CAPA: Airline margins likely to remain solid in 2017/2018 as capacity utilisation improves and low fuel prices stimulate growth

    CAPA’s latest six monthly update of its world airline industry operating margin model increases its forecasts to 2018 relative to the CAPA Jan-2017 update. 2016 was probably a cyclical peak, but the current outlook is for a more sustained period comfortably in excess of previous peak margins of around 6% – whereas previous peaks were usually followed by rapid downturns.

    The most fundamental reason for improved airline industry profitability is better capacity utilisation. Load factor continues to drive upwards to new highs and both daily aircraft utilisation rates and the proportion of the world airline fleet in use have been improving for almost a decade. In addition, lower oil prices have boosted traffic growth and airline industry margins since 2013.

    However, the airline industry cannot afford to be complacent. The International Monetary Fund, in the Jul-2017 update of its World Economic Outlook, noted that its GDP growth forecasts were still below pre-crisis averages and that medium term risks are “skewed to the downside”. CAPA forecasts margins to ease back in 2017 and 2018 due to increases in oil prices and in the rate of fleet growth, although both factors are moderating relative to the Jan-2017 update.

    The airline industry’s profitability is likely to remain cyclical, but if it can restrict the fall in margins in a downswing so that the midpoint of the cycle is higher than in previous decades, this will be a significant achievement.

    Capacity and cost discipline remain key – but low fuel and profitability reduce the ascetic edge

    With fuel costs forecast to start rising again, although not as much as in the previous CAPA forecast, the challenges for the industry remain as highlighted in CAPA’s Jan-2017 update of the model. These challenges are to maintain a tighter grip on its capacity discipline, which is necessary to shore up unit revenue, and to renew efforts to cut non-fuel costs.

    It is a commonly repeated theme across the industry that the intensity of cost reduction measures has been dimmed by the lower fuel prices. While there is little specific evidence of this (other than eg the retention of less fuel efficient aircraft in fleets that would otherwise have been grounded), this is a natural response where an (external) reduction in fuel prices can easily outweigh the fruits of internal cost management.

    Furthermore, the US majors in particular are showing greatly diminished willingness to keep a lid on salaries, even locking in significant increases for future years. These again are arguably inevitable as those airlines emerge from the dark days of bankruptcy and as staff become more reluctant to show restraint when profitability is being trumpeted to Wall Street. Yet these developments do have sobering echoes of earlier periods.

    In other areas where management do have direct control, the cut in forecast fleet growth for 2018 in this Jul-2017 update relative to the Jan-2017 model is encouraging for capacity discipline, although fleet growth is still rising in each year of the forecast.

    CAPA’s Jan-2017 update of the model noted: “The airline industry’s profitability is likely to remain cyclical, but if it can restrict the fall in margins in a downswing so that the midpoint of the cycle is higher than in previous decades, this will be a significant achievement.”

    The August update, with raised margin forecasts, suggests that the airline industry is getting closer to demonstrating this is possible. If CAPA’s margin forecasts are borne out, the world airline industry will have experienced at least four successive years of operating margins in excess of 7%, comfortably above the level previously associated with cyclical peaks.

    While encouraging – and over this period airline stocks have consistently outperformed the wider market as a result – this is certainly no grounds for complacency. Maintaining similar margins beyond 2018 should be the goal of current planning, if the industry is to evolve from being viewed as mere trading stocks into an investment grade business.

    For the full CAPA report, see: CAPA airline profit outlook: margins slipping as cost reduction intensity dims. Discipline needed