The economics of airline financial performance and wider economic benefits

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1 The economics of airline financial performance and wider economic benefits 6 th April 2018, Paris Brian Pearce, Chief Economist, IATA

2 Outline Why is the airline industry suddenly profitable? After decades of investor capital destruction Is the change widespread? Have the underlying economics of the industry changed? Why is the emergence of protectionism such a threat? How does air transport bring economic benefit? Users Wider economic benefits Come from the people, goods, capital and ideas we carry between cities Rather than the jobs required to run the service (with some exceptions)

3 % of invested capital Airlines have suddenly become profitable (for their equity investors) 12.0 Return on capital invested in airlines and their cost of capital 10.0 Return on capital (ROIC) Cost of capital (WACC) Source: IATA Economics using data from McKinsey, The Airlines Analyst, IATA forecasts

4 US$ billion After decades of investor value destruction 30 Difference between investing in airlines and investing in similar assets elsewhere Source: IATA Economics using data from McKinsey, The Airlines Analyst, IATA forecasts

5 And widespread airline failures European LCCs Iceland Express Air Finland Flying Finn snowflake Planet Nordic Thomsonfly airlink flyglobespan nexus FlyMe flyforbeans.com Viking GetJet mytravellite Sterling Cimber jetmagic Kiss duo Go Maersk Air Debonair buzz Air Wales Hamburg airlines EUjet Basiqair VBIRD centralwings VirginExpress Air polonia flywest HLX Smart Wings flyeco LTU Germania dba Skyeurope Aeris clickair Helvetic flybaboo Air Turquoise air lib express myair Clickair Volareweb fly gibraltar Ryanair Jet2 AerArann Aerlingus Monarch easyjet flybe Transavia airberlin Eurowings vueling Norwegian Volotea WIZZ SkyExpress Pegasus Atlas-blue WindJet Failed Survived Source: HSBC report early 2014 situation. Since then Monarch and airberlin have failed

6 EBIT adjusted for operating leases as % invested capital But improvement has been very uneven across the industry 20% Return on invested capital 18% 16% 14% 12% 10% 8% 6% 4% 2% Middle East North America Europe Industry average Latin America Asia Pacific Weighted Average Cost of Capital 0% Source: IATA Economics using data from IATA and The Airline Analyst

7 Debt adjusted for operating leases/ebitdar Balance sheet remain highly leveraged in some regions 8 Adjusted net debt/ebitdar Latin America Middle East Asia Pacific Industry average Europe North America Investment grade Source: IATA Economics using data from The Airline Analyst

8 There has always been a paradox at the heart of air transport : 9.7% Source: McKinsey presentation to IATA

9 Technology continues to cut costs dramatically Source: Lee

10 Typically airlines pass all gains through to consumers US$ in 2013 prices to fly a tonne kilometer US$ in 2013 prices per tonne kilometer Boeing 707 Unit cost and the price of air transport 1973 oil crisis US deregulation EU deregulation Unit cost (US$/ATK) 0.5 Price (US$/RTK) Source: IATA Economics using data from ICAO and IATA Statistics

11 In fact prices have fallen further than costs forcing up breakeven loads % ATKs 70% Breakeven and actual load factors 65% Load factor achieved 60% 55% Breakeven load factor +15% points 50% 45% Source: IATA Economics using data from ICAO and IATA Statistics

12 Have industry economics changed or is it just low fuel costs? ROIC, % of invested capital Jet fuel price, US$/barrel Airline industry ROIC and jet fuel prices Return on capital (ROIC) Jet fuel price Source: IATA Economics using data from McKinsey, Platts and own forecasts

13 The underlying economics of air transport Perishable Fixed costs high Barriers to entry low Competitive advantages hard to defend Aircraft are a platform to serve many markets Economies of scale in aircraft size but business travelers want frequency and flexibility Few scale economies in fleet size but economies of density in networks OUTCOME: Prices pushed down towards variable costs, But ways need to be found to cover fixed costs: Differential pricing, sequential use of coupons, non-refundable tickets.and now ancillaries Network density economies through merger prevented by bilateral and O&C regulation barriers: Leading to code shares, alliances and now ATI JVs and equity partnerships on international markets

14 % ATKs Improvement in performance pre-dates fall in fuel costs Breakeven and achieved weight load factors Load factor achieved Breakeven load factor Source: IATA Economics using data from ICAO, IATA Statistics, IATA forecasts

15 Airlines are sweating assets as well as improving margins Operating margin, % revenue Capital productivity, revenue/invested capital, US$ Components of return on capital 10 Operating margin Capital productivity Source: IATA Economics using data from ICAO, McKinsey, The Airline Analyst, IATA forecasts

16 Wide variety of successful business models EBIT margin, adjusted EBIT/revenue ROIC = adjusted EBIT/revenue * revenue/invested capital Jazeera Spring Mesa Ryanair Spirit Thai Allegiant Volaris Alaska PFIZER Hawaiian JetBlue Southwest Air China AMR JAL Delta United Easyjet Aeromexico Air Canada PIA IAG Qantas Cathay SIA ANA LATAM Comair Korean GOL AF-KLM Increasing return on capital (ROIC) Lufthansa WALMART Capital productivity ($ revenue per $ invested capital) Source: IATA using data from The Airline Analyst IATA Economics

17 Billion US$ Billion US$ Ancillaries are changing the nature of the airline product Airline revenues, tickets, cargo and ancillaries Passenger ticket revenue (left Ancillary revenue (right scale) Cargo revenue (right scale) Source: IATA Economics using data from ICAO, The Airline Analyst, PaxIS, IdeaWorks 0

18 Invested capital, $ billion Consolidation important but not simply because of size Return on invested capital versus invested capital, 2016 Emirates (2015) American United 30 Qatar Air China Delta 25 (2015) China Southern China Eastern 20 Singapore Lufthansa Cathay Southwest 15 AF-KLM Fedex Korean 10 Turkish LATAM IAG Ryanair 5 Alaska Allegiant Icelandic - -10% 0% 10% 20% 30% 40% 50% Return on invested capital, % Source: IATA Economics using data from IATA and The Airline Analyst

19 JVs doing better job than code shares/alliances to get density economies Source: Lufthansa

20 Protectionism (or the new localism ) is a major threat % of GDP 22 Share of goods trade (exports+imports) in global GDP Global financial crisis Source: IATA Economics using data from Netherlands CPB

21 Number of unique city-pairs US$/RTK in 2014US$ Benefits to consumers (and economy) arise from cheap city connections Unique city-pairs and real transport costs Unique city pairs Real cost of air transport Source: IATA Economics using data from ICAO, Boeing, OAG, SRS Analyser 0.50

22 Wider economic benefits Often measured by the jobs and GVA in the supply chain, through I-O models Economic footprint is a useful description But it measures cost not benefit Do labor productivity gains really mean lower wider economic benefits? Economic benefits generated by connecting cities at lower cost Air transport network is an infrastructure asset, a bridge between cities Boosting the productive capacity of an economy Generating flows of people, goods, capital, ideas, competitive pressure Raising productivity through agglomeration, gains from trade Higher GDP from the supply-side, in economies close to full capacity Demand-side/spending flows do matter where economies/regions under-developed More research and evidence required!

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