Was 2004 as good as it’s going to get for many of the world’s airlines? The Airline Business Top 50 shows who flew high and who hit turbulence
It is a gloomy prognosis, but nevertheless 2004 will most likely prove to be the peak of the current cycle for the airline business. For many it hardly felt they were riding the crest of a wave, as profit margins remained slim to non-existent. But in terms of passenger growth (13.8% for the world’s top 200 carriers) and revenue, which rose well past previous industry records, last year saw a strong performance.
“Last year was exceptional and the best year for economic growth for three decades,” says Brian Pearce, the chief economist at the International Air Transport Association. “The last 18 months should really have been when the industry was banking all its profits.” But this has not happened. The main culprit preventing carriers from reaping their rewards has been the cost of fuel.
“The high fuel price is completely driving the problem because the revenue environment has been strong,” says Pearce. The industry has gorged on good traffic volume while fuel surcharges are sticking in most regions. Moreover, carriers have been tackling their previously bloated cost bases with considerable success. IATA expects its members to shave 4.5% from their non-fuel-related costs this year, an improvement over the 3% trimmed in 2004. And there is more to come. “Without the rise in oil prices, this would have been one of the most profitable times,” says Pearce.
However, at the global level the industry continues to be dragged down by an oil price that has not only remained at historically unheard of levels, but has climbed well past the predictions of most analysts. In addition, the continuing woes of the US majors cast a long shadow over a business that has undergone such great change since the turn of the century.
With net losses of over $10 billion in 2004, the dire performance of North America’s airline industry easily cancelled out positive results in every other region. Globally, among the top 150 carriers, the industry lost $3 billion. It is of relatively small comfort that this was an improvement over the $6.7 billion lost in 2003.
Asian Tigers
While the overall result sees an industry in the red, there are huge regional variations. The Asia-Pacific region, in particular, has recovered spectacularly from the 2003 SARS epidemic. The region’s carriers made a collective net profit of $4.4 billion.
As the latest Flight International Top 50 financial ranking of the world’s airlines shows, carriers from this region posted some impressive results. Produced by sister magazine Airline Business in conjunction with sister online news and data service Air Transport Intelligence, the ranking shows that every single carrier from the region in the Top 50 made an operating profit. Only China Southern slipped into the red at the net level.
A deeper analysis of the top 150 airline groups by Airline Business saw nine out of the top 20 carriers with the highest operating and net profits coming from Asia-Pacific. Garuda Indonesia was the sole carrier from the region among the top 20 worst performers in terms of operating or net losses.
Buoyed by traffic volumes that rose by nearly 20% for the region as a whole, Asia-Pacific carriers cashed in with robust hikes in revenues. Chinese carriers again led the way, with Air China and China Eastern seeing their income rise by around half in 2004. Others, like Cathay Pacific and Malaysia Airlines, had rises of over 30%.
There is the expected change at the top of the financial ranking. The world’s largest airline group is now officially Air France-KLM, which is reported as a merged entity for the first time. This new leader is followed by Lufthansa and Japan Airlines. The US majors did post some decent revenue rises on the back of traffic that grew by just over 10% last year, but their dominance of the business in terms of pure size is waning.
Two of the few carriers that saw revenue falls among the top 50 in 2004 were troubled Alitalia and Swiss International Air Lines. Alitalia is struggling to restructure its cost base and balance sheet in the highly competitive Italian market, while Swiss is hoping that a new future under the wing of Lufthansa will help restore its fortunes. Both slumped to hefty losses in 2004.
Alitalia is typical of a flag carrier that has seen its traditional traffic base mauled by low-cost carriers. This is a sector that continues to see a host of new entrants, across all regions. The big are getting bigger too. Europe’s Air Berlin and Ryanair, which were bubbling just under the top 50 last year, have, as expected, broken into the chart. With their focused business model and lack of legacy costs, low-cost carriers are among the most profitable as well. Ireland’s Ryanair and Brazil’s Gol were the only two airlines among the top 150 with operating margins exceeding 20% in 2004.
Fares war
The largest low-fare players in North America – JetBlue and Southwest – could not boast such heady margins last year, but in the face of a continuing fares war in the USA and escalating fuel costs they managed to remain solidly profitable. The same cannot be said for any of the US major carriers. The most spectacular loss in 2004, at over $3 billion, was that of Delta Air Lines which lost its battle in September to remain out of the protection of the US bankruptcy courts. It filed for Chapter 11 on the same day as Northwest Airlines, leaving American as the only US major never to have gone into bankruptcy.
Spiralling fuel costs have nullified attempts to turn around the fortunes of US carriers. “The fuel bill itself will rise by $10 billion in 2005,” says David Swierenga, an independent aviation consultant and formerly the chief economist at the Air Transport Association, the US airline lobby group. “Without that increase I think the US industry would have been on track to a break-even year. Carriers have made a lot of progress, but rising fuel costs have undone all of their efforts,” he says.
There have been steps in the right direction. “What carriers have done with labour is pretty remarkable,” says Swierenga. “Although labour cost per employee has not come down it has reached a plateau, so is no longer rising at the rate it once was. In addition, by almost any measure productivity is improving. That’s where you find the real gains have been made to reduce unit costs.” And there is more to come. “Even the productivity achieved by the legacy carriers still does not match that of the low-cost carriers like Southwest.”
The high cost of fuel may have slashed away at carrier profits in the USA, but equally the low price of tickets has hurt, too. Load factors for US airlines may be running at record highs, but the pressure on prices has been downwards. This could be changing a little, says Swierenga, with a 5% yield increase being seen recently. “In the last few months we have seen prices rise. It is nothing spectacular, but is a real positive to me and shows that finally some carriers are able to raise prices.”
Looking ahead, the tough times will be hard for several US carriers to shake off. It is still too early to say how long Delta and Northwest will take to restructure. Both carriers are busy renegotiating aircraft leases and employee contracts under Chapter 11. United is finally planning to leave the relative safety umbrella of bankruptcy after 38 months in February.
During such troubled times, the talk is often of consolidation between carriers. Continental, Delta and Northwest, for example, already work together in domestic marketing. “The question is whether if they had a closer relationship they would be able to boost revenues and cut costs to make the hassle of the combination worth the effort,” says Swierenga. He doubts whether it is: “I just don’t see it as a high priority for anybody.”
Fuel factor
What all carriers are praying for is lower fuel prices, which have gone as high as $70 a barrel. Over the past 10 years the average barrel price was $21, says IATA. As a proportion of total costs, fuel has leapfrogged labour as the largest single outlay for carriers. In 2003 it was just 12% of total costs for IATA carriers, says Pearce, which contrasts sharply with the 24% it represents today.
Most analysts predict that oil prices will edge down in the coming year, but not by all that much. Estimates range that the price per barrel will be from $40-60 for 2006. “There will only be small progress on fuel prices in 2006,” says Swierenga.
For the US market he expects “the gains will come on the revenue side of the equation. Traffic will continue to move ahead with the growing economy and fares will rise slightly. I am looking for at least a 5% boost in revenues while costs, especially with declining fuel prices, will only increase by 1-2%. This leads the industry to an operating profit and a net loss of $2 billion. The key really is if we can get to $50 crude by the end of 2006.”
On a global basis, and in the light of skyrocketing fuel prices, IATA has once again revised its industry loss forecast upwards. It is now predicting a loss of $7.4 billion based on an average oil price for 2005 of $57 a barrel. “Oil is once again robbing the industry of a return to profitability,” IATA director general Giovanni Bisignani has said.
The regional picture on profits is mixed. While European airlines are expected to break even and Asia Pacific carriers will make in the range of $1 billion, losses by North American carriers could exceed $8 billion, says IATA. Cumulatively, airline industry losses for 2001-4 were $36 billion, $32 billion of which was lost in North America.
For economists, one of the chief worries about the high price of fuel is whether it will dampen growth. Up until now these concerns have been unfounded. “The first half of the year saw pretty strong passenger growth,” says Pearce. “Commentators have been surprised by how robust economies have been.”
But the slowdown may have arrived. After seeing international traffic numbers rise by 8.3% for the eight months to August, the rate for August alone fell to 6.1%. This is the first month during 2005 that passenger traffic has slowed. On the other hand, the cargo market has already softened. IATA expects cargo growth to fall from 12% in 2004 to just 3%.
However, this should not be a boom-and-bust cycle. “I think that while there is a general economic slowdown, what I am not looking for is a recession,” says Pearce. Traffic growth rates will slow, but they are not expected to be negative. But IATA has toned down its traffic forecast for 2006. Originally, its guidance was for 5-6% growth. This could fall to 4% or less as the effects on economic growth of high oil prices feeds to demand, says Pearce.
It is too early to assess how this new environment will affect aircraft orders. The growth spurt in traffic of 2004, followed by the solid performance of this year has seen confidence flow back into the manufacturers, lessors and financiers alike.
The turnaround in orders for some aircraft types has been remarkable. Less than 18 months ago the outlook for new Boeing 767 or 747-400 sales looked grim. But increased international flying and a demand for large capacity aircraft from the cargo sector have given a new lease of life to both types.
Order boom
Carriers from China, India and the Middle East, and those from the low-cost sector, are willing buyers. A liberalising Indian market is stirring an order bonanza both among start-ups and incumbents while the battle for market supremacy between Emirates, Etihad and Qatar Airways means that orders from the Gulf region continue to pour in for both Airbus and Boeing.
Lessors also returned this year in a big way as their confidence in the market returned. International Lease Finance and GE Commercial Aviation Services ordered more Boeing 737s at the Paris air show in June, as well as Boeing 777s and Airbus A350s, respectively. CIT Aerospace ordered Airbus A320s and A350s in August. This US lessor has recognised the improvement in the aerospace sector. “Demand from our clients for new aircraft is strong and growing, and rental rates have rebounded nicely,” says Rick Wolfert, vice-chairman of CIT Commercial Finance.
For those supplying the airline business, as well as those providing and managing it, the hope is that this demand will not weaken too much. Alongside this the most optimistic hanker for a chain of events that will peg back oil prices and allow carriers the luxury of respectable profits. The pessimists see more of the same, with the risk of airline failures and consolidation pressure on the rise.
MARK PILLING/LONDON
Source: Flight International
