Airline financials have thrived off the back of lower fuel costs and modest, if mixed, economic growth, but IATA's updated industry forecast underlines what third-quarter carrier commentary had already pointed to: profits are levelling off and starting to descend.
IATA on 8 December released its latest six-monthly outlook update, estimating collective airline net profits of $35.6 billion for 2016. While this would mark a new record profit for the industry, it is only slightly ahead of last year's previous record of $35.3 billion. Indeed, at an operating profit level IATA estimates industry profits of $58.3 billion – below 2015 levels.
The association also set out its first projection for 2017, in which it sees collective net profits falling to just under $30 billion. This would be the first fall in six years in collective airline net profits. But it would still be a standout year for airlines and mark what IATA director general Alexandre de Juniac termed a soft landing.
The tipping point in fortunes appears to have come by mid-year. There had still been enough optimism at the end of the first quarter for IATA in June to forecast net profits could top $39 billion. Its new forecast for 2016 cuts that projection by almost $4 billion.
"The upward momentum we saw in airline profitability does seem to have run out of steam in the first half of this year and dipped a little in the third quarter, albeit at historically high levels," says IATA chief economist Brian Pearce. "Essentially our forecast for 2017 is a continuation of that trend we have already seen setting in in the second half of the year."
While there have been plenty of shocks and uncertainties in 2016, and these have been significant for carriers in particular markets, the wider picture is more simplistic. Unit costs have stopped falling faster than unit revenues.
"For a long time, because of fuel, unit costs were falling further than unit revenues. Those lines crossed at the start of the year, essentially because we've seen fuel prices bottom out, spot prices on a rising trend," Pearce explains. "Unit costs [in the third quarter] are still lower than in the third quarter of 2015 – that's because of the delaying impact of hedging – so there is still some benefit of last year's fuel prices feeding through, but that's running out.
"Unit revenues are starting to get better, but there is still a bit more pressure on those than there are on costs. So that's why we have seen that loss of momentum," he adds.
FUEL BITES BACK
At the heart of the change in unit-cost momentum are fuel costs. Just as oil prices' sharp fall fuelled the profits surge, so their increases are having an impact. Oil prices remain at relatively low levels, but following a spike after OPEC's recent announcement it was to cut production, IATA is projecting the oil price will be around $10 per barrel higher. "Our forecast is based on staying at these sorts of level [in 2017]. The market is still as we speak oversupplied," says Pearce.
Hedging will take the edge off the pain for airlines in 2017. IATA projects the industry fuel bill creeping up $5 billion to $129 billion – a level that before last year had not been seen since 2006.
That is partly offset, though, by a slightly more positive economic outlook. "The industry was operating in a pretty sluggish world, where the economic cycle was starting to slow down," says Pearce. "The note of optimism is that in the second half of the year we've started to see things strengthen and in the last few months we've seen an upturn in business confidence. It does look as though we are moving into 2017 on a moderately improving trend for the global economy."
While there is plenty of uncertainty around Brexit and the Trump presidency, financial markets have interpreted evolving US economic policy favourably – focusing on potential tax cuts and infrastructure spending.
"Our expectation, along with the majority of other economic forecasters, is we are likely to see slightly stronger economic growth next year [of 2.5%], which will provide some counterweight to the effects of higher fuel costs," says Pearce.
SLOWING TRAFFIC
IATA, though, is projecting a slowing in passenger traffic growth in 2017, after several years of above historic trend growth. It sees traffic growing 5.1% in 2017, compared with just under 6% this year.
"In the last couple of years we've seen growth much faster than you'd expect given what's been a lacklustre performance in the global economy, essentially because have seen a lot of price stimulation coming through the fall of fuel prices. Now that's dying away, because spot prices are rising [and] hedges are falling away," says Pearce. "So as we go into 2017 that will be a headwind for air travel, offset a little by this improvement in economic confidence.
"But we are not expecting to see a dramatic slowdown," he adds, "In fact, growth of 5.1% is a pretty good result. It's not far away from the 20-year trend."
That growth of 5.1% is below the 5.6% extra capacity IATA expects airlines to add in 2017. That would mean another a second year of falling load factor. This has already slipped from the industry high of 80.4% in 2015 to 80.2% this year. For 2017, IATA sees this falling to 79.8%.
REGIONAL SPREAD
North American carriers continue to lead the industry in net-profit terms. Its carriers are projected to post collective profits of just over $20 billion this year and $18.1 billion in 2017. While that is down on the $21.5 billion net profit they made in 2015, it still means North American carriers will account for more than half the industry profit for a fifth consecutive year.
For all the uncertainty in Europe, IATA sees these carriers repeating their 2015 profit of $7.5 billion this year. As it does for all regions, IATA forecasts European profits slipping in 2017, to $5.6 billion. This will be helped by a slight rebound in demand after it suffered badly in this year by terrorist attacks.
IATA sees Asia-Pacific profits falling away less sharply in 2017, just $1 billion lower at $6.3 billion.
Latin American carriers will return to profit in 2016, albeit a modest one, after a difficult 2015.
IATA cut its 2016 profits projection for Middle Eastern carriers almost in half from its previous forecast – down from $1.6 billion in June to $900 million in its December forecast. One of the region's key airline, Emirates, has already disclosed a 75% fall in its first-half profits, impacted in part by the strong US dollar.
It remain a bleak picture for African carriers – IATA projecting a loss of $900 million in 2017 to follow this year's $800 million reverse. That would mark a sixth consecutive year of losses for the region's carriers, and Africa is the only region consistently failing to outperform its financial performance of a decade ago.
MANY HAPPY RETURNS
While it has trimmed its profit expectations for 2016 and set a lower level for next year, IATA notes this would still mean the industry had generated returns above the cost of invested capital for a third consecutive year – unheard-of territory in the previous decade.
"We should look at this slowdown in momentum with the perspective of the last few decades," says Pearce. "It [2017] is going to be a slightly less profitable year, but it's still going to be value-creating for investors and still far, far better than one would have expected if you had looked at the industry and these business conditions even five to 10 years ago."
Source: Cirium Dashboard
