Airline margins are descending – but will it be a hard or soft landing?

In its latest six monthly update of its world airline industry operating margin model, CAPA – Centre for Aviation has lowered its forecasts for 2019 and 2020. In the recently released Jul-2019 update, the trusted source of market intelligence for the aviation and travel industry reiterates the view that the industry has been in a cyclical downturn since a 2016 margin peak.

The cuts are quite notable. The 2019 margin is lowered from 6.9% to 5.5% due to lower GDP growth (cut from 3.0% to 2.7%), driving lower RPK growth (cut from 6.0% to 4.9%), and a very slightly higher Brent crude oil price forecast (raised from USD67.2 to USD67.7), only partially offset by lower fleet growth (cut from 4.6% to 3.1%).

The CAPA forecast of 2020 margin is slightly more optimistic, lowered from 6.6% to 5.9%, due to lower RPK growth (cut from 5.8% to 5.2%), and higher fleet growth (increase from 4.3% to 6.2%), only partially offset by a lower Brent crude oil price forecast (cut from USD70.0 to USD67.8).

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This represents CAPA’s third successive six monthly update of the model with cuts to forecast margins, following immediately after a period of four successive upgrades. It also includes a lowering of 2018 operating margins from 7.1% to 5.8%, in line with IATA’s most recent figure published in Jun-2019.

On a positive, CAPA says the oil price outlook appears to have stabilised relative to the 2014-2018 period, although it says this is always subject to macroeconomic and geopolitical caveats. This means that the balance of supply and demand is the key driver of airline margins.

Slowing global economic growth and softening passenger traffic growth (plus negative air cargo traffic growth) indicate weaker demand growth. Supply is indicated by fleet growth in the CAPA model, and this is complicated currently by the grounding of the 737MAX. The underlying trend in fleet growth appears to be upward, although not yet faster than demand growth.

CAPA says that in spite of the weaker outlook for airline profitability, operating margin is forecast to remain only slightly below previous cyclical peak levels of the order of 6% and to increase modestly in 2020 versus 2019. However, it warns, macroeconomic and geopolitical risks could precipitate a steeper decline.

The latest forecast shows suggests the airline industry is still cyclical, but CAPA says it appears to have achieved structural improvement. “Softening global GDP growth and slowing RPK growth appear to confirm that the recent cyclical peak in the world airline industry operating margin was just that – another cyclical peak. The industry remains cyclical and is currently in the downswing of the cycle,” it says.

Airlines have become better at some important things, it says, like capacity and cost discipline and are just starting to enhance their revenue skills. The current profit margin downturn began after the cyclical peak in 2016, but if CAPA’s current profit model is borne out, airline industry operating margins will remain above 5% until at least 2020, in contrast with previous cycles.

“This suggests that the industry’s economics have undergone a structural improvement,” says CAPA, but it adds that it will take “a full scale economic downturn” to reveal whether there has been a truly sustainable change in airline profitability, or “whether recent years have just been a kind of super cycle”.