| A need to resist temptation |
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Although there are still a number of mixed economic messages and some clear areas for concern that remain, for many countries the near term outlook is one characterised by growth rather than just recovery. As if we needed reminding the recent past clearly shows (again) that economic activity not only drives the volume of air travel but also has wider impact on revenue through its impact on mix. Making forecasts is often a bit of a nightmare particularly when there is an unstable operating environment. Even at a company level a forecast reflects the outcome of large numbers moving in different directions; at an industry level the sensitivity to small changes is clearly magnified. The nature of the recovery underway in the airline operating environment varies markedly between regions and companies and the corresponding improving (or for some less worse than expected outcomes) reflects to varying degrees cyclical and structural influences. It came as no surprise that IATA announced its latest forecast for 2010 at the time of the AGM in Berlin in the early part of June. Similarly it was no surprise that the new forecast includes a significant increase in operating profit to $12.7bn (previously $8.2bn); furthermore it also represents a near doubling of the initial forecast for 2010 which was made in September and the current expectation is some three times the $4bn forecast at the time of maximum concern in December 2009. At the net level there is now an expectation of a return to profit with $2.5bn compared with the previous forecast of loss of $2.8bn and reported net losses of $16bn in 2008 and $9.9bn in 2009. The main swing factor in the new forecast is a more optimistic view on revenue, some $70bn higher than the initial forecast for 2010; Comparing the September 2009 forecast with the latest one suggests an operating margin on this incremental revenue of just 10%. Costs are also forecast to increase markedly and here not only fuel costs but rather worryingly non-fuel costs too which are already expected to be back at 2008’s levels; revenue in 2010 however is forecast to still be some $20bn below that achieved in 2008. The forecast is also predicated on the industry achieving its highest ever weight load factor (66.1%) and a similarly record breakeven load factor (64.5%); in the original 2010 forecast the achieved load factor was forecast to be 62.5% and the breakeven to be 61.7%. Generalisations are always dangerous and whilst the news that the industry overall is expected to return to profit is good for sentiment, and all that goes with a more positive feeling towards the sector, the reality is that we are mostly interested in the performance of individual airlines, or a small group of airlines, for whatever reason; whether they are our competitors, targets or companies which we might analyse and provide profit estimates for. Whilst the ink used by the accountants may well be black rather than red, the recovery remains fragile and here there are both external factors as well as management actions that could impact the nature of the financial recovery. There is also a need to separate out the cyclical, structural and what appear to be random effects. Fuel, for example, remains a great unknown and indeed a concern with forward curves still suggesting over $100 a barrel and the current spot price is some 14% up on a year ago. Indeed the fall in the fuel price in 2009 played a major role in the actual outcome being less worse than feared; in this respect Ryanair’s latest results, for the year to March 31st 2010, showed an increase in operating profit of €258m with revenues up by €46m and the cost of fuel down by €363m; Ryanair’s cash position not only remains particularly strong but is also forecast to strengthen further; not only from operations but also as capital expenditure falls away when its current aircraft delivery programme ends. It is still possible to characterise the economic cycle using letters of the alphabet and whilst Asia is now moving up the right hand side of the V, the US appears to be following a U shaped path, Europe could still take the shape of a W or if not appear to have the shape of a gently sloping L. Indeed from an airline financial perspective Europe remains the only area where the expectation is for not just a loss but a relatively significant loss too at the net level. Here, as elsewhere, there is an expectation of a degree of cyclical recovery in revenue amongst Europe’s airlines and in this respect management at British Airways, which experienced a fall in revenue of some £1bn between FY2009 and FY2010, stated at its investor day that it expected an increase of some 6% in revenue in the current year to March 31st 2011, getting it halfway back to where it was in FY 2009. In its latest annual report BA’s management, against the background of the revenue fall, refers to a cost led recovery in its last financial year which for them was evident through a fall in their fuel bill of just under £600m and a fall in non fuel costs of some £390m. This resulted in effectively unchanged operating losses of £220m. Perhaps more important was BA’s net cash from operations which increased from £133m in FY2009 to some £331m in FY 2010. In so far as BA provides guidance on its future prospects it appears that the increase in revenue, continuing progress on non-fuel costs and a slight rise in the fuel bill could result in a swing to an operating profit close to £300m. The change in “mood music” generally occurred late in the final quarter of 2009 and the evidence of this is provided by those airlines reporting quarterly financial results as well as a range of other observable features. At an industry level, against the background of generally modest capacity increases, there are the signs of a virtuous circle emerging with a combination of rising load factors and fares. However there is still a long way to go before yields recover to previous levels; whilst the forecast is for passenger and cargo yields to increase by 4.5% in 2010, this is against the background of a 14% fall for each in 2009. Now perhaps more than ever there is a need to control the rate of increase in capacity, whether as the result of the re-introduction of aircraft, the restoration of previous flying programmes or from new deliveries, the latter are expected to a net increase in capacity of 800 aircraft in 2010. The experience of the ATA member airlines provides some compelling evidence of the benefits of constraining supply. Capacity for this group is back to levels last seen in 2000 and the latest news from the ATA suggested that whilst passenger numbers increased by just 2% revenues in May were some 21% higher – clear evidence, if any was needed not only how the rules of economics work but that they also apply to the airline industry too. For Delta systemwide passenger traffic in May was up by 2.7% with capacity just 0.6% higher resulting in a load factor of just under 84%; at United the increase in passenger traffic was 7.5% and with an increase in capacity of just over 3% and the load factor improved by some 3 percentage points. In Asia although AAPA does not publish monthly yield figures, the latest traffic figures for their organisation show RPKs up by almost 15% and with an increase in capacity of just over 3%, passenger load factors improved by 7.3% points to 78%. As ever it volume (a function of economic activity and price) followed by value (a function of mix and relative excess demand/restricted supply) represents the path to recovery. In the past the early stages of recovery have been characterised by what is best described as capacity discipline; in Europe “last time” there was also an effective vacuum into which Ryanair and easyJet rapidly expanded however this time around their rate of planned growth appears modest and whilst we expect them to growth substitution effects will be important, not least in respect of the potential yield benefits that are likely to result. The challenge for airline managements may be that with load factors already high and the scope to increase them limited by a number of factors, the temptation is to add capacity and go for market share and if this happens then nothing will have changed. The opportunity is to constrain capacity and manage yields higher. Looking ahead it is inescapable that the decisions and actions that are taken in the upswing of the cycle that in large part determine the ability to withstand the next (inevitable) downturn and just as there was a widespread view a year ago that there was a need to ensure that any actions taken in the downturn should not jeopardise the recovery the same sentiment should apply in the upswing of the cycle where after the peak the only thing to look forward to is the next trough. However as the likelihood is that profit forecasts for the most part are likely to increase as we move through 2010 and into 2011, holding back with capacity may be increasingly difficult to sustain as a preferred course of action and here the real issue is whether the growth is structural or just cyclical. As a result a key question remains unanswered, will it indeed be different this time or ultimately rather depressingly familiar – we watch and wait with interest to see. Source: Cris Tarry / Air Transport News, August 30, 2010 |
