Asia-Pacific carriers' profit outlook downgraded on Euro woes

Impact of European losses now expected to be more than doubled at $1.1 billion will take its toll on Asia-Pacific carriers, says IATA.

The International Air Transport Association (IATA) released its revised industry outlook for 2012. Global industry profits are expected to be $3.0 billion, unchanged from the last update in March. A fall in oil prices, stronger than expected growth in passenger traffic and a bottoming out of the freight market are driving some improvements in the profitability outlook. However, this is offset by the continued and deepening European sovereign debt crisis, which has led markets to expect a further deterioration and damage to economic growth, the adverse impact of which has been built into this forecast.

This will be the second year of declining returns since airline profits peaked in 2010 at $15.8 billion with a net profit margin of 2.9%. In 2011, industry profits fell to $7.9 billion for a 1.3% net profit margin. This year’s projected $3.0 billion industry profit would yield a net profit margin of just 0.5%.

Compared with the previous forecast in March, North American and Latin American carriers are expected to see improved prospects. The outlook for African carriers is unchanged. But the outlook for European, Asia-Pacific and Middle Eastern carriers has been downgraded, with European losses now expected to be $1.1 billion (nearly double the previously forecast $600 million loss).

“The $3.0 billion industry profit forecast has not changed. But almost everything in the equation has. Demand has been better than expected, so far this year. And fuel prices are now lower than previously anticipated, but that’s on the expectation of economic weakness ahead. The Eurozone crisis is standing in the way of improved profitability and we continue to face the prospect of a net profit margin of just 0.5%,” said Tony Tyler, IATA’s Director General and CEO.

“Although airlines face the common challenges of high fuel prices and economic uncertainty, the regional picture is diverse. Carriers in the Americas are seeing improved prospects for 2012. The rest of the world is seeing reduced profitability. For European carriers, the business environment is deteriorating rapidly resulting in sizable losses,” said Tyler.

According to IATA Asia-Pacific carriers are expected to make the largest contribution to industry profits ($2.0 billion), even with a $0.3 billion downgrade from the previous outlook, due to the weak first quarter performance. This is less than half the $4.9 billion profit that the region delivered in 2011 and a quarter of the $8.0 billion achieved in 2010.

"Asian carriers make up about 40% of the global air cargo business and the weakness of this market in 2011 was the reason why there was a large decline in the region’s profits. There has been little sign of the region’s airlines benefiting from the modest upturn in cargo markets this year. The slowdown in the Chinese and Indian economies is another factor in the slow growth environment," the report read.

Nevertheless, the region will benefit from stronger growth in aggregate passenger and cargo traffic this year, as a result of the rebound in demand in the Japan market following the tsunami and earthquake last year, IATA said. Regional demand is expected to grow at 3.9%, above the anticipated 3.3% growth in capacity, providing some protection to airline profits.

As the Eurozone crisis deepens, the revised forecast is based on a weaker European economic environment than previously forecast in March. In this central forecast, we assume that:

The worsening of the Eurozone situation is limited and does not deteriorate into a widespread banking crisis
The US economy continues to recover, but at a mediocre pace
Chinese economic growth slows, but a hard landing is avoided by policy stimulus

World GDP growth, a key driver of airline profitability, is expected to be 2.1% in 2012. That is slightly better than the anticipated 2.0% growth forecast in March. But this is still a slower growth environment than last year, and one in which airlines will struggle to recover cost increases. Historically, the airline industry has fallen into losses (at a global level) when world GDP growth drops below 2.0%.

Oil Prices: Oil prices have slipped below $100/barrel (Brent), as the Eurozone crisis generated fears of recession, having been above $120/barrel earlier this year. The forecast uses the latest consensus estimate for Brent, which has been revised down to $110/barrel (from the $115/barrel used in our March outlook). Even with this price softening, fuel is still expected to account for 33% of airline operating costs, the same as in 2008 when oil prices spiked.

Traffic: Given the actual slower economic growth environment it has been notable that up to April passenger demand, measured in revenue passenger kilometers, continued to expand at an above-trend rate of 6.0%. The strongest markets have been those linked with Asia, Latin America, and the Middle East, where economies have been more robust. However, a weaker second half of the year is expected as deepening problems in Europe damage confidence. Even so, the strength of travel demand in the first part of this year has caused an upward revision to the forecast for air travel growth to 4.8% from 4.2% in the previous forecast. Passenger numbers are expected to reach 2.966 billion this year, up from 2.835 billion in 2011.

Cargo demand has bottomed out, following a sharp fall in 2011, in line with the moderate improvement of business confidence in a number of economies outside Europe. But the upturn is weak and narrowly based, with only Middle Eastern airlines seeing significant volume gains. European economic weakness is expected to limit any further improvement. Overall 47.8 million tonnes of freight are expected to be shipped by air in 2012, basically unchanged from the 47.7 million tonnes carried in 2011.

Capacity: One of the notable features of this business cycle has been the limited expansion of capacity by airlines, and the resulting success in sustaining high levels of asset utilization. In any capital-intensive business this is a key factor behind profitability. On passenger markets, load factors reached record levels in the second quarter, and during the same period, freight load factors began to recover from their lows. Over the rest of the year the forecast anticipates that, although demand is slowing, airlines will add capacity at an even slower pace. Growth in available tonnes kilometers (a combined measure for the passenger and cargo capacity) is forecast to be limited to 3.3% this year, compared with growth in both passenger and cargo traffic of 3.5%. Load factors and aircraft utilization are expected to be kept close to current high levels, limiting the reduction in airline profitability.

Costs and Revenues: Limited capacity growth, high asset utilization and lower oil prices will help to contain cost increases in 2012 to 7.3%, down from a rise of 10.6% in 2011. However, revenue growth is expected to slow more significantly—from 9.3% last year to 5.7% this year. Air travel volume growth has been revised upward, but outside the United States this looks to have been partly achieved at the expense of yield. Both passenger and cargo yields have been revised down from the March forecast.

Profitability: Keeping revenues ahead of costs is the constant challenge in the airline industry. In 2012, operating revenues are expected to reach $631 billion, while operating costs will grow to $623 billion. The resulting operating profit or EBIT of $8.6 billion reflects the narrowness of the gap between revenues and costs. It doesn’t take much to eliminate the 1.4% operating profit margin. Moreover, these earnings are just sufficient to pay for debt interest, taxes, and other financial transactions. We forecast this will leave airline shareholders with a net profit of just $3 billion in 2012.