Looking at the Numbers
Profits still rising
We have made a small downgrade to our forecast for airline industry net profits in 2014, as a result of the impact of recent developments on jet fuel prices and emerging market growth. However, these adverse impacts have been offset somewhat by solid momentum in the recent cyclical economic upturn.
We continue to expect a significant improvement in airline profits this year compared to 2013. Industry-wide net post-tax profits are forecast to rise from $12.9 billion in 2013 to $18.7 billion this year, downgraded from our previous forecast in December of $19.7 billion for 2014.
This appears to be a substantial profit but for a $745 billion industry it represents a margin of just 2.5%. This year the industry is forecast to make an average profit of $5.65 per departing passenger. That’s still a fragile margin in a risky business environment.
The demand cycle is turning up
Evidence is strengthening that the cyclical economic upturn, evident from the second half of 2013, is more durable than the ‘false dawns’ of 2011 and 2012, when business confidence and economic activity started a promising rise, only to be forced down again by renewed economic crises.
Driving this cyclical upturn in the developed economies has been a reduction in the degree of budgetary tightening, continued loose monetary policy, and substantial progress in reducing the ‘headwinds’ from the financial crisis with much improved balance sheets in the household and banking sectors. This has boosted business confidence, domestic industrial production and international trade.
Air cargo volumes (FTKs) closely track the ups and downs of business confidence. The steady improvement of business confidence since mid-2013 led, a few months later, to a similar rise in worldwide FTKs. By January this year FTKs had risen back to the previous peak of early 2010.
Source: IATA, Markit
This cyclical upturn is stronger than we anticipated back in December and we have raised our forecast for air cargo volume growth to 4%. However, world trade is still only growing in line with domestic industrial production. In normal cycles world trade grows 2x as fast as domestic output. Without the current degree of on-shoring and non-tariff protectionist measures we would be forecast cargo growth closer to 8%.
Source: Netherlands CPB, IATA
Air travel is driven largely by the incomes and confidence of households and businesses, and is less affected by the weakness of international trade (although business travel is). The economic conditions facing most passengers, proxied in the chart above by industrial production growth, continued to rise to a much greater extent than international trade. The acceleration of industrial production through 2013 has been matched by an acceleration of RPKs.
But so are financial and political risks
The downside to recent events has been an increase in risk from a couple of sources. First, capital is flowing into US dollar assets causing problems for a number of emerging economies and slowing their growth. Growth in these emerging markets generates proportionately more air travel than in mature developed travel markets. Consequently, the emerging market slowdown has caused a small reduction in our forecast for RPK growth this year.
Second, the crisis in Ukraine has increased geo-political risk and put upward pressure on oil prices. The net impact on the profit forecast this year is a small negative. We have followed the market and raised our forecast for average crude oil prices this year from $104.5/b to $108/b.
Improvements in structure are helping
The financial results of the past year have shown airlines, particularly in the US, have been able to improve profitability despite a still difficult business environment. Consolidation in several large mature markets and the development of ancillary services have been key factors.
Structural improvements and the cyclical economic upturn are forecast to improve airline industry return on capital to 5.4% this year. The improvement is welcome but returns, on average, remain too low.