Economic fears cloud airline profit hopes

London
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This story is sourced from Airline Business
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Stock markets crashing around the world, amid renewed concerns over the potential spreading of the Eurozone debt crisis and weak US recovery, spell out a warning for the delicately poised airline recovery.

IATA has already had to twice downgrade its industry profits forecast for the year to $4 billion - less than a quarter of the $18 billion profit the industry enjoyed last year.

In making its revised industry forecast in June, IATA outlined one of the main risks to achieving the $4 billion profit was the weakening of global economic growth. Confidence in an already fragile economic picture, amid sluggish growth figures in the USA and parts of Europe, has been further hit in recent days with the dramatic stock market falls around the world and S&P downgrading the USA's credit rating

Crucially it has been the robust economic performance which has thus far helped to at least partially offset the impact of high fuel prices. In particular, confidence has remained high at a corporate level - in contrast to low consumer confidence which has been reflected in weaker non-premium demand.

So unlike 2008, when the soft economic environment made it difficult for airlines to recoup extra fuel costs through higher fares, this time strong demand for premium travel has helped airlines take the edge off fuel spike. As chief executive of British Airways parent, International Airlines Group, Willie Walsh said during a second quarter conference call a week ago: "The main driver behind the growth in the premium cabins is what I would call genuine business travel."

But while revenues come under press from a slowing economy, the flip side is it might also take some of the heat out of the oil price, and thus airline costs. IAG, for example, had already warned the second half would be more difficult to recoup higher fuel costs because its hedging was start to unwind. With Brent Crude Oil now trading below $110 per barrel - a level rarely seen since March and comfortably below prices in excess of $120 endured in April - there might be some respite on the way. "If we see a fall in the oil price, even temporarily, that gives airlines the opportunity to hedge at a lower price," notes CTAIRA analyst Chris Tarry.

Tarry though believes the key issue for the sector remains capacity and a slowing economy could mean airlines need to take "more capacity out for longer". Carriers on both sides of the Atlantic have already pledged to be watchful on capacity, for example the SkyTeam and Star Alliance North Atlantic joint ventures having already taken capacity out from the fourth quarter.

"One of the issues will be the cost of debt," adds Tarry. "Whilst in some parts of the world the base rate is low the risk premium for most airlines is already high. The problem is if you are financing aircraft or just refinancing existing debt, a higher rate of interest means more cash going out."

As for individual airline share prices, Tarry's advice is for airline executives to hold their nerve. "They [share prices] will be, what they will be," he says.