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Market outlook: Digging a little deeper

In last month's column we talked about the need to differentiate between cyclical and structural effects. I now feel it is worth probing a little deeper and considering variation at a company level. With this in mind, let's look at performance since the last peak of the cycle in 2007, and at 2008 and 2009. For this, we have used a data series from the Air Transport Intelligence website, covering the period 2005-09.

There will always be some airlines which fit into the categories of "the good, the bad and the ugly", based on their financial performance. But the majority lie within a relatively narrow band and occupy what might best be described as the middle ground, doing reasonably well in the good times and not too badly when things turn sour.

Swings in the performance at an industry level tend to reflect changes in the performance of only a small number of airlines, in keeping with the 80/20 rule.

The Chris Tarry Column
 Chris Tarry (thumb)
 See Chris' July column here on why now is a pivotal moment in the industry cycle

Against this background, we have compared performances among individual airlines for our three-year time span. In 2007, we are looking at outcomes when operating profit for the industry peaked. Moving on to 2008, operating losses were at their maximum. Finally, in 2009, losses were in fact less than feared.

Our sample was selected on the basis of the data being available for the complete time period, totalling 93 observations.

In the peak year of 2007, 83 airlines reported a positive operating result, while the remaining 10 posted a loss. By 2008, 43 airlines reported an operating loss. Nine of these were also among the loss-makers from 2007.

Fast forward to 2009 and the number of loss-markers had declined to 34. Within this group, six airlines had lost money throughout the whole of the review period. The total lost by this group was $1.9 billion in 2007, $3.2 billion in 2008 and $1.1 billion in 2009.

I would now like to return to the issue of the structural versus the cyclical. While economic well-being is a function of economic activity, as well as the rate of growth, attention tends to focus on GDP growth as being the key driver of airline traffic.

Given our continued stress on distinguishing between cyclical and structural growth, it may be useful to have a simple means of identifying one from the other. Perhaps the easiest way to differentiate between the two is by looking at long-term economic growth trends and the inescapable cycle around this trend.

To do this, we need to compare the slopes of the long-term GDP growth curves. Equally, if not more important, is the relationships between inflation-adjusted GDP and traffic, unadjusted GDP and airline revenue, and airline revenue as a share of GDP.

The traditional focus has been on the relationship between inflation-adjusted GDP and traffic. But while the view remains that traffic grows at twice the rate of GDP, this may be increasingly optimistic. Actual figures vary widely by region, for example in the USA, the long-term ratio is closer to 1.3-1.4 times, but for the industry overall the multiplier may be closer to 1.5.

To analyse the all-important topic of revenues, we need to look at the airline revenue multiplier, in other words comparing the rate of airline revenue growth with unadjusted GDP growth.

Between 2003 and 2008, the average multiplier was 1.0, with fluctuations ranging between 0.4 in 2003 up to 1.5 in 2006. In the USA, over a longer period, airline revenue has grown at just over 0.9 times that of unadjusted GDP.

An alternative way of looking at this is to calculate airline revenue as a proportion of overall GDP. Using IMF and IATA data, in the year 2000 airline revenue represented 1.02% of unadjusted GDP. Shift forward a decade to 2010 and this figure is forecast to drop to 0.88%. This, however, is actually an improvement on the 0.83% recorded in 2009. The bottom line is passengers have been getting more for less and that they will continue to do so.

Despite continuing mixed messages on the economic front, the climate is generally improving. We expect profit forecasts for the industry to continue to rise for 2010, but there are dark economic clouds forming and many will have to cut their 2011 outlook.

Inevitably attention will soon begin to focus on capacity decisions for summer 2011. Here too much too soon could be very damaging and quite clearly some difficult choices lie ahead.

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