Aviation industry anticipates reduction in net margins

The international air industry is looking forward to 2011 with a mixture of hope and trepidation.

Indeed, the year 2010 had begun with the International Air Transportation Association expecting a very difficult year due to prevailing economic conditions. However, as the year went on, the association’s predictions for net profit were revised upwards significantly. Following stronger third quarter performance, the projected US$8.9 billion profit was expected to instead reach $15.1 billion for the calendar year.

The drivers for the improved forecast were based on a passenger traffic growth of 8.9 per cent, which compared favourably from their previous forecast of 7.7 per cent. Also, passenger yield growth was 7.3 per cent – a metric that the association had not changed from its previous forecasts.

Revenue growth improved by $5 billion between the forecasts in September and December, ending on an anticipated $565 billion. Finally, the average oil price – always a large influence on industry forecasts – had remained in line with a previous prediction of $79 per barrel.

The director-general and CEO of the International Air Transport Association, Giovanni Bisignani, said that there were good reasons that the third quarter in particular had been so impressive for the industry.

 “The third quarter of 2010 was exceptionally positive in terms of passenger traffic volume. Airlines met increased demand by utilizing their fleets more intensely. Fixed costs remained constant, passenger yields firmed and the increased revenues went almost directly to the bottom line,” he said in a media release.

However, cargo operations did not improve as much as forecast. Initially, demand was reckoned to grow by 19.8 per cent by the association, which was revised down to 18.5 per cent. As a result, growth in yield was limited to 7 per cent, rather than the optimistic 7.9 per cent figure touted earlier in 2010. This was due to a leveling-out of the industry and a subsequent natural market correction, which is related to spending power by the consumer, explained the chief executive officer.

“The post-recession rebound drove a rapid expansion for cargo earlier in the year but it ran out of steam by the third quarter. Since May, overall volumes fell by 5 per cent. This will only pick-up when consumers have bought the products that are already on the shelves,” said Bisignani.

Looking forward
Looking forward to the next twelve months, the airline chief revealed that projected profits for 2011 had also been revised upwards. In their previous calculations, $5.3 billion was touted as the yearly profit across the industry. However, because of the improved conditions, this soared to $9.1 billion. Despite this, net margins remain very thin; during 2010 this was 2.7 per cent and the industry is bracing itself for a drop to 1.5 per cent in 2011. This is the key figure that the industry must look to, noted Bisignani.

“Our profit projections increased for both 2010 and 2011 based on an exceptionally strong third quarter performance. But despite higher profit projections, we still see the recovery pausing next year after a strong post-recession rebound. And the two-speed nature of the recovery is unchanged with European airlines continuing to underperform other regions.

“Margins remain pathetic. With a 2.7 per cent net margin in 2010 shrinking to 1.5 per cent in 2011, we are nowhere near covering our cost of capital. The industry is fragile and balancing on a knife edge. Any shock could stunt the recovery, as we are seeing with the results of new or increased taxation on airlines and travellers in Europe,” said Bisignani.

The association also noted that whilst its forecast shifts in absolute numbers can appear dramatic, it was important to context them and relate them to the size of the industry to imbue them with their true significance. For example, the $6.2 billion increase in profit projection in the December forecast as compared to September’s lower figure still represents only 1.1 per cent of the projected net revenues across the industry of $565 billion. This reveals the wafer-thin margins which are a feature of the current air industry.

“Any increase in profits is a welcome step in the right direction. But the fact that we can increase our profit forecast by 70 per cent and still be left with a net margin of just 2.7 per cent shows just how far this industry has to go to achieve a normal level of profitability,” said Bisignani.

Economic recovery, according to the transport industry, will pause in 2011.
“Although the $9.1 billion profit projection for 2011 is better than we had previously forecast, next year the industry will face tougher conditions than what we are experiencing today,” noted Bisignani.

Nonetheless, the improved forecast was based on stronger-than-anticipated traffic growth. The revised figures show passenger demand likely to rise by 5.2 per cent rather than 4.9 per cent, and cargo to rise by 5.5 per cent rather than 5.3 per cent. As a result, passenger yields will rise by 0.5 per cent, which was initially forecast to be flat in 2011. Cargo yields will not change from the plateau that the association had expected.

Challenges to the air industry include increased fuel costs. Oil is expected to increase to $84 per barrel, which would increase fuel costs to 27 per cent of operating costs, a 1 per cent increase on 2010. On a wider level, gross domestic product growth globally will slow from 3.5 per cent to 2.6 per cent. Austerity measures in Europe are expected to drive down demand and concurrent increased taxation will push travel costs up by 3 to 5 per cent. This, said IATA, will discourage travel and slow industry recovery.

There is still significant regional instability across the industry. Middle East is the fastest-growing region with 10.5 per cent anticipated in 2011, but Europe is still lagging behind the rest with below-trend demand of 3.5 per cent. Capacity in Europe will increase by 4.4 per cent during 2011, further weakening profitability.

Latin America’s $1.2 billion profits during 2010 are expected to fall to $700 million in 2011. Capacity, at 7.2 per cent, outstrips the demand of 6.3 per cent.

“Consolidation within the region and a robust regional economy, led by Brazil, will continue to support solid and profitable growth among the region’s leading carriers,” said IATA.
Finally, North America’s 2010 profit of $5.1 billion will decrease to $3.2 billion.

“Since 2007, US carriers have improved profitability successfully by adjusting capacity ahead of demand changes. The weak US economic recovery will limit demand increases to 3.7 per cent (below the global average of 5.3 per cent while capacity will increase by 4.6 per cent driving the decrease in profitability,” read the statistical analysis released by the air body.
Forecasts were made in advance of the intense disruption to air services due to the extreme weather conditions that befell Europe and North America over the Christmas period.