Airline financial returns failed to show much by way of any significant improvement last year on a dismal 2001, and may have to wait until the middle of the decade before a meaningful recovery starts to materialise
With the industry's final results now in for last year, any lingering hopes for a near-term recovery look slender indeed. Although the collective return from the world's major airline groups did not quite match their low of 2001, the net loss of around $8.8 billion still stands as the second worst in history. And with the picture so far in 2003 looking less than optimistic, financial analysts do not expect any signs of a significant recovery before 2005.
The extent of the damage shows through clearly in the latest financial ranking of the leading 150 airline groups, assembled by Airline Business together with sister data service Air Transport Intelligence. The headline net loss, together with the deficit in 2001, means that the industry as a whole has shed $20 billion over the past couple of years.
Revenues were virtually at a standstill, coming in at some $318 billion, and still as much as 8% below the peak hit in 2000 at the height of the boom. However, the underlying result was less bleak, with the industry more or less breaking even at operating level.
Low-cost growth
But the gloom has not been universal. The rankings still contain just enough high earners to make a top 20 of those that achieved double digit operating margins. The list is naturally headed by Ryanair with an unprecedented 31% margin, followed by US low-cost phenomenon JetBlue at nearly 17%. Alongside are a familiar mix of other low-cost entrants, regionals and some Asian majors, still largely unaffected by SARS in the 2002/3 year.
The real damage comes from the US majors, dominating the list of heaviest loss-makers. They helped North America post another $6 billion loss at operating level and a massive $11 million at net level - this time without the saving grace of Federal grants. That performance entirely cancelled out profits elsewhere, as Europe crept back into the black, led by a resurgent Lufthansa, and Asia-Pacific posted relatively robust profitability.
So is the worst over? Certainly airline share prices have been moving again this year. Even in the US market AMR's price has doubled since its flirtation with Chapter 11, with other US majors also showing healthy gains. Over the first half European airline stocks outperformed the general market by 7% - and by 19% after the end of the Iraq war.
Financial analysts are not all so confident that the market will return. Martin Borghetto, London-based airline analyst at Morgan Stanley, argues that "the long-term industry fundamentals remain flawed". However, he notes: "Investors have regularly taken us aside in recent weeks to dispute our bearish view about the outlook for the industry."
Borghetto puts the rise in stock prices down to the fact that airlines are now seen by investors almost exclusively as a vehicle for those betting on a cyclical economic recovery rather than a long-term investment.
He says the global market capitalisation of the airline sector is around $60-70 billion, with low-cost Southwest Airlines accounting for almost a fifth of that. "This is a broken investment industry," he adds. "Regulatory hurdles and global ownership restrictions continue to stall any sensible foray into the industry."
Restructuring prospects
The granting of a mandate to the European Commission to negotiate an aviation deal with the USA on behalf of the entire European Union has opened up the tantalising prospect for a long-awaited consolidation within the industry. However, the shape, timing and extent of such a deal is uncertain, and it is not likely to materialise until the second half of the decade at the earliest.
Indeed, Chris Tarry, consultant at CTAIRA, says the short-term mentality of most airline investors means that despite the huge losses racked up by US carriers, there is no great pressure from shareholders for a more positive stance on regulatory reform that would boost foreign investment and open the way for global consolidation.
US and European analysts alike, having already written off 2003, see little in the way of a significant upturn in 2004, pushing any meaningful recovery into 2005, at the earliest.
In the USA, UBS analyst Sam Buttrick says the current recovery is limited to recapturing revenues lost because of the Iraq war. "There is no evidence of a broader-based recovery yet," he says, noting that full-year profits remain unlikely until 2005.
Lehman Brothers analyst Gary Chase notes: "Profits in 2004 would require the largest full-year margin improvement ever. My best guess is that 2005 will be a profitable year for the industry, but 2006 is likely to be the first year that we can see peak earnings potential."
It is a similar story in Europe, with analysts predicting no significant recovery until 2005. As ever, a great deal depends on the much-vaunted but as now stuttering economic recovery.
"We assume a gradual improvement to historical mid-cycle profit levels," says ABN-AMRO analyst Andrew Lobbenberg but adds that "even the carriers themselves often lack visibility on next quarter's earnings".
Analysts say a double dip in operating margins, as happened in the early 1990s, is still a possibility if improved economic conditions fail to materialise.
In Asia, Singapore International Airlines saw its first ever quarterly loss in the three months to June as the SARS crisis peaked, and warns that while it appears that "the worst is over", the outlook for the next quarter and the rest of the year is "still uncertain".
Cathay Pacific posted a record loss for the half-year to June, but hopes to return to pre-SARS capacity levels by September - and there are other signs that traffic is picking up around the world.
But yields remain weak. Lobbenberg believes that travellers are still trading down classes from first and business, while economy fares within Europe and on Europe-Far East routes are "collapsing". He adds that although the Far East routes may recover, post-SARS, "European yields will not".
In Europe, Borghetto notes that carriers have plenty of spare seats available in the system, and that short-haul capacity could be increased 5-10% by more aggressive fleet utilisation.
It is a similar story in the USA. Chase says that after the initial recovery on post-11 September traffic up to March 2002, US airlines have generated nearly all of their revenue gains by increasing load factors rather than by raising prices. Buttrick adds that US capacity is now coming back at a rate of 1.5% a month.
While group revenues were down by nearly 12%in North America last year traffic appears to have been slightly down leaving yields off by some 5.6%.
The high growth of low-cost competitors is not only making it tough for majors to hold the line on price but also undermines attempts to maintain industry discipline on capacity. The huge volume of aircraft due to join low-cost fleets has the "the potential to mute the upcycle" warns Chase.
Cheap credit
Borghetto says the underlying capacity problem is a direct result of the access to cheap aircraft financing. He adds that airlines can usually fund aircraft acquisitions at close to base lending rates. "Even for lower quality players, access to cheap capital continues to be rather unproblematic, provided that lenders can seize the aircraft if the airline does not meet its debt obligations," Borghetto says.
Given the pressure on yields, carriers are looking at an aggressive attack on costs to drive profits forward. Despite efforts so far, the cost-gap between mainline and low-cost carriers in Europe is around 50% for Ryanair and 30-40% for easyJet. There are also signs of industrial relations are worsening - as the recent strike at British Airways demonstrates.
Borghetto also says labour costs, estimated by rating agency Standard & Poor's to account for up to 40% of costs at some carriers, have been a difficult hurdle for airlines. He notes that the momentum behind job losses and moves towards more productive working practices may fade once the market recovers. "We would expect staff to claw back some of the lost benefits when earnings start to rise again," he says.
It is, again, a similar story in the USA, where Standard & Poor's estimates Southwest's operating unit costs at around a third below the six largest US carriers, despite average sector lengths that are 60% lower.
All in all, there is a long way to go before the industry can start to talk about recovery, let alone making a decent return on capital. n
REPORT BY COLIN BAKER IN LONDON
Source: Airline Business
