Musings of an
Aviation Investor  Nov/Dec 2023

A chasm appeared across the Atlantic over the Summer financial quarter in terms of airline financial performance with yield falls suffered in the North American domestic market contrasting to continuing robust fares in Europe as demand held up there for a second year post-Covid.

The drop in domestic US yields was dramatic, at c15%-20% for the LCCs, with unit revenues down so dramatically that they fell below the averages achieved by their European peers, whereas in recent years US airlines had realised generous premiums.

Non-US carriers were exposed to a very high US Dollar in 2022 but were assisted by a 9% YoY dollar weakening, with consequential benefits to margins from lower Dollar-linked costs (ownership, fuel, maintenance, insurance, etc) in 2023.

The outcome was that some European LCCs achieved record profitability, while the main US LCCs fell into losses in a seasonal period when margins are usually high..

Stock prices plummeted for the likes of Spirit Airlines, Southwest and Frontier and despite some recovery in November remain well below yearly highs. In Europe, LCC share prices performed better but remain subdued as investors remain highly wary of the sector due to global political risk considerations in the light of the Israel/Gaza situation.

North American hardships were blamed by some of the carriers on a demand shift from domestic to international. While international travel was indeed up, this should not be viewed as the principal reason for the dramatic yield fall. The likes of Spirit (14% higher capacity YoY) and Frontier (+21% capacity) have huge order books for new aircraft and 2023 saw a big slug of deliveries, many consisting of high-gauge A321s.

The market simply became saturated proving unable to absorb these seats with airlines forced to drop fares to uneconomic levels to push up load factors. Headwinds from seemingly uneconomic labour pay awards, which in the US have been far more generous than in Europe driven by material pilot shortages, have placed US carriers at further disadvantage at a time of falling unit revenues.

Capacity restraint in Europe assisted yields. Failed/restructured airline capacity that was removed (Alitalia, SAS, Norwegian) has not been replaced in full, while other European carriers scheduled seats still remain below pre-Covid levels (Lufthansa Group, TAP). Key players such as easyJet (c8%) and Ryanair (c10%) moderated capacity increases for the Summer YoY, much less than the substantive rises of the US based LCCs. Impressive summer profit margins enabled several European airlines to reinstate and initiate dividends (eg, easyJet, Ryanair, Norwegian), shoring up share prices.

Notwithstanding summer earnings, the topic at the top of investor interest for the last six months and heading into the winter and 2024 is the continued deterioration in Pratt & Whitney Geared Turbofan (GTF) technical woes. Highlighted in the Aviation Investor piece (see Aviation Strategy, May 2023) as an issue to keep a close eye on, the maintenance fixes required to remedy the most recent “powder metal” defects will impact a far higher proportion of the engine population base, with longer times in shops and a considerably larger hit to airline capacity than had otherwise been anticipated.

Two big operators (Wizz, Cebu Pacific) of the A320 family of aircraft powered by the GTF have announced up to a whopping 25% of their fleets will be grounded in 2024 as a result of the enforced engine shop visits.

Perverse implications

So, what does this mean for near-to medium term airline financial performance? It would be easy to conclude a negative outcome because of lower seat availability. However, this could be too simplistic, ignoring the idiosyncrasies of complex air transport interactions. GTF induced capacity constraints (combined with other supply side new aircraft delays) may in fact produce yield support over the coming year assisting revenues across the sector, including a benefit for those airlines not directly exposed to GTF operations.

Those with GTF fleets and grounded aircraft will also have a benefit of (generous) compensation from RTX (P&W owner) receiving a double financial advantage. Perversely, such airlines conceivably could be better off next year than otherwise might have been the case.

Another consequence of the GTF saga although in this case to the slight negative, will be upward momentum of lease rates as carriers seek alternative capacity. Lessors will be sure to take full advantage pushing for longer lease terms for lease extensions and leases of older generation single aisle aircraft such as the A320ceo, a boon for older aircraft that many thought post-pandemic may have witnessed premature retirements well ahead of 25-30 year useful life expectations. Such on top of the headwind of higher interest rates to aircraft ownership costs, the sector will face higher lease rate factors from these excess aircraft demand pressures.