CAPA Outlook: State of the Industry | March 2024

Transcript

Jonathan Wober:Okay, so my name is Jonathan Wober, Chief Financial Analyst for CAPA, and I'd just like to add my welcome to the one expressed by Claudia earlier on. Unfortunately, I can't speak Spanish, so I won't attempt to match her Spanish. And also, thank you to our hosts from Granada and Andalusia. So I'm going to try and give you an overview of— a snapshot, I should say— of the industry as I see it today, very much a sort of macro top-down view, and also to try and touch on some of the issues which will be explored in more depth over the next couple of days. It's a great pleasure to be here in the historic and beautiful city of Granada, and I for one am going to spend a weekend and explore it more fully. But let me move on. Where are we now? So here's our agenda. What I'm going to do— those of you that have seen me present the last year or 2, I've done 15 numbers in the past. I'm giving you 5 more numbers for your money. I'm going to go through 20 numbers describing the state of the industry. But I also want to spend a bit of time at the end talking about the relationship between market structure and profitability, and also the relationship between return on capital in the airline industry and and what I believe are rather low barriers to entry and rather high barriers to exit. So moving on, first, the number— the topics I'm going to touch on and the numbers are there. Let's get into the numbers. All right, so the first 2 numbers, and I don't make any apologies for starting off with these numbers again, 26 years to achieve the net-zero carbon emissions target. The difference between the last time I did this is the The 27 has become 26. The clock is ticking, and this is the most important goal for the airline industry. Of course, the green transition—it cuts through everything else that we're going to be talking about over the course of the next couple of days. So then, a snapshot of where we are in terms of recovery from the pandemic, and this is a chart that comes straight from the CAPA website and numbers from the CAPA fleet database. So the number of jets. In service globally as of the end of February 2024 is 105% of the number of February 2019. So we're 5% above pre-pandemic numbers of jets in service in total globally. It doesn't talk about utilization or any of those other details, but overall that's back above pre-pandemic numbers. I've put some other numbers on the slide as well in terms of breaking it down by business model. And you can see that the— in terms of the 2 major business models in terms of aircraft numbers, major not in terms of their importance, full-service carriers 101%, but low-cost carriers out there in front at 116%. And then at the bottom right of the screen, you can see the other business models, regional down at 88% still, regional airlines, cargo airlines 117%, and charter carriers up at 121%. So that's numbers of jets in service. If I move on to the next slide, seat capacity as of the current week, the week beginning— what was it— the 4th of March. This is from the CAPA website as well, this chart, and we can see that globally 105% is the level that we've now got to relative to the same week of 2019. And if you split down that by regions, you can see that Africa is out in front with 115%, Latin America, 110%. The only 2 regions not quite yet up to 100% are Asia-Pacific at 98%, and, and here in Europe, we're still only at 95%. But overall, 105%, back above previous capacity levels. Okay, capacity is one thing. What about traffic? Well, traffic numbers we don't get with quite such an update of every week, but the last IATA global traffic figures show that passenger traffic measured in revenue passenger kilometers— this is for January 2024, the most recent month— they were almost back to 100%. I, I did originally have a rounded number of 100%, but I thought, no, let's be accurate, 99.6%. So almost. Cargo, of course, has been back above 100% for a little while at 102.8%. And just a little bit of detail in the slide there, domestic passenger traffic is above 100%, it's 106. whereas international only still at 95.7%. Okay, so then moving, if I can— yes, it works. So just a little detail here. Low-cost carrier seat share is for the, for the, for the period of January to March 2024, according to current schedules, will be at 33.3% in total, a little bit higher for Which one is it now? A little bit higher for domestic, a little bit lower for international. And that's a 3 percentage point increase on 2019 and a 5 percentage point increase on 10 years ago in 2014. So low-cost carriers have emerged from the pandemic with an enhanced seat share. Okay, so a slide that's trying to capture a lot of very complex issues and challenges in the supply chain. But if I look at the number of deliveries made by the 2 principal suppliers of jet aircraft to the commercial airline industry, Boeing and Airbus, in total last year in 2023, they delivered 1,263 aircraft. And if that— if you look at that number compared to history, that's the same number more or less that they delivered together 10 years previously. So a combination of factors, the pandemic, but also a number of other factors which you'll know about, have basically lost 10 years' worth of delivery, you could say. If I look at the detail between the two of them, Boeing last year delivered 529, which was the level that it was delivering between 2011 and 2012. So it's lost even more, you know, 12 years or so. Airbus at 736. 735 deliveries, was back to the level it was delivering in 2017. Now, estimates for 2024— Airbus has set a target of 800 deliveries. Boeing hasn't given a target because of the various problems it's been facing. But if we assume somewhere in the region of 600 to 650, which would be a substantial increase on the 529 of last year, then the total between them would be in the region of 1,400 to 1,450, and that would be the level that they were delivering between them back in 2015, 2016. So they'll be catching up a bit. There'll be only sort of 9, 8 or 9 years behind rather than 10 years behind. But still, there's a, there's a big shortage of aircraft, new aircraft deliveries compared with previous years and compared with demand. Now, another, another slide that's talking about aircraft deliveries is By the end of 2023, there were roughly 16,000 aircraft in the orders backlog. 16,000. And if you put that relative to the number of aircraft that were delivered last year, that's 13 years' worth of production in the backlog. 13 years' worth of production. Which, if you exclude the COVID years where that blue line spikes, spiked upwards. This is basically the highest it's ever been— 13 years' worth of production in the backlog. Production rates are increasing. If you went by the estimate of this year's production, it would come down to about 11 years, but that's still as high as it's ever been. Okay, so another little detail on the fleet, and just to briefly touch on leasing. I'm going to be moderating a panel discussion on leasing before lunch. So we'll get more about it then. But 53% of the global fleet is currently leased, and by business model, the leader, the leader in that respect is the low-cost carriers who lease 68% of their fleet. So another look at the supply chain is, is labor. So, and one snapshot or one example of the labor constraints is just the pilot workforce. These are numbers which I took from from CAE's Aviation Talent Forecast published last June. And the, the bar on the left-hand side shows the number of pilots in the active workforce in 2023, and then a projection of how many will be needed in 2032. And if you, if you, if you work that out as an average growth rate, the average growth rate needs to be 4.1% per annum in the active pilot workforce over the 10-year period. Now, trying to find global data on historic numbers of pilots globally is a bit tricky, but if I look at the US, the growth rate historically over the previous 10 years in the US has only been 1.4%. So that may not be a number you can extrapolate to the world, but let's, let's just assume that it's close. There, there is two— the growth in pilot numbers historically has been slower than is needed in the future. So there is a shortage of pilots globally. One slide that touches on costs, fuel cost, which together with labor is, you know, the 2 biggest costs for any airline. And this is IATA's forecast published in December. Fuel cost as a percentage of airline revenues is expected to be 29% in 2024. It was about 30% last year and 29% the year before So we've got a period of significantly higher fuel cost as a percentage of revenue, because in the years leading up to the pandemic, it was between 20 and 22%. So quite a big increase. That that line there, fuel cost as a percentage of revenue, not surprisingly, broadly follows the the the price of of crude oil. It very broadly does follow that. Another line that broadly follows the price of crude oil is this one. So this is Airfare inflation, both in the European Union and also in the UK. So the European Union is the blue line and the UK is the red line. This is year-on-year increase by month in, in the cost of passenger air transport. For the EU, in January it was at 5.9%, having come down from very strong double-digit growth through much of 2022. and into 2023. And if you put the oil price chart on top of that one, it would move up and down in a similar pattern. Not surprisingly, this is one of the, the big drivers, is the oil price. Of course, another driver of, of, of yield or of airfare inflation is, is supply, and some constraints on the supply of aircraft and capacity has also been helping yields. And the likes of, for example, Michael O'Leary Ryanair have recently said that the shortage of deliveries expected of new Boeing MAX aircraft in the summer will have a positive impact on airfares this summer. Moving on to a forecast by IATA of the global airline net profit for the current year. IATA is forecasting $25.7 billion of net profit. So that's a significant recovery, of course, from the massively unprecedented losses during the pandemic years. And it's actually back to within a whisker of the 2019 net profit, which was about $26 billion. So 97% of that 2019 profit number. And it's very much back in the ballpark of the, of the 10 years leading up to the pandemic. So between 2010 and 2019, It was the— it was unprecedented. 10 successive years of the airline industry achieving a positive net profit had never been done in history. 10 successive years. So those were the apparently good years. And then of course the pandemic came along, but we've recovered from that and profitability is returning. So that all sounds pretty good, doesn't it? Well, not necessarily, because if we— rather than just looking at the absolute number of dollars of net profit, if we look at the you look at the return on invested capital, and investors are looking for, you know, a return on their invested capital, that's the blue line, the dark blue line. This has consistently been below the weighted average cost of capital for the airline industry, which is the lighter blue line there. And of course, weighted average cost of capital is the minimum return that investors can— that investors want from an investment. If they don't get it, they'll put their money somewhere else. So it's actually— it's not just an academic exercise. It has a real impact on attracting investment into the industry, the achievement of that minimum level. If you look at the, the good years, the 10 years of, of successive profit before the pandemic, and, and you look at the difference between the profit that was actually achieved and what should have been achieved if the industry had matched its cost of capital, it translates to an average economic loss every year of $18 billion per annum. Economic loss being the difference between, you know, achieving your cost of capital and the profit you actually made. So that's a huge destruction of value. So maybe not quite so good. We're getting back to those kinds of levels, but we're still considerably below the cost of capital in terms of the airline industry globally. Okay, so I just want to talk a bit more about market structure. Structure and profitability and the connection between those 2. We've seen this terrible destruction of value that the industry manages to achieve by not matching its cost of capital. So one way of looking at market structure is just simply how many airline groups are there in the world compared to before the pandemic, just to give a, you know, use the 2019 numbers as a benchmark. This is from the scheduled numbers, scheduled, our schedules database, first week of 20th of July 2024 compared to the first week of July 2019. So globally, the bar on the left-hand side, the bars on the left-hand side, you can see there's been an 18% reduction in the number of airline groups globally. So that suggests there's been some consolidation. Number of airline groups operating has come down. And if you look across all the regions, there's been a reduction in every region in the number of airline groups competing. But that's— that doesn't really tell us very much about how much concentration or consolidation there has been. It just looks at a simple headcount of the number of airline groups. So I just want to get a little bit academic, but I think it's worth doing. A measure of market concentration which is often used by economists is the Herfindahl-Hirschman Index, which produces a number ranging from 0 to 10,000, and it's calculated as the sum sum of the squares of the market share of all the participants in an industry. This can apply to any industry. And for example, if you've got 10 participants, each with a 10% share, then the HHI is 1,000. If you've got a pure monopoly, one participant with 100% share, then the HHI is 10,000. So, if you, if you put an axis on the left-hand side together, numbers up to— roughly speaking, numbers up to about 1,500 are regarded as being competitive markets, no problem with concentration. Between 1,500 and 2,500, it's regarded typically as being moderately concentrated, and above 2,500, it's highly concentrated. So if we put the global airline industry onto this chart, using as a, as the, as the definition of market share, if we use seat share for the airline groups in each region, region based on the first week of July, then this is what we get. So you can see all of those bars are pretty low in the chart. In fact, 5 of the, of the regions of the world are what I would describe as highly competitive. They're in the competitive zone, but they're well below the threshold of 1,500, so I describe them as highly competitive. And only one, North America, could be described as moderately concentrated because it's just nudged over the 1,500 threshold, just. So that would be described as moderately concentrated. And this is very much a macro view. This is based on seat share across the region. It doesn't get down into any detail of city pairs or airport share or anything like that. So why does this matter? Well, airline market concentration does affect EBIT margins. This chart here shows us for 2019, on the horizontal axis, market concentration measured by the HHI that I've described, and on the vertical axis, it shows us EBIT margins for each region of airlines. And you can see that for 2019, North America is the most concentrated and has the highest EBIT margin. And then you repeat the exercise for 2024 based on IATA's forecast for margins, and again, North America, highest concentration and, and highest EBIT margin. So very much there is a relationship between market concentration and profitability. Now, a quick recap on the 20 numbers. Have you got all that? Don't worry, you can, you can get copies of these slides when we go away. I'm not going to go and repeat them all. But just before I finish, just some further observations to take some of this analysis to a conclusion. So we've established low return on invested capital in the airline industry, and that's been the case since anybody can remember, since the Wright brothers came along and invented invented powered flight. So this is an indication of too much competition in the airline industry. It's also— we've seen that consolidation has increased, but it hasn't been enough to drive returns up to the required level to meet the cost of capital. As an additional factor, almost an aside, but there are some airline investors and owners for whom return on invested capital is not necessarily the prime motive. Some examples might include some governments for whom ownership of an airline isn't about getting a return directly from the investment in the airline, but it's about wider economic benefits to their economy. And then what I would call hobbyists or brand builders, so maybe some businessman or woman for that matter, wealthy individual for whom having an airline is a good exercise in building the brand for their other business activities. That's not— that's been known to happen. So those, those that are operating an airline without looking for a commercial return on investment are making it harder for the others to actually achieve the return that they want. Now, low return on invested capital, I think, is partly because barriers to entry are low in the industry, whereas barriers to exit are relatively high in the industry. And let me just touch on what I mean in a bit more detail. So So barriers to entry, primarily you need to be able to get hold of aircraft and labor. I have already said that for the time being, there's some heightening of the barriers to entry when it comes to aircraft and labor. There are some constraints, some shortages on the supply of new aircraft and in terms of trained labor. But I wouldn't say that's a fundamental long-term change. It's something that's a challenge at the moment, but basically it's generally not that difficult to lease an aircraft, wet lease a crew, and start a small operation. In fact, there are currently 98 new startup airlines in the CAPA databases. So that's a suggest— that sort of suggests to me that the barriers to entry are not necessarily all that high. They're quite low. Of course, there's also technical and safety standards that need to be met, but I'm not saying that those are trivial at all. They're very important. But as long as you follow them, you can do it, right? So barriers to exit. Okay, so what are the barriers to exit that I'm talking about? This is a number of them. So government support, which is still very common, particularly in times of crisis, prevents airlines which otherwise might have left the market from, from leaving the market. Also bankruptcy protection. Various legislations, jurisdictions have different forms of it, but allows airlines to restructure rather than exit the market when they go into bankruptcy. But then I've got a couple of others which are obstacles to mergers and acquisitions. So airline exit doesn't necessarily just mean airlines disappear out of the market. It might mean that they're taken over by another airline. But when it comes to mergers and acquisitions, competition authorities are often a barrier to mergers by, by taking a very detailed view of what the market should be city pairs or specific airports, and looking at concentration at that level rather than the big picture level which I was showing you earlier on. And also foreign ownership limits, nationality clauses in the bilateral air service agreements between countries often prevent cross-border mergers and acquisitions, which might happen in another industry. Now, okay, where do we go to with all of this? And these barriers to exit are very much in the hands of governments and regulators, I would suggest. Where do we go to with all of this? So this is an Airlines in Transition conference, and the airline industry is facing a huge number of transitions, huge challenges, the most important of which I've already mentioned— the green transition, which is an existential challenge. There's also a number of infrastructure issues, obviously airports, air traffic control control surface access, and I would include labor and aircraft in, loosely, in that infrastructure category. And the challenge of digitalization, which I've, you know, I'm not going to go into in any detail, but that's a huge challenge. All of these challenges require massive investment in order to fund them. But as we've said, we've got a low return on capital, and at some point this starts to deter investors from investing in industry unless they can get a decent return. So to conclude, my view: governments must find ways to lower the barriers to exit and to allow consolidation and drive higher returns. And yes, this might mean that airfares rise for consumers, but I think it's time to start the debate and to move to an industry which can generate sustainable returns into the future and achieve all the challenges it needs to face. So with that, I'll, I'll thank you, and I'll pass over to our conference chairman, Marco Navarria. Thank you.

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