2012 FORECAST

Call it a year of contradictions. The global airline industry went on a spending spree in 2011 and sealed deals for new aircraft that broke all records.Yet it was also a year where economies faltered and oil prices soared, with their inevitable impact on airline profits. And as 2011 drew to a close, American Airlines, the only legacy US carrier never to declare bankruptcy, filed for Chapter 11.

Our 2012 forecast package tracks the highs and lows the industry has weathered this past year and also illustrates the continuing contradictions that will likely be the hallmark of 2012. Manufacturers are bullish about continued demand for new, fuel-efficient aircraft and there is optimism across much of Asia and Latin America where new middle-class markets are driving demand for air travel. But the uncertainty surrounding Europe’s economy and the ultimate outcome of the euro crisis is a concern not just for the European carriers but to all those carriers for which Europe remains an important market. Similarly, the sluggish US economy will likely have a global impact, albeit at a less severe level. US carriers, for the most part, are earning their profitability the hard way through strict capacity discipline. Cargo carriers, meanwhile, are showing signs of stress and are once again likely to prove to be the bellweather of things to come; tough economies typically hit the freight industry first. And even some of the traditional “hotspot” areas, such as the Middle East and China, are anticipating slower growth this year.

Reflecting this uncertainty, IATA has downgraded its 2012 forecast and highlighted the widening fortunes of those carriers in growing economies and those where the economic outlook remains bleak.

“Even our best case scenario for 2012 is for a net margin of just 0.6% on revenues of $618 billion. But the industry is really moving at two speeds with highly taxed European carriers headed into the red,” IATA DG and CEO Tony Tyler said at the organization’s forecast briefing in Geneva in December.

The regional differences expected in 2012 are stark, according to IATA forecasters:

European carriers are expected to fall into losses of $600 million, hit by the weakness of their home market economies and further increases in passenger taxes.

North American carriers are expected to generate profits of $1.7 billion, maintaining the strongest EBIT margin of 2.4%, as limited capacity growth is providing some protection against the downward pressure on profits.

Asia-Pacific carriers are expected to deliver the largest absolute profit at $2.1 billion. This is weaker than 2011’s performance but the deterioration is limited by high load factors on markets such as China, where the increases in demand are structural and to some extent shielded from the cycle.  

Middle East carriers are expected to post a $300 million profit, less than half the previously forecast $700 million profit, as long-haul market conditions deteriorate, in particular those linked to the weak European economies.

Latin American carriers will see profits decline to $100 million—a $400 million negative swing from the previous forecast, partly a carry-over from the recent weakness of profitability in the large Brazil market.

African carriers will fall into losses of $100 million, unchanged from the previous forecast.  Economies and air transport markets continue to grow in the region, but load factors are not expected to be strong enough to offset the impact of weaker yields on profitability.

Reflecting this uncertainty, IATA announced revisions to its industry outlook in December. For 2011, profitability remains weak but unchanged at $6.9 billion for a net margin of 1.2%. Looking ahead to 2012, however, IATA downgraded its central forecast for airline profits from $4.9 billion to $3.5 billion for a net margin of 0.6%.

At the top of IATA’s uncertainty factor is the eurozone crisis, which it says puts severe downside risk on the 2012 outlook. In a worst case scenario—a full-blown banking crises and European recession, IATA estimates that the global aviation industry could suffer losses exceeding $8 billion in 2012.

2011 Expectations

 “The global forecast for 2011 is unchanged at $6.9 billion. But regional differences have widened, reflecting the very different economic environments facing airlines in different parts of the world. And the overall margin of 1.2% tells you just how difficult the battle for profitability in this business is,” said Tony Tyler.

At the global level, IATA sees passenger demand expanding by 6.1%, stronger than the 5.9% forecast in September. Air travel growth has persisted at a stronger pace than we had expected. “This travel strength, along with tight capacity management, particularly in North America, has kept load factors high and is supporting a 4.0% increase in yields. This has helped a modest increase in forecast revenues, which we expect to total $596 billion [for 2011],”IATA said.

The slightly stronger-than-expected passenger performance helped offset worse-than-expected cargo performance and higher-than-anticipated oil prices. “At an average oil price of $112 per barrel, the industry’s 2011 fuel bill is expected to be $178 billion (up $2 billion from previous expectations). A downward trend in cargo since mid-year means that cargo likely will finish the year with a 0.5% contraction in volumes and flat yields,” IATA said.

2012 Trepidations

IATA forecasters believe that even if Europe avoids a banking crisis, it is unlikely that the region will avoid a brief recession. “Business and consumer confidence has already fallen too far,” they point out. Global GDP growth forecasts for 2012 were therefore revised downwards to 2.1%. This puts the airline industry in a precarious place because historically, it has seen profit turn into loss whenever global GDP growth falls below 2%. “This is driving the downgrade in the 2012 outlook,” IATA says.

The key variables driving IATA’s downgrade are:

Demand: Passenger demand is expected to grow by 4.0% (down from previously forecast 4.6%), while cargo is expected to show flat growth (down from the previously forecast 4.2% expansion).

Yields: Passenger and cargo yields are expected to remain flat in 2012. While this is unchanged for cargo, passenger yields were previously forecast to grow by 1.7%.

Fuel: Fuel costs are relatively unchanged from the previous forecast at $198 billion. That is based on oil at $99 per barrel (against a previous forecast of $100 per barrel).

Revenues and costs: Industry revenues are expected to grow by 3.7% to $618 billion. This will be outstripped by cost increases of 4.5% to $609 billion.

A large factor in IATA’s 2012 outlook revision was an economic outlook risk assessment on the European debt crisis issued late last year by the Organization for Economic Cooperation and Development (OECD). Based on the OECD’s view that a potential resulting banking crisis would cut global GDP growth to 0.8%, IATA estimates that this has the potential to cause global industry losses of $8.3 billion.

“In this scenario, all regions would fall into losses,” IATA said. “Europe would be expected to post the deepest losses at $4.4 billion, followed by North America at $1.8 billion and Asia-Pacific at $1.1 billion. The Middle East and Latin America would both be expected to post $400 million losses, while Africa would be $200 million in the red.”

Tyler said, “This admittedly worst-case—but by no means unimaginable—scenario should serve as a wake-up call to governments around the world. In a good year, the airline industry does not cover its cost of capital, much less in a bad one. But in a bad year, aviation’s ability to deliver connectivity and keep the heart of the global economy pumping becomes even more vital to initiating a recovery. Government policies need to recognize aviation’s vital contribution to the health of the economy.”

This scenario, IATA said, is based on global GDP growth falling to 0.8% in 2012 driven by Europe descending into deep recession. Historically, GDP growth rates below 2.0% have resulted in the airline industry producing a net global loss. In this scenario, airlines would see growth in passenger demand grind to a halt and a 4.7% contraction in cargo markets. Both passenger and cargo yields would fall by 1.5%.

More optimistically, IATA expects to see some relief in the fuel price. Based on oil at $85 per barrel, the fuel bill would be $183 billion and consume 31% of costs. However, overall expenses would be expected to grow by 1.9% (compared to 2011) to $592 billion. Revenues would see a fall of 1.3% (compared to 2011) to $589 billion. The net result would be an $8.3 billion loss and net margin of minus 1.4%.

“What we are seeing at the global level is the combination of very differing regional situations. Europeans, facing a sovereign debt crisis and economic austerity measures, are living a very different reality from their colleagues in Asia which is buoyed by the market dynamism of China. And our colleagues in North America are managing through a sluggish economy with tight management of capacity. And of course everyone has been hit by higher fuel prices,” Tyler said.