Just how bad a situation are the world's leading airlines in? Our survey, based on data from sister publication Airline Business, shows little sign of the gloom lifting
Alexander Campbell / London
American Airlines has just announced a net loss for the third quarter of almost $7,000 a minute - $924 million including special charges - and no one is surprised. In the first nine months of this year, the world's largest airline lost almost $3 billion, on top of nearly $2.5 billion lost last year. But by the peculiar standards of the airline business, American is doing as well as can be expected. United Airlines has made even bigger losses and may soon join other carriers that have been forced into bankruptcy.
Just days after the 11 September terrorist attacks, Flight International published its Top 50 Airlines ranking for 2000. A year later, recession, mismanagement, terrorism and impending war have combined to plunge the air transport sector into its deepest ever crisis. A year ago no one knew how far the industry would fall. That question seems to have been answered and a new one posed: when will the industry recover?
The most dramatic changes occurred soon after the attacks. Three Top 50 airlines - Swissair (number 11 last year), Sabena (29) and Ansett (41) - had collapsed by the end of 2001. For others, the chances of survival remain marginal. US Airways has retreated into Chapter 11 bankruptcy protection and United Airlines is poised to follow. More radical intervention, verging on nationalisation, has saved two more - Air New Zealand and Malaysia Airlines.
Another departure from the rankings is expected for sounder reasons: the merger of Japan Airlines (JAL) and Japan Air System (JAS) will create a single carrier with combined 2001 revenues of $16.9 billion, which would rank it second in this year's Top 50. The merger will not be completed until April 2004, although both already operate under a single holding company. JAL chiefs will be hoping the merger will fare better than last year's amalgamation of American and TWA, which finally gained regulatory approval in May 2001, just in time for the industry slump.
JAL and JAS have a better chance of a successful merger simply because of their location, as the effects of the airline crisis have not been spread evenly. By far the worst affected areas are North America and transatlantic and transpacific routes, with travellers within Asia relatively untouched by the crisis. This is reflected in both International Air Transport Association (IATA) figures and averaged airline results. In International Civil Aviation Organisation (ICAO) forecasts for the next 10 years, Asia-Pacific continues to lead the way (see graph left).
Growth of overall traffic to 2010 will average 4.5%, with Africa and Europe growing at around the average rate. The North American market will lag behind at 3%, with the rest of the Americas growing at about 5%. However, impressive 7% average annual growth for the next 10 years will take Asia-Pacific ahead of Europe, and close behind North America.
There are several reasons for this. Continuing peace in the region and the spread of liberalisation are fuelling sustained economic growth. China seemed to avoid the worst effects of the 1998 Asian economic crisis and is claiming annual GDP growth in the 7-8% range, although the real figure may be nearer 4-5%. The air travel market in Asia is also less mature than in Europe or North America and has more room to grow, except perhaps in the region's most prosperous countries - Japan and South Korea. There is also potential for more growth if and when international aviation agreements are liberalised - a development that still seems far off.
The capacity cuts many Asian airlines made during the 1998 crisis have given them a healthy base from which to grow.
Threat of terrorism
Unfortunately, recent events suggest Asia will not stay on the periphery of the war on terrorism for long. Militants seem determined to weaken national governments by attacking the vulnerable tourist industry, a strategy which could have serious effects in Indonesia, Malaysia, the Philippines and the whole Asia-Pacific region.
The industry trends over the past year are likely to continue, but for different reasons. Last year's decline in traffic was the symptom of a crisis, but in the long-term North America is still set to take a smaller share of world travel, simply because it is the most mature market. The European market will grow at about 4.5%, the world average, ICAO believes. Although the region's economy is unlikely to perform significantly better than North America's, its air transport market has more room to grow. Low-cost travel on the mainland in particular represents an almost untapped area. The Middle East's economic prospects are dubious, meanwhile. Israel's economy, the largest in the region, actually contracted 5% last year due to continuing violence.
Three of the largest regions by passenger traffic - North America and transatlantic and transpacific routes - face not only low long-term growth rates, but an immediate crisis which shows no sign of easing. It is now clear the post-11 September impact is not the same as the Gulf War effect of 1991. Both coincided with a wobbling US economy, and the initial drop in transatlantic traffic was similar at about 25%. But the current crisis not only reaches further, affecting US domestic and transpacific as well as transatlantic traffic, but has lasted longer. For the first time in history, traffic will shrink overall over two years. Only once before - in 1991 - has traffic fallen.
One year after 11 September, the future still looks dark. Airlines are cautious about predicting a bottom to the slump before late 2003 and, according to some analyses, break-even in the US market is not expected before 2005.
In the USA, airline negotiations with labour unions over cost cuts are slow and painful, and federal support is more difficult to obtain than in the days after the attacks. In addition, airlines face the threat of a war on Iraq - a conflict which would not only scare more customers off transatlantic routes, but could provoke more attacks on civil aircraft, as well as risk a rapid and sustained rise in fuel prices, which would increase operating costs further.
US carriers could ill support this. Already, operating margins (see Top 50 table P39) have been hit hard - around the world, but especially in North America. Every US carrier has seen its operating margins fall; all but Southwest are making operating losses. Around the world, only a handful have improved operating margins: only Air New Zealand, Air China, TAP, THY and South African report any significant improvement.
On the cargo side the picture is also poor. Although customer anxiety is much less of a problem, and the take-up of US capacity into the USAir Force Commercial Reserve Air Fleet has tightened the civilian market nicely for the capacity that remains, traffic has still fallen. The root cause is the economic downturn. Cargo volumes tend to be a leading indicator of economic performance: as sales start to fall, manufacturers cancel orders with their suppliers to avoid building up inventory. The continuing fall in cargo volumes (see table right) confirms that world GDP is still far from recovery.
But there are reasons to be more hopeful about cargo than passenger traffic. In the long term, the continuing trend in Europe and the USA towards just-in-time inventoryless manufacturing means steadily growing demand for air freight - well above underlying economic growth. In the shorter term, a war in Iraq will consume far more supplies and require far more air cargo capacity than the war in Afghanistan: this, and the inevitable post-war humanitarian effort, will particularly help the heavy-lift business, currently suffering especially from the downturn.
It is accepted that 11 September exacerbated a crisis that was brewing long before the attacks. While airlines point to long-term traffic growth at roughly twice the rate of economic (GDP) growth, a less welcome trend is the decline in yields.
Misplaced focus
Some analysts believe airline management is guilty of focusing on traffic, while ignoring steadily falling yields. The figures bear this out: over the last six months yields have continued to fall, (see First Half Results table P40) while fleets have changed little (see Fleets table P38). In some cases, even airlines making massive losses - such as United, for example - have continued to add to their fleets. The figures do not include idle aircraft - every jet is flying, adding more underperforming capacity to a still-oversupplied market.
"For at least the last 10 years, airline executives have been obsessed with market share," says airline analyst Chris Tarry. Using market share as a measure of success has driven airlines to buy more aircraft than the market can support. Meanwhile, liberalisation has opened markets to competition, and airlines have reduced fares to prop up market share and load factors. The result is a cycle of falling yields and margins.
Even after 11 September the same strategy applied. Airlines rushed to announce capacity cuts, but often the cuts were either not carried out or soon reversed. "The US majors, excluding Southwest, are now reporting an aggregate capacity reduction of 11% year on year, which is considerably less than the 20% most of them implemented immediately after the terrorist attacks last year," says Chris Avery of JP Morgan. Airlines have been more interested in keeping load factors high than improving the bottom line, he says. "Traffic appears to have roughly matched capacity, but this hides the major problem - the fare cuts required to stimulate even this traffic level."
With management increasingly under pressure to keep share prices high, the move is understandable. Had airlines made deeper capacity cuts, or refused to reduce fares, passenger numbers would have fallen still further and the loss of shareholder confidence in the airline industry would have been even greater than it is today. But airlines might still emerge from this crisis in better shape. Tarry cites the case of the Asian airline industry: "They had their own crisis [in 1998] and made the cuts, and are now in good shape."
The airline industry is also suffering from the chronic problem of moral hazard - the distortion of perceived risks and rewards caused by, among other things, promises of government support. For example, as happened in 1998, if an Asian bank is assured its government will not let it fail, it will make riskier loans at lower rates than another bank lacking that assurance. Airlines around the world work under a similar promise, because national pride is seen to be involved.
Flag carrier failings
To everyone's surprise, last year saw two European flag carriers, Belgium's Sabena and Switzerland's Swissair, being allowed to fail. Their governments were either unable (for reasons of anti-subsidy law) or unwilling (because of the scale of funding needed) to keep the carriers afloat. Further south, Alitalia and Olympic Airways did receive government support, although the European Union in both cases ruled it did not represent a subsidy.
Across the Atlantic, airlines have received $5 billion in US government grants and$10 billion in federal loan guarantees, and are lobbying for another $4 billion. Coupled with the Chapter 11 bolthole, which has no real counterpart elsewhere in the world, the effect is to keep struggling airlines on life support. Protected from creditors, US Airways can offer cheaper capacity. United may soon follow it into Chapter 11, further distorting the US market and making life harder for those airlines remaining outside bankruptcy protection. Most airlines find their way out of Chapter 11 and, with mergers remaining difficult in the USA, the same players look set to continue competing for an increasingly unprofitable and stagnant customer base.
Sluggish recovery
The longer the downturn, however, the more likely it is that carriers will disappear. No one is expecting a rapid recovery. For the US industry, "break-even in 2004 is our current best-case outcome", says Avery. Even the traffic figures will take time to recover. "We expect traffic levels to continue rising slowly throughout 2002, but don't see total passenger levels returning to pre-September 11 levels until 2003," says ratings agency Standard & Poor. Business travel, normally more profitable than leisure travel, has dropped off sharply, due to nervousness about flying as well as the economic slowdown. Even when the economy starts to recover, corporate travel budgets will probably not be relaxed immediately.
After 11 September, the drop in flying meant a temporary fall in demand for aviation fuel, working to reduce prices. The economic downturn also reduced crude prices by lowering demand. But crude and fuel prices are now at or above last September's levels, and tight supplies and the risk of war mean they could go higher still. Fuel represents 11-15% of an airline's operating expenses, and a rise in fuel costs, if sustained, could push profitable airlines back into the red next year.
Security costs will stay high and will not be easily reduced. They may even be increased, for example, if a terrorist attack using a shoulder-launched surface-to-air missile leads to airlines installing decoys or jammers on their aircraft. More generally, terrorist action would hit the tourism industry hard, cutting leisure travel still more.
Describing the current airline crisis as a downturn is misleading. It implies a dip in the standard business cycle that will soon be reversed. But the industry is not in the normal course of affairs, and probably never will be again. Many of the factors causing its troubles are not cyclical, but permanent - they cannot be ignored and ridden out, but must be confronted and overcome. Airlines must realise that today's gloom, and not the halcyon days of the late 1990s, represents the new definition of business as usual.
Source: Flight International
