… but challenges remain

IATA: “Strong profits continue in 2017...

Even though IATA has revised its 2017 industry profitability outlook upwards, it cautions that labour, fuel and supplier costs remain a challenge. Regional forecasts are given including for airlines in the Asia-Pacific area.

The International Air Transport Association (IATA) has revised its 2017 industry profitability outlook upwards, with airlines expected to report a $31.4 billion profit (up from the previous forecast of $ 29.8 billion) on revenues of $743 billion (up from the previously forecast $736 billion). “This will be another solid year of performance for the airline industry. Demand for both the cargo and passenger business is stronger than expected. While revenues are increasing, earnings are being squeezed by rising fuel, labour and maintenance expenses. Airlines are still well in the black and delivering earnings above their cost of capital. But, compared to last year, there is a dip in profitability,” stated Alexandre de Juniac, IATA’s Director General and CEO.

IATA has also revised (downwards) its estimation for 2016 profits to $34.8 billion (from $35.6 billion previously forecast). Industry level profitability peaked at a historically high level in the first half of 2016 but has since been slowly declining, the result of margins being squeezed by unit costs, which are rising faster than unit revenues. Additionally, net post-tax profits took a hit from fuel hedging losses.

Still, in 2017 airlines are expected to retain a net profit of $7.69 per passenger, down from $9.13 in 2016 and $10.08 in 2015. The average net profit margin stands at 4.2% ( down from 4.9% in 2016). “Airlines are defining a new epoch in industry profitability. For a third year in a row we expect returns that are above the cost of capital. But, with earnings of $7.69 per passenger, there is not much buffer. That’s why airlines must remain vigilant against any cost increases, including from taxes, labour and infrastructure,” observed de Juniac.

While overall industry performance is strong, major regional variations remain. About half the industry profits are being generated in North America ($15.4 billion). Carriers in Europe and Asia-Pacific will each add a $7.4 billion profit to the industry total. Latin America and Middle East carriers are expected to earn $800 million and $400 million respectively. Airlines in Africa are however expected to post a $100 million loss.

The IATA forecast is driven by a number of factors, particularly a demand environment that has been much stronger

than anticipated. Expectations for a 2.9 per cent GDP growth in 2017, if realised, will be the strongest global economic performance since 2011. Passenger demand is expected to grow by 7.4% over the course of 2017, the same growth rate as 2016 and 2.3 percentage points higher than previously forecast. Stronger demand translates into an additional 275 million passengers (over 2016), which will bring the total number of passengers expected to fly in 2017 to 4.1 billion. If achieved, this would be the largest year-on-year growth in absolute passenger numbers ever recorded.

What is most important for industry financial performance is that this surge in expected demand takes traffic growth ahead of planned capacity growth. As a result, the average passenger load factor is expected to reach 80.6% (slightly ahead of the 80.3% achieved in 2016), helping to boost unit revenues.

Cargo demand is expected to grow by 7.5% in 2017, more than double the 3.6% growth realised in 2016 and 4.0 percentage points above the previous forecast for this year. Total cargo carried is expected to reach 58.2 million tonnes, higher than previously forecast (by 2.5 million tonnes) and 3.9 million tonnes over 2016 levels. Air cargo typically grows strongly at the start of an economic upturn, as firms turn to rapid air transport to restock inventories – which is what is happening today. There are also retail trends, such as the switch to e-commerce and in pharmaceuticals which is supporting air cargo growth.

On the other hand, cost increases for fuel, labour and maintenance accelerated in the first quarter. Overall industry expenses are expected to rise to $687 billion, a $44 billion increase on 2016. Industry revenues are expected to increase to $743 billion, $38 billion more than 2016.

Cheaper fuel was responsible for most of the 8% fall in airlines’ unit costs in 2016, but that impact is coming to an end due to the influence of fuel hedges and rising spot prices. Some regions will still see some modest benefits from hedges but this will be insufficient to offset the rise of other operating costs. The total industry fuel bill is predicted to be $129 billion, slightly below the 2016 level of $133 billion, and accounting for 18.8% of the industry’s total costs. The forecast anticipates an average oil price of $54.0 per barrel for Brent Crude (up from $44.6/barrel in 2016 but close to current levels) reflecting a broad balance between OPEC supply cuts and new supply from US shale oil producers, which will lead to jet kerosene prices averaging $64.0 per barrel this year.

Aside from the effect of fuel prices and hedging, the main driver of increased costs in 2017 is coming from labour and industry suppliers which are exerting pressure for an increased share of the airline industry’s improved financial performance. In 2016 productivity gains offset wage increases, but this year unit labour costs will rise by almost 3%, continuing what has already been evident in the first quarter.

Yields are still expected to be down on 2016 levels, but there are signs of stabilisation in the first half of the year with a slight improvement anticipated towards year-end, driven by better capacity utilisation and the imperative to respond to the rise of unit costs.

Passenger yields are expected to fall by 2.0% over the course of the year. This is the smallest decrease in recent years (-8.8% in 2016, -11.9% in 2015, -5.5% in 2014, -3.9% in 2013). Cargo yields are expected to fall by 1.0% over the course of the year. This is also the smallest decrease in recent years (-12.5% in 2016, -17.4% in 2015, -2.0% in 2014, -4.9% in 2013).

Regional Forecasts

North America: Carriers in this region are expected to post a $15.4 billion net profit (slightly down from the $16.5 billion in 2016), which is equal to $16.32/passenger. Passenger demand is expected to grow by 4.0%, slightly behind expected capacity growth of 4.4%.

North American airlines are the powerhouse of industry profitability, generating about half of the collective global profit. This is owing to the restructuring of the industry, a relatively strong economy and a resilient US dollar. The region’s carriers also face challenges as limited fuel hedging delivered quick benefits when fuel prices fell. Conversely, there is less of

a buffer as fuel prices rise. A tight labour market is adding more pressure to profits by pushing up wages. Nonetheless, profitability remains at historically high levels, even if slightly down on 2016.

Asia-Pacific: Airlines in this region are expected to post a $7.4 billion net profit (down from $8.1 billion in 2016) which is equal to $4.96/passenger. Passenger demand is expected to grow by 10.4%, slightly ahead of expected capacity growth of 8.8%.

Cargo is playing a large role in strengthening the region’s carriers, which collectively account for about 40% of air cargo shipments. Cargo revenues are rising for the first time in several years and this trend should be boosted by the restocking of retailers and industry in the initial stages of the economic upturn. China continues to reorient its economy away from exports and toward domestic demand. The wider Asia region is still the key source of manufactured components and finished goods, which is showing strong demand at start of the cyclical economic upturn, seen in recent quarters.

Europe: European airlines are expected to post a $7.4 billion profit (down from $8.6 billion in 2016) which is equal to $6.94/ passenger. Passenger demand is expected to grow by 7.0%, slightly ahead of expected capacity growth of 6.9%.

Terror incidents in 2016 have dented European demand but performance over the first months of the year pointed towards the recovery of lost ground. However, recent terrorist attacks demonstrate that the threat continues to hang over the continent with potential negative impacts on demand.

The cargo business for the continent’s carriers is getting a demand boost from the weak Euro, improvement in world trade (with a direct positive impact on air cargo) and indications of political stability.

Latin America: Latin American airlines are expected to post a $0.8 billion profit (up from $0.6 billion in 2016) which is equal to $2.87/passenger. Passenger demand is expected to grow by 7.5%, well ahead of expected capacity growth of 6.7%.

The continent is seeing slightly improved trading conditions with its largest economy (Brazil) emerging from recession, political instability persists in many markets and rising costs in dollars (for fuel) presents challenges. Additionally the region suffers from an onerous regulatory burden on passenger rights. Brazil has been joined by Mexico with punitive passenger rights regimes that differ significantly from international norms, while the political chaos in Venezuela makes it unlikely that there will be a recovery of $3.8 billion of airline revenues blocked from repatriation. Nonetheless, the region’s airlines are responding to these challenges and Latin America is expected to be the only region to see an improvement in its business fortunes compared to 2016.

Middle East: Middle East airlines are expected to post a $0.4 billion profit (down from $1.1 billion in 2016) which is equal to $1.78/passenger. Passenger demand is expected to grow by 7.0%, slightly ahead expected capacity growth of 6.9%.

Trading conditions for the Middle Eastern carriers have sharply declined over the last six months. Profitability and load factors are down significantly, as traffic and some business models have come under pressure. There is growing evidence that the ban on large electronic devices in the cabin and the uncertainty created around possible

US travel bans is taking a toll on some key routes. Meanwhile the region is struggling with increased infrastructure taxes/charges and air traffic congestion.

Africa: African airlines are expected to post a $0.1 billion loss (in line with the $0.1 billion loss in 2016), which is equal to a loss of $1.50/passenger. Passenger demand is expected to grow by 7.5%, slightly behind expected capacity growth of 7.9%.

African carriers remain in the red, but without a deterioration on 2016 performance. On safety, the region’s carriers achieved a major milestone with zero jet hulllosses in 2016. And a general improvement in commodity prices is helping invigorate the continent’s economies (and offset fuel price increases). This trend, however, is unlikely to accelerate substantially. The burdens of high taxes, higher-than-global-average fuel prices, competition from the Gulf and limited intra-continental liberalisation remain. The balance of these factors is expected to result in continued small losses.

“The Business of Freedom”

“Air transport is the business of freedom. The safe and efficient global movement of goods and people is a positive force in our world. Aviation’s success betters peoples’ lives by creating economic opportunity and supporting global understanding. We must stand firm in the face of any rhetoric that would put limits on aviation’s future success,” said de Juniac.

Some key indicators of the strength of global connectivity include the 2017 average return airfare, expected to be $353 (2016 dollars), which is 64% below 1996 levels after adjusting for inflation; average air freight rates in 2017 are expected at $1.51/ kg (2016 dollars) which is a 69% fall on 1996 levels; air cargo’s share (around 35%) of the total value of goods traded globally; the number of unique city pairs served by aviation is forecast to grow to 19,699 in 2017, a 99% increase on 1996; and the global spend on tourism enabled by air transport is expected to grow by 5.2% in 2017 to $685 billion.

Keeping the production lines active, airlines are expected to take delivery of some 1,850 new aircraft in 2017, around half of which will replace older and less fuel-efficient aircraft. This will expand the global commercial fleet by 3.8% to 28,645.