Airline margins under increasing pressure, says IATA

The financial health of the global air transport industry is often described as cyclical in nature. Global highs, historically, are as common as global lows.


Summary:

  • Airlines have recently executed capacity and cost discipline, paired with new avenues of revenue, to reach new levels of profitability.
  • IATA, however, expects margins to be coming under increased pressure.
  • Rising fuel prices cited as the main cause of lower yields.

In the last decade, airlines have simply become much better at managing profitability. Much of this is an onset effect of the Global Financial Crisis in 2008 – major airlines exited global markets and those that remained were forced to grow with capacity and cost discipline.

As a result of this cost discipline and airlines finding new ways to generate revenue, such as through better deployment of ancillary offers, more beneficial partnerships and immersive loyalty programmes, the past three years have emerged as quite special for the airline industry on a profitability front. And although the industry is largely expected to remain in the black in 2018, the International Air Transport Association (IATA) argues that airline financials are coming under increased pressure.

GRAPH – 
Source: IATA

IATA’s most recent Economics Chart shows the development of industry earnings before interest and tax (EBIT) margins, on a quarterly basis since the start of 2011. The red line shows the figures taken directly from airline financial statements, and the blue line includes an IATA adjustment for regular seasonal fluctuations.

In seasonally adjusted terms, the EBIT margin peaked in early 2016 and after mildly retracting in 2Q16, was relatively stable for almost two years.

Over this period, a number of important input costs assumed a steady upwards trajectory. Oil prices are the most obvious – being up by close to 60% over the past year alone – paired with heightened labour costs in various key markets. The rise in costs means base fares are drawing lower yields, with airlines being hesitant to be the first to raise fares and risk losing passengers to their competitors.

Against the backdrop of declining base fare yields, airlines have responded to the upturn in unit costs in a number of ways, including (as noted before) developing additional sources of revenue. The other key response was a rise in passenger load factor during the peak northern summer 2018 season – at 85.2% in Jul-2018, load factors were actually recorded at the highest average level ever (in IATA’s 28 years of available data).

Through these market responses, at first airlines were able to match the rise in unit costs by gaining unit revenues, keeping the margin broadly steady – though at an elevated level.

But IATA warns that this has “changed considerably” in 2Q2018. A sizeable deterioration is evident in the latest industry EBIT margin data, with the figure now at around 7%. The increase in unit costs is now, again, outpacing that of unit revenues, delivering a lower margin outcome.

Looking ahead, IATA expects that increasing late-cycle inflation pressures in the wider economic environment mean that dealing with rising costs will remain a major challenge for airlines and the broader air transport industry. The question is: if oil prices were to suddenly level off, would the industry actually be positioned to leverage an even higher level of profitability from its market response?

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