CAPA airline profit outlook: bad news and good
The latest six monthly update of the CAPA world airline industry operating margin model lowers its forecasts for margins in 2018 and 2019. This partly reflects a downward revision to the margin reported by IATA figure for 2017 but, more importantly, reflects an increase in the oil price outlook.
The model reiterates the previous conclusion that the world airline industry's operating margin cycle peaked in 2016. However, if downward revisions to forecasts and falling margins are the bad news, there is also some good news in the airline industry's profit outlook.
The good news is that the current airline cycle is looking better than any other since the dawning of the jet age. Operating margins, even as they move into a downswing, look set to remain above levels that were associated with peaks in previous cycles. Whereas historic cycles tended to peak at an operating margin of around 6% before fairly quickly falling, the current cycle could record at least five consecutive years of margins at levels comfortably above previous cyclical peaks in 2015-2019.
Summary
The Jul-2018 update of the CAPA world airline operating margin model is summarised in the table below.
CAPA world airline operating margin model Jul-2018
|
|
2016 |
2017e |
2018f |
2019f |
Note/source |
|---|---|---|---|---|---|
|
Brent crude USD/barrel |
43.6 |
54.2 |
72.6 |
71.6 |
Reuters consensus 29-Jun-2018 |
|
World real GDP growth* % |
2.5 |
3.2 |
3.3 |
3.3 |
IMF forecast/Jul-2018 update |
|
|
|
|
|
|
|
|
Fleet** growth % |
3.9 |
2.8 |
4.3 |
4.5 |
CAPA model |
|
World RPK growth % |
7.4 |
8.1 |
7.0 |
6.6 |
CAPA model |
|
|
|
|
|
|
|
|
World airline operating margin % |
9.2 |
7.5 |
7.1 |
7.1 |
CAPA model |
Changes to the model versus the Jan-2018 update
The main differences between CAPA's Jul-2018 model and the Jan-2018 forecast are as follows:
- 2017 operating margin is lowered from 8.5% to 7.5%, in line with IATA's most recent figure published in Jun-2018. IATA gathers bottom-up data from airlines and so, this should more closely reflect the outcome. RPK growth rate for 2017 is raised from 7.7% to 8.1%, in line with IATA, but this is more than offset by higher cost figures.
- CAPA forecast of 2018 margin is lowered from 8.0% to 7.1%, due to a higher Brent crude oil price forecast (raised from USD59.9 to USD72.6). RPK growth and fleet growth rates are unchanged.
- CAPA forecast of 2019 margin is lowered from to 7.7% to 7.1%, due to a higher Brent crude oil price forecast (raised from USD61.3 to USD71.6), only partially offset by higher forecast GDP growth (raised from 3.2% to 3.3%) and higher RPK growth (raised from 6.4% to 6.6%).
World GDP and RPK growth forecast to remain above long term trend rates
The IMF's Jul-2018 economic outlook maintains its forecast for 2018 world GDP growth of 3.3% (at constant prices and at market exchange rates), extending this same growth forecast to 2019 fractionally above its long term historic trend rate of 3.1% for the first time since 2010.
After the world economy achieved growth of 3.2% in 2016, this would be the first time since 2004-2007 that world GDP has grown faster than its historic trend rate of 3.1% for three successive years.
Consequently, world RPK growth looks set to remain at, or above, its long term trend rate of 6.2% throughout the forecast period (and for five consecutive years, 2015-2019, if the forecast is borne out).
CAPA forecasts RPK growth easing back from 8.1% in 2017 to 7.0% in 2018 and 6.6% in 2019, a declining rate each year as the stimulating impact of lower oil prices enjoyed in 2015-2017 dissipates.
World GDP growth* and world airline RPK growth 1971 to 2019f
Fleet growth to increase from 2017, but retirement rates are the main uncertainty
Fleet growth took an unexpected dip in 2017, based on figures updated since the Jan-2018 CAPA model. Although data on deliveries were known earlier in the year, data on retirements have been revised upwards from 1.5% of the fleet to 3.2%.
This uptick in aircraft retirements was most likely stimulated by the rise in oil prices in 2017 (and the anticipation of further increases in 2018), and also reflects an increase in the number of old generation aircraft (737 Classics, 757s) reaching the end of their economic lives.
Aircraft* retirements as a percentage of deliveries (left hand axis) and airline fuel cost as a percentage of revenue 1979-2017e
This increase in retirements lowered the annual rate of growth in the commercial jet fleet in 2017 to 2.8% from a previous estimate of 4.6%. This interrupted an upward trend in fleet growth since it dipped to 2.6% in 2011.
For 2018, fleet growth is forecast to be 4.3%, the same as the previous CAPA forecast, although the lower growth in 2017 means that the world fleet will be a little smaller than previously modelled.
For 2019, fleet growth is forecast at 4.5%, which is a slight increase on the 2018 rate.
These 2018 and 2019 fleet growth forecasts would be higher than for any year since 2001 (when it was 5.6%), but still some way short of previous peak growth rates of more than 7% and below forecast traffic growth rates.
As was highlighted by the increase in aircraft retirements in 2017, future retirement levels are the biggest source of uncertainty in the fleet growth forecasts. Further oil price increases could trigger another year of higher retirement rates.
World airline industry deliveries and retirements as a % of fleet* and growth in fleet 1971 to 2019f
Oil price forecasts are raised significantly
The price of Brent crude oil averaged USD54.2 per barrel in 2017 and is now forecast to increase to USD72.6 in 2018, before easing back slightly to USD71.6 in 2019 (based on the most recent monthly consensus poll published by Reuters on 29-Jun-2018).
This is a significant increase on the forecasts used in the Jan-2018 CAPA model, which were USD59.9 per barrel in 2018 and USD61.3 in 2019.
Brent crude USD per barrel Jan-2000 to Jul-2018
The relationship between oil prices and airline fuel costs as a percentage of revenue is not exact, since a number of factors introduce distortions. These include fuel hedging, which smooths out and delays the impact of price fluctuations, as well as currency movements and long term improvements in the fuel efficiency of aircraft engines and airline operational processes.
Revised data from IATA now show that the world airline fuel bill was USD149 billion, or 19.8% of revenue.
Although this was a significant drop from 29.2% as recently as 2014 (and from a peak of 32.3% in 2012), it was higher than the 2016 figure of 18.6% and above the previous 2017 estimate of 17.2% of revenue (which would have been lower than the 2016 figure).
The upward turn in fuel cost as a percentage of revenue started sooner than previously expected (as noted above, it is not just a straightforward function of the oil price upturn).
This burdened the airline industry with some additional cost above what was previously forecast (helping to explain the lower operating margin figure for 2017) and probably helped to increase aircraft retirements.
Airline fuel cost as a percentage of revenue and airline operating margin 1979-2017e
The airline cycle may now be able to maintain a higher midpoint than in the past
Rising oil prices have led to lower margin forecasts in the CAPA world airline operating margin model for 2018 and 2019, with declines from the cyclical peak of 2016.
Nevertheless, CAPA's forecasts predict that the current cycle will enjoy at least five consecutive years of margins at comfortably above previous cyclical peaks of 6% in the period 2015-2019.
Profitability in the airline industry still appears to be cyclical, but it has gone some way towards showing that it can maintain a higher midpoint of the margin cycle.
World airline industry operating margin (% of revenue) 1975 to 2019f*
