Results from 2006 were as expected and the 2007 outlook is bright, writes Chris Tarry of CTAIRA.
The airline "results season" in North America and Europe is now well underway and predictions are generally in line with market expectations.
Reported results, however, only provide a partial guide, with management comments often yielding a more important insight into the future.
In the USA, management observations range from that of Southwest that the outlook is favourable and that it hopes to exceed its 15% target for earnings growth, to American and United's expectation of continuing positive momentum. Then there is Continental's "there's a lot more work to do" and Northwest's desire to "complete restructuring". Overall, however, there appears little to suggest that predictions of a return to net profitability in 2007 will not be met.
In Europe, management at both easyJet and Ryanair increased their predictions of performance for 2007 on the basis of the most recent quarter's experience. Elsewhere, the results from SAS were better than generally expected and although its management sees no signs of a slowdown in either the economy or the airline market, concern is expressed over the strength of growth and the "future competitive situation".
As expected, third quarter results from British Airways were affected by events in December. The final quarter's results, to be announced in May, will be hit by the threatened strike action by cabin staff, which was averted at the last minute. The staff newspaper suggests that there will be no staff bonuses this year - which may pose an issue.
Results from Air France-KLM were much in line with expectations. An area of disappointment was cargo where the "competitive situation remained highly aggressive".
On first sight, there is no reason to doubt the view that the outcome for 2007 will be better than that for 2006. At a global level this suggests an operating profit in excess of $10 billion, pointing to a margin of a little over 2%. Clearly there will be a range of outcomes, but the inescapable fact is that very few airlines will generate a return greater than their cost of capital (at least 8%). As a result they will be destroying shareholder value. Furthermore, few will be earning returns sufficient to enable them to fund their activities. If this is as good as it is likely to get and 2007 represents the peak year of the earnings cycle, it will, by definition, be downhill after then.
Important factors to bear in mind include:
Fuel: Recent headlines suggest that oil prices may fall to $30 a barrel later this year. Clearly this will support economic growth, although attention will inevitably focus on the validity of fuel surcharges, which appear to exhibit a degree of reluctance to move downwards. Overall profits will clearly benefit, although such increases will depend upon the nature and extent of fuel hedging by individual airlines.
Labour: Improvements in the financial performance of airlines almost always result in a change in the managerial balance of power. Not only is it more difficult to demonstrate the need for cost savings to the workforce, but the damage caused by disputes is greater. Furthermore, unions like to remind management of comments made about sharing gains in more profitable times. Although not universal, there is evidence both of less amenable work forces and the prospect of deals that will require real and meaningful increases in productivity to make them cost-free.
On the other side of the equation the economic outlook remains relatively favourable although forecasts are generally for lower growth than in 2006 - lower than was expected a year ago. Furthermore, with one or two notable exceptions (including the US) consumption is forecast to grow more slowly than GDP and increasingly the major element of air travel - leisure - reflects consumer preferences.
Changes in the so called geopolitical environment are another unknown and here the major risk appears to be in the Middle East and the increasingly strident US stance on Iran. While serious diplomatic efforts are now being made to avoid war, escalation to an exchange of more than just words would mean a predictable outcome for the airline industry.
Apart from possible developments in the Middle East there seems to be little to change the view that in earnings terms 2007 will be better than 2006 for many airlines. But the returns are likely to fall short of what is required and further improvement into 2008 and beyond looks unlikely.
Source: Airline Business
