IATA now projects industry profits will go down in 2008 as the credit crunch starts to bite
Many of the world's carriers turned their highest profits of the decade in 2007 but the celebration has been muted by a looming downturn.
IATA in mid-December dramatically lowered its industry profit forecast for 2008 from $7.8 billion to $5 billion. With $5.4 billion expected to be the final profit tally for 2007, all signs now point to a peak of the cycle that has just passed by.
"2007 looks to have been the peak of the cycle for both profitability and traffic," says IATA chief economist Brian Pearce. "Our outlook for 2008 is looking markedly more gloomy."
Carriers may find this hard to believe. In reporting record third quarter profits, several carriers said they saw no signs of a slowdown and that forward bookings remain very strong (see p56-57). But Pearce responds "there is always a lag in these things" and "we expect to see a softening in the New Year".
In addition to a likely softening of demand in early 2008, many carriers' fuel hedging programmes expired at the end of 2007, Pearce warns. "That insurance is expected to drop away but we still see oil prices that are very high."
IATA expects its members will still pay an average of $78 per barrel in 2008, up from $72 in 2007. Six months ago IATA was projecting an oil price of $60 for 2008 and that profits would go up to $9.6 billion. The latest spike in oil prices added $14 billion in costs, driving up the industry fuel bill to $149 billion. Back in 2003 the industry's fuel bill was only $40 billion.
But the gloomy forecast is not really driven by oil prices - after all, the industry posted a relatively healthy operating margin of 3.3% in 2007 despite record high oil prices. It is more driven by the US credit crunch. As a result, this downturn will disproportionately affect North American carriers.
North American carrier profits are now projected to be $2.2 billion in 2008, compared to $2.7 billion in 2007. Pearce says this drop is especially challenging to US carriers because their net debt to cash flow ratio is still "uncomfortably high". He adds US carriers may find it difficult to finance long overdue fleet replacements in this environment and will likely have to turn to the leasing market "as a way forward".
The impact of the credit crunch on Asia and Europe will not be so pronounced, with profits in both these regions projected to fall only $100 million compared to 2007 levels. Pearce says "Europe is looking more robust than the US" and is being buoyed by continued strength in Asia-Europe markets. Those European carriers with more links to the US market will be more impacted than others.
Pearce is also relatively bullish on Asia, where profits already have been on a slow downward slope since 2004 due to tremendous capacity gains in the region. Profits in the Middle East are expected to be stable and in Latin America they are projected to go up by $100 million.
Overall, Pearce emphasises the outlook is not nearly as gloomy as the credit crisis of 2000. Pearce expects a "dip" rather than a "drop" and "not a recession but a slowdown". While "his crystal ball is rather foggy at the moment", he thinks profits will go back up in 2009.
"It will be a short-lived downturn," Pearce predicts. "We see a renewed upturn in 2009."
He explains it is encouraging that central banks are trying to keep the current credit crunch from becoming an economic crisis by raising interest rates and that private banking institutions are raising capital. "But this situation is unusually uncertain," Pearce adds.
What is most discouraging, according to IATA, is that the peak seems to have passed without the profits of previous cycles. The industry was collectively in the red every year from 2001 to 2006 and the 1997 peak saw a much healthier 5.6% operating profit margin. "We saw the cycle peak before airlines were able to repair their balance sheets," Pearce says.
Adds IATA director general Giovanni Bisignani: "The peak of the business cycle is probably over and something we shouldn't forget is we are still $190 billion in debt. So we could be headed for a downturn with little cash in the bank to cushion the fall."
Pearce: "2007 looks to have been the peak of the cycle"
Source: Airline Business
