Profit outlook slashed for airline industry
June 6, 2011, Singapore - The International Air Transport Association (IATA) further downgraded its 2011 airline industry profit forecast to $4 billion.
This would be a 54 per cent fall compared with the $8.6 billion profit forecast in March and a 78 per cent drop compared with the $18 billion net profit (revised from $16 billion) recorded in 2010. On expected revenues of $598 billion, a $4 billion profit equates to a 0.7 per cent margin.
“Natural disasters in Japan, unrest in the Middle East and North Africa, plus the sharp rise in oil prices have slashed industry profit expectations to $4 billion this year. That we are making any money at all in a year with this combination of unprecedented shocks is a result of a very fragile balance. The efficiency gains of the last decade and the strengthening global economic environment are balancing the high price of fuel. But with a dismal 0.7 per cent margin, there is little buffer left against further shocks,” said Giovanni Bisignani, IATA’s Director General and CEO.
Fuel: The cost of fuel is the main cause of reduced profitability. The average oil price for 2011 is now expected to be $110 per barrel (Brent), a 15 per cent increase over the previous forecast of $96 per barrel. For each dollar increase in the average annual oil price, airlines face an additional $1.6 billion in costs. With estimates that 50 per cent of the industry’s fuel requirement is hedged at 2010 price levels, the industry 2011 fuel bill will rise by $10 billion to $176 billion. Fuel is now estimated to comprise 30 per cent of airline costs—more than double the 13 per cent of 2001.
“We have built enormous efficiencies over the last decade. In 2001, we needed oil below $25 per barrel to be profitable. Today, we are looking at a small profit with oil at $110 per barrel” said Bisignani.
This fuel price spike is substantially different from the one that occurred in 2008. First, while oil inventories are low, there is substantial spare OPEC and refinery capacity, which was not the case three years ago. Second, the monetary expansion that fuelled a surge in financial investments in commodities is ending, which will remove a major upward pressure on fuel prices. Nonetheless, volatility in the fuel prices remains one of the industry’s major challenges.
Demand: Despite high energy prices, world trade and corporate earnings continued to improve. As a result, global GDP projections increased by 0.1 percentage points to 3.2 per cent, which is supporting continued growth in demand for air transport. However, growth rates for both cargo and passenger markets have been revised downward because of higher fuel costs. Passenger demand is now expected to grow 4.4 per cent over the year, a full 1.2 percentage points below the 5.6 per cent previously forecast in March. Similarly, cargo demand is expected to increase 5.5 per cent and not 6.1 per cent as predicted earlier.
The number of price-sensitive leisure travelers has fallen 3–4 per cent over the past five months, as travel costs were forced higher by fuel prices and, in Europe, by new passenger taxes. Less price-sensitive premium travel demand has been more robust in the face of rising prices and continues to be driven by growing world trade and business investment. Premium passenger growth has dipped from the 9 per cent of 2010, but is expected to be close to the historical trend this year at a 5–6 per cent rate.
Capacity: Overall capacity (combined passenger and cargo) is expected to expand 5.8 per cent, which is above the 4.7 per cent anticipated increase in demand. The gap between capacity and demand growth has widened to 1.1 percentage points from 0.3 percentage points in the previous forecast. Due to schedule commitments and fixed costs, capacity adjustments are expected to continue lagging behind the fall in demand, driving load factors down. By April, passenger load factors were hovering around 77 per cent. This is more than a full percentage point below the 78.4 per cent achieved for international traffic in 2010. Aircraft utilization is also falling. This decline in asset utilization, represented by lower load factors and average hours flown per aircraft, is the most significant downward pressure on airline profitability.
Yields: Robust economic conditions have given airlines some scope to partially recover higher fuel prices. This is reflected in an increased yield growth forecast of 3 per cent for passenger traffic (double the previously forecast 1.5 per cent) and 4 per cent for cargo (up from the previously forecast 1.9 per cent). The problem is that higher travel costs are now weakening price-sensitive demand and airlines are not expected to be able to offset higher costs with increased revenues.
Risks: The key risk to this outlook is a weakening of global economic growth. High energy prices will certainly have a slowing impact on economic growth. However, the impact will be mitigated by two factors. First, while high oil prices previously triggered recessions, today’s economies (which generate a unit of GDP using just half the energy required in the mid-1970s) are less sensitive. Second, the corporate sector is cash-rich, business confidence is high, and world trade continues to expand at around 9 per cent annually. The International Monetary Fund and others have raised global growth projections, which would indicate a recovery in demand growth to the historical 5.6 per cent level for the second half of 2011. IATA’s forecast for continued, albeit lower, airline profits despite $110 a barrel oil prices, is dependant on a strong economy to generate sufficient revenues to partially offset higher fuel costs.
Asia-Pacific carriers are expected to earn $2.1 billion—the most profitable of all regions. Even so, this is dramatically down from the $10 billion profit that the region achieved in 2010. Airlines in this region are more exposed than others to cargo markets and fuel price fluctuations. Asia-Pacific airlines carry 40 per cent of all air freight volumes, while low labor costs and relatively low hedging means fuel accounts for a bigger proportion of total costs. In addition, the Japanese earthquake and tsunami are expected to dent the region’s prospects for the remainder of the year. However, this will be more than offset by robust growth in both China and India. The continued dynamism of these economies means that Asia-Pacific is the only region where demand increases (6.4 per cent) are expected to outpace capacity growth (5.9 per cent).
North American carriers will see the $4.1 billion profit of 2010 fall to $1.2 billion. The region’s carriers are being hit on the cost side by rising fuel prices, exacerbated by an older, less fuel-efficient aircraft fleet. The region is also taking a hit on the demand side with 12 per cent of international revenues linked to the Japan market. This is being offset somewhat by a stronger than expected US economy and stronger inbound demand and exports fueled by the weak US dollar. Careful capacity management is expected to see an overall demand increase of 4 per cent balanced by an equal increase in capacity.
European carriers will deliver a $500 million profit, down from $1.9 billion in 2010. The sovereign debt crisis is dampening demand from the peripheral European economies. Core economies are benefiting from strong exports, but new and increased taxation of passengers is damaging price-sensitive demand. Much of the profit forecast for this year is expected to be generated on more buoyant long-haul markets. A capacity increase of 4.8 per cent is expected to outstrip demand growth of 3.9 per cent.
Middle East carriers will deliver a $100 million profit, down from $900 million in 2010. Political unrest in parts of the region is hurting demand. The major airlines in the region are expected to continue to win market share on long-haul markets, flying passengers via Middle Eastern hubs. However, high fuel costs will weaken demand from key passenger segments and asset utilization will be under downward pressure. Capacity growth of 15.5 per cent is expected to outstrip demand expansion of 14.6 per cent.
Latin American carriers will be the only region to deliver a third consecutive year of profits. The regional economies continue to show good growth, and trade links with the United States and Asia in particular are boosting traffic. Innovative business models and consolidation have combined to generate reasonable profits from these growing markets. But a $100 million profit is down considerably on the $900 million profit of 2010. Capacity growth of 6.9 per cent will outstrip the 6 per cent increase growth in demand.
African carriers are forecast to be the only region to post a loss, $100 million, in 2011. Political unrest across Northern Africa is dampening demand, particularly in Egypt and Tunisia, which have proportionately large tourism industries. Economies and air transport demand in many African countries have grown strongly but the local industry has struggled to turn this into profitable growth, hampered by poor infrastructure and restrictive government regulation. To compound the problem, capacity growth of 7.4 per cent will outstrip demand growth of 6.5 per cent.