The Rocky Road
to Recovery Mar/Apr 2023

From the start of the jet age in the 1950s to the end of 2019 the commercial airline industry had generated around $200bn total net profits. In the three years since the start of the Covid-19 pandemic the industry is estimated to have lost $186bn. And those losses have in simplistic terms been covered by debts: IATA estimates that the world’s airlines' total debt burden has risen by over $220bn, or 50%, since the beginning of 2020 to give an industry total of $650bn.

But the industry is on the road to recovery. Airline traffic in domestic, US and European markets is gradually approaching, if not in some cases exceeding pre-pandemic levels. Sustained travel restrictions in Asia, combined with China’s zero-covid policy had restrained the ability to fly in that area of the world through most of 2022. That policy and those barriers have now gone, leading to a rapid recovery particularly in the Chinese domestic market: the latest figures from IATA for February show domestic traffic in the PRC only 8% below pre-pandemic levels. International traffic as expected has further to go: overall in February global RPKs were still 22% below those in the same month of 2019. But this masks a stronger performance in Western markets: IATA’s figures show demand on North- and Mid-Atlantic routes almost back to “normal”.

Recent results from the European and US majors have highlighted a distinct level of “pent-up demand” fuelling a willingness for travellers to pay inflated ticket prices for the opportunity of taking a flight denied for the previous few years. Pricing in the industry is generally a reflection of the demand/capacity environment, so with capacity below normal levels and strong demand, it is not surprising to see ticket prices surge. And capacity is being constrained: supply-chain issues at the OEMs delaying new deliveries; at the MRO bases delaying the return of stored aircraft; at the engine manufacturers restricting the provision of spares.

Unit revenues have been rising at eye-watering levels: up by 20-25% compared with the same period in 2019.

There has also been a very strong increase in operating unit costs, partly because of the reduced capacity, but also from very high fuel prices — for the major network players on either side of the Atlantic Q4 2022 unit costs were 15-20% higher than they had been in the same period in 2019 (slightly higher for the Europeans because of US dollar strength), half of that increase a result of fuel.

High ticket prices seem here to stay but will be absorbed by demand. Ryanair CEO Michael O’Leary has predicted that an expected 15% rise in airfares this summer (following a 12% increase last year) will have no impact on bookings.

In the Q4 figures the three US majors all reported record levels of quarterly revenues, 14-17% higher than the same period of 2019, and strong improvements in underlying operating profits compared with the pre-pandemic period. This trend has continued into the first quarter of 2023. (Southwest’s figures are distorted by an operational burnout in December storms). In Europe, the results were not so marked, partly because of a greater exposure to international flying: but operating profits were above 2019 levels for all the large carriers save IAG — and Ryanair uniquely among this group had higher capacity and traffic than in 2019.

It is rare to see airlines being able to fully recoup strong increases in fuel costs: higher ticket prices would normally have a negative impact on demand. Does this undermine the traditional view of price elasticity in the industry?

Whatever the validity of using “pent-up demand” as an economic term, this is the first (and extended) traffic downturn in the industry caused not by economic weakness, but the imposition of constraints on the freedom to travel (the Chernobyl disaster, eruption of Eyjafjallajökull, the SARS and MERS crises all pale into insignificance).

In 2019 the airline industry carried nearly 4.5bn passengers. Over the three years since the start of the crisis there may have been some 7bn passenger journeys that just did not take place because of health restrictions.

Business travel altered

One of the fallouts from the pandemic is a change in the nature of business and corporate travel. The significant rise in remote working and availability of technology such as Zoom to facilitate online meetings has been cited as a reason why business travel per se will never return to pre-pandemic levels. An increased emphasis on carbon footprint and ESG credentials is also providing an excuse for corporate unwillingness to book travel.

In Europe, Lufthansa notes that business traffic volumes are still only 60% of the level they had been pre-pandemic (although revenues only 30% down). It and the other network carriers have been highlighting the success of premium leisure. (Ryanair, needless to say doesn’t bother working out why people travel: it flies the planes and takes the money.)

But Delta and American in their latest results' calls noted that there has been a shift towards “blended” business and leisure travel away from traditional corporate sales channels. United also notes a shift in seasonality.

Corporate customers are apparently increasingly allowing personnel to book travel themselves, and encouraging them to “tack-on” leisure and weekend breaks. And this is probably being paid for through a branded credit card linked to frequent flyer programmes (and earning miles that can be spent on “free” flights): in the first quarter Delta’s remuneration from Amex reached a record $1.7bn, 38% higher year over year, from co-brand acquisitions and spend growth. (Delta expects full year 2023 benefits from its Amex relationship of $6.5bn, more than 50% higher than it had been in 2019). At the same time Delta mentioned that while SME sales might have recovered, sales through corporate channels were still 15% below 2019 levels.

This trend goes in hand with a continuing shift in distribution channels along with the rollout of NDC (New Distribution Capability). An IATA/McKinsey report looking at the impact of the pandemic on the aviation value chain (Dec 2022) points out that the proportion of bookings made online direct to the supplier in 2021 made up 48% of the total, with online travel agents accounting for another 18% — more than double the ratio it had been ten years earlier.

Does this undermine the traditional expectations of income elasticity when looking at future developments in the industry?

A return to long term trend?

In past cycles in the industry, traffic levels have in general bounced back to trend within five years of the downturn. Will it happen this time round?

In the graphs we show the traffic trends on select traffic routes since 2005 (in RPK terms). We have extrapolated a line from the level seen in 2019, before the pandemic obliterated expectations, using the 2019 forecast (from Boeing) of the medium term growth rates to project the levels of traffic we might then have expected to see by 2025.

We then add a line showing the annual rate of growth needed from 2023 in order to meet that long term trend in 2025.

The implied compound annual growth rates within North America and within Europe of 10-12% for the next two years appear plausible, as does the 17% for the North Atlantic. China’s domestic demand, by all accounts, could well exceed the 28% growth needed to bring 2023 levels of traffic above 2019 levels: India needs only an 18% growth this year to do the same. Chinese international travel, decimated by the zero-covid policy, has a very steep hill to climb: a recent survey by Dragon Trail Int’l suggests that only 15% of travellers had made plans to travel abroad in 2023, and that 30% had no intention to do so. (Only 40% of respondents had travelled abroad before).

A concern may be that to achieve a return to trend requires a solution to supply-chain issues. In the meantime the restraint on capacity, with continuing strength of demand, should provide the opportunity for airlines to generate the cash and profits to pay down the debt and the cost of the pandemic.

As Michael O’Leary, quoted in the Financial Times, said: “I would hope we are in for two or three years of reasonably stable capacity, reasonably stable pricing. But then fuel could mess it up. Or an Icelandic volcano — or war and pestilence somewhere”.