Fuelling concerns
The spectacular rise in fuel prices in the past four years has almost single-handedly robbed the industry of meaningful profits in what should have been the boom times. The industry has seen its fuel bill close to treble.
Average fuel prices are expected to ease in 2007, from $66 a barrel to $61, but will remain at 26% of operating costs, says IATA's Brian Pearce. Carriers have managed to claw back on average 50% of fuel cost increases through surcharges, and as oil prices ease in 2007 surcharges will reduce as well.
In an uncertain world, it appears that economists are pretty certain about one thing: global economies are slowing, but prospects of a market crash are thankfully faint. "Nobody sees global recession, which is why there is no actual fall in growth," says Brian Pearce, IATA's chief economist.
However, the brakes on industry growth are being steadily applied. From a high point in 2004, when passenger traffic soared by 13.8%, growth has been slowing (see chart on p29). Since then it has cooled to 8.2% growth in 2005 and around 5.5% last year. Importantly, this is about as far as it goes. IATA still predicts a 5% rise this year, while ICAO has a more optimistic 5.8% hike.
More worryingly, revenue growth is heading in a similarly downward trajectory. "The booming revenue conditions of the past two to three years is coming to an end," says Pearce. "We forecast, because of the slowdown in the US economy, airline revenue growth will slow from 8% this year [2006] to just over 4% in 2007." This is a sharper slowdown than IATA predicted in mid-2006, when it was looking at revenue growth of 6.5% for 2007.
Pearce does not believe in a "super cycle" of extended strong economic growth as some like Boeing's marketing guru Randy Baseler argue. The industry is more likely to see a "soft landing" with fairly benign economic conditions, says Pearce. That is the best to hope for, it seems. "At the moment we should have confidence we will keep continuing with this slow progress," he says.
Tougher environment
But this will not soften the impact on industry profits, which have been recovering. "It will be a tougher environment for the industry to improve profitability in 2007," says Pearce. "The point of concern is that the rise in fuel prices has eaten away at that revenue boom."
The industry is expected to record a $10 billion operating profit for 2006, which gives a 2.3% margin, but will stall at this level this year as growth slows, says Pearce. At the net level, IATA believes the final 2006 figures will show an industry almost returning to breakeven with a $500 million loss.
Airline Business figures for the Top 150 carriers ranked by revenue, which include low-cost carriers that are mostly not IATA members, showed the industry virtually at breakeven in 2005. This excludes the mammoth $20.6 billion restructuring charge United Airlines booked in 2005. The final result for 2006 will almost certainly show a net profit when the full Airline Business ranking is produced in mid-year.
The lack of low-cost players means that IATA's forecast for the industry's first net profit since 2000 lags by a year compared with the Airline Business figures. But the $2.5 billion it expects is still "peanuts", says IATA director general Giovanni Bisignani. "It is a margin of 0.5% on $450 billion of revenues."
To pay the cost of capital and see a return, the industry needs a margin of at least 10%, notes Bisignani. The industry has consistently failed to meet this challenge. Even during the last peak, in 1996-7, the industry's net margin only just topped 3%.
The region that will improve its profitability most in 2007 is expected to be the USA. "Conditions are much improved, and the initial economic outlook for 2007 is the most promising in years," says John Heimlich, chief economist at the Air Transport Association of America (ATA). "In addition to a healthy revenue environment, US airlines are seeing the results of painstaking, ongoing cost reduction efforts and balance-sheet repair."
Some $6 billion of restructuring costs in 2006 at Delta and Northwest Airlines - both in Chapter 11 bankruptcy protection - distorted a gradually recovering profit picture. However, assuming far lower restructuring costs this year at the US majors, the region should swing from a $3.7 billion net loss in 2006 to a $200 million profit this year, says IATA.
Although the US result is still modest, IATA is forecasting that it will be the only region to improve its profitability this year. ATA's Heimlich predicts the end result for its members is forecast to rise to $4 billion in 2007. This will follow a 2006 net profit in the $2 billion to $3 billion range. The difference between the IATA and ATA figures lies in the different US memberships of the two organisations. Unlike IATA, ATA's members includes all-cargo carriers and low-cost players like Southwest Airlines.
Back-to-back profits
If the US carriers do make these figures that would make 2006-7 the first back-to-back years of profitability since 1999-2000, says Heimlich. This is of scant consolation to an industry that lost $35 billion net between 2001 and 2005, excluding extraordinary charges.
Elsewhere, both Asia-Pacific and European airline profits will fall, predicts IATA. Andrew Herdman, director general of the Association of Asia Pacific Airlines (AAPA), says that his members have found it hard to translate traffic growth into improved profitability since the peak of 2004. "Airlines have not been successful in passing on fuel price rises with surcharges," he says. However, Asia's outlook remains positive, with solid growth and even a slightly improving profit picture. "I hope we can reverse the profit decline," he says.
Amid caveats around the profit picture there are bright spots. Some premium traffic markets are doing well. For example, says IATA, business travel between Europe and Asia is booming, with growth rates consistently above 10%. North Atlantic and Pacific premium travel is tracking upwards too.
Recent strong traffic levels have enabled carriers to raise yields on an annualised basis. "Industry-wide yields have gone up by 2.5% in 2006," says Pearce. However, slower economic growth will peg this back in 2007, with yields at best flat and the prospect of slightly less pricing power in the market this year.
The small yield increases since 2003 have not compensated for rises in inflation. Adjusted for inflation and exchange changes, yields have fallen in real terms throughout this decade. "The real yield for airlines is 30% below where it was five years ago," says Pearce.
An essential difference for the industry at this point in the cycle, compared with similar times in 1991 or 1999 just before previous downturns, is capacity constraint on the part of carriers. "In 1991 and 1999 you had aircraft arriving at a much faster pace. Profitability collapsed and yields collapsed," says Pearce, as the new capacity entered a market that was rapidly slowing.
According to AAPA's Herdman: "The region's airlines have a lot of aircraft on order, but deliveries are spread over several years." With traffic forecast to continue growing at a modest pace, the balance between supply and demand would seem to be fairly well matched. "In this cycle airlines are controlling their capacity better, which has been easy because passenger growth has been so strong," says Pearce.
Source: Airline Business
