KEVIN O'TOOLE / HENK OMBELET
Profits were depressed again in 2000 as cost increases ate away strong revenue growth. In the year ahead the revenues too have weakened sharply
The airline industry may have stayed in profit last year, but not by much. On the face of things, it should have been very different, with demand strong and capacity growth restrained. Yet upward pressures on costs conspired to wipe out the advantage. The prospect is of worst to come as growing jitters over the world economy raise a distinct possibility that the industry will struggle to stay in the black at all this year.
The extent of last year's dip in profitability shows through clearly in the latest Airline Business financial ranking of the world's top 150 airline groups. They ended 2000 showing a collective net margin of only 1.1% - the worst since the industry began to recover from the last recession six years ago. It marks a clear shift down from the 3% plateau where the net margin has rested for the preceding three years.
Admittedly these are group results, including non-airline operations and skewed by the occasional hefty extraordinary gains or charges. It is true that the 1999 net profit was artificially inflated by a round of windfall gains from share sales. In the opposite direction the 2000 results include some hefty provisions from the financially challenged. The Swissair Group alone posted a staggering $1.7 billion net deficit, as it attempted to drew a line under its liabilities to loss-making affiliates in which it has built up sizeable stakes. Three of those, Sabena, LTU and AOM, join the Swiss group in the list of last-year's heaviest loss-makers. With TAP and Turkish Airlines also represented, more than half of the Swissair-led Qualiflyer alliance was there.
Even stripping out such one-off items, this still leaves the 2000 result down on an already disappointing performance in 1999. The industry's operating margin, a trustier guide to underlying performance, edged down a whole percentage point to 4.2%.
That came despite booming demand and constrained supply. Passenger and freight traffic moved along healthily, pushing up overall revenues by a huge 8%. So what went wrong? The relentless decline in yields is again widely blamed, although in point of fact the fall of around 2-3% was slower in 2000 than it has been of late. The US majors actually ended the year showing a healthy 4% gain on their passenger services.
Rather the issue has been costs and not least the continued hike in aviation fuel. That was already a factor in 1999, but continued to hurt last year with a further 70% rise in the average spot price. Over the past two years fuel has climbed from a low of under ¢40 per gallon at the start of 1999 to a high of more than ¢100 towards the end of 2000. The price has since started to fall, although the impact of declines as well as rises takes time to filter through thanks to hedging strategies.
The International Air Transport Association (IATA) reckons that unit fuel costs rose for its members by close to 17% last year on international routes, which alone would give a penalty of some $4 billion at operating level.
In Europe the oil price hike was further compounded by a steep 15% dive in the value of the euro against the dollar, the currency in which fuel, aircraft and much else are naturally priced. The Association of European Airlines (AEA) reckons that its members nevertheless managed to bring down overall unit costs on their international services by a creditable 4.7% in dollar terms. However, yields which should have benefited from the dollar rise, fell faster still at 5.9%. The AEA points to weak business-class growth (2.6%) on European services which was only partially made up by an improvement in the mix on the North Atlantic.
The damage fed through to the groups results in this year's Top 150 ranking, with Europe's operating results cut in half. Even discounting the massive provisions at Swissair, the region's net result was only a little above breakeven.
Financial results for 2001 are expected to be equally grim. Andrew Light, analyst at Salomon Smith Barney expects pre-tax earnings at European carriers to fall by a third this year, not aided by weak traffic figures and hints of labour unrest. "We expect a recovery in earnings in 2002, but this depends critically on business and consumer confidence, capacity and cost control by the airlines, labour cost pressures and the outlook for oil," he says.
US unit cost hike
The US majors, despite their good work on yields, also suffered a major hike on unit costs. Soaring fuel prices were joined by further penalties from a mix of labour pressures and weather-related delays. So despite some fine traffic figures, operating margins slid by a couple of points to 6.5%. The North American region in the latest ranking came in at just over 5% despite a stellar 11.8% rise in revenues.
Since then the news has kept getting worse. Revenues so far this year have been falling at their fastest rate since the oil crisis era of the mid-1970s. The USA is still far from recession, although it may have started to feel that way. Economic growth rates have plunged from over 5% down to a likely 1.5% this year. Worse still, corporations have acted with surprising speed in slashing their travel budgets, while airlines have found their costs under yet more pressure from wage demands. Investment bank UBS Warburg puts it well in its latest state-of-the-nation review: "After bingeing out on high-priced travel in 2000, corporations purged their travel budgets this year just as airline labour bellied-up to the bar for a hefty wage refill."
The review goes on to emphasise just how important corporate travel has become.
"While airlines have traditionally been classified as consumer cyclicals, the economic truth of the matter is that the large network majors derive almost two-thirds of their revenue from corporate travel." Online alternatives to increasingly expensive business travel could help prolong this down cycle it warns: "While demand will recover to some extent with the economy, the rate of improvement certainly remains open to question."
The ATA, which represents the US majors, now sees a deficit of $1-1.5 billion this year, a far cry from its expectation just two months ago that the majors could make that amount in profits.
Rather, it has been the low-cost independents, led by Southwest Airlines, where the profits have continued to flow. History suggests that they should benefit as business budgets get tighter. Notably, the top four operating margins in the latest Top 150 ranking are all taken by such carriers, headed by Europe's Ryanair and veteran Southwest.
The high-point last year came from Asia's recovery. Cathay Pacific was able to reclaim its position among the world's highest profit earners, while all three of the major Japanese carriers also returned from their restructuring plans with profits to show. It was almost like old times as Asia-Pacific led with the world's highest margins and showed a rare improvement in profitability. So far this year the outlook has been bleak, with Singapore now moving into official recession alongside Japan.
Many Asian carriers suffered sharp traffic declines in the first half, primarily on the cargo side which saw volume drops some had never seen before on the back of a collapse in the US IT market.
However, airlines and analysts alike are cautiously optimistic about the second half of this year and 2002, saying there are signs the region may be at the bottom end of a short-lived but worrying downturn. "We are probably at or close to the bottom," says Hong Kong-based JP Morgan regional airline analyst Peter Negline, adding however that there are no certainties and that "no-one at this stage is on easy street".
The best hope at present for markets everywhere is that this downturn is shallow, with better to come in 2002 if and when confidence returns to the major economies. US analysts are already betting that profits for the majors will be back on course by then. In the meantime, more red ink is starting to look dangerously inevitable.
Source: Airline Business
