From a stock market perspective, there can be little doubt that airlines are out of favour. After a recovery in sentiment in the last two months of the year, share prices, since the start of 2000, have not only stalled, but dived sharply.
First came a profit warning from United Airlines. And although Europe had long been aware of two of the factors that it cited - fuel and lack of New Year traffic - that did not stop a sympathetic fall in price across the Atlantic.
Then there are the traffic figures. A weak December is history, while those for January seem a little more positive. KLM and Alitalia aside, most European airlines are making more positive comments about the fundamental operating environment. Indeed, the Commerzbank/Airline Business model suggests a fundamental potential for traffic growth of 6.9% against an increase in capacity of just 3.4%. That is much better than last year when our model suggested underlying international growth of 5.6% and the majors actually managed an 8.1% capacity hike.
As ever, the real story lies behind the headlines. It is not necessarily the quantity of traffic that matters, but the quality. Even more important is the difference between the break-even load factor (itself a function of cost and revenue) and the achieved load factor. In particular, the rate of change in unit revenue and unit cost.
Then there is the exchange rate factor, as clearly shows through in KLM's disappointing results for the December quarter. The headline figures include a positive effect of currency on yields but a negative impact on costs.
For each airline, the availability of the data to make this comparison varies. Some carriers publish it, others do not. KLM is one of those that does, and the message is that currency on yields was favourable to the extent of 6 percentage points. In other words, while yield per revenue passenger kilometre (RPK) was reported to be 3% higher (stripping out the currency effect), then underlying yields fell by 3%. Similarly, the reported 5% increase in yield per available seat kilometre (ASK) is, in reality, an underlying fall of 1%.
On the cost side of the equation, KLM's reported seat costs rose by 5% while its overall units costs per tonne kilometre were up 11%. Even stripping out the currency effect, the under-lying increase was still 7%. Little surprise that KLM has announced its plans for another cost cutting programme (details of which are due in mid-March) and that it paints a picture of a tough environment, partly to help condition the mindset for further cost reduction.
While British Airways also reported a similar 3.2%rise in passenger yield for the quarter, it had a different story to tell. After seven months of rising premium traffic (in part stimulated by the three for two ticket offer), BA reports that the bulk of its yield increase, around 2.5 percentage points, came from a better mix of traffic.
Currency accounted for a 1.4 point gain, offsetting a 0.7 point negative impact on price.
On the cost side, BA reported an increase of 5.2% in overall unit costs compared with the corresponding quarter last year. From BA's figures, it is not possible to assess the impact of currency, but comparisons are anyway complicated by the $95 million windfall on labour costs it received a year ago due to the release of a bonus provision that had been accrued in the first half and was clearly no longer needed. In BA's case, it is perhaps better to look at the development of unit costs over the first three quarters of the current year. Here, the reported increase was just 1.2%.
Air France too saw yields benefit from the weakness of the euro. Without it, a small 0.7%rise in passenger yields over the nine months to December would have been a negative. Yet Air France also held seat costs to a 1.1% rise and would have seen them fall by 1.4%without the fuel and currency factors. Evidence, perhaps that its reorganisation efforts are working despite piling on capacity.
Other of Europe's major carriers are just starting to report but there is some encouragement. Fuel remains a near-term issue, but hedging will ameliorate the full force for many. More significant is the continuing commitment to structural cost reduction. In the "slower and lower" environment for capacity growth, the opportunity to grow costs down clearly diminishes.
Today, the stock market is generally regarded as being expectant rather than convinced. So while investors are ready to see "greater things" emerge, it appears that for the airline sector they may want to touch and feel the results before they react, rather than anticipate too early.
Source: Airline Business
