Dark Clouds ahead?
As 2016 comes to an end, we reflect on the healthy profits airlines and airport around the world have been experiencing. How long can this go on?
Airlines are experiencing a decade long gold rush. Following 9/11, airlines around the world took the opportunity to restructure costs, save for some large European airline groups. Costs crept up again leading up to the 2008 global financial crisis, which provided yet another opportunity for airlines to lower costs again. Many did, some didn't. The airline sector has been enjoying increasing profitability for eight years. Interestingly, profits in 2016 have fallen, highlighting the effect costs are having on airlines. As well as a sense of some softening in yields.
Historical performance would suggest the industry is due for a downturn as it does about once every 10 years. Our hypothesis is that the softening of yields is due to dramatic increases in capacity in certain key markets, namely, for example, North America to Oceania, Europe to Oceania and China to Oceania. This has led to far too much capacity connecting, key European markets with Sydney, Melbourne and Brisbane, to name a few. This is in addition to key traffic flows from North Asia to Australia and New Zealand moving to nonstops offered by airlines from mainland China and the Taiwanese territory. Thus causing a shift in demand between Gulf and Asian hubs. Increasing capacity between North America and the Middle East and Turkey has allowed passengers to fly more efficiently between North America and the Indian Subcontinent, thus bypassing European hubs which rely on these flows. These changing flows are causing a change in the air.
An impending downturn
Falling yields, over capacity, etc, can only mean the industry should prepare for a reduction in profits in the coming years. Many airlines seem blind to these topics because they have introduced more efficient aircraft such as the 787, the A350, A321 etc. These aircraft efficiencies are hiding the increase in other costs and drop in yields.
Aviado Partners predicts
2016 will end slightly lower than 2015
Airlines will see lower real profits from 2017 onwards first through an increase in fuel prices and labour costs, and then through continuing lower yields.
Fuel prices will remain volatile. As airlines begin to control capacity to react to these trends, perhaps combined with continued geopolitical uncertainty, fuel prices will once again fall, thereby, continuing to hide the inefficiencies of overcapacity, excessive capex and creeping costs.
Airlines in Europe will be the first to go insolvent. Perhaps first with a Nordic carrier as well as one Central European carrier and an Eastern Europe carrier.
Rationalization in the UK and on the continent is needed. The large airline groups need to get their houses in order and stop any further acquisitions. These airline groups remain uncompetitive compared to North American, Gulf and Asian carriers. British Airways is the single large EU carrier which can overcome these problems without correction due to the power of demand to/from the UK. The others cannot continue with existing cost bases, inefficient aircraft, and overcapacity.