Market outlook: Rocks and hard places

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Less worse does not mean better, writes Chris Tarry. Analysis by Flightglobal Insight

Although the rate of decline needs to slow before a turning point is reached and recovery can begin, we are concerned that optimism generated by the slowingtraffic decline has been overdone: "less worse" does not mean better, particularly as traffic revenue is continuing to decline. At these times the focus should be on actuals, rather than rates of change, and the greatest focus should be on revenue. Even the most cursory glance shows the amount of "price action", iediscounting, which has been needed to contain traffic falls to current levels.

One of the airline industry's most over-worked terms is "low-cost" carrier. Low cost is a state of "economic being" and all airlines need a cost base appropriate to their market place and one which gives them the best chance of making a return.

And while a downturn gives management a catalyst to introduce cost-cutting programmes, these need to be fundamental. This means they will inevitably take time to implement and potentially significantcosts to achieve. The reality is thatlittle can be done in the near term to change controllable costs.

Indeed British Airways' Future Size and Shape programme,launched in 2002, took some six years to hit its target of a 10% operating margin against the backdrop of a cyclical upswing.

Even having implemented that programme, BA's performance swung by £1.1 billion ($1.8 billion) to a £220 million operating loss in the year toMarch 2009 and its operating cash also dived from £1.6 billion in the year to March 2008 to £470 million a year later. And brokers forecast further deterioration this year to an operating loss of some £350 million at the operatinglevel.

Cost reduction and ensuring the business is "fit for purpose" must be an ongoing process, but it is revenue and its variation - whether due to the cycle or the realisation of structural opportunities - that is the key to success in more normal times. For some airlines at the present time it will increasingly become a necessary condition for survival. Especially with IATA's latest forecast suggesting that industry revenue will fall by some $80 billion this year.

A recent Ryanair financial filing demonstrates this point, and the significance of ancillary revenue. For historical context, in the year ended March2005 Ryanair sold 84% of its available seats. Its average fare was €40.85 and, based on this alone, its breakeven load factor was 70%. Ancillary revenues stood at €6.92 per booked passenger, cutting the breakeven load factor to 63%.

Shifting forward to the most recent year Ryanair's load factor was 81%. Its average fare fell to €40.02, increasing the fare revenue breakeven to 98%. Ancillaries of €10.21 per booking brought the "overall" breakeven load factor down to 79% - up from 67% in the previous year.

For many so-called "low-cost" carriers the challenge is to generate new revenue streams, ideally two new ancillary items a year. But diminishing returns will inevitably set in and the focus will have to switch to increasing average fares. In today's climate this depends on taking traffic from higher fare competitors.

Any remaining doubts over whether short-haul travel is anything other than a commodity product should, by now, have evaporated. Where there is a choice, price is perhaps the only determinant now.

Despite some forecasts, we fear that 2010 will be worse than 2009. Adjustment to fit the current climate is a still work in progress and, with yet more capacity coming in to an already weak market, there will be considerably more pain before any gain. For some this is a time of opportunity, but for many airlines the key objective in 2010 will still be survival. This means the timing of revenue recovery is of key interest.