2015 Outlook December 2014
As it is the end of this year we are indulging in some speculation about issues which may be important in 2015.
Oil prices continue to tumble with most oil analysts now thinking about a stabilisation at maybe $60/bbl, but as the consensus forecast was around $110/bbl six months ago, and there are forecasters who are estimating a resurgence to $150, there is little reason for confidence about the price outlook. Nevertheless, IATA is becoming more optimistic largely because of fuel trends; global net profits for 2015 are now estimated at $25bn compared to $20bn this year.
Unfortunately, falling fuel prices aren’t always beneficial for airlines; Ryanair, for example, lost out badly in 2008 because of their hedges locked in higher-than-market price.
This time round Ryanair is 90% hedged for FY2015 at $96/bbl while the European network carriers have hedges covering about 70% of the next two quarters need at around the same price. The US carriers have been reducing their hedging positions over the past year, with American having no hedges at all, and so stand to benefit most strongly from the price decline. Some of the Asian carriers — SIA and Cathay Pacific, for instance -- which have a high proportion of their fuel hedged at over $100/bbl might be at risk again.
The graph below right is one way of looking at European airlines — how the stockmarkets rate the value of each passenger carried. IAG, with a very strong long-haul point-to-point traffic supporting its LHR/MAD hub system, is by far the most impressive performer, followed by the leading LCCs, which transport a different type of passenger, short-haul only, point to point. Lufthansa with a heavy reliance on short-to-long-haul connecting passengers, and recent union conflict, lags well behind. Air France/KLM is regarded with financial market distain.
The reason why AF/KLM, despite the financial signals, is not a take-over target for more efficient European carriers seems all too clear — antitrust issues, union power and state control (still 16% owned by the French state, with employees having a further 7%). But what about a break-up of AF and KLM? Throughout the 1980s and 90s BA saw KLM as its natural ally; might it be tempted to try again? At a recent CAPA conference Willie Walsh draw a clear distinction between efficient KLM and undynamic AF. Perhaps reading too much into a throw-away comment, but share price weakness has caused stronger European airlines to consider what might be regarded as unusual investments — BA recently trying to buy into into Aer Lingus, AF itself studying easyJet back in 2009 (according to a recent report in La Tribune).
Cynics have compared Etihad’s investment spree with Swissair’s ill-fated Hunter strategy — buying minority stakes in loss-making, inefficient airlines, justifying the purchases in terms of mutual feed and economies of scale, and seeking elusive synergies from different airline models in unrelated markets. For the record, here is a comparison of Swissair’s 2001 investments and Etihad’s equity purchases up to the end of this year. Despite a 13 year gap the total expenditures were roughly the same — about $2.2bn, both accumulated over a 18 month timeframe (if Swissair’s investments in catering and service companies are also included).
There the similarity may end. Swissair had no financial reserves to help it survive the consequences of September 11, and its bankruptcy brought down the other airlines in its empire. Etihad is backed by the immense oil wealth of Abu Dhabi. But Mubadala — the investment arm of the Abu Dhabi sovereign wealth fund — is certainly not irrational, especially when investments are being appraised in the light of collapsing oil prices. And many (most?) of the Etihad airlines are going to need secondary equity infusions in the next few years, which may be problematic with the EC busying itself with foreign ownership rules.
Private jet usage has closely tracked the economic cycle and in particular the financial market collapse. Now there are clear signs of a sustained recovery. UBS’s regular survey of “Business Jet Interest”, derived from a questionnaire sent to brokers, financiers and manufacturers, measures whether interest in private/business jets is improving or deteriorating. Since 2010 it has been improving according to UBS, with most interest concentrated on large cabin jets. There are major regional differences, however: confidence is strong in Latin America, good in North America and Europe but markedly weakening in Asia.
One of the fall-outs of the global banking crisis has been a certain unease among shareholders about having business jets on corporate balance sheets — they can be, in many cases, justified as genuinely improving top management efficiency when business is good but look too much like an over-indulgence if things go wrong. This is one of the reasons why several PE-backed entities are now proposing vehicles for introducing pure operating leasing to this sector — less than 1% of private jets are on operating lease compared to about 40% in the commercial jet sector.
“Customer-centric” is the new marketing buzzword. And as with many marketing terms, it is difficult to pin down exactly what it means and whether it actually signifies anything new. However, it seems to relate to the use of big data to enable airlines to interact more with their passengers; for example, monitoring the passenger’s travel patterns to remind him or her of important dates, to promote specific trips and to sell related products (not just hire cars and hotels).
The trouble is this trend seems to be driven at present by geeks obsessed with technology who don’t realise how intrusive and patronising their sales suggestions can be. A future trend: clean websites with clear booking processes and no irrelevant pop-ups, advertising and questionnaires. But is that a premium service?
Where is the future demand for freighter aircraft going come from? The European network carriers are following the US majors in downsizing their pure freighter operations or withdrawing completely. The leading Asian cargo operator, EVA, is cutting its fleet by one third. The two giant integrators — FedEx and UPS — are planning on reducing their freighter capacity over the next five years.
The market has been convulsed by the impact of the internet and miniaturised IT. It has lost documents to email; 200 i-pads are equivalent to one old desktop.
Moreover, new technology and non-airline innovators could take the cargo industry in a new direction more rapidly than anticipated. Most noticeably, Amazon is currently accelerating its development of drones designed to fly goods to delivery collection points or directly to homes. Logically, the next step would be unmanned large cargo aircraft, and, although the FAA is finding it challenging coming to terms with the concept of unmanned aircraft, it has designated inspectors to work with Amazon in its research.
Depressed oil prices should imply low inflation and interest rates which is generally good for the operating leasing business, probably extending the upturn in this sector.
However, there is a new factor. Three LCCs — norwegian, AirAsia and Lion Air — between them have orders for over 1,000 narrowbodies (equivalent to approximately half the operating lessors’ total orderbook) and have signalled their intention to lease out aircraft. One of the thoughts behind the move is that leasing companies have historically made a higher profit margin than airlines. Some of the intention may be for inter-group leasing; some may be for efficient use of ordered equipment that is surplus to requirement when delivery approaches.
However, none of them have publicly addressed the logic of the disparity between the airline model and aircraft leasing model. It could be commercial suicide for an airline to pursue a business of leasing aircraft that are surplus to its own requirements to another airline. And then there is the issue of the effect on lease rates and operating lessor profitability if this additional capacity goes in this sector.
|Darwin (Etihad Express)||10|
|Air Outre Mer||80|
|Air Europe Italia||85|
|Aviation service companies||925|