Some six years ago we unveiled our so-called TDI (traffic demand indicator) analysis to examine the strength of fundamental demand. The model essentially estimates “underlying” traffic demand on the basis of forecasts of GDP (gross domestic product). This was based on the relatively straightforward premise that there is a relationship between the rate of economic activity and airline traffic.
While the rule of thumb suggests that traffic grows at a rate twice that of inflation-adjusted GDP, the reality is that the movement in traffic is, in fact, explained increasingly by factors other than GDP. More importantly, an average taken over the past 30 years suggests that the relationship is much closer to 1.5 times. Furthermore, it would appear that it only hits the twice GDP rate for relatively short periods in the “good times” as the industry is at or close to the peak of a cycle.
Looking at what 2006 might hold, it is worth considering the nature and strength of this and other “big picture” relationships, particularly given the nature of new aircraft ordering behaviour which, itself, is reminiscent of the late 1980s. The reality is that the economic outlook, despite some strong individual performances in 2005, remains mixed. The fact that gold has now reached a 24-year high is an interesting sign – although there has undoubtedly been some “me-too” buying. Gold is seen as a safe haven in times of uncertainty.
Historical perspective
How have traffic and capacity moved in relation to real or inflation adjusted GDP over the past 30 years? The average rate of GDP growth over this period has been 3.5%. Global revenue passenger kilometres have increased at an average rate of 5.8%, according to ICAO, and global available seat kilometres by 5.0%. This gives a traffic multiplier of 1.5 times and a capacity multiplier of 1.45 times, 25% lower than has been generally assumed.
With the exception of one negative value, over this period the range for the traffic multiplier has been from 0.2 (2002) to 3.5 (1979). For capacity, the range has been from 0.4 (2003) to 3.2 (1980).
What is the outlook for 2006 and beyond? The latest International Monetary Fund forecast for global real GDP growth is 4.3%. Based on the weighted average of traffic statistics for the year to date (as published in Airline Business) traffic appears to be growing at a rate of some 6.2% or 1.44 times the rate at which GDP is growing. The July forecast from ICAO expected traffic to grow by 7.6% in 2005, giving a GDP multiplier of almost 1.8.
While traffic at these rates is above the long term trend of 5%, would it be reasonable to expect an acceleration to re-establish a two times multiplier? In the near term, traffic is unlikely to increase fast enough to reach this point, irrespective of what value this traffic may have.
This leads us neatly into another measure relating airline revenue and nominal GDP – the airline revenue ratio (ARR). Using the same 30-year time period and data from the same sources, the average annual rate of change in nominal GDP over the period has been 7.3% and for airline revenues 8.6%. The average ARR (traffic growth divided by nominal GDP growth) is 1.1 times. Excluding the negative values for 2001 and 2002, the ratio over the 1975-2004 period ranges between almost zero (1982) and 2.7 (1987). If we split the time periods up into three then for the 1975-1984 period, the average ratio is 1.1; for the 1985-1994 period 1.4; and for the period 1995-2004 it is just 0.7. The latter did include two negative years, although it might be argued that the ratio of 2.2 in 2004 is a corresponding recovery value.
So what might it all mean for 2006? Using the long-term multiplier of 1.5 times as the relevant factor suggests that if GDP growth does materialise in 2006 at the forecast rate of 4.3%, then traffic growth should be in the order of 6.5%. This is exactly the figure that ICAO stated as its forecast for 2006. Turning to airline revenues, global nominal GDP is forecast to grow by some 6.5% in 2006. Again using the long-term average, this time 1.1, the implication is that revenues for the airlines will grow by 7% – somewhat below the long-term average.
With aircraft orders at record levels and delivery rates rising, the question becomes whether fundamental traffic levels will be sufficient to absorb this additional capacity without a decrease in yields. If yields do fall, will carriers be able to cut costs sufficiently and quickly enough to be able to absorb the extra capacity profitably? ■
CHRIS TARRY - CTAIRA
ANALYSIS FABRICE TACOUN
Source: Airline Business
