The airline industry is now moving out of survival mode and into a new period of growth, but, argues  RAeS Head of Research, Professor KEITH HAYWARD, profits may still be elusive. Is this another bubble heading for a nasty collision with economic reality? Analysis. [caption id="attachment_8600" align="alignnone" width="376"] New aircraft are now entering service - but will airlines make any profit with them?[/caption] The world airline industry has begun to recover from a difficult time, reflecting the economic problems in two of its key markets. Unsurprisingly, according to IATA data — Asia was the leading air transport market last year, with 947·9m passengers, followed by North America (808·1m) and Europe (780·6m). Emerging market destinations were again the most buoyant, responsible for 65% of 2012 growth.  

Where are the profits?

But profits remained illusive: this year, the world’s airlines are expected to make $711m on revenues of $12·7bn — a derisory 1·8% margin, or $4 per passenger, and Asia-Pacific airlines are expected to deliver a third of the world total. This year Gulf-based airlines are also fancied to do well — with growth rates as high as 15% with the prospect of improved yields and profitability.  

European misery continues

In Europe, the legacy carriers continued to struggle against the LCCs. Market leaders Ryanair and EasyJet recorded solid growth in the face of difficult times last year. Total 2013 profits are likely to be in the region of $1·6bn, substantially up on last year’s $0·8bn, but still poor by world standards. Returns on capital are also derisory, with only African carriers showing a worse performance. And without the legal muscle provided by a US-style bankruptcy system, as well as residual political interference, European airlines are unlikely to undergo US-style restructuring and industry rationalisation. Currently the leading five US airlines control 86% of their domestic market compared to 45% for the European top five — although it looks as though the US Justice Department has called time on further rationalisation by challenging the American-US-Air merger. Where there have been European mergers, such as the International Airline Group’s BA-Iberia link, improvements in efficiency have hardly begun to match US levels of savings. One effect is that European flag carriers will still be struggling to close the profit gap on the discount sector. This has led one quasi-official French report to argue that European legacy carriers could face a fatal squeeze between LCC taking their domestic network feed and the power of well supported and financed Gulf-based airlines on long haul services.  

And how to buy the metal?

Fuel accounted for 33% of airline costs last year; and price rises since 2010 have added over $60bn to the industry’s total fuel bill. Fuel efficiency is creeping up (1·7%), but still poses a major challenge to industry revenues and underlines the importance of acquiring a new generation of fuel efficient aircraft. But this looks even more challenging given the $4-5tr in capital investment needed to meet the predicted market growth in air travel. Returns on capital invested averaged 4·1% between 2004 and 2011, nowhere near the average cost of capital at 7·5%, and well below the level needed to attract investment. With a period of stable fuel prices predicted, the world’s airlines should be able to improve profitability. As world economic growth picks up, with traffic predicted to increase by 4% this year compared to 2·5% last year. But the airline industry still seems to drift above the laws of rational economics; one has to wonder if this is another bubble on the way to a nasty collision with reality. The crunch time may yet come if the looming economic problems in a number of key emerging markets blow up into a full-blown economic crisis. Given that recovery in the US and Europe is still fragile, late 2014 or 2015 might see another rough time for the airline sector.   This article previously appeared in the October edition of AEROSPACE.  Read Keith Hayward’s incisive commentary on the global aerospace secotor every month in the RAeS flagship magazine, AEROSPACE.

Royal Aeronautical Society
4 October 2013