but most forecasters are expecting 2016 to be a slightly better year than 2015," says Pearce. "If you look at the developed economies, we have seen significant improvement over the last few years and I think there are good reasons to expect that improvement to continue into next year because of the continued boost to consumer income from low energy costs.
"I think the more uncertain future is around the emerging economies," he adds. "The BRIC ]countries] are no longer the poster child for growth. We’ve got Brazil and Russia in deep recession and the airlines are struggling as a result."
But he adds: "By contrast India is now the strongest of the big emerging economies, very rapid growth in air travel. I think China is not as bad as people paint it, because I think what we are seeing is a shift from investment-led to consumer-led growth, which is good for aviation. We are seeing strong performance on travel and airlines are doing okay."
Such is the importance of Brazil to the Latin American region, together with wider exchange rate challenges, that IATA now sees Latin American carriers posting a loss this year. But it expects carriers in the region to return to profit next year, in part because greater exchange rate stability should enable more fuel savings to push through.
Heavy currency falls against the strong US dollar have been regular theme among airline results commentary during the year, for many eradicating the benefits of lower fuel prices. "We have seen an awful lot of volatility in the last year. Economies like Brazil and Russia have seen currencies fall to such an extent that they are not seeing any benefits from lower oil prices at all. That is one of the reasons we are seeing quite a diverse performance among the airlines," says Pearce.
For 2015 the mature markets of Europe and North America are expected to deliver four-fifths of airline profits. While there are other factors at play as well, two of the regions hardest hit by currency falls, Africa and Latin America, are both now expected to end 2015 in the red.
But Pearce is more confident of exchange rate stability 2016. "I think some of the big factors that drove this volatility are priced into these exchange rates," he says.
The improved profit performance this and next year means the industry's return on capital is likely to exceed its cost of capital in both years. "This is a historic achievement for an industry that is notorious for destroying capital throughout its history," says IATA director general Tony Tyler. "Achieving returns that barely exceed the cost of capital means that airlines are finally meeting the minimum expectations of shareholders. For most other industries this is the norm not the exception.
But he adds: "This is coming as expectations build that we are nearing the top of the business cycle. The industry's profitability is better described as fragile than sustainable."
Pearce believes the economy is a more significant risk to airline profits than rising fuel costs. "The industry has always been able to do reasonably well with a strong economy. With a weak economy, even with low fuel prices, that’s always been a difficult environment."
He adds: "They’ve [economic cycles] typically been eight or nine years and the last downturn was 2009. But I think it’s a mistake to think there are regular cycles, because we don’t have regular cycles anymore. What we do see are shocks. They are periodic but not forecastable. No doubt there will be another one."
One such possible upset is the impact on travel demand from further terrorism, which is already impacting demand in North Africa and more recently Paris.
"Its always difficult to know how these events will impact traffic. All we have to go on is how it has had an impact in the past," says Pearce. "What we find, certainly in the developed countries, traffic is surprisingly robust, probably because a lot of it is business travel. What we have found in the past is, six to nine month later, we have seen a rebound in traffic."
Source: Cirium Dashboard
