Airlines won’t make as much money in 2018 as first predicted, but IATA still sees strong global profitability

As anticipated, the International Air Transport Association (IATA) has revealed an expected -12% reduction in global airline profits for the current calendar year from its previous forecast in Dec-2017. It predicts airlines to achieve a collective net profit of USD33.8 billion (4.1% net margin) in 2018, down from the previous forecast of USD38.4 billion. Despite the decline, caused by rising costs (primarily fuel and labour) and also the upturn in the interest rate cycle, IATA highlights that airlines are still expected to deliver “a solid performance” for the full year.


Summary:

  • International Air Transport Association (IATA) reveals a -12.0% decline in expected annual airline net profits for 2018 due to rising costs and the upturn in the interest rate cycle;
  • The revision will see expected annual net profit levels decline from a previously forecast USD38.4 billion to USD33.8 billion, delivering a 4.1% net margin;
  • Based on these predictions for 2018, the annual return on invested capital is expected to be +8.5% (down from +9% in 2017). This still exceeds the average cost of capital, which has risen to +7.7% (+7.1% in 2017);
  • IATA sees annual profits across all regions of the world with the exception of Africa where losses will still amount to more than USD100 million.

The forecast is in line with the original expectations for 2017 (estimated at USD34.5 billion) but which were subsequently revised up to a record USD38.0 billion. IATA says comparisons to this, however, are severely distorted by special accounting items such as one-off tax credits which boosted 2017 profits. It adds that profits at the operating level, though still high by past standards, have been trending slowly downwards since early 2016, as a result of accelerating costs.

“Solid profitability is holding up in 2018, despite rising costs. The industry’s financial foundations are strong with a nine-year run in the black that began in 2010. And the return on invested capital will exceed the cost of capital for a fourth consecutive year,” says Alexandre de Juniac, IATA’s director general and CEO. “At long last, normal profits are becoming normal for airlines. This enables airlines to fund growth, expand employment, strengthen balance sheets and reward our investors.”

Based on these predictions for 2018, the annual return on invested capital is expected to be +8.5% (down from +9% in 2017). This still exceeds the average cost of capital, which has risen to +7.7% on higher bond yields (+7.1% in 2017), says IATA. This is critical for attracting the substantial capital needed by the industry to expand its fleet and services, it adds.

It is clear that inflation pressures are starting to emerge at this late stage of the economic cycle and airlines are facing significant pressures from rising fuel and labor costs in particular. IATA expects the full-year average cost of Brent Crude to be USD70/barrel. This is up from USD54.9/barrel in 2017 (+27.5%) and its previous 2018 expectation of USD60/barrel. Jet fuel prices are expected to rise to USD84/barrel (+25.9%).

Fuel costs will account for 24.2% of total operating costs (up from a revised 21.4% in 2017), according to the IATA estimates. This will push up overall unit costs, which are forecast to rise +5.2% this year, after a +1.2% increase in 2017; a significant acceleration.

Providing some offset to accelerating costs is what IATA describes as “a strong revenue environment,” as demand from passengers and shippers continues “to expand well above trend,” and pricing has turned positive. Overall revenues are expected to rise to USD834 billion (up +10.7% from USD754 billion in 2017). Unit revenues are expected to rise by +4.2% in 2018, lagging the +5.2% rise in unit costs. “This will squeeze profit margins,” says IATA.

In terms of demand, IATA predicts passenger air travel to expand by +7.0% in 2018. This is slower than the +8.1% growth recorded for 2017 but still faster than the 20-year average (of +5.5%) for the sixth consecutive year. Demand is getting a boost from stronger economic growth and the stimulus from new city-pair direct services, it says.  Meanwhile, capacity is expected to grow by +6.7% (the same pace as in 2017).

The passenger load factor is expected to be 81.7%, up a little on 2017 (81.5%). Total passenger numbers are expected to rise to 4.36 billion (up +6.5% from 4.1 billion in 2017) and passenger yields are expected to grow by +3.2% in 2018 after a -0.8% decline in 2017. “This will be the first year for strengthening yields since 2011, driven upwards by the 5.2% rise in unit costs,” says IATA.

In the freight sector IATA notes demand has benefitted from the largely unexpected acceleration in the growth of the global economy over the past year. As businesses rushed to respond, they turned to air transport to replenish inventory, producing strong air cargo growth in 2017, but that restocking cycle has now come to an end.

IATA predicts cargo demand to grow by +4.0% in 2018, a major drop from the +9.7% growth experienced in 2017, but in line with the 20-year trend growth rate. Total cargo carried is expected to increase to 63.6 million tonnes (from 61.5 million tonnes in 2017). Pharmaceuticals, e-commerce and other premium cargo services are expected to lead growth in 2018, says IATA, and cargo yields are expected to improve by +5.1% (versus +8.1% growth in 2017).

With over 1,900 aircraft expected to be delivered to airlines in 2018 (up from 1,722 in 2017), there will be a boost in capital expenditure, says IATA. Since cash from operations “will be squeezed by accelerating costs and capital spending is rising,” free cash flows are expected to fall to around USD4 billion, according to the airline association. However, key balance sheet ratios, such as net debt adjusted for operating leases/EBITDAR, have improved significantly since 2014 and further debt reduction is expected to be sufficient to stabilise this ratio in 2018, reports IATA.

But, growing uncertainty in the direction by which global affairs will evolve could present risks to the industry’s outlook, says IATA. These include the advancement of political forces pushing a protectionist agenda, uncertainty following the US withdrawal from the Iran nuclear deal, lack of clarity on the impact of Brexit, numerous ongoing trade discussions and continuing geopolitical conflicts.

“Aviation spreads prosperity and enriches the human spirit. That truth lays the foundation for a very important message. The world is better off when borders are open to people and to trade. And our hard work as an industry has primed aviation to be an even stronger catalyst for an ever more inclusive globalisation,” says Mr de Juniac.