ANALYSIS: Airline profits to halve in 2012 as Europe falters

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Amid all the current economic uncertainty, one thing for airlines seems certain about next year. Things are going to get harder. The question is by how much.

IATA's latest industry profits forecast, presented in Geneva today, indicates it will for airlines, at the very least, get a little bit tougher than they thought three months ago. IATA downgraded its collective industry profit forecast for 2012 by $1.4 billion to $3.5 billion. This is roughly half the profits airlines are expected to make this year.

But all this presupposes European policy-makers are able to prevent the current Eurozone woes spiralling into a full-blown banking crisis

Key to the downgraded profits projection are the tougher market conditions which are expected to curb air transport demand. IATA chief economist Brian Pearce noted international trade, a key driver of business travel, has stopped growing and business confidence has slumped. All this as austerity measures in Europe put the brakes on economic growth.

IATA expects this to slow passenger growth in 2012 to 4% - lower than the 4.6% it projected three months ago, and well below the 6.1% expected this year. Likewise it now also sees air freight traffic, which began sliding in the summer, to stay flat next year rather than returning to growth. It had originally seen growth of 4% for next year.

"We are faced with a slow growth environment at best," said Pearce, noting even this is based on governments resolving the Eurozone crisis. "We are likely to see passenger travel [growth] slow. In the air freight market we are expecting no growth. And this is quite a sharp downward revision on what we were expecting in September."

At the same time there is little sign of respite from high fuel prices, traditionally at more benign levels when economies slow. "We've seen oil prices come down from their peak, but they are still 30% up on last year," said Pearce. "The forecast does not expect the market to fall much below $100 a barrel for next year. And the airline hedges are starting to roll off, so the actual price paid by airlines will be higher."

The expected weaker demand climate will also make it harder for airlines to claw back some of the higher fuel costs through surcharges, as they were able to do during the first half of 2010.

Yet even these downward revisions come with a caveat. The IATA forecast assumes the Eurozone crisis is resolved. But such is the magnitude of failing to resolve the issue, that IATA has taken the unusual step of issuing a separate forecast based on a worst case scenario. This would see all regions slip into loss, headed by European carriers racking up more than half of the $8 billion losses IATA fears the industry could incur.

"There are risks and they are focused around the Europe. Optimism for a solution has increased, but we need to be aware of the downside risk of policy makers getting it wrong," said Pearce. "Our central forecast is for the industry to see lower profits, but we think it is important to point out there is a pretty substantial downside risk at the moment."

The economic difficulties in Europe highlight one of the most striking elements of the latest forecast. There are widely diverging regional fortunes, with European carriers positioned squarely in the eye of the storm.

"Europeans, facing a sovereign debt crisis and economic austerity measures, are living a very different reality from their colleagues in Asia, which is buoyed by the market dynamism of China and our colleagues in North America are managing through a sluggish economy with tight management," noted IATA director general Tony Tyler.

 IATA FORECAST FOR 201/12

 iata dec 11 forecast chart

Though IATA's headline profit figure for the current year is unchanged at $6.9 billion, the numbers behind them are much changed and illustrate the differing fortunes. It expects North American and Asia-Pacific carrier profits in 2011 to be $800 million and $500 million higher than it thought in September. But it has wiped $400 million off European, Middle East and Latin American carrier profit expectations for 2011.

High fuel prices and the fallout of intense competition in the key Brazilian market are at the heart of the Middle East and Latin American downgrades respectively, and IATA sees only minimal profits for the two regions' carriers in 2012. But this is brighter than the $600 million loss it forecasts for European carriers.

"Airlines in other regions, particularly in North America where we are seeing capacity reductions, are limiting the downside on profits. There is very much a two-speed environment for 2012," said Pearce.

The outlook sees North American carriers posting $500 million higher profits at $2 billion this year than IATA thought three months ago, and for North American carriers to retain most of these profits in 2012.

While Asia-Pacific carriers have been hit by slowing cargo and the continued fallout from the March tsunami and earthquake in Japan, they have seen load factors rise while the Chinese domestic market has expanded. Consequently IATA has raised its forecast for the region by $800 million to $3.3 billion in 2011, and still sees it as the most profitable region in 2012

Between them, Asia-Pacific and North American carriers are expected to deliver the lion's share of industry profits next year.

Asked whether the slowing economic picture could result in airlines deferring or cancelling aircraft, Tyler said he could not rule it out. But he added: "Deferring new deliveries at short notice is a very a expensive business. So it's a very difficult decision to defer or cancel capacity at short notice, which is one of the reasons it is not easy for airlines to show capacity discipline which from the outside seems to make sense."