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Bad and worse – IATA’s two-case scenario for 2012

9-Dec-2011

IATA has unusually provided two forecast scenarios for 2012 – a ‘central forecast’ and ‘banking crisis’ forecast – or perhaps more accurately, the ‘bad’ and ‘worse’ forecasts. Both show that global airline profitability is expected to be sharply lower than previously forecast. IATA is downgrading its ‘best case’ 2012 profit by 29% from USD4.9 billion, as forecast in Sep-2011, to USD3.5 billion for a net profit margin of just 0.6%, down from the previous forecast of 1.2%. The USD1.4 billion downgrade, which highlights the continued profitability challenge facing the world’s airline industry, will see global airlines report at best a 49% year-on-year reduction in net profitability from forecast profit levels of USD6.9 billion in 2011.

The reduction reflects the risk of recession in Europe and slower global economic growth, with IATA warning the industry could face a loss of USD8.3 billion if the euro zone crisis becomes a full-blown banking crisis. This ‘banking crisis’ forecast foresees every region having a net loss in 2012 while the ‘central forecast’ sees only Europe and Africa reporting net losses in the year. Meanwhile, the profitability forecast for 2011 remains unchanged, at USD6.9 billion for a weak net margin of 1.2%.

While this forecast remains unchanged, IATA director general and CEO Tony Tyler noted “regional differences have widened, reflecting the very different economic environments facing airlines in different parts of the world”. Mr Tyler commented that “the biggest risk facing airline profitability over the next year is the economic turmoil that would result from a failure of governments to resolve the Eurozone sovereign debt crisis. Such an outcome could lead to losses of over USD8 billion – the largest since the 2008 financial crisis”.

Central forecast – Weakening traffic and yield conditions with European carriers headed into the red in 2012

The most pressured airlines in 2012 will be European airlines, according to IATA, which believes it is “unlikely that Europe will avoid a brief recession”. All regions are, however, expected to show profit deterioration from 2011 levels, although there will be a “marked divergence” of financial performance between regions. Contrasting performances are shown by North American airlines, where capacity cuts are providing some protection to profitability, and in Asia where IATA is forecasting “significant profits” generated by high load factors on China’s expanding domestic market.

IATA regional divergence in net post-tax profits (USD billion): 2011, 2012 Central and 2012 Crisis

Based on the central forecast, IATA expects global passenger demand to increase by 4.0% in 2012 (down from previously forecast growth of 4.6% and the 6.9% increase forecast for 2011), while cargo is expected to show flat growth (down from the previously forecast 4.2% expansion). Airlines are expected to invest around USD100 billion in 2012 on new aircraft, resulting in a 6% increase in capacity. Global passenger and cargo yields are expected to remain flat in 2012. While this is unchanged for cargo, passenger yields were previously forecast to grow by 1.7%.

Fuel cost estimates are relatively unchanged from the previous forecast at USD198 billion based on oil at USD99 per barrel (against a previous forecast of USD100/barrel). Overall cost increases are expected to increase by 4.5% to USD609 million, outpacing the forecast industry revenue growth of 3.7% to USD618 billion.

IATA 2012 forecast by region

Region

 IATA ‘Central Forecast’

IATA  ‘Banking Crisis forecast’ (net results)

Europe

Expected to fall into losses of USD600 million impacted by home market economic weakness and further increases in passenger taxes. IATA commented that “regardless of the scenario, we see the continent’s carriers falling into losses next year. The only open question is how deep they will be”.

USD4.4 billion loss, the deepest of any region.

North America

Expected to generate profits of USD1.7 billion, maintaining the strongest EBIT margin of 2.4%, as limited capacity growth provides some protection against the downward pressure on profits.

USD1.8 billion loss

Asia Pacific

Expected to deliver the largest absolute profit at USD2.1 billion. This is weaker than the 2011 performance but the deterioration is limited by high load factors on markets such as China, where the increases in demand are structural and to some extent shielded from the cycle, according to IATA.

USD1.1 billion loss

Middle East

Expected to post a USD300 million profit, less than half the previously forecast USD700 million profit, as long-haul market conditions deteriorate, in particular those linked to the weak European economies.

USD400 million loss

Latin America

Will see profits decline to USD100 million, marking a USD400 million negative swing from the previous forecast. IATA noted that this is “partly a carry-over from the recent weakness of profitability in the large Brazil market”.

USD400 million loss

Africa

Will fall into losses of USD100 million, unchanged from the previous forecast.  “Economies and air transport markets continue to grow in the region, but load factors are not expected to be strong enough to offset the impact of weaker yields on profitability,” IATA said.

USD200 million loss

Losses of up to USD8.3 billion if euro zone crisis deteriorates to renewed banking crisis

The outlook worsens based on the ‘banking crisis’ forecast, which Mr Tyler stated is the “worst-case – but by no means unimaginable – scenario”. Based on this scenario, IATA estimates global aviation industry losses could reach USD8.3 billion, with a net margin of minus 1.4%, with losses across all regions. European carriers would contribute over half of the losses under this scenario. At an EBIT level under the banking crisis forecast, only North America and Asia Pacific would post small profits.

This second scenario is based on OECD’s latest economic outlook, which carried a risk assessment on the European sovereign debt crisis, with this scenario foreshadowing the potential for the euro zone debt crisis to “spiral out of control”. The scenario is based on global GDP growth shrinking to 0.8%, driven by a “deep recession” in Europe. Key to IATA’s forecasting of this scenario is that the historical trend is one where the “airline industry has seen profit turn into loss whenever global GDP growth falls below 2%”, with global GDP growth forecasts for 2012 being revised downwards to 2.1%.  

OECD scenario of the economic effects of a banking crisis

In the ‘banking crisis’ scenario, airlines would likely see growth in passenger demand “grind to a halt” and a 4.7% contraction in cargo markets. Both passenger and cargo yields would decline by 1.5%. The silver lining would be the likely relief in the fuel price. Based on oil at USD85 per barrel, the fuel bill would be USD183 billion, consuming 31% of costs. However, overall expenses would be expected to grow by 1.9% (compared to 2011) to USD592 billion. Revenues would see a fall of 1.3% (compared to 2011) to USD589 billion.  

2011 – Profit forecast unchanged but regional differences widen

The IATA global forecast for 2011 is unchanged at USD6.9 billion, with IATA noting that financial performance is “still reasonably good” as at 3Q2011 after peaking in 3Q2010. During 3Q2011, EBITDA in the three largest regions stood at between 5% and 10% and cash flows had “more or less stabilised” after pressures in 4Q2010 and 1Q2011, IATA said. 

EBITDA as % revenues, seasonally adjusted

While the overall global profit remains unchanged, every region with the exception of Africa has seen a change in profitability forecasts. North America and Asia Pacific has seen an upward forecast, while Europe, Latin America and the Middle East have witnessed a downward revision.

IATA global net profit outlook development for 2011

Region

Sep-2010

Dec-2010

Mar-2011

Jun-2011

Sep-2011

Dec-2011

Global

USD5.3 billion

USD9.1 billion

USD8.6 billion

USD4.0 billion

USD6.9 billion

USD6.9 billion

Europe

Breakeven

USD100 million

USD500 million

USD500 million

USD1.4 billion

USD1.0 billion

North America

USD1.4 billion

USD3.2 billion

USD3.2 billion

USD1.2 billion

USD1.5 billion

USD2.0billion

Asia Pacific

USD3.0 billion

USD4.6 billion

USD3.7 billion

USD2.1 billion

USD2.5 billion

USD3.3 billion

Latin America

USD600 million

USD700 million

USD300 million

USD100 million

USD600 million

USD200 million

Middle East

USD300 million

USD400 million

USD700 million

USD100 million

USD800 million

USD400 million

Africa

Breakeven

USD100 million

Break even

(USD100 million)

USD0 million

USD0 million

IATA 2011 forecast by region

 

Result

Commentary

Europe

Collective profit of just USD1.0 billion, down from the previously forecast USD1.4 billion, and an EBIT margin of 1.2%.

European carriers are “by far in the most challenging position”. Higher passenger taxes and weak home market economies have limited profitability in Europe. Low profitability has been the case despite European airlines being one of the fastest growing regions in terms of traffic in 2011. Yields have suffered and the base of strong demand grows more fragile as the sovereign debt crisis escalates, IATA said.

North America

Collective and improved profitability of USD2.0 billion (up from the previously forecast USD1.5 billion).

North American carriers are in a much more benign environment, IATA said. These carriers have seen yield and load factor improvements as a result of tight capacity management. The US economy has also grown at a faster pace than Europe. This gives the region the strongest EBIT margin of 3.2%. Nonetheless, the bankruptcy filing of American Airlines indicates the region faces intense competitive challenges as well, IATA noted.

Asia Pacific

IATA upgraded its forecast for the region by USD800 million to a USD3.3 billion profit. This is the largest absolute profit among the regions.

Asia-Pacific carriers  saw stronger though varied trading conditions. Japan’s domestic market still has not fully recovered from the 11-Mar-2011 earthquake and tsunami, and load factors remain under pressure. By contrast, airlines have improved load factors and profitability on China’s expanding domestic market.

Middle East

Expected to see profits of USD400 million, down from the previously forecast USD800 million.

High fuel costs squeezed profit margins on the more price sensitive long-haul traffic connecting over Middle Eastern hubs.

Latin America

Profits will see a downgrade to USD200 million from the previously forecast USD600 million.

Performance has been mixed across the region with much of the downgrade due to the impact of intense competition and falling load factors on Brazil’s domestic market.

Africa

Still expected to breakeven.

New trade lanes with Asia are developing and markets within the continent are reflecting the improvement in economic development in many African economies.  However, competition has been fierce and the region’s airlines have struggled to keep load factors at profitable levels.

Passenger demand expanding at faster-than-expected pace

At the global level, passenger demand is expected to expand by 6.1%, stronger than the 5.9% forecast in the previous forecast from Sep-2011, as air travel growth continues at a stronger pace than previously expected. This robust air travel demand has occurred despite weakening business and consumer confidence in Europe and US, although the outlook is expected to weaken.  

The demand strength, along with tight capacity management (particularly in North America) has kept load factors high and is supporting a 4.0% increase in yields. Simultaneously, airlines have generally been able to increase breakeven load factors, through yield improvements and reductions to non-fuel unit costs. As well as stabilising breakeven load factors on passenger markets up until 3Q2011, airlines have also maintained high aircraft utilisation.

Passenger load factor (%) and aircraft utilisation (average daily hours flown) (seasonally adjusted):
2007 to 2011

These factors have helped a modest increase in forecast revenues, despite the weaker-than-expected cargo performance and higher-than-anticipated oil prices, with revenue forecast at USD596 billion in 2011. IATA is forecasting a 0.5% contraction in cargo volumes and flat yields in 2011, while the 2011 fuel bill is expected to increase by USD2 billion from previous forecasts, at USD178 billion, with oil prices averaging USD112/barrel. 

While demand has held up, freight markets have been declining since mid-2011, with declines of 5% between May-2011 and Oct-2011, reflecting declining world trade and business confidence.

Total air travel (RPKs per month, billions) and air freight volumes (FTKs per month, billions) (seasonally adjusted):
2007 to 2011

Challenging conditions to benefit LCCs

Mr Tyler stated the challenging conditions will likely benefit LCCs. He commented that Asian LCCs, in particular, have successfully demonstrated their ability to succeed in difficult environments through lower costs and increased efficiency. At the same time, he said the traditional carriers have also been showing good revenues through their own efforts. "They have been successful in their own corners," he said, adding that enlightened government policies and the entrepreneurial drive among Asian carriers had also helped to bring about positive results.

Aviation industry to remain in ‘normal state of crisis’ in 2012

The IATA outlook for 2012 highlights that achieving traffic growth and profitability are two different stories, with profitability remaining and continuing are often elusive challenge for the industry. This has prompted Mr Tyler to note that the “normal state of aviation is crisis and once in a while we have a few consecutive months of benign conditions”. He added that “this industry is all about turnover with very little leftover”. Assuming the IATA ‘central 2012’ scenario is correct, the airline industry will have lost since 2001 over USD26 billion on revenues of USD5.5 trillion. Over the last 40 years, airlines have been in the black but with a weak 0.3% margin.

In 2012, European carriers will face the most difficulties, although the overall picture of the industry remains precarious. The exact outlook for 2012 remains highly dependent on the problems of debt and competitiveness in the euro zone, IATA said. At the best case scenario, the “world would remain ‘two-speed’ and this would lead to a divergence of financial performance between airlines in Europe, exposed to weak home markets, and those in other regions, with a greater exposure to growth markets”.

IATA's chief economist Brian Pearce, meanwhile, stated that in the worse-case scenario, cash reserves held by the carriers would allow them to survive three months of sustained losses. “The average cash balance is about 20 percent of annual costs and annual revenues, so if they’ve got negative revenues and outflows, that would last a quarter,” Mr Pearce said.

APPENDIX: IATA Financial Forecast

IATA EBIT margin (%) and net profit (USD billion): 2009 to 2012F

IATA global traffic (TKPs) and capacity (ATKs) growth (%): 2009 to 2012F

IATA financial results and forecasts: 2003 to 2012F


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