Prospects for the airline industry in the year 2012

Air travel is a multi-billion industry that is one of the most dynamic sectors in the business world. It has always been taken as a direct derivative of business climate around the globe. The profits of commercial airlines define the state of health of economic and business activity in a particular part of the world. The importance of international air travel with regards to commerce cannot be underestimated, since it links business people across the world, and is also a means of shipping cargo.

Battle of profitability
Airlines in the world are struggling hard to win the battle of profitability in the business but the time and climate appears to be against them. Since the last decade, the cost of flying aero planes have literally ‘flown up’ due to rocketing fuel prices, post 9/11 security arrangements, global recession and political turmoil. Financially speaking, the airlines that continued to suffer heavy losses during 2011 are likely to continue landing and taking off at business-slippery runways during their flight operations of 2012.

Industry outlook 2012
IATA has revised its industry outlook for the year 2012 that shows that profitability will be weaker than 2011. “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 billion—the largest since the 2008 financial crisis,” said Tony Tyler, IATA’s Director General and CEO.
The Eurozone crisis puts severe downside risk on the 2012 outlook as illustrated by the recently published 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 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.

Regional performance
In its sectorwise analysis of IATA, the global airline industry is imminently having losses. However, Asia Pacific and Middle East regions will remain profitable although the ratio is likely to fall as compared to 2011. North America is the only region with improved profitability on the cards. African carriers are still expected to break-even.

Europe
European carriers are by far in the most challenging position. Higher passenger taxes and weak home market economies have limited profitability in Europe. The region’s carriers are forecast to generate a collective profit of just $1.0 billion, down from the previously forecast $1.4 billion. Low profitability has been despite European airlines being one of the fastest growing regions in terms of traffic this year.

America
North American carriers are 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.
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 Brazil’s domestic market.

Asia Pacific
Asia Pacific carriers also saw stronger though varied trading conditions. Japan’s 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 China’s 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
Middle East carriers are 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.

Africa
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 region’s airlines have struggled to keep load factors at profitable levels.

Cost cutting
After decades of frenzied competition and staggering losses, domestic airlines have taken a more sober approach to the business of flying, with their first priority simply making money. And so the fancy fuselages and lively paint have gone the way of free meals, pillows and checked bags. The color of choice these days is sensible white. White does not fade as fast in the sun and requires fewer touchups. And without the added flash of color, less paint is needed, making planes lighter and saving fuel.
“There used to be romance in air travel,” said Steve Cone, a marketing expert who helped create the first frequent-flier programs. “The airlines were run by dreamers, creative types and entrepreneurs. “They’ve been replaced by penny-pinchers who don’t think about the real estate outside of the plane.” The staid designs reflect the current state of the industry. Unlike in their heyday in the 1970s, the airlines today have little reason to stand out.

Time of reckoning
Joe Sherkey, an airline industry analyst wrote an article titled ‘Airlines Are Retrenching, and Alternatives Are Slim’. “The coming year will be a time of reckoning in business travel, as airlines reduce service at many airports and prospects fade for practical alternatives to flying, including the long-term promises of high-speed rail. Consider the new realities of air travel. Competition is decreasing, fares are rising and airlines are adjusting routes (and charging extra fees) in ruthless calculations to extract the greatest possible revenue per mile flown”, he wrote in the article.

Capacity reduction strategy
Michael Boyd, the president of the consulting company Boyd Group International, sums up the phenomenon succinctly. “The cost of flying airplanes across the sky has eclipsed the ability to support it at many communities,” he said in a recent forecast. In 2012, he predicts, airlines will accelerate the mothballing of smaller 50-seat jets, the workhorses for connecting service between many midsize airports, and even some big ones. Many airlines will continue shrinking overall capacity and trimming domestic routes in 2012. During the first quarter of the New Year, American will “ground some planes and resize our network,” the company’s chief executive, Thomas W. Horton, recently told employees. In addition, John P. Heimlich, the chief economist of the trade group Airlines for America, said, “Capacity reduction is one of the steps the industry is taking to preserve profitability.”

Key factors of 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.

Pakistan’s national carrier
Amid the no-win situation prevailing in the industry, PIA’s failure to return to profitability is no surprise. National flag carrier of the country, Pakistan International Airlines (PIA), keeps bleeding heavy losses for the current fiscal year. The accumulative losses for the company have reached a staggering Rs. 100 billion as the airlines
keeps sinking towards a point of no return. In a recent meeting of the National Assembly Standing Committee on Defence, it was revealed that the national flag carrier is leaking out heavy losses on continuous basis. The Committee was told that PIA needs Rs 58 billion bailout package which included Rs 45 billion for debt services while Rs 13 billion for immediate liabilities payment. According to sources, the government has concluded that the prevailing crisis in the national carrier is because of ‘mismanagement’ and ‘bad governance’ and not financial shortcomings. The government turned down an Rs20 billion immediate bailout package requested by the management to help it come out of a ‘financial crisis’.
“The government does not have the capacity to provide cash support. We can help them in loan restructuring but they will have to meet performance indicators,” Finance Secretary Dr Waqar Masood Khan said. The most interesting contradiction in PIA as an organization is that it has an average manpower of 450 employees per aero plane as compared to 225 in the other airlines. The recruitment criterion is more political than professional and the employees union is more powerful than their bosses. The precedent of sacking of its top official at the demand of the union is ample evidence that this is a workforce that has a de’facto authority to hire and fire its own boss.