Outgoing IATA director general Tony Tyler closed the association’s AGM in Dublin with a quip about how host carrier chief Stephen Kavanagh, in contrast to the hailstorms of Cape Town in 2013, had delivered uninterrupted sun for the event.
If the warm climate that accompanied IATA airline executives’ week in the Irish capital earlier this month was unexpected, the same could probably be said about the industry’s financial performance, which continues to shine.
As IATA raised its half-yearly outlook for a fourth consecutive time and aggregate profits look set for another year of improvement in 2016, an industry whose financial performance has historically lurched into the red with each economic headwind and external shock suddenly has a remarkably solid look about it.
Not only are profits at indisputably record-high levels and the industry finally delivering returns above its cost of invested capital, but airlines are doing so against a background of resolutely unspectacular economic growth.
DECOUPLING FROM ECONOMIC GROWTH
In raising its profits outlook for airline in 2016 by $3 billion to almost $40 billion, IATA chief economist Brian Pearce points to the industry having to some extent decoupled its financial fortunes from those of the global economy.
“Essentially the world seems to be stuck in a relatively slow-growth path between 2% and 3%. I think this means the industry's performance is pretty impressive, given its traditionally been leveraged on the economic cycle,” he says. “It’s performed very well despite, what many people call the 'new-norm', of lower economic growth.”
That is most evident in the passenger market where IATA projects recent strong above-trend growth in air travel to continue. “It's been a very strong market. There has been some price stimulation, most recently from the fall in fuel prices, and we think there is more to come, because the impact of hedging has delayed the impact of benefits of the fuel falls we saw last year."
While he notes that the pace of air travel is showing signs of slowing from the peaks of 2015, IATA still expects passenger growth of 6.2% this year. "That is well above the [historical average] trend," he says.
The strength of the passenger market is illustrated by the sharp growth in passenger revenues, which have nearly doubled since 2004 – in sharp contrast to the struggling cargo sector where revenues are roughly back where they were.
Industry passenger revenues – and with it total sales – have though fallen away in the last couple of years. IATA sees total industry revenues down $9 billion at $709 billion in 2016. While that is partly a distortion because of the strong currency impact in converting against the US dollar, it does also reflect the weaker yield environment which dominated the first quarter earnings season.
UNIT REVENUE WEAKNESS
“There is clearly some downward pressure on unit revenues as well. It’s a competitive industry,” says Pearce.
That was evident among European and North American carrier commentary around their first quarter results. Despite the strong profits performance among US carriers – the big three of American Airlines, Delta Air Lines and United Airlines posting first quarter operating profits of $3.5 billion – a return to positive passenger unit revenue is proving elusive for many. American for example does not now see this returning until next year.
That pressure was reiterated by Delta chief financial officer Paul Jacobson, who told the Deutsche Bank Global Industrials & Materials Summit on 8 June that the Atlanta-based carrier will either come in at the low end of its down 2.5% to 4.5% guidance or just below it. "The revenue environment has been challenging," he says.
But despite the challenges around falling yields, Pearce believes for industry profits as a whole, the picture is bright.
"The reason I don’t think the worries about falling unit revenues are a major cause of concern is that unit costs have been falling further, so cash-flows and profitability of the business is improving," he says. "So falling revenues hasn’t been a sign of weakness of the industry, it's been a sign of market conditions and of lower fuel prices. This year we expect to see unit costs fall further than the decline in unit revenues."
The sharp fall in fuel costs have been hugely significant. IATA projects fuel costs will fall to under a fifth of airline costs this year – unchartered territory in recent years – and total estimated airline spend on fuel of $127 billion in 2016 is nearly $100 billion less than in 2014.
While the recent upward movement in the barrel price of Brent crude oil – which has moved back above the $50 mark for the first time since the autumn – fuel savings continue to filter through, particular for those heavily-hedged carriers who are only now seeing the benefits. These carriers too have the knowledge that the same hedges which capped their fuel cost savings last year, will lock in lower prices should the rise in oil price continue.
HEAVY LOADS
These lower fuel costs have contributed to a fall in airline breakeven load factors. Average industry load factors ran at pretty much the same level as breakeven load factors for most of the difficult last decade. But IATA figures show the industry has since 2010 been able to put more distance between these – and will do so again this year.
"That gap between load factor and breakeven load factor is the thing that is driving [improved] return on capital," says Pearce. But he stresses this has been happening even without the boon of lower fuel costs. "That has been widening in the last few years, and started to widen before the fall in fuel price," he says, noting this provides some comfort that airlines can continue to deliver profits even should fuel prices jump sharply.
That would also provide some comfort for airlines in markets with commodity-based economies – notably in Africa and Latin America – where performance has suffered in line with faltering economies and currencies.
The gap has also been driven by higher utilisation of aircraft, evident in passenger load factors at record high levels. But higher levels of capacity growth could impact this. Airlines' high order backlog and areas of heightened competition – for example in the European short-haul market this summer – could see airlines struggle to fill their aircraft and hitting these high load factors.
"At the moment we are not seeing any signs we are returning to the old days of very cyclical profitability," says Pearce. "Load factors are still very high. We are seeing them come off their peak, but we are still expecting to see load factors on average of 80% in 2016. And remember breakeven load factors are likely to fall further because of the impact of fuel pricing and fuel hedging. So at the moment things look stable."
SPREADING GAINS
IATA's latest forecast again illustrates the extent to which North American carriers dominate overall industry profitability. IATA again sees North American carriers – with projected net profits of $22.9 billion – accounting for over half the industry gains in 2016. It would mean North American carriers will have contributed $63 billion out of the just shy $100 billion profits the industry will make between 2013 and 2016.
But despite this, Pearce does see strong performance spreading elsewhere. "In 2015, there was a much wider spread of good performance. In 2014, it was really only the US carriers who were generating reasonable returns for their investors. There is now a much wider spread in Europe and Asia-Pacific of airlines that are generating the sort of returns that investors should expect."
This is contributing to a second year of the industry as a whole delivering returns above their cost of invested capital – something IATA terms as a normal for other industries.
But for all the evidence of structural change helping airlines decouple their fortunes from economic development, Pearce still sees the latter as the biggest risk to continued strong profits. "I think the main worry we have is the fragility of the world's economy. As well as the industry has done to decouple itself to some extent from that... it's still quite difficult for the industry to do well in difficult conditions, so that's what worries us the most," he says.
"But what we've seen, particularly from airlines in North America, that they have been strengthening their balance sheets and business models to deliver in a weaker environment," he adds
Source: Cirium Dashboard
