Eurozone Crisis Biggest Risk to Profits : Regional Differences Widen

The Eurozone crisis puts severe downside risk on the 2012 outlook as illustrated by the recently published OECD economic outlook. In a worst case scenario, should the Eurozone crisis evolve into a full-blown banking crises and European recession, IATA estimates that the global aviation industry could suffer losses exceeding $8 billion in 2012.

The biggest risk facing airline profitability over the next year is the economic turmoil that would result from a failure of governments to resolve the Eurozone sovereign debt crisis. Such an outcome could lead to losses of over $8 billionthe largest since the 2008 financial crisis, said Tony Tyler, IATAs Director General and CEO.

2011

The global forecast for 2011 is unchanged at $6.9 billion. But regional differences have widened, reflecting the very different economic environments facing airlines in different parts of the world. And the overall margin of 1.2% tells you just how difficult the battle for profitability in this business is, said Tyler.

Highlights of regional performance:

• European carriers are by far in the most challenging position. Higher passenger taxes and weak home market economies have limited profitability in Europe. The regions carriers are forecast to generate a collective profit of just $1.0 billion, down from the previously forecast $1.4 billion, and an EBIT margin of 1.2%. Low profitability has been despite European airlines being one of the fastest growing regions in terms of traffic this year. Yields have suffered and the base of strong demand grows more fragile as the sovereign debt crisis escalates.
• North American carriersare in a much more benign environment. They have seen yield and load factor improvements as a result of tight capacity management, which has improved profitability to $2.0 billion (up from the previously forecast $1.5 billion). The US economy has also grown at a faster pace than Europe. This gives the region the strongest EBIT margin of 3.2%. None-the-less, the bankruptcy filing of American Airlines indicates that the region faces intense competitive challenges as well.
• Asia-Pacific carriersalso saw stronger though varied trading conditions. Japans domestic market still has not fully recovered from the March earthquake and tsunami, and load factors remain under pressure. By contrast airlines have improved load factors and profitability on Chinas expanding domestic market. We have upgraded our forecast for the region by $800 million to a $3.3 billion profit. This is the largest absolute profit among the regions.
• Middle East carriersare expected to see profits of $400 million (down from the previously forecast $800 million) as high fuel costs squeezed profit margins on the more price sensitive long-haul traffic connecting over Middle Eastern hubs.
• In a similar pattern Latin American profits will see a downgrade to $200 million (from the previously forecast $600 million). Performance has been mixed across the region with much of the downgrade due to the impact of intense competition and falling load factors on Brazils domestic market.
• African carriers are still expected to break-even. New trade lanes with Asia are developing and markets within the continent are reflecting the improvement in economic development in many African economies. However, competition has been fierce and the regions airlines have struggled to keep load factors at profitable levels.

At the global level, passenger demand is expected to expand by 6.1% which is stronger than the 5.9% forecast in September. Air travel growth has persisted at a stronger pace than we had expected. This travel strength, along with tight capacity management, particularly in North America, has kept load factors high and is supporting a 4.0% increase in yields. This has helped a modest increase in forecast revenues, which we expect to total $596 billion this year.

This slightly stronger-than-expected passenger performance is offsetting (1) worse-than-expected cargo performance and (2) somewhat higher-than-anticipated oil prices. At an average oil price of $112 per barrel, the industrys 2011 fuel bill is expected to be $178 billion (up $2 billion from previous expectations). A downward trend in cargo since mid-year means that cargo likely will finish the year with a 0.5% contraction in volumes and flat yields.

2012Central Forecast

Even if government intervention averts a banking crisis it is unlikely that Europe will avoid a brief recession. Business and consumer confidence has already fallen too far. Global GDP growth forecasts for 2012 have been revised downwards to 2.1%. Historically the airline industry has seen profit turn into loss whenever global GDP growth falls below 2%. This is driving the downgrade in the 2012 outlook.

Key variables driving this downgrade:

• Demand: Passenger demand is expected to grow by 4.0% (down from previously forecast 4.6%), while cargo is expected to show flat growth (down from the previously forecast 4.2% expansion).
• Yields: Passenger and cargo yields are expected to remain flat in 2012. While this is unchanged for cargo, passenger yields were previously forecast to grow by 1.7%.
• Fuel: Fuel costs are relatively unchanged from the previous forecast at $198 billion. That is based on oil at $99 per barrel (against a previous forecast of $100 per barrel).
• Revenues and Costs: Industry revenues are expected to grow by 3.7% to $618 billion. This will be outstripped by cost increases of 4.5% to $609 billion.

All regions are expected to show profit deterioration from 2011. However, the regional differences in 2012 are stark:

• European carriers are expected to fall into losses of $600 million, hit by the weakness of their home market economies and further increases in passenger taxes.
• North American carriers are expected to generate profits of $1.7 billion, maintaining the strongest EBIT margin of 2.4%, as limited capacity growth is providing some protection against the downward pressure on profits.
• Asia-Pacific carriers are expected to deliver the largest absolute profit at $2.1 billion. This is weaker than 2011s performance but the deterioration is limited by high load factors on markets such as China, where the increases in demand are structural and to some extent shielded from the cycle.
• Middle East carriers are expected to post a $300 million profit, less than half the previously forecast $700 million profit, as long-haul market conditions deteriorate, in particular those linked to the weak European economies.
• Latin American carriers will see profits decline to $100 milliona $400 million negative swing from the previous forecast, partly a carry-over from the recent weakness of profitability in the large Brazil market.
• African carriers will fall into losses of $100 million, unchanged from the previous forecast. Economies and air transport markets continue to grow in the region, but load factors are not expected to be strong enough to offset the impact of weaker yields on profitability.

Even our best case scenario for 2012 is for a net margin of just 0.6% on revenues of $618 billion. But the industry is really moving at two speeds with highly taxed European carriers headed into the red, Tyler said.

2012The Threat of a Banking Crisis

The OECDs last economic outlook carried a risk assessment on the European sovereign debt crisis, which caused IATA to develop a second scenario for 2012 taking into account the possibility of the Eurozone crisis deteriorating into a renewed banking crisis. Based on the OECDs view that this scenario would cut global GDP growth to 0.8%, IATA estimates that this has the potential to cause global industry losses of $8.3 billion.

In this scenario, all regions would fall into losses. Europe would be expected to post the deepest losses at $4.4 billion, followed by North America at $1.8 billion and Asia-Pacific at $1.1 billion. The Middle East and Latin America would both be expected to post $400 million losses, while Africa would be $200 million in the red.

Tyler said, This admittedly worst-casebut by no means unimaginablescenario should serve as a wake-up call to governments around the world. In a good year, the airline industry does not cover its cost of capital, much less in a bad one. But in a bad year, aviations ability to deliver connectivity and keep the heart of the global economy pumping becomes even more vital to initiating a recovery. Government policies need to recognize aviations vital contribution to the health of the economy.

This scenario is based on global GDP growth falling to 0.8% in 2012 driven by Europe descending into deep recession. Historically, GDP growth rates below 2.0% have resulted in the airline industry producing a net global loss. In this scenario, airlines would see growth in passenger demand grind to a halt and a 4.7% contraction in cargo markets. Both passenger and cargo yields would fall by 1.5%.

Some relief in the fuel price would be expected. Based on oil at $85 per barrel, the fuel bill would be $183 billion and consume 31% of costs. However, overall expenses would be expected to grow by 1.9% (compared to 2011) to $592 billion. Revenues would see a fall of 1.3% (compared to 2011) to $589 billion. The net result would be an $8.3 billion loss and net margin of minus 1.4%.