The Economics of Airline Financial Performance and Wider Economic Benefits
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The economics of airline financial performance and wider economic benefits 6th April 2018, Paris Brian Pearce, Chief Economist, IATA www.iata.org/economics Outline • Why is the airline industry suddenly profitable? • After decades of investor capital destruction • Is the change widespread? • Have the underlying economics of the industry changed? • Why is the emergence of protectionism such a threat? • How does air transport bring economic benefit? • Users • Wider economic benefits • Come from the people, goods, capital and ideas we carry between cities • Rather than the jobs required to run the service (with some exceptions) Airlines have suddenly become profitable (for their equity investors) Return on capital invested in airlines and their cost of capital 12.0 Return on capital 10.0 (ROIC) 8.0 6.0 Cost of capital (WACC) % of invested capital % of invested 4.0 2.0 0.0 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Source: IATA Economics using data from McKinsey, The Airlines Analyst, IATA forecasts After decades of investor value destruction Difference between investing in airlines and investing in similar assets elsewhere 30 20 10 0 US$ US$ billion -10 -20 -30 -40 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Source: IATA Economics using data from McKinsey, The Airlines Analyst, IATA forecasts And widespread airline failures European LCCs Iceland Express Air Finland Flying Finn snowflake Norwegian Planet Nordic Thomsonfly airlink flyglobespan Ryanair nexus FlyMe Jet2 AerArann flyforbeans.com Viking GetJet mytravellite Aerlingus Monarch SterlingCimber jetmagic Kiss duo easyJet Go Maersk Air flybe Debonair buzz Transavia airberlin SkyExpress Air Wales Hamburg airlines EUjet Basiqair VBIRD centralwings Eurowings VirginExpress Air polonia HLX flywest Smart Wings flyeco LTU Germania dba Skyeurope WIZZ Aeris Helvetic flybaboo AirclickairTurquoise Volotea air lib express vueling myair Clickair Volareweb Pegasus fly gibraltar Atlas-blue WindJet Failed Survived Source: HSBC report – early 2014 situation. Since then Monarch and airberlin have failed But improvement has been very uneven across the industry Return on invested capital 20% 18% 16% North America 14% Europe 12% 10% Industry average Latin America 8% Asia Pacific 6% Weighted Average Middle East Cost of Capital 4% 2% EBIT adjusted for operating leases as % invested capital leases as % invested operating for EBIT adjusted 0% 2010 2011 2012 2013 2014 2015 2016 Source: IATA Economics using data from IATA and The Airline Analyst Balance sheet remain highly leveraged in some regions Adjusted net debt/EBITDAR 8 7 Latin America 6 Middle East 5 Asia Pacific 4 Industry average Europe 3 North America 2 Investment grade Debt adjusted for operating leases/EBITDAR operating for Debt adjusted 1 0 2010 2011 2012 2013 2014 2015 2016 Source: IATA Economics using data from The Airline Analyst There has always been a paradox at the heart of air transport 2015-18: 9.7% Source: McKinsey presentation to IATA Technology continues to cut costs dramatically Source: Lee Typically airlines pass all gains through to consumers Unit cost and the price of air transport 4.0 7.0 Boeing 707 3.5 6.0 3.0 5.0 1973 2.5 oil crisis 4.0 2.0 US deregulation 3.0 1.5 EU deregulation 2.0 1.0 Unit cost (US$/ATK) US$ in 2013 prices per tonne kilometer US$ in 2013 prices to fly a tonne kilometer 0.5 1.0 Price (US$/RTK) 0.0 - 1950 1960 1970 1980 1990 2000 2010 Source: IATA Economics using data from ICAO and IATA Statistics In fact prices have fallen further than costs forcing up breakeven loads Breakeven and actual load factors 70% Load factor achieved 65% 60% Breakeven load factor +15% % ATKs % 55% points 50% 45% 1970 1975 1980 1985 1990 1995 2000 2005 2010 Source: IATA Economics using data from ICAO and IATA Statistics Have industry economics changed or is it just low fuel costs? Airline industry ROIC and jet fuel prices 12.0 160 Return on capital (ROIC) 140 10.0 120 8.0 100 6.0 80 60 4.0 Jet fuel price, Jet US$/barrel ROIC, % of invested capital % of invested ROIC, Jet fuel price 40 2.0 20 0.0 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Source: IATA Economics using data from McKinsey, Platts and own forecasts The underlying economics of air transport • Perishable • Fixed costs high • Barriers to entry low • Competitive advantages hard to defend • Aircraft are a platform to serve many markets • Economies of scale in aircraft size but business travelers want frequency and flexibility • Few scale economies in fleet size but economies of density in networks OUTCOME: • Prices pushed down towards variable costs, • But ways need to be found to cover fixed costs: • Differential pricing, sequential use of coupons, non-refundable tickets….and now ancillaries • Network density economies through merger prevented by bilateral and O&C regulation barriers: • Leading to code shares, alliances and now ATI JVs and equity partnerships on international markets Improvement in performance pre-dates fall in fuel costs Breakeven and achieved weight load factors 71 Load factor achieved 69 67 65 63 % ATKs 61 Breakeven load factor 59 57 55 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Source: IATA Economics using data from ICAO, IATA Statistics, IATA forecasts Airlines are sweating assets as well as improving margins Components of return on capital 10 1.5 Operating margin 8 1.4 6 Capital productivity 1.3 4 1.2 2 1.1 0 1.0 Operating margin, % revenue margin, Operating -2 -4 0.9 Capital productivity, revenue/invested US$ capital, revenue/invested productivity, Capital -6 0.8 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Source: IATA Economics using data from ICAO, McKinsey, The Airline Analyst, IATA forecasts Wide variety of successful business models 2015 ROIC = adjusted EBIT/revenue * revenue/invested capital 0.45 0.40 Jazeera Increasing return Spring 0.35 Ryanair on capital (ROIC) 0.30 Mesa Spirit Allegiant 0.25 Volaris Alaska PFIZER Hawaiian Southwest 0.20 JetBlue Air China AMR JAL Delta 0.15 United Easyjet Aeromexico Air Canada 0.10 PIA IAG Qantas Cathay SIA ANA Lufthansa LATAM 0.05 Comair GOL AF-KLM WALMART 0.00 Korean -0.05 EBIT margin , adjusted EBIT/revenue , adjusted EBIT margin -0.10 Thai 0.00 0.50 1.00 1.50 2.00 2.50 Capital productivity ($ revenue per $ invested capital) Source: IATA using data from The Airline Analyst IATA Economics www.iata.org/economics Ancillaries are changing the nature of the airline product Airline revenues, tickets, cargo and ancillaries 700 120 Passenger ticket revenue (left 600 100 500 Ancillary revenue 80 (right scale) 400 60 BillionUS$ 300 BillionUS$ Cargo revenue 40 200 (right scale) 20 100 0 0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Source: IATA Economics using data from ICAO, The Airline Analyst, PaxIS, IdeaWorks Consolidation important but not simply because of size Return on invested capital versus invested capital, 2016 45 American 40 Emirates (2015) 35 United 30 Qatar Air China Delta 25 (2015) China Southern China Eastern 20 Singapore Lufthansa Cathay Southwest 15 AF-KLM Fedex Korean TurkishLATAM IAG 10 Ryanair Invested capital, $ billion $ capital, Invested 5 Alaska Allegiant Icelandic - -10% 0% 10% 20% 30% 40% 50% Return on invested capital, % Source: IATA Economics using data from IATA and The Airline Analyst JVs doing better job than code shares/alliances to get density economies Source: Lufthansa Protectionism (or the new ‘localism’) is a major threat Share of goods trade (exports+imports) in global GDP 22 20 Global financial 18 crisis 16 % of GDP 14 12 10 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Source: IATA Economics using data from Netherlands CPB Benefits to consumers (and economy) arise from cheap city connections Unique city-pairs and real transport costs 22000 3.50 20000 Unique city pairs 18000 3.00 16000 pairs - 2.50 14000 12000 2.00 10000 8000 1.50 US$/RTK in 2014US$ Real cost of air transport Number Number of unique city 6000 4000 1.00 2000 0 0.50 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Source: IATA Economics using data from ICAO, Boeing, OAG, SRS Analyser Wider economic benefits • Often measured by the jobs and GVA in the supply chain, through I-O models • Economic footprint is a useful description • But it measures cost not benefit • Do labor productivity gains really mean lower wider economic benefits? • Economic benefits generated by connecting cities at lower cost • Air transport network is an infrastructure asset, a bridge between cities • Boosting the productive capacity of an economy • Generating flows of people, goods, capital, ideas, competitive pressure • Raising productivity through agglomeration, gains from trade • Higher GDP from the supply-side, in economies close to full capacity • Demand-side/spending flows do matter where economies/regions under-developed • More research and evidence required! .