Industry revenues swung back sharply last year to hit a new high, but there is still a long way to go before the damage of the past three years is repaired. Leading the way were some stellar performances from Asia-Pacific, as well as the low-cost and regional sectors
The good news is that after three years of slump, the industry finally saw revenues turn upwards last year, putting them back above the peak, at least in headline terms. The bad news is that net losses continued for a fourth straight year, pinned back by the soaring price of oil. And as demonstrated by the latest financial ranking of the Top 150 airline groups , although operating margins recovered to just under 3%, they nevertheless remain the lowest for a decade.
While overall, airline groups ended the year showing another $3 billion in net losses, the gloom was far from evenly spread. Asia-Pacific carriers ended last year back to their traditionally robust profits, after faltering during the SARS epidemic of 2003. But those gains were more than offset by a spectacular $10 billion net loss from North America.
The best of the operating margins again came from the low-cost carriers, led by Gol and Ryanair, although the sector’s overall net result was dragged down by a massive net loss from the USA’s failing ATA Airlines as it shed more than $800 million. The most buoyant results came from the regional groups. These independent regionals have continued to grow rapidly, especially in the USA, where they have even come to the aid of their major partners, and they ended last year with a collective operating margin only a shade below 10%.
Even the headline revenue growth figures come with a health warning. On the face of it, revenues soared by 16% last year, to $392 billion, well above even the $346 billion reported at the height of the last boom in 2000. However, a large part of that rise over the past couple of years is due to the effect of translating revenues into US dollars, which have rapidly shed their value against most other major currencies. Stripping out exchange rate factors and inflation means that in constant dollars the industry has seen little or no real revenue growth over the past four years. In fact, based on an analysis of the Top 150, revenues last year would have been down by as much as 1% compared with the 2000 peak in constant dollars.
In part due to the weakening currency, US majors have lost their grip at the top of the world revenue rankings. That is now led by Air France-KLM, reporting as a merged group for the first time. Lufthansa and the merged Japan Airlines are close behind, leaving American, United and Delta Air Lines in their wake. And although the US majors have begun to show more robust growth over the past year, they have a long way yet to go before they recapture the lost ground of the past four years in terms of real underlying revenue growth.
This performance contrasts with the impressive rise of Asia-Pacific carriers. As a whole, the region’s carriers showed real revenue growth of 19% in constant deflated dollars compared with the 2000 peak. The region also broke the $100 billion barrier for the first time in 2004, as its carriers continue to close the gap with Europe and North America.
It is significant too that the Asia-Pacific, while rebounding sharply from the SARs-induced traffic slump of 2003, has managed decent profits, both at operating and net levels. This contrasts with the more modest, albeit profitable, performance of European carriers last year and the continuing heavy losses seen in North America. At the operating level, the profit margin of 6.7% for Asia-Pacific carriers was over twice that managed in Europe. At the net level, Asian carriers continued their strong performance, while European airlines achieved a net result of just over $1 billion. Carriers in Africa, the Middle East and Latin America achieved respectable results too, although not all report full financials.
“The regional variations in performance are quite dramatic,” observes Andrew Herdman, director general of the Association of Asia Pacific Airlines. The showing of his members, which account for many of the carriers (excluding China) that contributed to this result, comes down to several key advantages, he believes. “Compared to European or US airlines, Asia-Pacific carriers have more competitive labour costs and high productivity levels, networks that are focused more on long-haul flying and a big cargo component,” he says.
Asia-Pacific carriers have managed to leverage these benefits to achieve profitability, despite the high price of oil. It is a burden carriers share the world over. “The problem now is that fuel is into the mid-20% level in the cost mix,” says Herdman. Prior to the surge in oil prices it was around 15% of total airline operating costs. In addition, Asia-Pacific carriers see some labour issues on the horizon.
“There are one or two pressures emerging on labour costs in Asia, particularly for pilots and other qualified staff and in those countries which are expanding rapidly and there are start-ups,” says Herdman. For example, India’s fast-growing carriers are recruiting pilots from all over South-east Asia to fuel their expansion, tightening supply in other regions. As the market becomes more competitive, wages begin to climb. Malaysia Airlines recently gave its pilots a significant pay rise, partly to combat a drift of pilots to other carriers.
While the Asia-Pacific is the poster child for the sector, the results from North American carriers continue to drag the industry as a whole into the red. High oil prices and the tough US marketplace mean analysts expect the industry as a whole to be unprofitable once again this year. This was not the case earlier in the year. IATA was predicting an industry profit of $1.2 billion as oil prices began to ease at the end of 2004. But this was based on an average price of $34 per barrel for oil. As this year has progressed, prices have risen sharply again to over $60 per barrel at their peak. “We have just seen incredibly volatility in this major industry cost,” says Brian Pearce, IATA’s chief economist.
Profit warning worsens
As oil prices rose, IATA revised its forecast in April to a $5.5 billion loss followed by an increase in its profit warning to a $6 billion loss in June. The climb in the oil price has surprised analysts, for the summer months tend to signal a seasonal dip. In fact they have risen and averaged $49 in the first half of the year. Although an academic point, Pearce notes that if oil prices had been $21 per barrel last year, the average for the past 10 years, the industry would have seen some “pretty healthy performance figures that took it back to the operating and net margins last seen at the end of the 1990s”.
What this shows is that the underlying performance of much of the industry is relatively strong. Since 2001, carriers have restructured their businesses and stripped out costs. This year, IATA expects carriers to reduce their non-fuel-related costs by 4.5%, on top of a 3% fall in 2003, with a similar fall forecast for 2006. A combination of continued cost cutting and an oil price in the $40 per barrel range could “see some good results coming through” in 2006, says Pearce. However, much depends on what happens with oil prices.
There seems no let up in the pressure on US carriers in the intensely competitive and low-yielding domestic market, even though IATA says it made money on its international services last year. John Heimlich, chief economist at the Air Transport Association of America, which represents US carriers, notes that fares are running at late 1980s levels and is projecting losses of at least $5 billion in 2005 for its members.
Slowing economies mean most expect the revenue environment to tighten. “With the slowdown in traffic and revenue growth, and oil prices being so high, carriers are just going to have to take out more costs,” says Pearce.
MARK PILLING LONDON
Source: Airline Business