Airline stock prices have been edging up in Europe on the back of better news on oil prices, but elsewhere the fundamentals give less cause for optimism, cautions Chris Tarry of CTAIRA

In stock-market terms, at least, Europe's airlines appear to have ended 2004 much as they began it, with a modest uptick in their share prices from the autumn lows. Yet the dip in between is perhaps more telling. After a bright start in 2004 on the back of some apparently encouraging traffic results, the share price performance for most carriers remained unsteady and if it is now improving that appears increasingly centred upon a single factor :the price of oil.

British Airways is a case in point. A year ago the stock market reacted with surprising optimism to a strong set of December 2003 traffic results. With BA noting an improvement in long-haul premium traffic, other less encouraging facts were not allowed to get in the way of a good story. But after peaking in March its share price has moved more or less in line with oil.

For easyJet and Ryanair, the combination of high rates of capacity growth and falling yields brought about a series of profit warnings and a fall from grace. This fall appears to have begun to be recovered by a mix of falling fuel prices and Ryanair's capacity adjustment, as well as Icelandair's decision to buy a stake in easyJet, for reasons still to become clear.

Elsewhere, Lufthansa vowed to focus more closely on its core competency in the passenger business and Air France, unsurprisingly, increased its estimate of realisable cost savings from the KLM merger. After that the French government reduced its stake in the combined group.

In reality, apart from a little excitement early in the year, including a rights issue from Lufthansa, the trend until quite recently has been downwards. The upswing since mid-October owes almost everything to the fuel price movement. Unfortunately it is a factor well outside the control of the airline industry, while indications on the revenue side of the equation remain less than encouraging.

The most recent traffic release from BA states with some familiarity that "market conditions are broadly unchanged. All markets remain price sensitive and yield declines are expected to continue." In its September quarter, yield per seat fell by 2.7% and per tonne kilometre by 3.4%. The Austrian Airlines group also recently slashed its operating profit forecast for 2004 from e50 million ($65 million) down to only e10 million.

It is worth noting that BA, unlike most others, shows its fuel surcharge as a separate revenue item, which it expects to bring in £160 million ($300 million) in the current year. Others count their surcharges as traffic revenue, potentially risking the illusion of a rise in yields, which presumably must disappear if and when fuel prices fall.

It is true that traffic improved in 2004. For all airlines the Asian markets have recovered strongly from the fall-out of the SARS epidemic in mid-2003 and growth continues. Elsewhere in the long-haul market the outlook is less clear cut. Theories about continued growth on the transatlantic route are worth particular attention. Although it seems realistic to argue that European carriers will continue to benefit from Europeans heading to the USA attracted by a weak dollar, the industry's recent numbers do not appear to bear the theory out.

Latest figures from the Association of European Airlines (AEA) show slowing growth rates on the North Atlantic for the European majors. The USAir Transport Association, meanwhile, shows double-digit growth for its members across to Europe. While the weak dollar may be a positive factor in terms of boosting east-to-west traffic, which is the growth part of the market, it is also helpful in providing the US majors with some pricing headroom in their attempts to gain market share.

It is reasonably clear that it still is a buyer's market and, despite the hope in some quarters that corporate discounts may begin to reduce in 2005, the current economic outlook seems to suggest otherwise. The problem is simply too much capacity in the market for any single airline to exert real pricing power in the European marketplace. Stripping out the effect of fuel surcharges there should be both the prospect and the expectation that yields will fall further in 2005.

As a consequence, the near term outlook remains uncertain. And, as witnessed over the last year, nobody, even the low-cost carriers, is bigger than the market, no matter how good they believe their business model to be. In its outlook statement for 2004-5, easyJet noted that for the rest of the winter its visibility was "limited" and that "competition will be intense". Overall, easyJet's management expects the year to be "tough" and wants to reduce costs.

So what about share prices? Airline stocks have always been for trading rather than for long-term investing and this is not likely to change. A real issue is whether a fall in the fuel price and its effect on sentiment towards the sector might be sufficient to offset what appear to be weakening fundamentals in an environment where there are outstanding cost issues to be resolved. But, of course, this may all be hypothetical if fuel costs ultimately fail to fall.


Source: Airline Business