Airlines fly high despite persistent economic storm

International Air Transportation Association (IATA) has upgraded its outlook for the global aviation industry. It expects global airlines to report a profit of $12.7 billion in the current year (an increase of more than $2 billion from its earlier forecast of $10.6 billion) in view of the lower oil prices and the cost-cutting measures being taken by them. In 2012, the industry made an aggregate profit of $7.6 billion.

In a report released at its annual general meeting (AGM) in Cape Town last week, IATA said business confidence and export orders have been rising from what now seems to be their low point in late 2012. The association also anticipates gains from the mergers and joint ventures that have taken place recently to boost industry net post-tax profits. However, it said margins will continue to be under pressure as the Euro zone problems are still a threat to the industry’s growth. It indicated a very thin 1.8 per cent margin on revenues of over $700 billion, generating an inadequate level of returns for investors.

Improving profitability

At the moment, however, financial markets seem resilient to the uncertainties in Europe, and that has lowered the risk of a renewed crisis. The resulting improvement in business confidence has started reflecting in a slow improvement in air travel markets. And stronger export orders should benefit air cargo sector.

It will be the developed markets, especially those linked to the Euro zone, which will continue to grow slowly in 2013. Airline profitability should, nevertheless, improve over the next 12 months. Much of that improvement, of course, will depend on achieving further efficiency gains and on keeping asset utilisation high. Consolidation, too, will be critical to generating this better performance.

IATA says that the improvement is most clearly seen in North America, where margins have been improving since 2011 despite continued high jet fuel prices and sluggish economic growth. Consolidation, on domestic markets through mergers and acquisitions on the North Atlantic through joint ventures, has more than offset difficult market conditions.

Asia-Pacific airlines continue to generate the highest margins, but they have fallen sharply since 2010, largely due to the weakness in cargo markets. A moderate upturn in cargo this year should help to improve profits in this region, IATA added. In 2010, airlines in the Asia-Pacific region posted a net profit of $11.1 billion, which fell to $5.5 billion in 2011 and $3.7 billion in 2012. IATA has, however, upgraded its outlook for the region and expects it to post a net profit of $4.6 billion in 2013.

North America region is expected to post a net profit of $ 4.4 billion in 2013 as compared to a net profit of $2.4 billion in 2012.

Growth and aviation

The level of profitability in 2013 represents a return on invested capital of 4.8 per cent. This would enable the industry to pay for its debt interest costs and pay equity investors a small dividend. However, returns of 4.8 per cent are still lower than the seven to eight per cent investors should expect to earn at a minimum (the cost of capital).

With $4-5 trillion of new capital estimated to be required to buy the aircraft needed to serve expansion in demand in emerging markets over the next 20 years, this level of return is still inadequate. While structural improvements in financial performance have taken place, more are needed, IATA said in its annual financial forecast for 2013.

Faced with multiple headwinds, it was not surprising for airlines to report lower profit last year. Over the past 20 years, whenever global economic growth has fallen to two per cent, the airline industry has gone from profit to loss. According to IATA, global GDP growth in 2012 slowed to 2.1 per cent, and the average price of jet fuel rose to a high of $129.5 a barrel.

Explaining the critical situation that the airline industry is facing, Tony Tyler, Director General and Chief Executive Officer (CEO), IATA, said, “Airlines are delivering weak profits in difficult times."

In 2012, the industry made an aggregate profit of $7.6 billion (less than the $8.8 billion achieved in 2011). On revenues of $638 billion, that’s a 1.2 per cent net profit margin. That airlines made any money at all, with GDP growth at 2.1 per cent and oil averaging a record high of $111.8 a barrel (Brent), was a major achievement. To put that into perspective, in 2003 the industry was in the red, with oil at less than $30 a barrel.

Defying norms

The airline industry’s return on capital was four per cent, still way below the seven to eight per cent investors would normally consider the minimum for an industry with the risk profile of the aviation industry. Nevertheless, the industry was profitable when economic conditions suggested a loss.

This is a measure of the industry’s improvements in efficiency and industry structure, Tyler said. However, there is a long way to go before investors receive an adequate return, but progress has been made.

Asia-Pacific airlines generated the highest margins and profits in 2012, with net profits of $3.9 billion. But that, too, was a decline from the previous year and reflected the weakness of air freight markets.

The reason for this robustness was the strength of emerging markets. Economic growth and air travel have been weak in the developed economies. Emerging markets, however, in Asia, Latin America, and Africa, have experienced strong economic growth. This, in turn, has supported the growth of air travel by more than global GDP numbers suggest.

During 2012, 65 per cent of the growth in passenger numbers in international markets took place in markets linked to emerging economies. Travel within Asia accounted for just over half of this growth.

Other important growth markets were between Europe and Asia and on segments connecting Europe and Asia via the Middle East. Markets from Africa to the Middle East and to Asia were also strong, reflecting the development of new South–South trade lanes.

> nivedita.ganguly@thehindu.co.in

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