2014 Outlook December 2013

As always at this time of year we ask the question “where are we in the aviation cycle?” As usual we get conflicting answers. IATA recently upgraded its financial forecasts for the industry. The Geneva-based industry organisation is now looking for the global industry to produce net profits of $12bn in 2013 and nearly $20bn in 2014 — raising its forecasts by 10% in the current year and by 20% in the next. These figures still only represent industry-wide net margins of 1.8% and 2.6% respectively.

It is always difficult forecasting global industry profits; because margins are so low and there are so many elements to operations outside the control of individual airlines, any small change in a major or minor forecast assumption can have a huge impact on the net bottom line. In the end it appears that Brian Pearce and his team have slightly tweaked their forecast on the basis of slightly lower fuel price expectations and what they term as improved efficiency in the industry seen in the quarterly results so far this year.

On a regional basis IATA is estimating that North America will produce 45% of industry profits in 2013 and 42% of the total in 2014 with operating margins in the region nearing 6.5% on that year. This compares with profits for the region of $4.2bn in 2010, or 21% of the industry total (albeit at operating margins in that year of 5.7%). IATA implicitly highlights the consolidation in the US and on the Atlantic as one of the main reasons for the improvement in outlook, along with an improved US economic outlook.

For Europe IATA is suggesting that net profits will quadruple to $1.7bn in 2013 and nearly double again in 2014 to $3.2bn (respectively reflecting operating margins of 1.3% and 2.0%). Although here the legacy carriers in particular are hampered by weak home markets in the Eurozone and on its periphery, the performance of the ATI joint ventures on the Atlantic are expected to improve profitability. In the Asia-Pacific region, however, it anticipates a reduction in profitability to $3.2bn in the current year down from $4bn in 2012 before recovering to $4.2bn in 2014.

For the Middle East the forecasts suggest an average growth in net profits of 50% a year between 2012 and 2014 to $1.6bn in that year showing the impact of the increasing power of the three Super-connectors. In Latin America it is forecasting profits of $700m in the current year, up from a loss in 2012 of $200m and profits doubling again next year. This again is no doubt predicated on the consolidation moves in South America following the mergers of Lan Chile and TAM and Avianca/TACA. As for Africa, results around break-even are expected for both years.

Of course one of the principal drivers for the industry is economic performance and at least here some of the risks that had been lurking in the background in the past two years seem to be receding. The latest World Economic Outlook from the IMF shows encouraging development in the US over the next few years with prospects of GDP growth there approaching 3.5% by 2016. Europe while somewhat lacklustre as a whole also seems to be showing a modest return to growth of around 2% in the medium term — although the Eurozone still has its problems and 2013 is likely to have continued in recession.

The two-speed development of the world economy in the last few years — with significantly higher growth in the developing world (and in particular the BRICs) and very lacklustre performance in the developed — appears to show some convergence. China’s economy in particular is seen to be slowing towards an annual 7% rate of growth in the expectation that it will need to foster domestic consumption, while that of India is projected to be able to accelerate towards 7% by 2018. Overall world GDP growth in 2013 is expected to show an increase slightly below 2012’s 3.2% but start to accelerate to over 4% by 2016.

Does it really feel as if we are in recovery towards the next peak in the cycle? The airline industry has shown in the past few years how resiliently it can recover from major shocks to its income base (the economy) and its cost base (fuel) — it just never seems to make much money as an industry overall. IATA once again presented the value gap between weighted average cost of capital and the industry-wide returns showing that airline shareholders continue to pay passengers to fly. Of course it can be dangerous to look at the industry as a whole; there are some airlines that do make money and with the largest carriers in the consolidated US market and the consolidating European market pursuing positive returns above WACC into 2015 it is possible that this upturn could be longer than we currently expect.