While it has been another tough year for airlines, particularly
in Europe, their overall performance has been more robust than might
have been expected after Malev and Spanair
became high profile financial casualties early in 2012. Overall airline
profitability this year is expected to be only a little down on 2011,
there is a slight easing in some of the downward pressures on the sector
and the consolidation and efficiency efforts of network carriers in
mature markets are making some progress.
The
first question in any forecast is usually: are things going to get any
better? For airlines in 2013, as with everything else in this industry,
that is going to depend on where you are sitting.
The prospects may be very different if you are a network carrier in the new-found profitable land of North America or one still gripped in Europe’s recessionary vice. Comfort levels vary in Asia, depending on whether you are an airline exploiting the region’s dynamic growth or one wrestling with air cargo stagnation. And the outlook for a big carrier with strong partnerships differs from a small one left on the shelf.
IATA, in its latest forecast, has lifted its expectations for collective industry profits in 2013 to $8.4 billion. The vast majority of this will come from North American and Asian carriers. For others, and European carriers in particular, there is little immediate reason to be cheerful on profits.
“It is still a quite a difficult economic environment, but it’s one where the downward pressures are starting to ease,” said IATA chief economist Brian Pearce, presenting the forecast in Geneva. “I think we are past the low point. We are expecting modest improvements in profitability.
“We see slightly better world trade growth and a slight decline in oil prices. We expect to see a further expansion of passenger travel. We expect it to break the 3 billion passenger mark in 2013. Because we see the US economy starting to pick up a bit, we expect to see some moderate improvement in cargo volumes.”
Also helping the outlook is that things in 2012 appear not to have been as bad as might have been feared, especially given that oil prices remain high and economic growth weak. IATA now expects collective profits for this year to reach $6.7 billion in 2012, although this remains below the $8.8 billion recorded in 2011.
The brighter picture is built on the back of stronger traffic, improved yields and efficiency measures implemented by restructuring and consolidating airlines. Passenger yields are expected to rise 3% and traffic up by 5.3% in 2012. Although IATA sees growth moderating in 2013, it still expects global passengers numbers to reach 3.1 billion.
Read a full analysis of IATA's latest airline outlook here.
An
air of resignation, at best, and gloom, at worst, pervades the air
cargo business at present as faint signs of a recovery are repeatedly
being extinguished, writes Peter Conway.
The 3.5% year-on-year fall in IATA cargo traffic figures for October 2012 was typical, crushing hopes kindled by a 0.9% rise in September. Particularly shocking was Asia-Pacific performance, down a whopping 6.8% year on year. But airlines elsewhere had nothing much to cheer about, with North American airlines down 5.3% and European down 4.3%.
The sole bright spot was the Middle East, whose carriers continue to live in a bizarre parallel universe. They saw growth of 13.4% in October after a 14.3% growth in the nine months to September. Not all of that is due to expanding fleets – in October, these carriers lifted capacity only 8.6%.
The rest of the industry seems to have more or less written off the first half of 2013. David Shepherd, global head of sales for IAG Cargo, talks of “low expectations for the first half, crossing my fingers for the second half”. Karl Ulrich Garnadt, chairman of Lufthansa Cargo likewise says he does not expect the market to come back till later 2013.
Neither can
identify any geographical market that is bucking the trend. Earlier in
2012, Lufthansa at least had the consolation of relatively strong German
exports, but Garnadt says these ground to a halt in September. Shepherd
says he is “hopeful” of an upturn in Europe, but admits to nervousness
about the USA. He says IAG was pleasantly surprised to get something of a
peak season out of Asia in recent months, but admits that was probably
because it had low expectations.
This is compounded by increased belly capacity from continued growth in the long-haul passenger business and the delivery of cargo-friendly aircraft such as the Boeing 787 and 777. This is making capacity management a nightmare for cargo.
Lufthansa Cargo, for example, managed to reduce its capacity by 7.9% in the first three quarters of 2012 only by cutting freighter capacity more than 10%. The German carrier is lucky in that its Boeing MD-11 freighter fleet is fully written down and can be grounded with relatively little cost. But other carriers are not so fortunate. Cathay Pacific, whose traffic was down by 2.8% in October after a 2.4% rise in September, has the unenviable task of filling 10 expensive new 747-8 Freighters.
If these trends continue in 2013, many airlines could start to seriously question if they need freighters at all. Air cargo is also haunted by other nightmares – that its rapid growth years on the back of global manufacturing off-shoring may be over; that exporters may become more sophisticated in using sea freight, reducing long-term demand for air freight.
An upturn in cargo demand, which marked the end of previous downturns, would silence such doubts. But will 2013 be the year?
Asia-Pacific
remains the most profitable region for airlines and is forecast by IATA
for a small increase in profit in 2013 to $3.2 billion. But the honour
of being the most profitable region is likely to be passed to the North
American carriers in 2013 as stagnating cargo weighs heavy on many of
its airlines.
“We’ve been through the recession. We’ve had the big rebound and Asian airlines had a good year in 2012. We have continued to do better than other others, but we are not immune,” says Andrew Herdman, director general of the Association of Asia Pacific Airlines.
“A year ago there was a lack of visibility and there was anxiety. But passenger numbers have increased 7% in 2012 [so far],” he says. However, he notes that over the year the strength of demand has dropped and growth has moderated. Passenger numbers grew by less than 3% in October.
“Cargo is still very weak,” he says. Freight is down 4% for the year to date, and 6% in October. “After the bounce back, it continues to stagnate.”
While carriers in the region have kept freighter capacity in check, growing passenger traffic has brought its own challenges “It is the belly capacity that has really exaggerated the freighter capacity,” Herdman says. Yields too are weak, having a sharper impact on revenues.
“The cargo market [on its own] is probably loss-making, so they have to trim capacity and hunker down and try to get to break even. Because unlike passenger traffic, you can’t stimulate cargo traffic,” he says.
Nowhere
was the scale of change in the network carrier world more apparent than
in partnerships. Long-standing positions shifted as market pressures
built, resulting in the break-up of traditional alliances, with airlines
turning instead to unlikely allies from the Gulf and the low-cost
carrier sector. Qantas was at the heart of much of this. It ended its
alliance with British Airways on the Kangaroo route and embraced Emirates to help shore up its international operations. Qatar Airways’ move into Oneworld and Etihad’s tie-up with Air France-KLM further shows a new warmth to the Gulf mega-carriers.
The spread of low-cost carriers continued, notably in Asia where Japan was the latest to embrace the model. Peach, AirAsia Japan and Jetstar Japan all began operations. It continues a theme, seen in Asia, where the network airlines have linked up with the major budget brands.
After a change of the guard at the top of many airlines, 2012 was a year of few moves at the top. None of the 20 biggest airline groups changed chief executives over the year. But the leadership merry-go-round returned at Alitalia, LOT and Thai Airways this year. Gol pioneer Constantino de Oliveira Jr stepped down in June, while long-standing Virgin Atlantic boss Steve Ridgway announced his departure.
Economies have been under pressure and none more than in Europe. Most of its carriers have felt the heat, or more accurately the winter chill, that saw Malev and Spanair fall. The big network carriers are pushing through major cost cutting within their groups; while several mid-sized and smaller carriers are facing even more drastic action.
Europe was also at the heart of another big cloud over the industry as the deadlock over its inclusion of aviation in its emissions trading scheme threatened to spiral into a full-blown trade war. That threat has been lifted, at least for now, and all eyes turn to ICAO.
Given
little likelihood of a let-up in the weak economic and high fuel price
environment, for European carriers, much will depend in 2013 on how
labour reacts to the various restructuring efforts. Iberia is likely to
be an early flashpoint for International Airlines Group as it has set an
end-of-January deadline to push through major restructuring in time to
turn round the Spanish carrier’s profitability in time for the summer.
The carrier is one of many in the region which needs to tackle its
cost-base, particularly on short-haul flights.
North
American profitability, aided by a sustained period of capacity
discipline and consolidation in the sector, has been one of the success
stories in recent years. American Airlines, the last of the US majors to
enter Chapter 11 protection, has made plenty of progress in its
restructuring. It has been hoping to leave Chapter 11 by March, but much
still needs to be done. All eyes will be on what role, if any, US
Airways will play in American’s end game.
The next year should give some indications as to whether the African market is ready to embrace the low-cost carrier model on a wider basis after the high profile arrival of Fastjet late in 2012.
IATA’s new touchy-feely approach came off the rails a little when its new distribution capability initiative prompted anger from parts of the travel agent and global distribution systems community. The move, though, underlines airlines’ determination to tackle distribution issues.
Airlines have become pretty used to having to deal with external shocks since the turn of the century. Second guessing these is pretty difficult, but all eyes are certain to be on geopolitical developments, particularly around Iran. Any escalations of tensions would not only impact air travel demand, but hopes of an easing in high oil prices. Neither has the debt problem gone away as North America still peers over a fiscal cliff and Europe has little sign of a return to growth.
Airlines
in the USA enter 2013 with considerable momentum. Cost structures
across various operators have significantly converged. Passengers are
growing increasingly accustomed to ancillary fees, which are highly
lucrative for the industry. Consolidation has afforded many benefits,
one of which is the inherent improvement in pricing power associated
with hub closures.
Managements are finally acting as such, truly managing the industry in a manner that provides a modest return on the capital that they have been entrusted with. More market share is concentrated in the hands of the top four operators than ever before, along with higher fuel prices acting as a disincentive for new entrants. The industry has produced three consecutive years of solid profitability, the longest profit stretch since the late 1990s and the streak should continue in 2013. If it feels like things are different this time, that is because they are – they are better.
Turning towards 2013, most challenges facing management are little different from 2012. Labour cost escalation is one such challenge, although consolidation provides sufficient value for distribution between both employees and stakeholders alike. Managements logically need to be ready for any unexpected shocks, such as a disconnect between economic output and oil prices, but maintaining flexibility and ensuring adequate liquidity is what they are paid to do.
Managements obviously need to resist any temptation to squander surplus cash on unnecessary, new aircraft. These are far from insurmountable challenges. So where is the greatest challenge? The greatest task facing US airline executive teams in 2013 is providing improved returns to stakeholders. Equity performance has been, for the most part, pitiful. Analysts and managements may profess that things are different this time, but the equity market is not buying it. Valuations are at or near generational lows. A significant chasm remains between the strength of the fundamental story and the weakness of the equity story. Managements have to identify ways in which capital providers are rewarded with better returns. Share buybacks and dividend policies are two such strategies, and may indeed become increasingly common threads in the industry fabric, as 2013 wears on.
Jamie Baker is a New York-based airlines equity analyst with JP Morgan
I
was reminded the other day of the joke about two hunters pursued by an
angry bear. The older hunter, ever critical, comments: “You don’t seem
to be running very fast?” to his younger sidekick. “Ah, but I really
only need to run faster than you,” is his mournful reply. The event that
reminded me of this was the surge in EasyJet’s and Emirates’ profit
results revealed in the third quarter of 2012.
As the airline industry is pursued yet again by numerous “bears” representing the economy – ageing fleet, high fuel prices, established staff costs, government taxation – and not a few other grizzly events, the key to airline profit growth is actually making sure you are one step ahead of the competition.
For decades, the convergence in aircraft types and performance, similar bilateral operating models, low fuel prices, common industry practices and in some cases, blind passenger brand loyalty, have made it difficult for any individual airline to run faster and gain a reward from doing so. This is increasingly not the case. As we look to 2013, which still looks set to produce net traffic growth against an uncertain global economy, the quest for short-term competitive advantage is becoming an imperative of long-term survival.
In terms of aircraft, a diversity of current and future aircraft types beckons as never before. The cost difference between “new” and “old” matters very much indeed, with net advantages ranging from fuel cost per seat to lower maintenance costs, and on to higher brand value.
Low-cost Middle East and Chinese airlines, which concluded highly advantageous deals in the last decade for new and future aircraft, will certainly achieve increasing net cost advantages against their European and US peers.
The brand war may already be lost if we look at indicators such as the passenger quality surveys among long-haul airlines, which feature the Middle East’s “Big three” and some top Asian carriers. As one business traveller puts it in the recent Flightglobal Ascend Corporate Travel Survey – “better price, better product, what is not to like?”
So will 2013 see a market recovery by the more venerable legacy airlines, particularly in the USA and Europe? It seems unlikely, given that they appear preoccupied just with the challenge of getting their own houses in order, let alone taking on more competitors in diverse markets. Most of all, the fiscal tightrope that many of them are walking on simply does not allow for an aggressive response in product, service or pricing. For some, the alliance created in 2012 by Qantas and Emirates can be seen as a crucial watershed moment, when the bell tolled for the old order. Another indicator in the wind was the profitability of EasyJet against the tough European short-haul market environment that has already challenged British Airways/Iberia, Air France and Lufthansa, and written off Malev and Spanair.
Some hope is placed in the development of regional offshoots and low-cost subsidiaries, but while these options appear to be used on the “widows and orphans” routes, low-cost carrier competition continues to step up pressure on the major connecting services. It is difficult to envision equilibrium in this scenario, with the low-cost carrier continually driving down costs, expanding flexible networks, while the European network carriers face an internal war of attrition on costs, only some of which they can control.
So what is the long-term survival strategy? I would advocate that pursuing real global diversity of cost base, network and market will provide the only way to put some distance on the older hunters.
Peter Morris is chief economist at Flightglobal consultancy Ascend
As
the major western economies emerge from the turmoil of the global
financial crisis, we find ourselves in a strange and uncertain world.
Growth rates are disappointing, relative to those before 2007. In the UK, for example, economic growth averaged at 3% per annum from 1982 until 2007, more than doubling the size of the economy in 25 years. But since 2009, UK economic growth has averaged little more than 1% per annum.
Other major western economies are also struggling. From 2011 to 2013 inclusive, US economic growth is set to average just 2% and the euro area is projected to grow by less than 1% per annum. By contrast, emerging and developing economies are performing better. Growth may have slowed in some of the emerging superpowers like China and India, but the International Monetary Fund still predicts growth of up to 6% in the emerging and developing world this year and next.Strong growth outside the West is pushing up energy and commodity prices, there is relatively high inflation and volatility in financial markets is continuing to add to uncertainty about economic prospects and access to finance. These are all features of a “new normal” economy that reflects three big changes in the economic environment from before the financial crisis.
The
first change is in the financial system. From the 1980s until 2007,
western economies enjoyed an era of easy money. A liberalised global
financial system provided consumers and businesses with relatively easy
access to finance, and allowed a build-up of debt. Now, banks are more
cautious and their reluctance to lend is reinforced by new regulatory
requirements.
The second change is affecting the cost of imports. From the mid-1980s – when oil prices fell sharply – until the mid-2000s, Western consumers benefited from cheap imports from the rest of the world. However, as these large emerging market economies have developed, the tables have turned. Strong growth in the emerging world is exerting more inflationary pressure in the world economy. The era of cheap imports has been eroded by successive waves of energy and commodity inflation since the mid-2000s.
A third change since 2007 has been the ability of governments and central banks to underpin confidence in the private sector. Before the financial crisis, they appeared to be able to support growth, contain inflation and maintain orderly financial conditions. This confidence has been dented by the financial crisis.
Three tailwinds that supported growth for more than two decades before the financial crisis – easy money, cheap imports and strong confidence – are no longer available to support growth in Western economies. So what does this mean for airlines and airports? Growth is likely to be relatively weak in the mature aviation markets of the USA and Europe and the major engine of growth will be the dynamism of Asia and other emerging markets. This is already evident in IATA global traffic data for the year.
Long-haul air travel is also likely to benefit from this shift in the centre of gravity of the global economy. As Western businesses seek out opportunities in Asia and other emerging markets, new business travel flows are likely to develop. Trade between the EU and China, for example, has doubled since 2003 – and flows of international trade and investment are major drivers of long-haul air travel for business purposes. Airlines and airports need to reposition themselves to take advantage of these growth opportunities.
Air travel is also sensitive to fluctuations in GDP and financial shocks, evident by the global financial crisis and after 9/11. The slim operating margins and high proportion of fixed costs in the sector mean fluctuations in demand can create large swings in profitability and cashflow.
These vulnerabilities are exacerbated by the lags in the investment cycle. There are many examples of airlines and airports which have found that investments planned in the upswing of the cycle come on stream just as demand is turning down. This creates a double blow for profitability and cashflow.
There is no simple strategy for managing these vulnerabilities – but there are lessons from past experiences on managing the risk. First, ensure capacity expansion is gradual, reducing the risk of having to fill large numbers of new aircraft, or a large airport expansion, in weak demand conditions. Second, spread risk among suppliers and business partners by ensuring contract conditions can be varied in the event of a fall in demand. And, third, try to ensure a diversification of revenue in a range of geographies and market sectors. Economic and financial shocks normally have a regional or sector-specific component.
major surge
Airlines and airports also need to adjust to a new era of high and volatile energy and commodity prices, particularly oil. When I joined British Airways in 1998, the norm was a $15-20/barrel oil price. Now, it can move by $15-20/barrel in a few weeks and the norm is $100-120/barrel. This is not a temporary phase. Since the mid-2000s, every time the emerging world and the major western economies have both been growing healthily, we have seen a major surge in oil prices.
The IMF’s baseline scenario for the oil market is for a rise to $200/barrel by 2020. And if the global economy picks up again from the recent weakness associated with the euro crisis, we could see a renewed surge towards $150/barrel in 2013 or 2014.
Andrew Sentance is senior economic advisor for consultancy PwC. He was formerly chief economist with British Airways
SLOW ROAD TO PROFIT RETURNS |
|---|
The prospects may be very different if you are a network carrier in the new-found profitable land of North America or one still gripped in Europe’s recessionary vice. Comfort levels vary in Asia, depending on whether you are an airline exploiting the region’s dynamic growth or one wrestling with air cargo stagnation. And the outlook for a big carrier with strong partnerships differs from a small one left on the shelf.
IATA, in its latest forecast, has lifted its expectations for collective industry profits in 2013 to $8.4 billion. The vast majority of this will come from North American and Asian carriers. For others, and European carriers in particular, there is little immediate reason to be cheerful on profits.
“It is still a quite a difficult economic environment, but it’s one where the downward pressures are starting to ease,” said IATA chief economist Brian Pearce, presenting the forecast in Geneva. “I think we are past the low point. We are expecting modest improvements in profitability.
$6.7 billion |
|---|
|
IATA's collective profits forecast for airlines in 2012
|
“We see slightly better world trade growth and a slight decline in oil prices. We expect to see a further expansion of passenger travel. We expect it to break the 3 billion passenger mark in 2013. Because we see the US economy starting to pick up a bit, we expect to see some moderate improvement in cargo volumes.”
Also helping the outlook is that things in 2012 appear not to have been as bad as might have been feared, especially given that oil prices remain high and economic growth weak. IATA now expects collective profits for this year to reach $6.7 billion in 2012, although this remains below the $8.8 billion recorded in 2011.
The brighter picture is built on the back of stronger traffic, improved yields and efficiency measures implemented by restructuring and consolidating airlines. Passenger yields are expected to rise 3% and traffic up by 5.3% in 2012. Although IATA sees growth moderating in 2013, it still expects global passengers numbers to reach 3.1 billion.
Read a full analysis of IATA's latest airline outlook here.
SLIM PICKINGS FOR AIR FREIGHT |
|---|
The 3.5% year-on-year fall in IATA cargo traffic figures for October 2012 was typical, crushing hopes kindled by a 0.9% rise in September. Particularly shocking was Asia-Pacific performance, down a whopping 6.8% year on year. But airlines elsewhere had nothing much to cheer about, with North American airlines down 5.3% and European down 4.3%.
The sole bright spot was the Middle East, whose carriers continue to live in a bizarre parallel universe. They saw growth of 13.4% in October after a 14.3% growth in the nine months to September. Not all of that is due to expanding fleets – in October, these carriers lifted capacity only 8.6%.
The rest of the industry seems to have more or less written off the first half of 2013. David Shepherd, global head of sales for IAG Cargo, talks of “low expectations for the first half, crossing my fingers for the second half”. Karl Ulrich Garnadt, chairman of Lufthansa Cargo likewise says he does not expect the market to come back till later 2013.
 |
|---|
Lufthansa Cargo |
This is compounded by increased belly capacity from continued growth in the long-haul passenger business and the delivery of cargo-friendly aircraft such as the Boeing 787 and 777. This is making capacity management a nightmare for cargo.
Lufthansa Cargo, for example, managed to reduce its capacity by 7.9% in the first three quarters of 2012 only by cutting freighter capacity more than 10%. The German carrier is lucky in that its Boeing MD-11 freighter fleet is fully written down and can be grounded with relatively little cost. But other carriers are not so fortunate. Cathay Pacific, whose traffic was down by 2.8% in October after a 2.4% rise in September, has the unenviable task of filling 10 expensive new 747-8 Freighters.
If these trends continue in 2013, many airlines could start to seriously question if they need freighters at all. Air cargo is also haunted by other nightmares – that its rapid growth years on the back of global manufacturing off-shoring may be over; that exporters may become more sophisticated in using sea freight, reducing long-term demand for air freight.
An upturn in cargo demand, which marked the end of previous downturns, would silence such doubts. But will 2013 be the year?
MIXED PICTURE FOR ASIA |
|---|
“We’ve been through the recession. We’ve had the big rebound and Asian airlines had a good year in 2012. We have continued to do better than other others, but we are not immune,” says Andrew Herdman, director general of the Association of Asia Pacific Airlines.
“A year ago there was a lack of visibility and there was anxiety. But passenger numbers have increased 7% in 2012 [so far],” he says. However, he notes that over the year the strength of demand has dropped and growth has moderated. Passenger numbers grew by less than 3% in October.
“Cargo is still very weak,” he says. Freight is down 4% for the year to date, and 6% in October. “After the bounce back, it continues to stagnate.”
While carriers in the region have kept freighter capacity in check, growing passenger traffic has brought its own challenges “It is the belly capacity that has really exaggerated the freighter capacity,” Herdman says. Yields too are weak, having a sharper impact on revenues.
“The cargo market [on its own] is probably loss-making, so they have to trim capacity and hunker down and try to get to break even. Because unlike passenger traffic, you can’t stimulate cargo traffic,” he says.
2012: A YEAR OF CHANGE |
|---|
The spread of low-cost carriers continued, notably in Asia where Japan was the latest to embrace the model. Peach, AirAsia Japan and Jetstar Japan all began operations. It continues a theme, seen in Asia, where the network airlines have linked up with the major budget brands.
After a change of the guard at the top of many airlines, 2012 was a year of few moves at the top. None of the 20 biggest airline groups changed chief executives over the year. But the leadership merry-go-round returned at Alitalia, LOT and Thai Airways this year. Gol pioneer Constantino de Oliveira Jr stepped down in June, while long-standing Virgin Atlantic boss Steve Ridgway announced his departure.
Economies have been under pressure and none more than in Europe. Most of its carriers have felt the heat, or more accurately the winter chill, that saw Malev and Spanair fall. The big network carriers are pushing through major cost cutting within their groups; while several mid-sized and smaller carriers are facing even more drastic action.
Europe was also at the heart of another big cloud over the industry as the deadlock over its inclusion of aviation in its emissions trading scheme threatened to spiral into a full-blown trade war. That threat has been lifted, at least for now, and all eyes turn to ICAO.
2013: NEW YEAR, SAME CHALLENGES |
|---|
 |
|---|
American Airlines |
The next year should give some indications as to whether the African market is ready to embrace the low-cost carrier model on a wider basis after the high profile arrival of Fastjet late in 2012.
IATA’s new touchy-feely approach came off the rails a little when its new distribution capability initiative prompted anger from parts of the travel agent and global distribution systems community. The move, though, underlines airlines’ determination to tackle distribution issues.
Airlines have become pretty used to having to deal with external shocks since the turn of the century. Second guessing these is pretty difficult, but all eyes are certain to be on geopolitical developments, particularly around Iran. Any escalations of tensions would not only impact air travel demand, but hopes of an easing in high oil prices. Neither has the debt problem gone away as North America still peers over a fiscal cliff and Europe has little sign of a return to growth.
ANALYST VIEW: JAMIE BAKER ON US SECTOR |
|---|
Managements are finally acting as such, truly managing the industry in a manner that provides a modest return on the capital that they have been entrusted with. More market share is concentrated in the hands of the top four operators than ever before, along with higher fuel prices acting as a disincentive for new entrants. The industry has produced three consecutive years of solid profitability, the longest profit stretch since the late 1990s and the streak should continue in 2013. If it feels like things are different this time, that is because they are – they are better.
Turning towards 2013, most challenges facing management are little different from 2012. Labour cost escalation is one such challenge, although consolidation provides sufficient value for distribution between both employees and stakeholders alike. Managements logically need to be ready for any unexpected shocks, such as a disconnect between economic output and oil prices, but maintaining flexibility and ensuring adequate liquidity is what they are paid to do.
Managements obviously need to resist any temptation to squander surplus cash on unnecessary, new aircraft. These are far from insurmountable challenges. So where is the greatest challenge? The greatest task facing US airline executive teams in 2013 is providing improved returns to stakeholders. Equity performance has been, for the most part, pitiful. Analysts and managements may profess that things are different this time, but the equity market is not buying it. Valuations are at or near generational lows. A significant chasm remains between the strength of the fundamental story and the weakness of the equity story. Managements have to identify ways in which capital providers are rewarded with better returns. Share buybacks and dividend policies are two such strategies, and may indeed become increasingly common threads in the industry fabric, as 2013 wears on.
Jamie Baker is a New York-based airlines equity analyst with JP Morgan
ANALYST VIEW: PETER MORRIS ON 2013 CHALLENGES |
|---|
As the airline industry is pursued yet again by numerous “bears” representing the economy – ageing fleet, high fuel prices, established staff costs, government taxation – and not a few other grizzly events, the key to airline profit growth is actually making sure you are one step ahead of the competition.
For decades, the convergence in aircraft types and performance, similar bilateral operating models, low fuel prices, common industry practices and in some cases, blind passenger brand loyalty, have made it difficult for any individual airline to run faster and gain a reward from doing so. This is increasingly not the case. As we look to 2013, which still looks set to produce net traffic growth against an uncertain global economy, the quest for short-term competitive advantage is becoming an imperative of long-term survival.
In terms of aircraft, a diversity of current and future aircraft types beckons as never before. The cost difference between “new” and “old” matters very much indeed, with net advantages ranging from fuel cost per seat to lower maintenance costs, and on to higher brand value.
Low-cost Middle East and Chinese airlines, which concluded highly advantageous deals in the last decade for new and future aircraft, will certainly achieve increasing net cost advantages against their European and US peers.
The brand war may already be lost if we look at indicators such as the passenger quality surveys among long-haul airlines, which feature the Middle East’s “Big three” and some top Asian carriers. As one business traveller puts it in the recent Flightglobal Ascend Corporate Travel Survey – “better price, better product, what is not to like?”
So will 2013 see a market recovery by the more venerable legacy airlines, particularly in the USA and Europe? It seems unlikely, given that they appear preoccupied just with the challenge of getting their own houses in order, let alone taking on more competitors in diverse markets. Most of all, the fiscal tightrope that many of them are walking on simply does not allow for an aggressive response in product, service or pricing. For some, the alliance created in 2012 by Qantas and Emirates can be seen as a crucial watershed moment, when the bell tolled for the old order. Another indicator in the wind was the profitability of EasyJet against the tough European short-haul market environment that has already challenged British Airways/Iberia, Air France and Lufthansa, and written off Malev and Spanair.
Some hope is placed in the development of regional offshoots and low-cost subsidiaries, but while these options appear to be used on the “widows and orphans” routes, low-cost carrier competition continues to step up pressure on the major connecting services. It is difficult to envision equilibrium in this scenario, with the low-cost carrier continually driving down costs, expanding flexible networks, while the European network carriers face an internal war of attrition on costs, only some of which they can control.
So what is the long-term survival strategy? I would advocate that pursuing real global diversity of cost base, network and market will provide the only way to put some distance on the older hunters.
Peter Morris is chief economist at Flightglobal consultancy Ascend
ANALYST VIEW: ANDREW SENTANCE ON THE NEW NORMAL |
|---|
Growth rates are disappointing, relative to those before 2007. In the UK, for example, economic growth averaged at 3% per annum from 1982 until 2007, more than doubling the size of the economy in 25 years. But since 2009, UK economic growth has averaged little more than 1% per annum.
Other major western economies are also struggling. From 2011 to 2013 inclusive, US economic growth is set to average just 2% and the euro area is projected to grow by less than 1% per annum. By contrast, emerging and developing economies are performing better. Growth may have slowed in some of the emerging superpowers like China and India, but the International Monetary Fund still predicts growth of up to 6% in the emerging and developing world this year and next.Strong growth outside the West is pushing up energy and commodity prices, there is relatively high inflation and volatility in financial markets is continuing to add to uncertainty about economic prospects and access to finance. These are all features of a “new normal” economy that reflects three big changes in the economic environment from before the financial crisis.
6% |
|---|
IMF projection for emerging econies GDP growth |
The second change is affecting the cost of imports. From the mid-1980s – when oil prices fell sharply – until the mid-2000s, Western consumers benefited from cheap imports from the rest of the world. However, as these large emerging market economies have developed, the tables have turned. Strong growth in the emerging world is exerting more inflationary pressure in the world economy. The era of cheap imports has been eroded by successive waves of energy and commodity inflation since the mid-2000s.
A third change since 2007 has been the ability of governments and central banks to underpin confidence in the private sector. Before the financial crisis, they appeared to be able to support growth, contain inflation and maintain orderly financial conditions. This confidence has been dented by the financial crisis.
Three tailwinds that supported growth for more than two decades before the financial crisis – easy money, cheap imports and strong confidence – are no longer available to support growth in Western economies. So what does this mean for airlines and airports? Growth is likely to be relatively weak in the mature aviation markets of the USA and Europe and the major engine of growth will be the dynamism of Asia and other emerging markets. This is already evident in IATA global traffic data for the year.
Long-haul air travel is also likely to benefit from this shift in the centre of gravity of the global economy. As Western businesses seek out opportunities in Asia and other emerging markets, new business travel flows are likely to develop. Trade between the EU and China, for example, has doubled since 2003 – and flows of international trade and investment are major drivers of long-haul air travel for business purposes. Airlines and airports need to reposition themselves to take advantage of these growth opportunities.
Air travel is also sensitive to fluctuations in GDP and financial shocks, evident by the global financial crisis and after 9/11. The slim operating margins and high proportion of fixed costs in the sector mean fluctuations in demand can create large swings in profitability and cashflow.
These vulnerabilities are exacerbated by the lags in the investment cycle. There are many examples of airlines and airports which have found that investments planned in the upswing of the cycle come on stream just as demand is turning down. This creates a double blow for profitability and cashflow.
There is no simple strategy for managing these vulnerabilities – but there are lessons from past experiences on managing the risk. First, ensure capacity expansion is gradual, reducing the risk of having to fill large numbers of new aircraft, or a large airport expansion, in weak demand conditions. Second, spread risk among suppliers and business partners by ensuring contract conditions can be varied in the event of a fall in demand. And, third, try to ensure a diversification of revenue in a range of geographies and market sectors. Economic and financial shocks normally have a regional or sector-specific component.
major surge
Airlines and airports also need to adjust to a new era of high and volatile energy and commodity prices, particularly oil. When I joined British Airways in 1998, the norm was a $15-20/barrel oil price. Now, it can move by $15-20/barrel in a few weeks and the norm is $100-120/barrel. This is not a temporary phase. Since the mid-2000s, every time the emerging world and the major western economies have both been growing healthily, we have seen a major surge in oil prices.
The IMF’s baseline scenario for the oil market is for a rise to $200/barrel by 2020. And if the global economy picks up again from the recent weakness associated with the euro crisis, we could see a renewed surge towards $150/barrel in 2013 or 2014.
Andrew Sentance is senior economic advisor for consultancy PwC. He was formerly chief economist with British Airways
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