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Look at the Numbers

Difficult conditions but improved performance

Airline financial performance continues to improve slowly, despite difficult business conditions.  In our Q2 forecast, we have further upgraded our outlook for industry profits in 2013. We now expect the industry to generate net post-tax profits of $12.7 billion, compared to the $10.6 billion forecast in March. Although the direction of change is positive, that is still a very thin 1.8% margin on revenues of over $700 billion.Airline net post-tax profit margins

The reason for the upgrade is that we have seen further evidence of structural changes, improving the ability of the industry to generate profits given economic conditions. In fact recent economic conditions have been mixed. 

The outlook for global economic growth has deteriorated slightly, as the recession in Europe proves to be deeper than expected. However, oil prices are lower this year, partly because of softer growth expectations, but also because expectations of new supply from the US are having a strong impact on prices. These changes net out to have a slightly positive impact on the forecast for airline profits, but the more material influence has been a structural improvement in airline performance.

The improvement is most clearly seen in North America, where margins have been improving since 2011 despite continued high jet fuel prices and sluggish economic growth. Consolidation on domestic markets through mergers across the North Atlantic through joint ventures has more than offset difficult market conditions. Asia-Pacific airlines continue to generate the highest margins, but they have fallen sharply since 2010 largely due to the weakness in cargo markets. A moderate upturn in cargo this year should help to improve profits in this region this year. European performance is also improving, from a low level.

Hesitant upturn in global economic growth

We are still expecting a moderate acceleration in economic growth this year, after two consecutive years of slowdown. But the expected pace of that acceleration this year has been cut and we now see structural change and airline efficiency measures to be the more important drivers of an improved financial performance this year.

The profile of business confidence has led not just the path of air freight volumes, but also industry profitability. Since a low point towards the end of last year, business confidence has risen once more.  However, in recent months the improvement has stalled. At the moment the pattern of business confidence looks worryingly like a repeat of the 2011 and 2012 ‘false dawns’. 

The ups and downs of business confidence and air cargo over the past three years have mirrored periods of optimism and pessimism over the Eurozone. Consumers in the developed markets of Europe and North America are important drivers of the high value/low volume goods shipped by air. In the past decade there has been a dramatic change in the pattern of trade, with far more growth from the emerging economies. Much of the growth in air travel is currently being driven by markets linked to emerging economies. 

Industry is still far from adequate returns

Travel markets have been expanding faster than the historic relationship with global GDP as growth has been concentrated in the emerging economies, where economic activity generates proportionately more air passengers than the mature developed markets. The industry has also changed the historic relationships between airline profits and global GDP. 

In the past whenever global economic growth (aggregated using market exchange rates) slowed to the rates seen the previous year, airline industry profits would slip into loss. The fact that airlines continue to generate profits, albeit at a relatively low rate, is evidence of a structural improvement in financial performance.

Return on invested capital in airlines and their WACC

These changes are in the right direction. However, this level of profitability in 2013 represents a return on invested capital of 4.8%. This would enable the industry to pay for its debt interest costs and pay equity investors a small dividend. However, returns of 4.8% are still materially lower than the 7-8% investors should expect to earn at a minimum (the cost of capital).

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