21-Mar-2012 5:19 PM

2011 airline profitability revised upwards but profitability to weaken in 2012: IATA

Analysis

The global aviation industry could report losses of USD5.3 billion in what is set to be another tough year in 2012 amid weak global GDP growth and rising fuel costs. Average oil prices could reach as high as USD135/bbl in 2012, according to IATA's 'oil spike' forecast for 2012. However, the industry body's 'central forecast' outlines an expected profit decline from USD3.5 billion to USD3 billion in 2012 for an "anemic" 0.5% profit margin, based on fuel prices at USD115/barrel. However, the forecast marks an improvement from the 'banking crisis' forecast provided in Dec-2011 of a potential USD8.3 billion loss.

These latest observations from IATA are yet another reminder of the fragility of the aviation business. Its exposure to myriad externalities and uncertainties make sustained profitability difficult.

Summary

The global aviation industry is expected to report losses of USD5.3 billion in 2012 due to weak global GDP growth and rising fuel costs.
Average oil prices could reach as high as USD135/bbl in 2012, which would further impact the profitability of airlines.
Despite improvements in macro-economic conditions, global GDP is expected to grow by only 2% in 2012, posing a risk to the aviation industry.
Rising oil prices are the major driver for reduced profitability in 2012, with fuel costs expected to reach USD213 billion, accounting for 34% of total operating costs.
Asia Pacific airlines are expected to deliver the largest absolute profit in 2012, while Europe and Africa are forecasted to face losses.
Passenger and cargo markets are expected to see a 2% yield improvement in 2012, driven by higher fuel costs, tighter capacity management, and modest improvement in business confidence.

IATA director general and CEO Tony Tyler also cautioned that despite improvements in macro-economic conditions, global GDP is expected to grow by only 2% in 2012. "The risk of a worsening Eurozone crisis has been replaced by an equally toxic risk - rising oil prices. Already the damage is being felt with a downgrade in industry profits to $3.0 billion… With GDP growth projections now at 2.0%...it will not take much of a shock to push the industry into the red for 2012," Mr Tyler said.

World economic growth and airline profit margins: 1970 to 2011

Oil prices weighing heavily on airlines

The major driver for the reduced profitability forecast in 2012 is rising oil prices. IATA, which based its Dec-2011 forecast on oil at USD99/barrel, noted the risk of an escalation in fuel costs related to concerns that Iran could close the Strait of Hormuz, cutting off vital supply links. "In this scenario, oil prices could spike at USD150/barrel for Brent crude mid-year, for a full year average of $135. In such a scenario, global GDP growth would fall to 1.7%, plunging the entire industry towards losses of over USD5 billion," IATA cautioned.

IATA has separately forecast the new fuel price average for 2012 would be USD132.7/barrel, having a USD37 billion impact on the 2012 fuel bill. In 2012, the airline fuel bill is expected to reach USD213 billion, which is 34% of total operating costs. In the week commencing 09-Mar-2012, jet fuel prices stood at USD139.5/barrel, up 5.4% year-on-year, according to the IATA Fuel Monitor. The average price year-to-date is approaching USD120/barrel with the current forecast based on an USD115/barrel full-year price.

Jet fuel and crude oil prices: May-2007 to Feb-2012

Airline commentary on the impact of jet fuel increases has heightened in recent weeks, with a number of carriers increasing jet fuel surcharges and seeking to manage fuel costs through hedging activity. See CAPA's newly upgraded profile on jet fuel for more information.

Regional differences widen, with Asia Pacific airlines to again deliver largest absolute profit in 2012

All regions are forecast to see reduced profitability in 2012 compared to 2011, and Europe and Africa will see losses. The profit forecast for North America was downgraded, while the forecast for Asia Pacific and the Middle East was raised by IATA compared to its 'central' forecast of Dec-2011. IATA noted that Asia Pacific airlines have performed well in the current environment, particularly the Chinese airlines. The region was behind an upwardly revised profit forecast for 2011 of USD7.9 billion. European airlines, unsurprisingly, have been under downward pressure from weak economic growth in the euro zone.

IATA regional divergence in net post tax profits for 2011 and 2012 (USD billion)

Passenger yield improvement of 2% forecast

IATA is now forecasting a 2.0% yield improvement in 2012 for both passenger and cargo markets, compared to a Dec-2011 forecast of flat yields this year. IATA said higher fuel costs, tighter capacity management in passenger markets and the stabilisation of freight markets expected to drive the increase, with a modest improvement in business confidence also having a positive impact on business travel trends. "This uptick in confidence is consistent with further growth, albeit in low single figures, of business travel and the important premium travel segment," IATA said.

Premium travel and business confidence: Jan-2007 to Jan-2012

In Jan-2012, premium traffic was up 2.9% year-on-year, while economy traffic increased by 6.1%, above the 5.1% rate seen in 2011.

International air passengers by seat class (seasonally adjusted): 2004 to Jan-2012

Premium passengers as a percentage of the total: 2004 to 2012

Demand to outpace capacity growth in 2012 marking reversal from Dec-2011 forecast

For 2012, IATA is expecting overall capacity (passenger and cargo combined) to grow by 3.2% (based on announced schedules), with capacity forecast to grow at a slower pace than the anticipated 3.6% expansion in demand. This is a reversal of the expectation in Dec-2011 of capacity expansion (3.1%) outstripping demand (2.9%). Passenger demand is expected to grow by 4.2% (0.2 ppt ahead of the Dec-2012 forecast).

2012 began with a further rise in air travel, but a decline in airfreight. Worldwide traffic (RPKS) increased by 5.7% year-on-year, a slight acceleration from Dec-2011 growth rates. Even after correcting for the Chinese New Year distortion to air travel, the growth trend remains upwards in early 2012, albeit at a slower pace than during 1H2011.

Total air freight and passenger volumes (seasonally adjusted): 2006 to Jan-2012

Load factors and aircraft utilisation return to pre-recession levels

Passenger load factors and aircraft utilisation, a key element to profitability in the capital intensive airline business, have returned to or above pre-recession levels, with load factors more than 2 ppts above pre-recession levels in Jan-2012.

Passenger load factor and twin aisle aircraft daily hours (seasonally adjusted): 2007 to 2012

Freight markets stabilising but market remaining weak

IATA stated it expects airfreight to be flat in the coming months, following "signs that the shrinkage of freight volumes was levelling out at the end of last year" and amid improving signs relating to purchasing trends and consumer confidence. IATA continued: "There is also no sign of any business inventory overhang that would usually precipitate a substantial cutback in air freight."

World trade in goods and air FTKs: 2007 to 2012

Meanwhile, freight load factors remain weak, and were down 6% from their 2010 peak in Jan-2012, with average hour flows by freighter aircraft also weaker, by 11%. "Falling asset utilisation, declining yields from mid-year and the second half weakness in freight markets made cargo a more difficult business in which to sustain profitability than the passenger business," IATA noted. Looking forward, however, IATA expects capacity to grow at a slower pace than demand, "producing a supply-demand environment that will limit the damage to profitability from high jet fuel prices".

Total freight market load factors (seasonally adjusted): 2006 to 2012

Total freight market (domestic and international) traffic (monthly FTKs, billions): 2006 to 2012

Aviation industry to remain in 'normal state of crisis' in 2012

IATA, which provided two forecast scenarios for 2012, has again underscored the fragility of the aviation sector, which continues to be rocked by many and varied external factors. Profitability remains an elusive challenge for the industry, and IATA notes that the best collective margin of the last decade of 2.9% (2007 and 2010) "does not cover the cost of capital". While predictably criticising governments for regulatory, tax and infrastructure burdens, IATA also noted the need for airlines to improve the efficiency of their own operations.

IATA operating profit margin and net profit margin: 2003 to 2012F

IATA financial forecast for 2012 based on Mar-2012 forecast

IATA financial forecast by region for 2012 based on Mar-2012 forecast

IATA traffic forecast by region for 2012 based on Mar-2012 forecast

2012 financial forecast for 2012 by region

Region	Forecast	Commentary
Europe	Unchanged at USD600 million net loss and an EBIT margin of 0.3% of revenues.	European carriers face the most challenging environment in 2012 according to IATA who noted: "While it appears that a major worsening of the Eurozone crisis has been averted, many European economies are in deep recession which will see continued weakness in both the cargo and passenger business. At the same time air travel is being hit by taxation and the cost of the EU ETS."
North America	Profit of USD900 million, down from previous forecast of USD1.7 billion.	A forecast 2.0% EBIT margin shares top position with Asia-Pacific carriers. Higher fuel costs are responsible for the downgrade, but airlines will likely "see the smallest deterioration from the 2011 performance among the major regions, as a result of the very small increases in capacity expected", according to IATA.
Asia Pacific	USD2.3 billion profit, USD200 million more than previously forecast.	Asia Pacific carriers continue to "perform well", according to IATA. Better than expected performance in 2011, particularly by the Chinese carriers, saw an upward revision of 2011 profits from USD3.3 billion to USD4.8 billion. For 2012, the region's airlines are expected to again deliver the largest absolute profit. "Higher fuel costs will more than halve profits this year but the region's relatively strong economies will continue to generate more rapid growth in travel and cargo than the other large regions," IATA said.
Middle East	Profit of USD500 million, up from previous forecast of USD300 million.	IATA noted that financial performance "was already seen to be better than previously expected in 2011, with an upgrade from USD400 million to USD1 billion". In the passenger business, load factors have improved due to a slowdown in new capacity additions, and long-haul markets have been relatively robust.
Latin America	USD100 million, unchanged.	IATA noted that performance is mixed across the region, but intense competition in some major markets and slowing economies will make it more challenging for the region's airlines to recover the increase in fuel costs they face this year.
Africa	Loss of USD100 million, unchanged.	IATA noted that some of the region's economies are growing strongly and generating expanding demand for air transport. "However, passenger and freight load factors are very low on average for airlines in this region which will make it difficult to recover the rise in fuel costs," IATA said.