Challenges to profitability Brian Pearce Chief Economist www.iata.org/economics To represent, lead and serve the airline industry
Jan 2007 Apr 2007 Jul 2007 Oct 2007 Jan 2008 Apr 2008 Jul 2008 Oct 2008 Jan 2009 Apr 2009 Jul 2009 Oct 2009 Jan 2010 Apr 2010 Jul 2010 Oct 2010 Jan 2011 Apr 2011 Jul 2011 Oct 2011 Jan 2012 Apr 2012 Jul 2012 Oct 2012 Jan 2013 Weighted Score (50 = No Change) Your CFOs are getting more confident Survey question: What are your expectations for the change in profits? 100 90 80 70 60 50 40 30 20 10 0 Last three months Next twelve months Source: IATA quarterly survey of airline CFOs IATA Economics www.iata.org/economics 2
% revenues Outlook for profitability is improving slowly 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013F US$ billion 6.0 3.0 0.0-3.0-6.0-9.0 Global commercial airline profitability EBIT margin (left scale) Net post-tax losses (right scale) 20 15 10 5 0-5 -10-15 -20-25 -30 Source: ICAO (history), IATA (2012 estimate and 2013 forecast) IATA Economics www.iata.org/economics 3
Evidence of structural improvement 20% Largest 8 airlines, EBITDA as % revenues, seasonally adjusted 15% Asia-Pacific 10% US 5% 0% Jet: $82/b GDP: 4% Europe Jet: $130/b GDP: 2.1% -5% 2006 2007 2008 2009 2010 2011 2012 Source: Bloomberg, IATA IATA Economics www.iata.org/economics 4
Entry appears to be harder post financial crisis 160 Number of new airlines formed 140 120 100 80 60 40 20 0 1995 2000 2005 2010 Source: Ascend IATA Economics www.iata.org/economics 5
Exit now occurring e.g. Europe s LCCs consolidating Iceland Express WOW Air Finland Flying Finn snowflake Nordic Thomsonfly Planet airlink flyglobespan nexus FlyMe flyforbeans.com Viking GetJet mytravellite SterlingCimber 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 germanwings vueling Norwegian Volotea WIZZ SkyExpress Pegasus Atlas-blue WindJet Failed Survived Source: Andrew Lobbenberg, HSBC IATA Economics www.iata.org/economics 6
But more is needed 2012 worldwide airline financial results per departing passenger 220 $214.64 $212.04 200 Ancillary $12.14 180 160 140 120 100 80 60 40 20 0 Air fare $171.20 Cargo & other $31.30 Revenues Costs $212.04 Costs $2.56 Net profit Source: Ancillary revenues from Idea Works 2012 estimate, other data IATA. Costs include operating items and debt interest. IATA Economics www.iata.org/economics 7
% of invested capital A lot more! 10.0 Return on invested capital in airlines and their WACC 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 WACC Investor value losses ROIC 0.0 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013F Source: IATA IATA Economics www.iata.org/economics 8
Just to depress you Industry median ROIC, without goodwill Percent 1st quartile Median 3rd quartile 1965 2007 Average Industry 0 5 10 15 20 25 30 35 Pharmaceuticals Software IT Services Beverages HH & Personal Products Apparel Retail Broadcasting Restaurants Health Care Equipment Computers & Peripherals Food Products Machinery Chemicals Movies & Entertainment Aerospace & Defense Auto Components Building Products Energy Equipment & Services Health Care Facilities Integrated Oil & Gas Department Stores Trucking Construction Materials Metals & Mining Paper Packaging Paper & Forest Products Integrated Telecom Electric Utilities Airlines 1 ROIC after tax, excluding goodwill; For charting purposes, ROIC values are cut off if beyond (-5%, 50%) IATA Economics www.iata.org/economics 9
Returns in distribution are excessively high ROIC excluding goodwill of sample, period 2004-2011, % Weighted average (BAR) 75% percentile Median 25% percentile 45 40 35 30 25 20 15 10 5 0-5 Cost of Capital 15 9 5 7 Manufacturers 4 14 9 9 Lessors 20 5 11 11 All services (MRO, Cat, GrH, Fuel) 5 10 7 6 Airports 1 4 13 9 8 ANSPs 8 5 2 4 Airline 31 22 16 20 CRS -5 44 44 17 Travel Agents 2 18 14 9 15 Freight Forwarders 9-11 9-11 7-9 6-8 6-8 7-10 10-11 8-11 7-8 45 40 35 30 25 20 15 10 5 0 IATA Economics www.iata.org/economics 10
ROIC % invested capital Best-worst ROIC Airlines end up bearing too much of the risk as well Risk and return in air transport 25% 20% 15% 10% 5% 0% ROIC Risk (right scale) 8% 7% 6% 5% 4% 3% 2% 1% 0% IATA Economics www.iata.org/economics 11
But most of the excessively profitable sectors are small Invested capital and revenue in the value chain Travel agents Catering CRS MRO Ground Freight Forwarders ANSPs Manufacturers Lessors Airports Airlines Revenue Invested capital - 100 200 300 400 500 600 US$ billion IATA Economics www.iata.org/economics 12
Profiteering suppliers not prime cause of airline losses Average economic profit 1, USD billion, 2004-2011 -0.6-0.2 0.3 0.5 0.2-3.7 0.7-17.0 Estimate 2 0.5 0.0-2.0 1.3-16.0-18.0 Manufacturers Lessors MRO Ground Catering Airports 3 ANSP Airlines CRS Travel agents Freight Total Forwarders 1 Based on invested capital excluding goodwill, extrapolated to total industry 2 Sample too small to give meaningful estimate 3 Economic profit for airport sector extrapolated based on weighted average of sample excluding AENA. AENA subsequently added back to sector estimate IATA Economics www.iata.org/economics 13
Fuel is a culprit but most profit is far upstream Breakdown of jet fuel price USD per barrel Estimated crosscycle profitability USD per barrel Estimated cross cycle industry net profit pool USD bln Crude oil 108,7 1 14 to 27 19-37 Refining uplift 18,8 1-2 to 7-3 to 9 Logistics cost uplift 2,2 0 to 1 0 to 1 Handling cost uplift 12,3 0 to 1 0 to 1 Total jet fuel 2 142,0 12 to 35 16-48 IATA Economics www.iata.org/economics 14
US $, US domestic services Labor captures $3-4 billion of value annually Nominal pilot and flight attendant pay per block hour 1,200 Large mainline average 50th percentile whole sample 25th percentile whole sample 1,000 800 600 400 200-8% -30% - 1990 1995 2000 2005 2010 IATA Economics www.iata.org/economics 15
Real price of air transport Real unit costs But the industry has been successful at cutting cost 2.60 Real price of air transport and real unit costs Source: ICAO, IATA 1.40 2.40 1.30 2.20 1.20 2.00 1.10 1.80 1.60 Airline real unit costs (right scale) 1.00 0.90 1.40 0.80 1.20 0.70 1.00 0.60 0.80 0.50 0.60 0.40 1970 1975 1980 1985 1990 1995 2000 2005 2010 IATA Economics www.iata.org/economics 16
Real price of air transport Real unit costs But there is a problem retaining efficiency gains 2.60 Real price of air transport and real unit costs Source: ICAO, IATA 1.40 2.40 1.30 2.20 1.20 2.00 1.10 1.80 1.60 Airline real unit costs (right scale) 1.00 0.90 1.40 0.80 1.20 1.00 Real price of air transport (left scale) 0.70 0.60 0.80 0.50 0.60 0.40 1970 1975 1980 1985 1990 1995 2000 2005 2010 IATA Economics www.iata.org/economics 17
Michael Porter hadn t seen anything quite like it! Five Forces in the Airline Industry Threat of Substitute Products or Services: MEDIUM and RISING Bargaining Power of Suppliers: HIGH Rivalry Among Existing Competitors: HIGH Bargaining Power of Channels: HIGH Bargaining Power of Buyers HIGH Threat of New Entrants: HIGH 7 Copyright 2011 Professor Michael E. Porter IATA Economics www.iata.org/economics 18
Diagnosis of the low profitability problem High exit costs/low entry barriers Consolidation held back by investment rules and competition policy Commoditization as product innovation copied/not differentiated Fragmentation of industry Efficiency gains passed through to customer Over-capacity Long-run fall of yields Low returns ROIC<WACC Fuel, labour, airports and other key suppliers have market power to raise their costs to airlines Suppliers take surplus returns in upcycle and limit cuts in downcycle Cyclical loss of value IATA Economics www.iata.org/economics 19