By Brendan Sobie in London
Industry revenues hit a new high again last year, but growth is slowing and the industry as a whole remained in the red. The outlook is hazy as fuel prices continue to eat into airline profits
The industry recorded double-digit revenue growth for the second consecutive year in 2005 but it appears the peak has already passed. This is a cycle in which carriers have not banked much in the way of profits during what should have been the good times.
Skyrocketing oil prices kept the industry in the red for the fifth straight year, with the top 150 airline groupings posting a combined $20.7 billion net loss. Even excluding $20.6 billion in extraordinary restructuring charges at United Airlines, the industry remained slightly in the red last year. Perhaps even more worrying, the mean operating margin slipped slightly from 2.6% to 2.5% and revenue growth cooled from the 16% figure posted in 2004.
Revenues at the top 150 airlines combined were still up a very healthy 11.7% and reached $440 billion, marking the first time they have exceeded $400 billion. But IATA chief economist Brian Pearce does not expect the run of double-digit revenue growth will continue and estimates revenue growth will slow to 8.5% in 2006 and to 6% in 2007. "This is as good as it gets," he says.
"There's no doubt 2004 was the peak," agrees Peter Harbison, chair of the Centre for Asia Pacific Aviation. "I don't think we'll see another year like that, particularly in this region."
Growth in Asia-Pacific, which has accounted for the bulk of new aircraft orders in recent years, slowed more sharply than any other region. Revenues from carriers in the region were still up 11.6% to $112 billion. But that pales when compared to the 22.6% revenue growth recorded by top Asian carriers in 2004.
"What we're looking at is 2004 as an aberration. But 2005 was still a good year," says Harbison. "2004 was vastly exaggerated by the rebound from SARS," adds IATA's Pearce, referring to the Asian crisis which drove down revenues and profits in 2003.
Net profits among Asian carriers in the top 150 rankings, which were compiled by Airline Business sister online news and data service Air Transport Intelligence, dropped 59% last year from $4.5 billion to $1.9 billion. Operating profits also fell 39% from $6.4 billion to $3.9 billion. Harbison says losses at the major Chinese carriers primarily drove the decline. Some of the region's major flag carriers also slipped into the red including Japan Airlines (JAL) and Malaysia Airlines (MAS) while most of the others saw their profits fall including China Airlines, Cathay Pacific Airways, Korean Air, Singapore Airlines and Thai Airways International
JAL slipped from third to fifth in the top 150 global airline revenue rankings while Thai slipped from 24 to 26 and MAS from 28 to 32. China Southern and China Eastern went up eight and nine places in the rankings, respectively, but this was driven by the new inclusion of revenues from subsidiary carriers.
Asian carriers still averaged an operating profit margin of 3.6% but in 2004 they led all groups except Middle East/Africa with a 6.5% operating margin. In 2005 carriers in Europe, Latin America and the Middle East/Africa all enjoyed better operating margins than their Asian counterparts.
In Europe, revenue growth also cooled in 2005 and it was the only region not to chalk up a double-digit figure. European carriers in the global top 150 recorded 14.7% revenue growth in 2004 and this figure slipped to 9.3% last year. But operating profits in Europe surged 41% from $3.5 billion to $4.8 billion and as a result the operating margin improved from 2.9% to 3.9%. Net profit among European carriers rose 27% from $3.2 billion to $4.1 billion.
London-based ABN-AMRO analyst Andrew Lobbenberg says Europe's major flag carriers have benefited from a spike in demand for premium business travel, which is still continuing. "It's an extremely strong premium travel environment at the moment but I do think it has peaked," he says.
Air France/KLM and Lufthansa remain one and two, respectively, in the global revenue rankings while British Airways stayed in eighth place. But several smaller European flag carriers including Aer Lingus, Finnair, LOT, Malev, SN Brussels and Swiss all dropped several places in the rankings. Lobbenberg says the big European carriers "are riding the wave of premium traffic but it's not there to support Malev, TAP, Swiss" and other carriers with home markets in secondary hubs that have less premium class demand.
North American carriers, meanwhile, registered improvements in almost every category last year and analysts say the peak of the cycle appears to be 2005 or even 2006 rather than 2004, when their counterparts in Europe and Asia seemed to hit the peak. North American carriers in the top 150 rankings saw their revenues grow by 12.2% last year to $154 billion, beating growth of 11.3% in 2004. The operating loss also shrunk from $2.3 billion to only $130 million, resulting in a significant improvement in the operating margin from -1.7% to -0.1%. The net loss would have been slashed from $10.5 to $7.1 billion if it was not for the extraordinary one-time charges at United.
The revenue growth allowed American Airlines to leapfrog ahead of JAL in the rankings from the fifth to fourth spot. United, Delta, Continental Airlines and US Airways Group all retained the same spots they held in 2004 while Air Canada jumped from 16 to 14. "Growth in the North American market has been extraordinary," says Blair Pomeroy, senior partner of New York-based Mercer Management Consulting.
Air Transport Association (ATA) chief economist John Heimlich expects US carriers to record further financial improvements this year and next but warns of a possible slowdown in 2008. "Industry-wide results are improving in the USA," Heimlich says. "Though I don't expect the industry to break even in 2006, it should close the gap substantially on surprisingly strong revenue performance and impressive reductions in non-fuel expenses.
"At the current course, US airlines should be able to see profitability in 2007 despite soaring fuel costs. In 2008, we could see another economic slowdown as well as pressure for snapbacks in wages for some labour groups."
North American recovery
IATA's Pearce also expects further improvements among North American carriers this year because of restructuring efforts. But Pomeroy warns the current upswing and the load factors that legacy carriers are now enjoying cannot be sustained. "I'm certain legacy guys will go through another trance of anguish in America and Europe," Pomeroy says. "The trick of running away from low-cost competition to international can't continue forever. You can't cut domestic capacity forever."
Low-cost carriers continue to grow much faster than legacy carriers and in 2005 recorded 20.3% revenue growth to $23.9 billion. In fact the revenue growth gap between low-cost carriers and major carriers grew further last year - the low-cost grouping saw revenue growth increase from 20% to 20.4% while major carriers saw revenue growth cool down from 15.5% to 10%.
Low-cost carriers also enjoyed a 6.1% operating profit margin last year while major carriers only posted a 1.6% mean operating margin. Not surprisingly, several low-cost carriers have leapfrogged ahead of legacy carriers in the top 150 rankings. For example, JetBlue Airways jumped from 55 to 50, making it into the top 50 for the first time. AirTran Airways rose from 67 to 58, Brazil's GOL from 92 to 74, flybe from 121 to 117 and Norwegian from 151 to 139. The world's largest low-cost carrier, Southwest Airlines, remained in 17th spot while easyJet rose from 45 to 43 and Ryanair stayed steady at 47.
IATA's Pearce points out that despite the impressive growth in the low-cost sector only some of the carriers are highly profitable, including GOL, Southwest and Ryanair. "Most of the others are still losing money and dragging it down for the others," he says.
Regional carriers also fared well as a grouping, registering 24.6% revenue growth in 2005 to $10 billion. Regionals also enjoyed a 7.7% operating margin, although this was down from the 9.9% margin posted in 2004. The world's largest regional carrier, Utah-based SkyWest Airlines, jumped 11 places in the top 150 rankings and now stands at 49.
Middle Eastern carriers continue to chalk up huge growth figures. Top carriers from the Middle East/Africa region chalked up 18.3% revenue growth to $25.1 billion. The growth figure was second only to Latin America, which recorded a 19% increase in revenues to $15.7 billion. More impressively, Middle Eastern and African carriers posted a 6.4% operating margin last year.
The growth in the Middle East was partly driven by rapid expansion at Qatar Airways, which leaped from 84 to 71 in the world rankings. The largest Middle Eastern carrier, Emirates, jumped from 22 to 20. Pomeroy expects Middle Eastern carriers will continue to record double-digit growth as the economies in the region continue to surge. But their rate of expansion is surpassing even the torrid economic growth rates the region is experiencing. As a result, Pomeroy predicts Middle Eastern carriers will become increasingly bigger players on long-haul sectors, forcing yields to be depressed and diverting traffic from some European hubs.
Competition is also expected to intensify as carriers, in particular from the Middle East and the Indian subcontinent, begin to take delivery of aircraft from some of the record orders placed recently. "Last year was an extraordinary year for aircraft orders," says Pomeroy. "At some point all the aircraft will hit the market. Unless we have a favourable tailwind in all aspects we may be heading for some difficult times."
He points out orders are traditionally placed just after the peak is passed or at the start of a down cycle. "The aircraft that are due to be delivered in the next few years are a concern given the cycle is going down," agrees Pearce.
"I think there will be a little bit of softening but nothing material at this point," says a more optimistic Steve Udvar-Hazy, chief of leasing giant ILFC.
Carriers also must deal with escalating fuel prices just as competition looks to intensify and yields may begin eroding. "Fuel is starting to really bite now," says Harbison. "We are going to see lower profits this year."
IATA's Pearce still expects operating margins to improve slightly in 2006, driven by cost reduction initiatives. But he says the margins will still fall well short of the 9% to 10% required to cover the cost of capital. In 2005, the operating margin globally was about seven percentage points short of that figure and in North America it remained negative. The global net margin was -5.1% last year but when excluding the one-time United charges it was just under break even at -0.1%.
"The industry is now close to break even, but it is the peak of the revenue cycle and oil prices are too high," Pearce says. "These should have been extremely profitable years for the industry given the revenue growth." ■