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Market outlook: Why less may be more for airline profits

Even from the earliest days of 2011 there should have been little or no doubt that this year was going to be considerably more difficult for the airline industry than 2010, when a combination of particularly favourable circumstances resulted in record profits.

Recent events suggest the outlook on the demand side could become even more testing, although not to the same degree in every region.

During the past few weeks, against a background of headlines suggesting "market meltdowns" and that a repeat of the 2008 financial crisis may be close, attention has inevitably focused on the shape of the future path for a number of global regions.

With the "W" associated with a "double dip" considered possible in a number of world economies, the immediate consequence has been another bout of uncertainty and an environment where fear has become the key factor underlying stock-market behaviour.

If it is, we are in for a bumpy ride for the latter part of 2012 at least. However, as we have suggested in the past, the actual impacts will depend on where you are and what you are doing.

Generally, the main problem is one for the developed economies of the northern hemisphere.

A common feature, at least in Europe, has been the decline in household spending.

The link between air travel, economic activity and consumer spending, in particular, remains inescapable. While the traditional view is that traffic grows at 1.5 times that of real GDP, this is more of a long-term relationship and indeed varies - reflecting the extent of market maturity. Indeed, in a number of markets the rate of growth is broadly similar to that of GDP, with a resulting multiplier of 1.

Against this backdrop, Airbus forecasts an annual average rate of passenger-traffic growth for the industry of 4.8% through to 2029, while Boeing predicts some 5.1% during the same period.

These multipliers, however, only relate to traffic growth, which is a necessary but insufficient condition for success as revenue from the traffic is of equal, if not more, importance.

The difficulties associated with planning for the longer term - against the background of a rapidly changing short-term environment - are perhaps illustrated by the latest announcements in the "order fest" that started at the time of the Paris air show.

The sharp deterioration in expectations concerning the economic outlook has coincided with another raft of large orders.

In the order announced by American Airlines, there is also significant financial support to be provided by the manufacturer.

The pressing issues for now are what might happen to both traffic and fares into 2012-13 and, in particular, the nature and timing of any turning points.

We will each have our own views of what will be the best leading indicators of turning points and of the associated "trigger" values.

These are likely to include indicators relating to consumer and business confidence and other forward-looking, rather than lagging, indicators - which will include actual or estimates of output or spending.

What we have seen recently is a type of "double impact", with firstly a downturn in consumer spending and then a contraction of the multiplier - both in the UK and the USA - of 0.003.

Although in isolation this might not seem such a large number, the effect is brought into sharp relief when the number being multiplied is expressed in trillions of dollars.

It is often said the darkest hour is the one before the dawn and to an extent, in terms of recovery for the airline industry, 2010 has proved to be a false dawn.

In this respect, 2011 is likely to be a turning point and indeed, as we have suggested in the past, the path from the 2008-09 downturn was never going to be a straight line to the next peak.

Furthermore, although it is reasonable to expect consumer expenditure to grow/recover next year - a key factor to watch will be the capacity announcements for the summer 2012 timetable, which should begin to emerge after the IATA Schedules conference in November.

In terms of profitability, less may indeed be more.

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