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Date: 20 September 2011

Remarks of Tony Tyler, Revised Economic Outlook

Good afternoon to everyone here in Singapore and around Asia.  And good morning to those joining us from Europe and elsewhere. Today, we are announcing our revised outlook for the global air transport industry for 2011 and our first look into 2012. I understand that you all have copies of the embargoed press release, so you already know the headline story that we are upping our forecast profit for 2011 by $2.9 billion to $6.9 billion and that this will fall back to $4.9 billion in 2012. Margins are razor thin—1.2% this year falling to 0.8% in 2012. Unfortunately, poor margins seem to be a characteristic of the industry. Even in 2010, when airlines made a record absolute profit of $15.8 billion (restated), margins were just 2.9%. Airlines put in a lot of effort for very poor returns.

But given the strong headwinds—high oil prices, the continuing European debt crisis, the shocks in Japan and inflation fighting measures in China—air transport markets are holding up comparatively well. Certainly the industry is weak, but it is still profitable. Let me examine some of the trends behind the headline.

The biggest factor impacting aviation is the global economy. GDP growth projections for 2011 were downgraded from 3.2% in June to 2.5%. Historically, when economic growth slips below 2%, the airline industry loses money. We are just above that threshold.

But why are we doing better than previously expected? It is about travel volumes. Despite the economic doom and gloom, people are traveling. Over the first seven months of the year we saw passenger traffic expand by 6.4%. That is based on strong business and consumer confidence at the beginning of the year. But by July, growth had slowed to 5.9% which coincidentally is also what we see passenger growth to average for the full year. This is an upward revision from the 4.4% that we forecast in June.

Cargo, on the other hand, is stagnating. Over the first seven months of the year cargo grew by 1.0%. In July, markets contracted by 0.4%. In fact cargo markets have slumped some 4% since their post-recession peak in 2010 which was driven by the re-stocking cycle. We have significantly downgraded our expectations for cargo growth from 5.5% in June to just 1.4%.

Airlines have been doing a good job of filling seats. The passenger load factor for July stood at 83.1% and 77.7% for the first seven months of the year. Airlines are utilizing aircraft assets more intensely to meet increased passenger demand, which is good. Airlines have found it more difficult to sustain utilization rates in soft freight markets, and additional capacity has driven the freight load factor down to about 45% in July.

This has an impact on yields. We expect passenger yields to grow by 3.0%, unchanged from our June forecast. But it is half the 6.1% growth recorded in 2010. And we still have not made up for the 14% fall in yields in 2009.

On the cargo side, low occupancy rates are taking away the opportunity to improve yields. We revised our 4% growth expectation down to zero.

On the cost side, the fuel price is still high but unchanged from our June forecast. We are still expecting a crude price of $110 that would translate into jet fuel at $126.5 per barrel for a $176 billion bill. That will be 30% of our costs.

So if I could summarize the macro aspects of the revised forecast, it is really being driven by volume growth based on strong passenger demand in the first half of the year. This has compensated for stagnation in freight markets.

2012

For 2012 we see profitability falling back to $4.9 billion. We could well see the market reaching its weakest point at the end of this year and extending into early next year.

Indeed, for 2012 we expect more or less a similar result to this year. Industry revenues will grow by 6.4% to about $632 billion. But total costs will creep up by 6.9%.

Global economic growth is expected to weaken slightly from 2.5% this year to 2.4% in 2012. This will slow passenger traffic growth to 4.6%. But we are hopeful that cargo traffic will pick up from 1.4% growth to 4.2%.

We expect yields to be flat for cargo which will mean no change since 2010. And passenger yields will grow by 1.7%, about half the 3.0% growth that we expect this year.

We expect the oil price to fall slightly to an average of $100 per barrel for the year. But due to the impact of hedging it will actually increase fuel to 32% of costs and for the first time, the industry fuel bill is expected to exceed $200 billion.

So the story for 2012 basically is that we will see slower growth in traffic and passenger yields. Costs will increase marginally faster than revenues and we face a tough year that will deliver a $4.9 billion profit and a 0.8% margin.

Regional Breakdown

There are some big regional differences that occur against the backdrop of these global trends. There are also some similarities.

In 2011, all regions are expected to report a profit—except Africa which is expected to break even. All regions are expected to perform better than we thought in June. But at the same time all regions will see profitability reduced from what they made in 2010.

Going into 2012 all regions will see a decline in profitability.

So, what are the most interesting regional stories?

The first is Europe. The weak Euro is helping the industry on volumes—encouraging inbound travel and boosting exports. European airlines have also done well on international markets. We revised our $500 million profit projection for 2011 to $1.4 billion. This is the biggest contributor to our improved outlook. But we do not see this improvement as sustainable. We expect profitability for European carriers to fall to $300 million in 2012, due to the particularly weak economic situation on the continent. This $1.1 billion fall accounts for over half of the projected drop in profits at the industry level.

In absolute amounts, Asia-Pacific will deliver the most to the industry’s total profit with a net return of $2.5 billion, $400 million better than our June forecast. But this is a $5.5 billion drop from 2010 as a result of the weakness of air freight markets and the lingering impact of the Japanese earthquake and tsunami which continue to put a damper on the region. We expect the region to be relatively stable at this level into 2012 with profits dropping by $200 million to $2.3 billion. It will still be the largest contributor to the industry’s profit.

North American carriers face a difficult situation with the continuing economic gloom. None-the-less we have revised our projections upwards from $1.2 billion to $1.5 billion based on stronger-than-expected volumes at the beginning of the year. And we see profits falling to $1.2 billion in 2012.

The pattern for Latin American and Middle Eastern carriers is similar. In June, we expected each to deliver $100 million in profit. But the Middle East traffic held up better against political unrest than expected. And similarly, the Latin American economy was less impacted by the slow US economy than we expected. So we revised our forecast upwards to $800 million for the Middle East and to $600 million for Latin America. Both of these will fall by $100 million each in 2012.

And finally Africa, which we have revised from a $100 million loss to break even. But the region is expected to slip back into losses of $100 million in 2012.

At the regional level, Europe stands out for its weakness. Putting aside absolute profits, this is very clear in the EBIT margins. In both 2011 and 2012, North American, Latin American, Middle Eastern and Asia-Pacific carriers will see EBIT margins in the range of 2.4% to 3.4%. Europe is a complete step below at 1.5%. And this is expected to fall to 0.8% in 2012. Africa is the worst performer with its 0.7% 2011 EBIT expected to fall to 0.2% next year.

Conclusion

Today’s announcement confirms that aviation is a resilient industry. Even in these uncertain economic and political times and even with all the extraordinary shocks that we have had this year, people are still flying.

And this is positive, because aviation is an engine for economic growth supporting employment for 33 million people while connecting people and business.

With an outlook of weak profitability extending into 2012—particularly in Europe—it is important that governments focus on aviation policy as part of their overall economic strategy. Not to tax us and add even further burdens but to set an environment for aviation to grow stronger and provide opportunity across all sectors of the global economy dependant on connectivity.

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