The International Air Transport Association (IATA) revised its 2013 global industry outlook downwards to $11.7 billion on revenues of $708 billion. Airline performance continued to improve in the second quarter; however at a slower pace than was expected with the previous projection (in June) of $12.7 billion. This reflects the impact on demand of the oil price spike associated with the Syrian crisis and disappointing growth in several key emerging markets.
Performance in 2013 is considerably better than the $7.4 billion net profit of 2012. The upward trend should continue into 2014 when airlines are expected to return a net profit of $16.4 billion. This would make 2014 the second strongest year this century after the record breaking $19.2 billion profit in 2010.
“Overall, the story is largely positive. Profitability continues on an improving trajectory. But we have run into a few speed bumps. Cargo growth has not materialized. Emerging markets have slowed. And the oil price spike has had a dampening effect. We do see a more optimistic end to the year. And 2014 is shaping up to see profit more than double compared to 2012,” said Tony Tyler, IATA’s Director General and CEO.
Airline performance remains strong. This year, airlines are expected to post the same operating margin (3.2%) as in 2006, even with a 54% hike in jet fuel prices. The industry has been able to absorb this enormous cost increase as a result of changes in the industry structure (through consolidation and joint ventures), increased ancillary sales and reduced new entry due to tight financial markets. Moreover, the industry is expected to have a relatively good year even with global economic growth at 2.0%. Previously 2.0% gross domestic product (GDP) growth was considered the point below which airlines posted losses.
Major Forecast Drivers for 2013
Economic Growth : Airline profits generally follow broad economic trends. Business confidence bottomed out at the end of 2012 and we have been expecting an acceleration of economic activity to follow. That has not yet materialized. GDP growth in 2013 is now expected to be 2.0% which is slightly below the 2.2% recorded in 2012. Within that overall trend, we have seen an acceleration of improvements in developed markets (particularly the US) and a deceleration of growth in some key emerging markets (India, Brazil and to some extent China).
Oil Price : Oil prices are expected to average at $109/barrel (Brent) for the year. While this is $1.0 higher than previously expected, jet fuel prices have softened slightly. We now expect jet fuel prices to average $126.4/barrel ($1.0 less than expected). The net impact on the overall fuel bill (which is expected to total $213 billion and account for 31% of total costs) is expected to be neutral. The impact of the Syrian crisis and higher oil prices has been felt more through a dampening of demand.
Passenger : Passenger growth remains robust at 5.0%, although slightly below the 5.3% previously projected and below the 5.3% growth recorded in 2012. Passenger numbers are expected to grow to 3.12 billion—the first time that they have topped the 3 billion mark. Yields are expected to be flat for the year (below the 0.3% growth previously projected). It should however be noted that load factors are at record highs (80.2%) and yields in the US are above pre-recession levels.
Cargo : Cargo markets remain in the doldrums. Growth of 0.9% is expected (down from the previously projected 1.5%). The ability of airlines to match cargo capacity to demand is limited by the natural growth in belly capacity that occurs as airlines respond to passenger demand. As a result of this mismatch, cargo yields are expected to fall by 4.9% this year (deeper than the 2.0% decline previously projected). Cargo revenues are expected to show an $8 billion decline to $59 billion from their peak in 2011. By comparison passenger revenues expanded by $68 billion to $565 billion over the same period.
Regional Divergence in 2013
North America : North American airlines are expected to post the strongest performance at $4.9 billion profits (up from the previously forecast $4.4 billion) for an Earnings Before Interest and Taxes (EBIT) margin of 4.3%. This is more than double the $2.3 billion profit of 2012. Along with an improved overall economic outlook, the North American industry’s improved profitability is being driven by the impact of a better industry structure. Consolidation and international joint ventures on major markets are driving efficiency gains. Consumers are benefitting both from expanded networks with more travel options and from significant investments to improve service levels. Passenger demand is expected to grow by a modest 2.0% which is the slowest growth of any region. But this will outstrip the 1.6% expansion in capacity. Concerns over the trend towards more onerous regulation in the US have increased considerably with unfounded objections to further consolidation by the US Department of Justice.
Europe : European airlines are expected to record profits of $1.7 billion (up from the previously expected $1.6 billion). While this is a considerable improvement on the $400 million profit that European carriers made in 2012, the EBIT margin of just 1.3% is the weakest among the major regions and well below the industry average of 3.2%. Slowly improving performance is largely being driven by long-haul markets and economic stabilization in the Eurozone. The benefits of these improvements are not being equally shared. On a geographical basis we see stronger performance in the German and UK markets. There is also a divergence of performance based on size and scale. Larger airline groups and airlines with well-developed long-haul operations are performing better than smaller carriers largely dependent on intra-European travel. Overall, we expect a 4.0% expansion of passenger demand with only a 2.8% increase in capacity.
Asia-Pacific: The outlook for Asia-Pacific airlines is downgraded by $1.5 billion to $3.1 billion profits largely driven by slower growth among the region’s emerging economies. Asia-Pacific carriers are the largest players in global cargo markets and the most impacted by its flat performance. This has been somewhat offset by a strengthening domestic market in China. Japanese carriers are also seeing a boost as a result of monetary expansion, more favorable exchange rates and the impacts of industry restructuring. We expect robust passenger demand growth of 6.6% to be outstripped by a 6.9% increase in capacity.
Latin America: The outlook for Latin American carriers is unchanged at $600 million profits. Economic weakness in Brazil is being offset by performance improvements as a result of restructuring and capacity discipline. The long-haul market between North and South America continues to grow. New South-South connectivity to Africa and Asia (particularly for cargo) is also showing promise, although obscured somewhat by the cyclical downturn in many emerging economies. Passenger demand growth of 6.0% is expected to outstrip capacity expansion of 5.3%.
Middle East : Middle East carriers are expected to post profits of $1.6 billion which is marginally ahead of the $1.5 billion previously forecast. The region’s efficient hubs continue to support strong performance on long-haul markets. And the impact of the Syrian crisis has been limited. Passenger demand is expected to grow by 10.5%, the strongest among all regions. But this will be slightly outstripped by capacity growth of 11.3%.
Africa : This region’s carriers will fall into losses of $100 million (down from a previously projected profit of $100 million). Long-haul markets face stiff competition, while intra-Africa market development remains constrained by a restrictive regulatory environment. Although African economies are among the world’s fastest growing, the region’s airlines face the significant impediments of high costs, onerous taxes, government interference, inefficient fleets, and poor infrastructure. Demand growth is expected to be a robust 7.8% ahead of a capacity expansion of just 5.5%.
The Outlook for 2014
Airlines are expected to see a significant boost in 2014 with profits of $16.4 billion on revenues totaling $743 billion. Rising business and consumer confidence levels should indicate an uptick in the global business cycle (2.7% GDP growth is expected) which has a direct impact on airline profitability. Oil prices are expected to fall to $105/barrel (Brent, from $109 expected this year) on the back of reduced geo-political tensions and an improved US energy outlook. A fall to below $100 would be expected from normal market forces. But the OPEC cartel is preventing the full realization of the benefits of better supply prospects. Furthermore, the benefits of improving market structures on several regions are expected to continue to drive performance and consumer benefits.
We expect slightly more robust passenger growth (5.8%) and a significant improvement in cargo growth to 3.7%. Yields, however, for both passenger and cargo markets are expected to continue to fall by 0.5% and 2.1% respectively.
All regions will see improved profitability, but divergence in performance will remain.
- 2014 is expected to be particularly strong for North American carriers ($6.3 billion net profit, the industry’s strongest) as the economy improves. Capacity discipline is expected to see yields improve, bucking the global trend.
- European carriers are also expected to see a near doubling of profits to $3.1 billion (although even this will only generate an EBIT margin of 1.9% with only African carriers being lower).
- Asia-Pacific is expected to see a modest improvement in profitability to $3.6 billion, largely on the back of improved cargo performance, the growing Chinese domestic market and the benefits of restructuring in Japan.
- Middle East carriers are expected to post a $2.1 billion profit (their highest ever).
- Carriers in Latin America are expected to see profits rise to $1.1 billion.
- African airlines are also expected to return a combined profit of $100 million.
Even with the significant improvements expected for 2014, an industry profit of $16.4 billion implies a return on invested capital of just 5.2%. That remains significantly below the industry’s weighted average cost of capital which is hovering between 7% and 8%.
“Airlines are demonstrating that they can be profitable in adverse business conditions. Efficiencies are being generated through myriad actions—consolidation, joint ventures, operational improvements, new market development, product innovations and much more. When market forces drive action, we get results that both strengthen the industry and benefit the consumer. Quite simply, stronger airlines can invest more in improving connectivity and service innovations. If more policy makers incorporated that into the cost-benefit analysis when developing regulations, we would have a much healthier industry generating even broader economic benefits,” said Tyler.
The balance between profit and loss remains delicate despite the forecast improvement for 2014. “A $16.4 billion profit for transporting some 3.3 billion passengers means that airlines will retain an average of about $5.00 per passenger. That very simple calculation demonstrates that even a small change in the operating environment—a new tax or other cost increase for example—could change the outlook quite significantly,” said Tyler.