AVIATION MARKET FOCUS 2017
How Brexit and a weak Pound threaten the Aviation industry s contribution to UK economic growth The UK is in a period of political and economic uncertainty which impacts businesses all over the country. Growing inflation and a weak pound are pressuring both households and companies while consumers tighten their purse strings. The Aviation sector is a key part in British economic growth and with Brexit casting doubt in many industries, the question remains - will the aviation sector stall or climb? 2
How much is the Aviation industry worth to the UK economy? Aviation is an important pillar in UK economic growth and reaps impressive statistics each year. The UK has the third-largest aviation network in the world (behind the USA and China). In 2015 144 million passengers flew in the network. According to Sustainable Aviation, the aviation industry has an annual turnover of 60 billion and contributes 52 billion to UK gross domestic product (GDP). The sector offers 961,000 jobs and 3,500 apprenticeships. Research and development in the industry totals 1.7 billion annually. The UK is the second-largest aerospace manufacturer and holds a sixth of the global market. UK aerospace manufacturing exports 27 billion annually with Rolls Royce accounting for 2% of overall UK exports. 3
What does Brexit mean for the Aviation industry? The word Brexit has spread like a virus through UK industries and some businesses have announced that they plan to leave London and the UK to head to other cities remaining in Europe. However, UK airports can t move overseas and with consumer spending expected to take a dive as Brexit, inflation, and a weak pound cast doubt in households, there is the potential passenger traffic will taper. Moody s Analytics have stated: Demand for air travel will be driven by weaker economic sentiment as a result of uncertainty over the shape of the UK s future trading agreements with the EU, as well as with other major economies with which the UK has trade agreements in place by virtue of its currency membership with the EU. It s expected that passenger numbers will slow in a trend that allows UK airports to withstand the immediate impact of Brexit. However, airports such as Manchester, Luton and Birmingham which are dominated by outbound traffic are going to be more exposed to weaker domestic economic prospects and sterling weakness. Heathrow and Stansted hold higher numbers of inbound traffic and so are shrouded with more protection from the Brexit effect. But it s not just about the airports; it s about the carriers too. A weak pound will restrict holiday goer s plans as they wait to travel overseas until it becomes more affordable. This is especially true when it comes to areas like the USA where the pound is particularly vulnerable against the US dollar following the recent 20% GBP/USD depreciation. Airlines like Virgin and British Airways who focus on long-haul travel are expected to feel the impact most. A weaker pound makes it easier for overseas residents to travel to the UK for a holiday and enjoy a cheaper trip, but Moody s research suggests that Britain may not be expecting an influx of tourists. Recent bouts of European terrorism are expected to limit the number of Americans heading for the UK in an attempt to stay safe. 4
How are Aviation businesses affected? Manufacturers are also feeling the impact of Brexit. Rolls Royce recorded its biggest loss in history thanks to a weaker sterling. The engine-maker registered a 4.6 billion statutory pre-tax loss in 2016 marking one of the biggest corporate losses in British history. The majority of this is accredited to the pound to US dollar (GBP/USD) exchange rate which has fallen by almost 20% since the referendum. Rolls Royce had to write off 4.4 billion in currency contracts causing its end of year accounts to show a loss. This is because the company hedges its currency up to five years in advance so it can be certain of the rate it will receive. However, as the market shifted post- EU referendum, it could have gained significantly more. Rolls Royce is just one of many businesses that chooses to forward buy their currency to ensure the business bottom line is protected from major market shifts. In recent accounts Rolls have a GBP/USD exchange rate of 1.59, however; any hedges made at present will see a substantial decline to around the 1.20 level. BAE isn t alone, the parent company of British Airways, IAG Group, reported a 31% increase in annual profits to 2 billion, despite feeling a 389 million hit from market movements following the drop in the pound. Tui has stated its forex strategy is to hedge the majority of its jet fuel and currency requirements for future seasons in order to provide the company and accounts with economic certainty which is needed for planning and pricing. Tui, like many other airlines hedges the majority of its currency and fuel requirements a year in advance. On the other side of the spectrum, BAE Systems expects to see a 5-10% increase on its earnings in 2017 as defence spending increases. The leading weapons and aviation group registered a sales increase to 19.02 billion in 2016 following 2015 s 17.9 billion all courtesy of foreign exchange rates. 5
How much does the EU benefit the Aviation manufacturing industry? The UK aviation sector receives significant benefits from it s current EU membership. Rolls Royce is a global leader in producing aero engines for both corporate jets and large civil aircraft. The company is also the second-largest supplier of defence aero engines and services. Rolls Royce is one of the most established members of the EU s Clean Sky programme which works towards strengthening ties between Europe in aviation collaboration and has a 4 billion budget. The company was part of the Advanced Low Pressure System (ALPS) programme which has helped to develop new technologies that has delivered a 20% fuel efficiency saving. The EU funded project received 45 million. A study by the Aerospace, Defence, Security & Space (ADS) and KPMG reports that the EU funds nearly 100 million in UK research and development in the aviation sector every year which supports exports, jobs and innovation. 6
What deals need to be made to limit Aviation disruption? As Theresa May has signalled Britain will be leaving the Single Market and by extension the European Single Aviation Market, there s a number of possibilities as to what will happen to the landing rights of UK flights. There s a chance that the UK will be able to maintain its European Common Aviation Area (ECAA) membership post-brexit. Moody s suggest it s a possible outcome, but that it s not guaranteed. Spain has already suggested that it would block EU air access deals unless they exclude Gibraltar airport. The 300-year old dispute over the rock could cause significant problems as any inclusion of Gibraltar in a deal would signal that it legally belongs to the UK. Ideally, an agreement needs to be made swiftly to limit the amount of disruption to the aviation industry, but as the debate over Gibraltar has continued over centuries, it could cause some delays. If an ECAA agreement cannot be made there may be attempts to seek a bilateral open skies agreement which is expected to come with many more restrictions. No matter which way the UK goes, there will need to be support and unanimous agreements from all the UK member states. EasyJet is already on its way to securing a European Air Operator s (AOC) certificate to enable it continue operating the 30% of it s network that doesn t touch the UK. The move is a smart one by EasyJet as the International Air Transport Association (IATA) chief believes EU airlines may use Brexit to achieve a competitive advantage by lobbying to restrict UK carriers access to ECAA. BAE Systems has already benefited from the UK s recent efforts to increase foreign trade outside the EU following the June referendum. Chief executive of the aerospace giant Ian King travelled to Turkey with Theresa May recently to agree a 100 million defence deal with the nation to manufacture fighter jets. Airbus UK s chief operating officer has spoken out following Theresa May s statement suggesting she was willing to walk away fro the EU with no deal. Tom Williams said that US competitors of the company would be more than delighted to see the UK leave on those terms which would force the nation to adopt World Trade Organisation (WTO) rules. Airbus employs 15,000 people in the UK and the company states a further 100,000 jobs are supported indirectly through an extended supply chain of 1,000 companies. The domino effect on businesses is likely to be great and so Britain needs to attain a favourable aviation agreement in order to avoid disruptions. It s also worth noting that plenty of these businesses hire employees from across the EU so agreements regarding the free movement of people could also play a significant role. 7
How will the weak Pound impact the Aviation industry? The fall of sterling is expected to impact the UK aviation sector in a number of ways; firstly, UK flights overseas could experience a decline in footfall, which will result in less spending in airports. Low cost carrier (LCC) Ryanair s chief has already hinted that the airline could abandon the UK domestic market which makes up 1.67% of its overall network capacity. Meanwhile, European airlines report in Euros, including British Airways which is owned by the International Airlines Group (IAG) based in Spain. British citizens may pay in Pounds but this is converted into Euros and a weaker pound will bring less profit for the business. This could see BA raise prices despite there being heightened competition from low cost airlines. Consumers will notice the cuts as in-flight meals for flights under five hours have already been removed and virtual check-ins costing 40 have been implemented. UK growth across the whole economy. If growth falls it could cause business confidence to take a knock and in turn cause delays in company expansion, wage growth, and employment. The UK aerospace and manufacturing industry is the most prolific in Europe and has a 31 billion turnover, of which 27 billion are exports. In 2016 the UK aerospace industry grew by 6.5% helped by a weaker pound and an upswing in demand and production. However, while the demand is good now, it s been suggested that the UK is falling behind competition in the EU and as research and development continues there s the possibility the UK could have work pulled away from it. The Pound s weakness and general economic uncertainty hasn t been favourable for investment either as post- EU Referendum outlooks paint a less rosy picture. Hesitation and a decline in investment is likely to be a factor in slowing 8
Can lower oil prices benefit the Aviation industry? Softer oil prices have been a boon for the aviation industry as jet fuel has been significantly cheaper. However, US airlines have enjoyed weaker prices more than European aviation companies as oil is a Dollar commodity. Sterling weakness has meant that the benefit of weaker fuel prices has been limited the GBP/USD exchange rate has fallen by around 20% since the Brexit referendum. 9
How Brexit impacts the European Aviation industry The EU could benefit from Britain s exit if aviation businesses abandon the UK and establish themselves in European cities. Many companies have openly announced that they ll be leaving their bases in London or elsewhere to instead join a European hub this has been particularly true of banks and manufacturers. However, if freedom of movement is limited and there are new regulations in place, European workers may not head for the UK and that could see a decline in both business and tourist travellers. A host of European airlines rely on a number of key high-yield flights into the UK and so the possibility of severe turbulence in negotiations or a potential halting of flights could cause catastrophic consequences. It would appear as if European airlines have an awful lot to lose and so a smooth transition and a swift deal is in the EU s favour as well. 10
How can you manage an inconsistent Pound exchange rate? Aviation industry businesses are likely to be vulnerable to the impact of Brexit and a fluctuating Pound in coming years as agreements between the UK and EU are made. It s worthwhile consulting an industry expert to ensure currency transactions are favourable in the face of a volatile market. Global Reach Partners has a suite of products and services available to businesses wanting to maximise their funds and limit their exposure to market risk in uncertain times. Whether that s fixing an exchange rate for two years or protecting funds with a stop loss order, there are a host of options we can discuss to benefit your business bottom line. Contact us today to discuss how we can help your foreign exchange needs. Contact Global Reach Partners on 020 3465 8200 today, to speak to a currency expert about how we can help with your foreign exchange strategy for 2017. Alternatively, email info@globalreach-partners. com for more information and someone will get back to you. 020 3465 8200 info@globalreach-partners.com www.globalreach-partners.com T: 020 3465 8200 F: 020 3465 8201 E: info@globalreach-partners.com www.globalreach-partners.com Global Reach Partners Woolgate Exchange, 25 Basinghall Street, London, EC2V 5HA Global Reach Partners Limited (GRP) and Global Reach Markets Limited (GRM) are companies registered at Woolgate Exchange, 25 Basinghall Street, London, EC2V 5HA. GRP is authorised by the Financial Conduct Authority ( FCA ) and regulated by HMRC as an Authorised Payments Institution for the provision of payment services. GRM is authorised and regulated by the FCA.