IATA is forecasting a further improvement in industry profits in 2007 and 2008. But recent signs point to a downturn sooner rather than later. The "super cycle" many were hoping for may no longer be on the cards and with oil prices rising again, things could get ugly
If only oil prices were reasonable. The industry is almost certainly at the peak of the cycle but profits, thanks to sky-high oil prices which seem to spike every time it looks like they are finally going down, have simply not been substantial enough to weather another downturn. And that is surely where the industry is headed.
IATA in June raised its industry profit forecast for 2007 and 2008 to $5 billion and $9.6 billion, respectively. But its figures are based on oil prices at only $63 per barrel in 2007 and $60 in 2008. Oil prices have increased in recent months and will likely hit $80 this year. While demand is hardly plummeting, there are signs of a possible economic slowdown in the key European and North American markets. As a result, both the US-based Air Transport Association and Association of European Airlines now expect profits will go down, not up, in 2008.
The Centre for Pacific Aviation also expects profits in the Asia Pacific will start cooling off next year. The result is that, contrary to what IATA is forecasting, while global profits may go up slightly in 2007 compared to 2006, they will likely start to retreat in 2008.
US majors are especially cautious. While aircraft are full, bookings are heavy and demand is burgeoning, US airline executives can now plainly see the downside of the slope. Consumers have begun resisting fare increases, fuel will not moderate and the overall US economy, hobbled by overall slower consumer spending and an incipient credit crunch spurred by a faltering real estate market, all point to a slowdown.
Seeing "softening yield" and a "tough domestic revenue environment", Continental chief executive Larry Kellner says the carrier will reverse course and cut 2008 growth to between 3% and 4%, from a previously planned 5% to 7%. Continental is also selling 10 of its Boeing 737-500s and is negotiating the sale of five more. This follows moves by Northwest to sell nine of its relatively young Airbus A319s and Southwest to trim deliveries of new 737s.
As the danger signs appear, it is clear the industry has been enjoying the good times. Last year carriers in the Airline Business top 200 traffic ranking averaged a record 77% load factor. Year-on-year growth in passenger traffic and revenues among the world's largest carriers tempered in 2006 but load factors and yields have continued to improve steadily.
Operating margins for carriers in the magazine's top 150 financial ranking have improved as a result and last year reached 4.2%. But bankruptcies, in particular at US majors, have prevented the industry from banking the net profits they have in past peaks. The industry as a whole was barely in the black last year and while profits will probably improve this year, the likely upcoming downturn could push the industry back into the red sooner rather than later.
At this time last year there was much talk of the elongated or "super cycle". Airline boardrooms are more inclined to believe that normal cyclical service is resuming. In the mature western markets competition is intensifying just as the larger economic picture and consumer confidence steps back for a breather.
With oil prices approaching $80 and a possible slowdown approaching, this is not exactly the best time to launch an airline in these markets. But in the USA that is exactly what some start-ups such as Skybus and Virgin America are doing. So are new long-haul low-cost carriers, which combined with the growth of all-premium carriers will put more pressure on the long-haul operations of network players.
Labour problems also lurk with unions plotting aggressive moves to get their slice of the profit pie. The trouble is the pie is still pitifully small and not ready to rise. The message to labour is moderation. This is not the time for expansive claims and dramatic clawbacks.
If fuel prices were closer to the historical average of around $25 per barrel the picture would be entirely different. But fuel prices are forecast to remain doggedly high. "Fuel is killing us," one chief executive said recently. Even Southwest is cutting jobs to offset rising fuel costs as its hedges start to expire.
As the market slows many in this tough industry will find themselves better equipped than in the last downturn to survive. Excess fat has been chopped away. Many are leaner just as the climate gets meaner. They will need to be.
Source: Airline Business
