Musings of an
Aviation Investor
Nov/Dec 2022
Airline equities have been all over the place in recent years driven by pandemic market dislocations but have recently showed modest signs of stabilisation.
I hope to provide in this column, and on a regular basis, a bit of a synthesis and cut-through of the market with my own unique perspectives of key market drivers at play, with new take-aways and insights to be reported as observed. Hopefully, I will be able to include some interpretations that may not already have been widely written about.
My focus will be towards the lower cost and leisure side of the industry, mostly avoiding the complex financial business models of the US Majors and other international legacy network and flag carriers, which are volatile and tend to be exposed too often to unexpected influences from historic “baggage”. This makes them less “investable” in the view of the writer.
With most Q3 results published, the northern hemisphere summer season was characterised by strong earnings and reasonable profitability (vs the 20/21 pandemic period), driven by record yields and fares as pent-up demand drove traffic levels. However, fuel costs, labour and other inflationary factors caused unit costs to be also driven higher, such that overall margins whilst improved against recent two-year performances, remained weak compared to pre-COVID.
The healthiest results came from those best hedged for fuel (eg Ryanair, Pegasus, IAG, and Jet2) and the worst came from those that elected not to hedge at all (eg Wizz).
Average aircraft utilisation rates remained low across many markets as scheduled capacity increases did not keep pace with existing fleet numbers combined with new aircraft deliveries (Spirit and Frontier in the US provide good examples of sub-optimal utilisation driven by new aircraft deliveries).
OEM deliveries accelerated in 2022 in many cases catching up after initial short-term pandemic deferrals. This “excess” capacity has exacerbated unit cost pressures, but gives scope for positive earnings progress into 2023 with many LCC operators saying that their aircraft utilisation will be returning to the more optimal c12-13 Block Hours (BH) per aircraft per day by Summer 2023. This tail wind will hopefully offset other inflationary pressures which are likely to continue well into next year (labour, ownership driven by higher interest rates, airport, handling, navigation, etc).
On a more negative note, a few carriers reported operating cashflow that was weaker than could otherwise be anticipated (Spirit and Frontier negative, Ryanair and Volaris weak) as the runoff of advance ticket sales worked through working capital. These will remain reliant upon “Christmas” bookings and continued ticket sales momentum going into Summer 2023 in order to avoid debt/equity issuances.
On a geographical perspective, yield improvements vs 2019 were seen to be more moderate in developing markets (eg Mexico, Philippines), which suggests that these markets are more exposed to cost and oil price rises and airlines may find it difficult to pass on increased fuel costs to customers. It would seem obvious that lower comparable per capita income levels in such “less rich” countries would mean air travel price elasticity would be high, but this is dangerous for local airlines faced with frail balance sheets from 2 years of COVID shutdown, high fuel prices as well as in many cases weak exchange rates.
In western developed markets, pent-up demand has reduced price elasticity.
Another key factor to consider going into the new year is that fuel hedge benefits are wearing off and that hedges written for 2023 are at much higher rates, exposing those with the largest positions to significantly higher YoY unit fuel costs, but also competitively exposing them if oil prices fall. Note that Ryanair’s average hedged price for 2023 is $93, which at the time of writing is appreciably higher than the market price. Notwithstanding, such hedges even at higher rates will have been committed at levels to ensure positive operating margin levels, so should only prove to be a competitive disadvantage.
In the near-term into winter 22/23, which is typically the weaker shoulder period, the majority of airlines are indicating a strong outlook (highlighted by Ryanair’s recent profit upgrade), with the yield and demand environment remaining buoyant with some carriers trimming winter capacity out of cautiousness and to help keep pricing high. A final observation for this piece is to note that a long awaited China re-opening and ditching of the PRC’s zero-Covid strategy may also provide a much belated resurgence of fortunes for Far-Eastern and SE Asian airlines.
