Chris Jasper/LONDON
The financial performance of the global airline sector last year raises one very important question: just how ambitious is the modern air transport industry? Because though the sector as a whole was comfortably profitable, the margins it achieved were definitely second-rate. And with the US economy still booming, Europe on a steady upward curve and free of recession, and Asia all-but recovered from its bout of flu, airlines should surely be cashing in after suffering a difficult couple of years.
Relatively few carriers actually did, although Asia, at least, appears to be back on track, with profits up above the world average and revenue growth at 14%. A year earlier it had accounted for most of the major losses, yet even its worst offender, Philippine Airlines, managed to survive. Major Asian success stories included Cathay Pacific, now firmly back among the big profit makers, while Japan also edged back.
The picture was bleaker in Europe, with high capacity growth wreaking havoc. AEA carriers managed pretax profits of just $619 million on international services, down from $2.3 billion.
Air France was Europe's most improved carrier, with rival British Airways the industry's biggest flop, its once bulging profits transformed into heavy losses.
A survey of the industry as a whole shows that net margins stood at around 3.3% at year-end, hardly a significant figure, and even this was artificially high, boosted as it was by windfall gains from the sale of shares in computer reservations systems and SITA subsidiary Equant that were such a distinctive feature of 1999.
Analysis by Flight International's sister publication Airline Business shows that the gains from such disposals totalled $3 billion for the top 20 carriers alone, and with these stripped out the net margin would have been closer to 2%, confirming the airline industry's status as a low-profit industry. The concern must now be that the sector has reached its profits ceiling, and that what appeared to be sustained profitability three years ago actually represented the peak of a cycle.
Operating margins, for example, reached a high of 7% in 1997 before sliding back due to the Asian decline and, later, fuel price hikes, and last year were back to 5.7%, a figure close to that at the start of the current cycle. Figures on core airline - rather than group - operations paint an even bleaker picture, with the International Civil Aviation Organisation quoting an operating margin of just 4.1%, down from 5.4% in 1998, and suggesting that net margins may slip below 2.5% after hovering just below 3% for the past two years. The International Air Transport Association (IATA) states operating margins as 4.5% and net margins as just 1.6%.
Airline analyst Chris Tarry of Commerzbank argues that massive industry overcapacity in the middle half last year compounded problems stemming from the Asian situation and high fuel costs. "Last year was trouble, and you right it off, because there was simply too much capacity," he says. "And if you look at what has followed, the margins are improving for some, but the gains have not been huge."
Tarry points to 'incremental margins', which analyse change in profit against change in revenues, as macro indicators of the approximate operational gearing of airlines. During the second quarter of this year, SAS performed most strongly among European carriers, for example, with a margin of 93.7%. Merger candidates KLM and BA were at 12.9% and 3.4% respectively, and Lufthansa a paltry 2.3%.
Improving yields
The second quarter also showed evidence of improving yields, but these were distorted by currency changes, reducing BA's figure for example, and amplifying the gains of mainland European carriers. When these fluctuations are factored out, KLM's 14.4% increase per available seat kilometre remains a respectable 8%, while Lufthansa's 4.1% is revealed as almost entirely currency-derived.
Fuel costs were a crucial factor last year, and look set to have an even greater impact this year. Jet kerosene prices have risen by 50% over the first six months, and with fuel accounting for 10% of cost, half of the industry's profits could easily be wiped out, even allowing for hedging and currency fluctuations. Fuel supplements therefore seem inevitable: "After all, 4% on a $200 fare is barely the price of a couple of designer capuccinos," says Tarry.
While finances should improve via a better balance between traffic and capacity, slowing the decline in yields, Tarry stresses: "What airlines really need is structural cost cutting".
Source: Flight International
