Kevin O'Toole/LONDON
Two years ago, the world airline industry swung out of recession in style, producing its best-ever set of profit figures. The question for 1996 was whether the recovery would continue to gain pace or whether this now represented the peak for this latest business cycle. In the event, figures for 1996 look more like plateau than progress.
If anything, the industry's profits slipped slightly over the year, as confirmed by the results from this year's Flight International Top 50 ranking of the world's leading airline groups. On a rough calculation, the carriers' collective operating margin dropped by almost one percentage point.
While some are clearly making the most of the boom, including spectacular performances coming from the major US carriers, the industry as a whole is still finding it difficult to throw off the last traces of red ink. Despite being two years into recovery, there are actually more groups within the Top 50 showing an operating loss for 1996 than there were in 1995.
The figures come with the usual warnings about variations in accounting standards around the world and the impact of currency fluctuations - not least 1996's steady rise in the US dollar. The ranking is also based on group results, including non-flight operations and other businesses, although this arguably gives a clearer picture of overall corporate health. Certainly, the leading 50 groups represent the majority of sales within the world industry, essentially covering airlines with annual sales of more than $1 billion.
The lacklustre results tally with preliminary findings from the International Civil Aviation Organisation (ICAO). It gives a tentative estimate that, despite strong traffic growth, operating margins dipped to 4.3% in 1996, having climbed to a high of just over 5% in 1995.
If there is some encouraging news, then it comes from evidence that the good housekeeping carried out during the recession in reducing debts and slimming down costs is beginning to show in a steady stream of net profits, which are calculated after financing costs, charges and taxes. The Top 50 ranking shows the net result virtually unchanged, at around $4.4 billion. ICAO has yet to calculate the net profitability for its members, but is optimistic that there will be an overall improvement, thanks to lower interest charges, stronger balance sheets and fewer restructuring charges. Those factors should help to raise the net result again in 1997.
Preliminary results from the International Air Transport Association (IATA) paint a similar picture. Its member groups saw a dip in corporate operating margins, but lower financing charges helped add $1 billion on to net profits, taking the total above $5 billion (see graph, P38).
These figures, representing a net margin of under 2%, remain less than encouraging for an industry in the midst of a boom, however. It is worth noting that, after two years of record profits, the industry still shows a net deficit over the last decade of around $6 billion. In fact, the profit margin has not been in double figures since the highly regulated days of the mid-1960s, apparently unable to climb above the 5% mark for more than 30 years.
After the promising results for 1995, the hope had been that the industry would finally break free of this apparent ceiling and go on to achieve a new sustainable level of profitability.
From the start of the year, IATA admitted that the 1996 result was going to be too close to call. After having posted $5.1 billion in pre-tax profits for international services in 1995, the cautious prediction was for anywhere between $4-8 billion in 1996. That depended on what happened to the delicate balance between yields and costs. In the end, the result was $4 billion. This initial prospects for 1997 are for $4.4 billion - a slight recovery, but nothing exceptional.
Familiar plateau
For those who study industry statistics, the plateau looks depressingly familiar. Airline profits have tended to move swiftly in line with the world's general five- or six-year economic cycles, plateauing at the peak for two or three years before tailing off. On this basis, the concern is that the industry may now already have already reached its peak.
Much, however, hangs on the vagaries of the world economy. That has been growing steadily since the depths of depression in 1991. Last year world growth reached 3.8% in real terms and appears to be gathering pace so far this year, taking it back close to the peak of the boom in the late 1980s. Best estimates suggest that the slowdown could still be a few years away, perhaps early in the next century.
ICAO's latest long-term forecast suggests that world passenger growth rates should pick up over the next ten years to average 5.5%, against 5% over the last decade. Growth on Asia/Pacific routes is expected to continue to outstrip the average, at 8.5%, but elsewhere around the world honours are about even, with most regions expected to average somewhere in the 4-5% range.
Passenger markets have certainly been buoyant over the past year or so. IATA estimates that traffic on international scheduled services soared by more than 9% in 1996. That was one percentage point ahead of capacity growth, despite the round of fleet re-equipment, so allowing load factors to reach an all-time high of 69%. The reason that profits failed to follow suit comes down to the simple fact that the 1% fall in unit costs was unable to keep pace with a 2.5% decline in yields. In part, the industry was unlucky. A sharp mid-year rise in oil prices pushed up the cost of aviation fuel by one quarter. For many non-US airlines, the misery continued with the rise of the dollar, adding to operating costs and debt servicing. The compensation of a rise in dollar income was little comfort. The pattern is the reverse of 1995, when yields had risen for the first time in four years, while costs have remained virtually unchanged.
Profit prospects for 1997 hinge on airlines being able to repeat this performance, stemming the erosion in yields while continuing to keep costs under control.
Meanwhile, the outlook for traffic growth remains strong. So far this year, IATA reports that international passenger growth is continuing unabated, and that load factors had hit the 70% mark over the first four months.
If there are concerns, then they centre on the fear that the airlines may be tempted to indulge in a bout of ill-advised expansion. It was more or less at this point in the last cycle when the industry began to whip itself into a frenzy of aircraft ordering, only to be hit a couple of years later with market recession and a heavy bill.
So far, the airlines have been relatively restrained, keeping capacity in check. The number of aircraft orders has begun to take off after the drought of the early 1990s. Over 1996, the jet-airliner fleet grew by only around 150 aircraft after retirements to stands at nearly 12,600 aircraft. The ordering over the year, however, climbed close to 1,000 units. Concerns are beginning to surface over the need to keep expansion in check this time around. ICAO notes that, while load factors have continued to rise, the growth is beginning to level off - giving this as one of the reasons for the fall in yields during 1997.
IATA predicts that capacity could even begin to grow ahead of traffic this year. Director General Pierre Jeanniot issued a memorable warning earlier this year against adding excessive new capacity, advising that "-it is harder, but sometimes smarter, not to buy aeroplanes".
There are factors likely to help smooth out the ordering cycle this time round, including more responsive lead times from manufacturers and the likelihood of a gentler movement in the world economy. Not least, there is the memory of the excesses of the last recession, although it remains to be seen how long that continues to exercise its influence.
Reshaping the world
The market is also going through some serious structural shifts in the wake of deregulation. The formation of global alliances is already beginning to reshape the industry worldwide and more is promised.
The Lufthansa/SAS/United Airlines pact has for the time-being taken the initiative with the creation of the Star Alliance earlier this year, cementing relations with Air Canada, Thai Airways, and later with Varig.
A giant rival is under construction by American Airlines and British Airways. The process of passing anti-trust approvals has been protracted, but the partners should at the latest have the deal in place for their 1998 summer schedule. BA brings with it the Qantas link and its partners in Europe, while American has a stake in Canadian Airlines and has agreed a deal with Aerolineas Argentinas, sparking talks with Iberia.
The alliances could well progress further, especially in Asia. Japan Airlines is talking more openly about the potential for a tie-up with American, and its rival All Nippon Airlines (ANA) has been in discussions with the Star Alliance partners, although it says that it is keeping options open. SAS partner British Midland and Lufthansa's links with South African Airways could yet entice those carriers towards an agreement. Air New Zealand is also working closely with United, and could bring with it an even greater prize via its own new three-way tie-up with Ansett and Singapore Airlines.
Elsewhere, Swissair has been attempting to bring together a third grouping with Austrian Airlines, Delta Air Lines and Sabena, while KLM is building on the Northwest Airlines link, with Air UK and Kenya acquisitions.
If the deals can be tied up, these groupings would together account for close to half of the Top 50 airlines and control not far off half of the world scheduled passenger traffic.
In short, the strongest airline groups are beginning to take advantage of freer world markets to build around themselves powerful global networks. There already seems to be some evidence of a widening gap between the large and increasingly profitable carriers at the top and the smaller flag carriers, which are having to consider their traditional stand-alone role.
The major US carriers, resurgent from their long bout of restructuring and cost-cutting, are clearly helping to set the industry pace. American, Delta, Northwest, United and the perennially profitable Southwest are turned in double digit operating margins for 1996 - the sort of level required by the whole industry if it is to appeal to investors.
Continental, too, is up with the leaders, after its dramatic transformation from one of the poor relations, and US Airways is not far behind. Of the Chapter 11 bankruptcy survivors, only Trans World Airways (TWA) continues to languish.
The only other major airline group outside the Asia/Pacific region which can report similar margins is, perhaps unsurprisingly, BA.
With restructuring charges now mostly out of the way, net profits also flowed in earnest during 1996. Excluding Delta's restructuring charge, the top ten US carriers made collective net profits of $3.3 billion, even after accounting for TWA's losses. The result comes largely as a result of a buoyant US economy and a roaring air market. Even a mid-year rise in fuel prices and re-imposition of the US federal ticket tax appears to have failed to stem the flow of profits.
The 1996 figures hold their warnings for the top ten US carriers. Unit costs rose by close to 4%, partially because of fuel prices, but also because of a wave of expansion. Yields grew, but by only around 1%, and have come under pressure through the rise of the dollar, especially against the Japanese yen.
Early figures for the first six months of this year show that traffic is still growing steadily. Profits remain largely on track with further improvements still to come from carriers such as US Airways.
European improvement
Europe, too, should see some better results this year after a dismal performance in 1996. The Association of European Airlines (AEA) estimates that its members dipped back into the red, making a small collective operating loss of around $100 million on their main international routes. This compares to a profit of just under $1 billion in 1995.
The industry was badly hit by the fuel increase, which the AEA estimates added $700 million to costs, and whittled away what should have been a significant improvement in unit costs to only 0.5%. At the same time, yields fell. Passenger yields were down by around 2.3% in local currency terms - otherwise the fall was over 4%, given the strength of the US dollar.
Heavy discounting in the increasingly competitive European air market drove down fare levels. Much of the region, including France and Germany, were suffering from a mini economic downturn as governments tightened finances ahead of the single European currency.
Nevertheless, traffic continued to forge ahead. International air traffic increased by nearly 8% and load factors stayed above 70%. The traffic growth has been running even higher over the first few months of this year and, with economies back on track, there seems to be a good chance of majors such as KLM and Lufthansa recovering their poise in 1997.
After three years of painful restructuring, Europe's state-owned flag carriers are also beginning to re-emerge from their losses. Iberia turned in a net profit, as did Groupe Air France, although continuing losses at its strike-hit regional sister company Air France Europe dragged the group result into the red.
The SAir/Swissair group also put aside a hefty sum to cover the write-down of its holding in Sabena and a little extra to give room for further trimming of its own operations. Sabena itself presented dreadful losses after providing for its own restructuring, but promises to work back towards profits in 1998.
Alitalia, too, is looking in better shape, posting a modest profit for the first half of 1997 and is now increasingly optimistic of making it back into the black by the year end. The group has already begun its restructuring, having agreed a package with unions a year ago, and finally won European Commission approval for its state-aid application earlier this month.
Patchy Asia/Pacific profits
The Asia/Pacific carriers joined Europe in a patchy profits performance. Traffic growth is still running in double figures, but the region is beginning to experience some of the familiar pressures of rising costs, increasing competition and heavier debt burdens familiar to carriers in less booming regions. Overheating in several of the key economies has not helped, especially since around half of traffic for the Asia/Pacific carriers comes from routes within the region.
Korean Airis a case in point. Rising fuel charges and the impact of a strong US dollar on its debt burden sent the group into losses, while tightening up of the South Korean economy sent yields plummeting. Asiana, its fast-growing rival, also slumped to losses, forcing the group to postpone plans for a stock-exchange listing. Elsewhere in the region, Philippine Airlines and Garuda remained in losses, albeit with better news from Thailand and Malaysia.
Japan's major carriers have also found it difficult to shake off the lingering effects of the country's recession, despite signs of an upturn in 1996. Although All Nippon Airways swung back to profit, Japan Airlines reported yet another loss, but the carrier has promised to reach break-even this year as its restructuring grinds forward.
Even Singapore Airlines and Cathay Pacific, two of the world's strongest profit performers, found the going tough as costs rose and yields continued to erode. Both took a small dip in operating margins, though they remain leaders among the Top 50.
Elsewhere, China's airlines are beginning to emerge onto the world scene with a string of public listings. China Southern is climbing up the Top 50 with heady growth rates. China Eastern and others are not far behind. They perhaps are among the few who will not have to worry too much about filling capacity.
Source: Flight International
