If current traffic predictions hold true, then Europe should have a relatively easy ride over the coming year or so, despite the spectre of a pending global downturn. Yet, while passenger numbers may hold up, questions remain as to whether the region's carriers are ready for the likely fall in yields and premium traffic.
The latest forecasts from the International Air Transport Association (IATA) suggest that international scheduled passenger numbers in the region will indeed edge down from the current 6.7% mark over the next five years, but still leaving respectable average growth at above 5%. Much of the fall is due to come from an easing of traffic on the main North Atlantic and intra-European routes, but IATA expects that to be offset by a strong rally in passenger numbers to Asia - the forecast is for 1998's dismal 2% growth to rebound to more than 6%in 1999.
So far, so good. But what these statistics fail to show is the declining quality of passenger traffic and its inevitable fall-out on yields. On top of that come concerns over the state of cargo demand, some lingering doubts over seat capacity growth and worries about weakening load factors.
The stock-market performance of many of Europe's major carriers has already begun to reflect such concerns. Since the mid-year mark, airline stocks have been on a steady slide as financial markets fretted over the impact of economic slowdown. By year end most airline shares were trading at close to their historic lows compared with their local market indices.
Even the perennially profitable British Airways has had its share of woes, and followed disappointing recent results with further warnings about declining yields - principally due to a fall-off in business travel. KLM has issued similar warnings, and even the resurgent Lufthansa has seen its share price slip despite doubling profits. The German group had itself warned over the outlook for lower earnings in 1999 and slower growth in prospect. Investors took note and downgraded the stock.
Airline analysts are in no doubt that a downturn is on the horizon. Chris Smith, London-based analyst with SalomonSmithBarney, warns of a "sharp" decline in revenue growth in 1999, with yields falling by around 3%, against a long-term trend of an 2% per year. Chris Avery at Banque Paribas confirms that financial markets "-clearly now expect a deep cyclical trough for airlines". He believes the airline profit cycle peaked in August when BA identified a weakening of demand for premium class, adding that this was a key ingredient of the disaster which hit Europe's carriers in the last recession.
"The first half of 1999 will still be tough," says another London-based analyst, predicting that the pressure on yields and load factors will only ease off in the second half of the year. A large part of the fear is that capacity from Asian routes will continue to appear on the North Atlantic, so driving competition up and fares down.
As slowdown in Europe looms ever larger, analysts are watching closely to see that airlines do not repeat the mistakes of the last recession - in particular, that they manage capacity. Back in the order spree of the late 1980s, airlines racked up 600 new aircraft orders in just three years. As growth disappeared they were left with too many seats to fill and the industry went steaming into the red.
There are some signs that seat capacity is already nudging ahead of demand. Traffic was lagging capacity by around 1% on the North Atlantic as the industry went into the final quarter of last year and by 1.5% on the Asia-Pacific run, according to the Association of European Airlines. Capacity growth is set for around 7% over the coming year, which is already a point higher than the long-run average and significantly ahead of the expected 4.5% increase in passengers, according to SalomonSmith-Barney. Load factors fell slightly in 1998 as a whole, and this trend could worsen in 1999.
Analysts remain cautious about just how ready the region's carriers are to cope with this expected slump. "There are still many who have not reacted," says Avery at Paribas, hinting that the lead may again be set by BA. It was the only European airline to deliver a dividend to shareholders for two successive years during the last downturn. "Those who survive are those who cut hardest," says Avery.
Capacity cutbacksThen, as now, BA has been among the first to take remedial action, slashing its capacity growth for 1999 from 9% to 2%. KLM has also pegged growth at the same level for 1999 (down from earlier plans for 5%) and expects then to grow at around 3% a year. Although Lufthansa announced plans for an 8% capacity increase on long-haul routes this year and 3-4% for short haul, chairman Jürgen Weber quickly followed with a statement that the company's "operational flexibility" would allow it to "-reduce capacity as the market dictates".
Like their US counterparts, Lufthansa and other European majors have been holding onto ageing aircraft longer than planned, to cope with the good times and ready to jettison them in the bad. They also highlight the added flexibility of franchising and wet-leasing deals.
Air France, meanwhile, is planning a 10%growth in capacity for 1999, but points out that half of its 40-strong Airbus order is held in options, while it could also accelerate the withdrawal of its ageing 747 fleet should growth in capacity prove "too optimistic". Having frightened investors with an announcement that it planned to increase capacity by 13%, Swissair also indicated that it could cut back this growth to just 5%.
AlliancesEuropean carriers should be helped by membership of a global tie-ups, which will help allay fears over market share as capacity is pruned. Codeshares in Asia, for example, allowed European carriers to maintain a presence on key routes, while cutting capacity to the region. "Carriers can adjust capacity with their alliance partners," says Frank Wade of aviation consultancy SH&E.
On the other hand, Wade emphasises the disadvantages for those outside a global grouping. "Air France, by operating a global network on its own, is more vulnerable to shifts in the demand of capacity," he says, adding that the airline is particularly dependent on the fortunes of its home market.
It remains to be seen whether Europe's airlines have got their costs down far enough to weather capacity cutbacks and their impact on sales revenues. But the hope is that alliances will help to achieve these twin goals:revenue growth in the near future and cost reduction in the medium term.
KLM, which finds itself heavily exposed on the oversupplied Asian and cargo markets, could find its "saviour" in Alitalia, according to SalomonSmithBarney, which predicts increases in passenger yield, capacity utilisation and cargo traffic as a result of an alliance with the Italian flag carrier.
Lufthansa's impressive recent results were due in no small part to the contribution from the Star Alliance. The DM400-500 million ($235-295 million) boost to revenues will increase slightly in 1999 with new Asian partners Air New Zealand, Ansett Australia and All Nippon Airways, according to the German group's investor relations manager, Stefan Link. Cost savings from Star are expected to start flowing in the coming year as Lufthansa intensifies co-operation at airports and in procurement with its global partners, says Link.
Europe's airlines are not just making hard decisions in the cyclical troughs, but also in the peaks. Most have been implementing cost-cutting programmes ahead of the slowdown. Many are ahead of target, particularly Lufthansa and BA, the latter having recently accelerated its Business Efficiency Programme. Labour costs, however, are a possible problem area - KLM's staff bill rose by 9% in the September quarter, while Lufthansa faces what promises to be a tough pay round after a two year wage freeze.
Some observers question just how well Europe's state-owned carriers will fare in deteriorating market conditions without government help. Those such as Alitalia, Air France and Iberia, all of whom are heading for privatisation in 1999, are now more commercial and are finally profitable despite increased competition.
Alitalia, for example, following its latest capital increase, now has one of the strongest balance sheets in Europe, with a lower debt to capital ratio than its principal quoted European competitors, and a comparable break-even load factor. And, as a result of failing to exploit their potential in the past, carriers which have remained in the public sector have plenty of upside on revenues and scope for cost reduction. "Before, we filled the aircraft without considering the ticket price,"says Alitalia, adding that progress has followed the introduction of a yield management system in 1997. Yields leapt by 8% in the first half of 1998 alone.
Air France is also in a much stronger position. "It has been doing its homework well on cost reduction," says Raphael Bejar at the Paris-based International Aircraft Consortium consultancy. Iberia, meanwhile, has just sealed its alliance with British Airways and American with their acquisition of a minority stake in the carrier.
Yet, despite the new political resolve for privatisations, there is the small matter of attracting private investors, whose nervousness is bound to continue as long as fears of the health of the world economy persist. A number of listings have already been postponed in 1998 and, analysts say, the state-owned carrier's share offerings could also suffer in 1999.
Europe's majors will need to be particularly vigilant about losing out to low cost carriers as business passengers seek out better deals. UK-based British Midland, Brussels-based Virgin Express and Spanair of Spain, are likely to benefit from a reduction in corporate travel budgets, according to Wade at SH&E.
To some extent, the majors have already hedged their bets on this front: BA has launched Go and built a network of franchise partners; KLM has subsidiaries KLM uk and excel, as well as its links with Eurowings; and Lufthansa already has Cityline, which was responsible for turning the carrier's German operations to profit, and has long been studying a new low-cost operation.
Next year will also be a test of whether Europe's fledgling no-frills carriers are sufficiently well-established to tough out their first taste of downturn.
They could stand to gain if business travellers start to watch costs and European tourists swap expensive long-haul holidays for vacations closer to home.
One ray of hope, is that if the airlines get through 1999 relatively unscathed, analysts believe they can go into the new millennium with a much more balanced market.
Source: Airline Business
