Airline finance managers attending this year's International Air Transport Association (IATA) finance summit in New York could have been forgiven for feeling a little brow-beaten by the end of the conference. Time and again, a speaker kicked off his presentation with an all-too familiar chart that showed airline finance results zig-zagging wildly between highs and lows and a second slide that highlighted the tendency, even in good times, for airlines to under-perform the market.
So what's new? Many carriers, but especially the US majors, might well respond that a great deal has changed. Since the last, catastrophic, downturn in the early 1990s, they have learned many lessons - cost control, market share discipline and the use of yield management systems. That appears to have paid off, with most of the majors, certainly in the USA, turning in their most most profitable run ever.
But those same airlines still struggle to convince investors, financiers and insurers that they are a good bet. Even more difficult is the task of persuading the finance community that they now have the know-how and the discipline to ride out the next industry downturn relatively unscathed.
Sitting in the heart of the world's leading financial centre, airline finance managers also might not have overlooked the irony of their situation. At the same time as Wall Street analysts were telling them why they are regarded as a bad bet, the NASDAQ and the Dow were rollercoastering into a bear market largely triggered by over-enthusiasm for the "virtual profit" dot.com companies that sprout up daily and appear to possess - at least until mid-April - no limits to their investor appeal. So what is the trick that airlines are missing in their efforts to win over Wall Street?
Here, the conference speakers were more helpful. IATA director general Pierre Jeanniot led the way by pointing out a hard fact - regardless of the dot.com trend, profit is still king. "As an industry we have become largely privatised, but we continue to ignore a fundamental truth - that the one major reason why private capital makes investments is profit," says Jeanniot.
"Although lack of profitability may not have mattered in an over-regulated and government-ownership past, it certainly does matter today and will even more so in the future."
Profits warning
Jeanniot then gets to the heart of the matter by revealing the latest set of financial results, collected by IATA for the international operations of its members. On the surface the operating figures are encouraging: international traffic increased by 6.9%, running more than a full point ahead of the 5.5% rise in capacity. Unit costs also declined, by a solid 2.1%. But then came the damage as average yields slipped by 4.1%. That left the industry showing net profits of $1.9 billion, against $3.1 billion in 1998.
Based on figures collected so far this year, traffic growth of 6% is again expected to outstrip capacity by a percentage and yields will tumble a further 2%. IATA calculates that if unit costs fall by another 1%, depending on fuel costs, then net profits should edge up to close the year at $2.2 billion. Jeanniot points out that this means that the industry over two years has produced a net margin no better than 1.4%of revenues. "Even if all that profit were devoted to rewarding shareholders, it would not set the world on fire," he notes.
He goes on to offer a roadmap to reverse the picture. It includes creating consistently less capacity than the market forecasts; improving yields in a good economic environment by 3-5%; ensuring that at least half of any cost reduction is devoted to improving the bottom line; resist chasing traffic growth at any price; and putting the shareholder at the top of the priority list for rewards rather than at the bottom of the food chain.
Such a plan, rigorously adhered to, ought to massage profits into better shape. But, as the wave of interest in high-tech stocks illustrate, that is not the end of the matter when courting today's shareholder. As Michael McGhee, managing director, corporate and investment banking at CSFB, makes clear - airlines will have to do more to attract investor interest.
Rewarding risk
With the exception of a few stars, such as US low-cost carrier Southwest Airlines and its European counterpart Ryanair, investors tend to regard the airline industry as risky because it is capital intensive, historically cyclical, highly competitive, vulnerable to cost increases, such as oil price hikes, and typically operates under powerful labour groups and a strange mix of political and regulatory interference that put a leash on profitability.
But airlines do possess qualities that investors like. These include their international brands and great customer reach, as well as good growth prospects and cheap stocks. Even in a regulated environment, with little hope of outright acquisitions, there is the potential for greater efficiencies via "virtual mergers", such as the proposed Alitalia/KLM partnership.
The repeated message of the conference was that, even in a brutally competitive environment, airlines can do much to downplay the bad points and play up the good. In doing so they can attack the root cause of the earnings inconsistency that investors dislike so much. Airline boards might consider, for instance, paying a premium in labour contract negotiations in return for longer-term deals that would erase repeated threats of costly disruptions.
Fuel hedging, although essentially an insurance premium, is also welcomed by the investor as offering longer-term stability. While such measures come at a price, they provide a comfort factor to the investor that everything possible is being done to iron out the worst of the troughs.
Airlines can also box clever in their capital investments. As Sam Buttrick, managing director at Paine Webber, laments: "Regrettably, Airbus and Boeing still charge for their products!" But where the size of the order is right, airlines can sew together deals that give them more flexibility and control over what is delivered when.
Aircraft investments
Some analysts also point to the inherent flexibility of smaller jets, including the regional jet, which permits airlines to think in terms of seat capacity control rather than aircraft capacity control and to transfer blocks of seats between markets easily. Airlines should consider hard their purchase versus lease options.
John Willingham, chief operating officer at lessor Bouilloun Aviation, encourages airlines not only to weigh up the initial options, but also consider sale and lease backs in advance of disposal dates. In weak re-sale markets, he advises, some might want to return leased aircraft and keep their owned fleet; when the market turns around they should do the reverse.
In the discussion over the desire for ever greater control over seat capacity and capital assets, American Airlines won praise for its new plan to remove 7,000 economy seats in both its domestic and international fleet - improving customer service and controlling capacity in one fell swoop.
Several speakers also highlighted the opportunities that the Internet and e-commerce offer. "You have to develop your IT strategy," says Nick Morrell, president of SITA's Americas operations. "This is the future battleground for the global enterprise and it determines your future." Analysts agree that many new investors are looking for signs of a clear IT strategy and a demonstrable plan for unlocking e-business opportunities.
But over and above all these measures, airlines are reminded that they must protect their brands, which is essentially what the investor is putting his money behind. Here, airlines that are moving to differentiate their product and ensure the customer feels he is getting value for money score well.
"Premium revenue has been lost by major carriers where there are not clear service differentiators, especially on short-haul, point-to-point routes," says Peter Morris, director of aviation information research at IATA. "It's about moving from a supply-driven to a demand-driven market."
Source: Airline Business
