REVERSAL OF FORTUNES

The world’s airlines are collectively forecast to report their best profit for almost 50 years in 2015, but the most frequent top earners, the Asia-Pacific carriers, have slipped down the results table. Over-capacity, uneven air cargo performance and intense competition are taking a toll on the region’s earnings.

by TOM BALLANTYNE FROM MIAMI  

July 1st 2015

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For the industry it was an historic moment. At the annual general meeting of the International Air Transport Association (IATA), held this year in Miami, the organisation’s director general and CEO, Tony Tyler, announced that the global airline industry is forecast to report its highest profit margin since the mid-1960s in 2015. Read More »

For first time since IATA began collecting comprehensive data on airline profits more than two decades ago, the industry’s return on investment (ROI) will be 7.5%, exceeding its cost of capital (6.8%), Tyler said. Global airlines are collectively forecast to earn a net profits of US$29.3 billion, on revenues of $727 billion, for the year.

In 2015, North American carriers will replace Asia-Pacific airlines as the industry’s top earners. U.S. airlines are expected to generate more than half of the industry’s global profits, at $15.7 billion, up from $11.2 billion in 2014. On a per passenger basis, U.S. airlines are making an average profit of $18.12 per passenger.

For Asia-Pacific airlines, who have been the industry’s outperformers since the 1990s, the devil is in the detail – and it is not all good news.

Airlines in the region will still be profitable, but only to the tune of $5.1 billion, for a 2.5% net margin, or $4.24 per passenger. The average non-U.S. airline is struggling with returns below the cost of capital and holds significant debt.

Asia-Pacific airlines have suffered, said IATA, because they have been disproportionately impacted by air cargo losses in a market where they hold 40% of global air freight business. The slowdown in Mainland China’s economy also has had a dampening impact on profitability.

Lower fuel costs will improve profits, but an rising U.S.dollar will reduce the benefit for Asia-Pacific carriers.

 “Historically, Asian airlines have been the outperformers,” the director general of the Association of Asia Pacific Airlines (AAPA), Andrew Herdman, told Orient Aviation during the Miami Beach gathering.

“The normal rule of thumb was that Asia-Pacific airlines accounted for about half of the profit pool. That honour has now gone to the United States. They have been in a sweet spot where they are delivering good levels of profitability.”

Herdman said it was clear 2014 was a year of growth in both passenger and cargo volume in Asia, but that revenue growth did not lead to profitability. “In aggregate, Asian airlines were barely above break-even. There was a very wide dispersion of results,” he said.

“Chinese carriers and Japanese carriers, for example, tended to do rather better. But Southeast Asia is ultra-competitive, regardless of any business model being used, so even the low-cost carriers are struggling to be profitable.”

The outlook for 2015 is a bit better, because of lower fuel prices, Herdman said. “Some of that will be passed on in lower fares. It will stimulate travel demand and travel itself is going to be very affordable because of lower fares.

“So overall, the demand side should look pretty firm. I’d expect some of that benefit to show up in improvements in margins for Asian airlines.”

Analysts said the strong U.S. performance clearly shows the significant benefits consolidation has brought to North American airlines in the last five years. Six big U.S. airlines are now three giant carriers: American Airlines, Delta Air Lines and United Airlines.

With a recovering economy and a lower fuel price in play, U.S. carriers are using their profits to renew fleets, pay down debt and deliver a normal return to investors through dividends and share buy-backs.

Can Asia-Pacific airlines duplicate the consolidation that has taken place in the U.S.? It is a development many industry insiders believe could be a key to long-term industry viability.

Said Herdman: “It’s hard to envisage anything like that happening in Asia because of the national ownership and control rules. I can’t see a situation where cross-border consolidation into large groups could happen. That’s not the answer.

“On the other hand, if consolidation in the region means that some smaller players go out of business that will happen. We are already witnessing this among some of the smaller LCCs.”

Unlike Europe, where LCCs are doing exceptionally well, Asian budget carriers are finding it’s a tough business, said Herdman. “The competitive pressure the LCCs are experiencing is the same for all airlines,” he said.

“LCCs and full-service airlines are overlapping. They are not separate segments or separate markets. All the airlines are competing on the same routes against each other.”

One airline chief, newly arrived in the Asia-Pacific, begged to differ. At Miami, Malaysia Airlines’ new chief executive, Christoph Mueller, told media industry consolidation will happen much quicker in Asia than it has in Europe or the U.S.

He expected “major progress” in that regard within the next five years as countries in the region continue to liberalize air service agreements and allow their national carriers to combine forces. Few would agree with Mueller, given the huge diversity of cultures in Asia and the shield many governments throw up to allow their flag carriers to survive.

The AAPA boss said Asia-Pacific airlines must focus on capacity because it was slightly ahead of demand. “Over-capacity took away pricing power. Margins were squeezed. The solution is to carefully manage capacity to match the growth in demand by taking a hard look at new deliveries, retirements and so on. I think we will see a better supply demand situation this year,” he said.

In the critical air freight area, regional analysts described the sector as having “mixed signals” for 2015. However, Herdman believed the sector is undergoing a sustained recovery. “It will be some time before we achieve a complete supply-demand balance, but it’s on the mend. I’m an optimist on medium-term freighter demand,” he said.

On the wider industry front, Tyler and his member airlines were far from smug about the industry’s improved profits. “For the airline business, 2015 is turning out to be a positive year,” said Tyler. “Since the tragic events of September 2001, the global airline industry has transformed itself, with major gains in efficiency.

“This is clearly evident in the expected record high passenger load factor of 80.2% for the year. The result is a hard-earned 4% net profit margin. On average, airlines will retain $8.27 for every passenger carried.”

He added: “Apple, a single company, earned $13.6 billion in in the second quarter of this year. That’s just under half the expected full-year profit of the entire airline industry. We don’t begrudge anyone their business success. But it is important for our stakeholders, particularly governments, to understand the business of providing global connectivity is still a very tough one.”

Willie Walsh, chief executive of International Airlines Group (IAG), the parent company of British Airways, said it was “unacceptable” that the industry is only just earning its cost of capital, a sentiment shared by many at the AGM.

'Asia-Pacific LCCs and full-service airlines are overlapping. They are not separate segments or separate markets. All the airlines are competing on the same routes against each other'

Andrew Herdman Director General of the Association of Asia-Pacific Airlines

Leading up to the AGM, there were expectations of a clash between U.S. and Gulf airlines over alleged subsidies. The big three American carriers claim the largest Gulf airlines have received US$42 billion in government aid in the last decade and that these funds breech international Open Skies agreements.

Gulf carriers have counter claimed U.S. airlines have been subsidised by bankruptcy protection, and government assistance after 9/11 and for industry pension support.

But there were no fireworks. The heads of two U.S. airlines, Delta’s chief executive, Richard Anderson, and United’s president and chief executive, Jeff Smisek, attended the closed door IATA Board of Governor’s meeting at the beginning of the AGM and then disappeared for the two days of debate that was open to the press.

American’s chairman and chief executive, Doug Parker, was left to sidestep the repeated media inquiries about the row. Clearly trying to take the heat out of the situation, he said he had met with Qatar Airways boss, Akbar Al Baker, “and we had a nice talk”.

Parker insisted the campaign by the three U.S. carriers “has nothing to do with protectionism”, but was about “competing with governments”. He reiterated that he expected the U.S. government “to take some action in the future”.

Not surprisingly, the outspoken Al Baker attempted to bring the debate into the AGM’s general session. After Tyler’s keynote address, the Qatar boss called on IATA to stand up against “protectionism”. He told the gathering he saw a risk that Open Skies and liberalization policies could be rolled back because of the U.S. airlines actions. He said any changes to U.S. policy and the interpretation of the Open Skies deals in question would “reverberate around the world” and lead to more “protectionism”.

IATA should reassert the “agenda for freedom” it adopted in 2008, he said and added he did “not agree that we should not comment”.

Tyler, however, made it clear the airline association was staying out of the dispute. He said IATA represented all its members and did not have a mandate to take a position on the issue, He said it was no secret that there was “an underlying tension in our industry” but said “IATA is not the battleground on which a solution can be found”. The matter was not on the official agenda but Tyler did say the group backed liberalization and free and fair competition.

At the AGM, IATA called for a deeper partnership with governments based on global standards in the critical areas of safety, infrastructure, security, regulation, and environment. Tyler said aviation is built on partnerships and its relationship with governments was critical.

“Airlines and governments are well-aligned on safety, but in other areas of government responsibility including infrastructure, security, regulation, and environment, there are opportunities for a deeper partnership,” Tyler said.

This year 3.5 billion people and 55 million tonnes of cargo will travel safety by air over a global network of 51,000 routes. Airlines directly employ 2.5 million people and support another 56 million jobs in the industry’s value chain. Its role as a catalyst of economic growth is evident as some $6 trillion of goods find their way to global markets via air transport,” he said.

“For nations, connectivity is much more than a competitive advantage. It is an economic necessity. And aviation’s intangible benefits make it a force for good in the world. So there is a tremendous common interest with governments to support safe, efficient and sustainable global connectivity that only air transport can provide,” said Tyler. He warned that aviation can only deliver its significant social and economic benefits if it has adequate, cost-efficient infrastructure capacity to meet growing demand. He noted several critical infrastructure challenges where more alignment is needed, including keeping costs at Hong Kong International Airport competitive as it funds construction of a third runway, and improving efficiency in Chinese air traffic management.

Another critical ongoing issue for airlines that continues to concern airlines is security. Tyler said the aviation industry and governments are partners in aviation security. “We have a common interest in keeping our passengers, crew and cargo secure with efficient and respectful processes built around global standards,” he said. “While there has been tremendous progress over the last few years, our customers regard security and border controls as big pain points in their journeys.”