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Monday, 6 June 2011

IATA blames profit drop for 2011 entirely on external circumstances: Are they right? Or is there something structurally wrong in aviation industry?

Today the IATA, the International Air Transport Association, published its Profit Outlook for 2011. Conclusion: the profit forecast is slashed to $4 bln for 2011. Main causes: high oil prices, natural disasters and political unrest.

Here are the pertinent snips of the
IATA’s press release:

Airline Industry 2011 Profit Outlook Slashed to $4 Billion

High Oil Prices, Natural Disasters, and Political Unrest Take Their Toll

Singapore -The International Air Transport Association (IATA) further downgraded its 2011 airline industry profit forecast to $4 billion. This would be a 54% fall compared with the $8.6 billion profit forecast in March and a 78% drop compared with the $18 billion net profit (revised from $16 billion) recorded in 2010. On expected revenues of $598 billion, a $4 billion profit equates to a 0.7% margin.

“Natural disasters in Japan, unrest in the Middle East and North Africa, plus the sharp rise in oil prices have slashed industry profit expectations to $4 billion this year. That we are making any money at all in a year with this combination of unprecedented shocks is a result of a very fragile balance. The efficiency gains of the last decade and the strengthening global economic environment are balancing the high price of fuel. But with a dismal 0.7% margin, there is little buffer left against further shocks,” said Giovanni Bisignani, IATA’s Director General and CEO.

Forecast Highlights:

Fuel: The cost of fuel is the main cause of reduced profitability. The average oil price for 2011 is now expected to be $110 per barrel (Brent), a 15% increase over the previous forecast of $96 per barrel. For each dollar increase in the average annual oil price, airlines face an additional $1.6 billion in costs. With estimates that 50% of the industry’s fuel requirement is hedged at 2010 price levels, the industry 2011 fuel bill will rise by $10 billion to $176 billion. Fuel is now estimated to comprise 30% of airline costs—more than double the 13% of 2001.

Demand: Despite high energy prices, world trade and corporate earnings continued to improve. As a result, global GDP projections increased by 0.1 percentage points to 3.2%, which is supporting continued growth in demand for air transport. However, growth rates for both cargo and passenger markets have been revised downward because of higher fuel costs. Passenger demand is now expected to grow 4.4% over the year, a full 1.2 percentage points below the 5.6% previously forecast in March. Similarly, cargo demand is expected to increase 5.5% and not 6.1% as predicted earlier.

The number of price-sensitive leisure travelers has fallen 3–4% over the past five months, as travel costs were forced higher by fuel prices and, in Europe, by new passenger taxes. Less price-sensitive premium travel demand has been more robust in the face of rising prices and continues to be driven by growing world trade and business investment. Premium passenger growth has dipped from the 9% of 2010, but is expected to be close to the historical trend this year at a 5–6% rate.

Capacity: Overall capacity (combined passenger and cargo) is expected to expand 5.8%, which is above the 4.7% anticipated increase in demand. The gap between capacity and demand growth has widened to 1.1 percentage points from 0.3 percentage points in the previous forecast. Due to schedule commitments and fixed costs, capacity adjustments are expected to continue lagging behind the fall in demand, driving load factors down. By April, passenger load factors were hovering around 77%. This is more than a full percentage point below the 78.4% achieved for international traffic in 2010. Aircraft utilization is also falling. This decline in asset utilization, represented by lower load factors and average hours flown per aircraft, is the most significant downward pressure on airline profitability.

Yields: Robust economic conditions have given airlines some scope to partially recover higher fuel prices. This is reflected in an increased yield growth forecast of 3% for passenger traffic (double the previously forecast 1.5%) and 4% for cargo (up from the previously forecast 1.9%).

Risks: The key risk to this outlook is a weakening of global economic growth. High energy prices will certainly have a slowing impact on economic growth. However, the impact will be mitigated by two factors. First, while high oil prices previously triggered recessions, today’s economies (which generate a unit of GDP using just half the energy required in the mid-1970s) are less sensitive. Second, the corporate sector is cash-rich, business confidence is high, and world trade continues to expand at around 9% annually.
IATA Chairman Giovanni Bisignani held a keynote speech, called “The State of the Industry” after the presentation of the 2011 Profit Outlook. Here are the pertinent snips of this keynote speech:
Unity, Leadership and Innovation
Singapore - The International Air Transport Association (IATA) called on the global aviation industry to build a platform for a sustainable future based on renewed leadership, continuous innovation, and a united stand in addressing challenges and finding solutions.
Vision 2050
“After a decade of crises and shocks, airlines today are safer, stronger, leaner, and greener. But sustainable profitability remains elusive. We expect airlines to make just $4 billion profits this year on revenues of $598 billion. The challenge is to prepare to handle 16 billion passengers and 400 million tonnes of cargo by 2050 with efficient infrastructure and effective technology, while making sustainable profits and satisfying customer needs,” said Bisignani.
“We need efficient processes to cope with the volumes and evolving customer demand. We need technology-based solutions for the environment and security challenges, and we need air traffic management that goes beyond national borders” said Bisignani.
Sustainable Profitability: Bisignani noted that sustainable profitability would be the biggest challenge for an industry with a net return of 0.1% over the last four decades. “We know what will not work. Cost-cutting alone does not increase long-term profits. Unbundling erodes the value of the base product. And re-regulation would kill efficiency and innovation,” said Bisignani.
Safety: Safety improved 42% with a 2010 industry hull loss rate for Western-built jet aircraft of 1 accident for every 1.6 million flights. IATA member airlines made the IATA Operational Safety Audit a condition of membership and outperformed the industry, with an accident rate of just 1 western-built hull loss for every 4 million flights.
Cost savings: Over the last decade, airlines radically restructured to slash non-fuel costs 9%, increase fuel efficiency 24%, and deliver a 67% improvement in labor productivity. IATA contributed to a more cost efficient industry with $59 billion of savings over the period 2004–2009: $7 billion in reduced taxation, $17 billion in cost efficiencies by monopoly suppliers, $17 billion by Simplifying the Business, and $19 billion in fuel efficiency gains and other cost reduction initiatives.
Environment: IATA led industry consensus to address climate change by improving fuel efficiency an average of 1.5% annually to 2020, capping net emissions from 2020 with carbon-neutral growth, and halving net emissions by 2050 compared to 2005.
However, some important unfinished business issues require immediate solutions:
IATA demands that Europe abandon its plans to include international aviation in its Emissions Trading Scheme (ETS) from 2012. “Uncoordinated and punitive regional measures distort markets and undermine global efforts to reduce emissions. The EU ETS is a $1.5 billion cash grab that will do nothing to reduce emissions. BASTA! (Enough!) to Europe’s short-sighted actions. It’s time to be serious about climate change and honest in developing global solutions,” said Bisignani.
IATA asks governments to stop compromising economic growth with aviation taxes. “Governments need a textbook on aviation’s role as an economic catalyst. The first chapter is entitled Basta to More Taxation,” said Bisignani, noting specifically:
  • The UK for its $4.5 billion Air Passenger Duty, the highest aviation tax in the world
  • Germany for its $1.3 billion departure tax announced in June 2010
  • Austria for following Germany with a $119 million departure tax
  • And India for the $450 million impact on aviation of its Service Tax
The Dutch Government repealed a $412 million departure tax because it cost the Dutch economy $1.6 billon. Similarly, the Irish Government is planning to cancel its $165 million Travel Tax because it has cost the economy $494 million and 3,000 jobs.
“Don’t kill the goose that lays golden eggs. Aviation facilitates the global trade that is stimulating economies and restoring government budgets. Tax the bankers who created the mess. Their billions of dollars in bonuses should help clean it up,” said Bisignani.
Chairman Giovanni Bisignani maybe has a point, when he called the aviation industry the “Goose with the Golden Eggs”. It is indeed a big driver for jobs, international economies and general prosperity all over the world.

And of course we had our share of setbacks in 2010 and 2011, thus lowering the profitability of the airliners: the ash cloud from the Icelandic volcano, the societal acrimony in North-Africa and Arabia, the earthquake and tsunami in Japan and the high oil prices that were the results of it. But hey, these are normal business risks and a healthy industry wouldn’t hardly notice those.

My opinion is that there is something structurally wrong within the aviation industry. When an industry has had a net return of 0.1% over the last forty years and when sustainable profitability for the aviation industry is still a mirage, like it is today, then you could seriously question the earnings model for the whole industry.

Especially when you consider that aircraft fuel – the main driver for aviation costs – is still free of taxes, due to an international agreement, where ALL other kinds of fuel for cars, trucks and other means of transport are (heavily) taxed by governments all over the world: gasoline, diesel/gasoil, LPG (Liquified Petroleum Gas) or fuel oil for ships.

You cannot see this loose from the development of passenger aviation over the last 20 years. Passenger aviation turned from a high-priced, high quality and high-service means of transport for the rich elite into a low-budget, mass transport medium that carries billions of people per year for bottom prices under – in some cases – poor circumstances.

The industry did this by slashing the ticket prices and stashing as many people as possible into an aircraft, while looking for maximization of the utilization rate of the airplane, by letting it fly almost around the clock. The relatively small group business class flyers pay – objectively looking – for the race to the bottom for economy class-passengers. This race to the bottom was triggered by price-fighters like Easyjet and Ryanair in Europe, but was soon taken over by the established aviation companies. This is not a sustainable development, as in the end something's got to give.

And that 'something' seems to be: safety and service. Although safety is still paramount in the aviation industry, the number of airlines that is secretly slashing its maintenance costs is rising. And this will eventually lead to more accidents in the sky.

And concerning service: everyone that has flown 'tourist class' in an airplane knows how green peas in a can feel. No room for your legs and no room to move. Getting thrombosis is a serious risk, especially on long flights. The corridors are so narrow, that you can't reach the toilet when a stewardess blocks the corridor with her trolley and besides that, safety regulations want passengers to move as little as possible. Free meals on board are more and more a thing of the past and prices for food and beverages are very high, in general. And still the profits of airliners are extremely low.

Another way to earn extra income is the invention of extra charges for almost anything. Especially Ryanair, the Irish low-cost carrier flying around in Europe, is world champion in inventing extra charges for the most ridiculous things, thus increasing the “cheap” ticket prices to a price they actually earn something with:
  • Charges for non-handheld luggage
  • Extra charges for excess luggage
  • Charges for reservation
  • Charges for handling
  • Charges for using a credit card
  • Charges for using another way of payment than credit cards
  • Charges for last-minute bookings
  • Charges for heavier persons (I'm not sure if  Ryanair actually established this, but they certainly talked about it)
But still the earnings model for many airliners is so wobbly that the littlest of interferences in the world can mean havoc on the balance sheet and the P&L.

So instead of blubbering about that nasty European Union and those terrible European countries that want to impose all kind of taxes on the aviation industry, the IATA should really do some thinking on how to get the whole industry profitable again, even if aircraft fuel would carry taxes, like all normal fuels do.

And the airline industry can’t escape anymore from growing into a more environmentally-friendly and fuel-efficient industry. This means the development and purchase of new airplanes that are environmentally friendly and very fuel-efficient and the purchase of right-sized planes, that carry the right amount of passengers against the lowest prices.

Flying around with planes of 20+ years old is like driving with a car of 20+ years old: it uses more fuel, creates more noise, is less clean and doesn’t offer the safety features that current airplanes do. Aviation companies should therefore be pushed to abolish their old airplanes and purchases modern ones.

One thing is clear, however: the race to the bottom for economy class-ticket prices should be over and the general profitability should be far up. Otherwise a large number of airliners will fall over in the coming years and only the largest, most profitable airliners will survive.

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