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.
SLOW ROAD TO PROFIT RETURNS
|
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.
$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
|
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.
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Lufthansa Cargo
|
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.
2013: NEW YEAR, SAME CHALLENGES
|
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.
 |
American Airlines
|
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.
ANALYST VIEW: JAMIE BAKER ON US SECTOR
|
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
ANALYST VIEW: PETER MORRIS ON 2013 CHALLENGES
|
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
ANALYST VIEW: ANDREW SENTANCE ON THE NEW NORMAL
|
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.
6%
|
IMF projection for emerging econies GDP growth
|
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
