The economics of airline financial performance and wider economic benefits 6 th April 2018, Paris Brian Pearce, Chief Economist, IATA www.iata.org/economics
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)
% 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) 8.0 6.0 Cost of capital (WACC) 4.0 2.0 0.0 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Source: IATA Economics using data from McKinsey, The Airlines Analyst, IATA forecasts
US$ billion After decades of investor value destruction 30 Difference between investing in airlines and investing in similar assets elsewhere 20 10 0-10 -20-30 -40 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Source: IATA Economics using data from McKinsey, The Airlines Analyst, IATA forecasts
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
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% 2010 2011 2012 2013 2014 2015 2016 Source: IATA Economics using data from IATA and The Airline Analyst
Debt adjusted for operating leases/ebitdar Balance sheet remain highly leveraged in some regions 8 Adjusted net debt/ebitdar 7 6 5 Latin America Middle East Asia Pacific 4 3 2 1 Industry average Europe North America Investment grade 0 2010 2011 2012 2013 2014 2015 2016 Source: IATA Economics using data from The Airline Analyst
There has always been a paradox at the heart of air transport 2015-18: 9.7% Source: McKinsey presentation to IATA
Technology continues to cut costs dramatically Source: Lee
Typically airlines pass all gains through to consumers US$ in 2013 prices to fly a tonne kilometer US$ in 2013 prices per tonne kilometer 4.0 3.5 3.0 2.5 2.0 1.5 1.0 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) 0.0 1950 1960 1970 1980 1990 2000 2010 7.0 6.0 5.0 4.0 3.0 2.0 1.0 - Source: IATA Economics using data from ICAO and IATA Statistics
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% 1970 1975 1980 1985 1990 1995 2000 2005 2010 Source: IATA Economics using data from ICAO and IATA Statistics
Have industry economics changed or is it just low fuel costs? ROIC, % of invested capital Jet fuel price, US$/barrel 12.0 10.0 8.0 6.0 Airline industry ROIC and jet fuel prices Return on capital (ROIC) 160 140 120 100 80 4.0 2.0 Jet fuel price 60 40 20 0.0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 0 Source: IATA Economics using data from McKinsey, Platts and own forecasts
The underlying economics of air transport Perishable Fixed costs high Barriers to entry low Competitive advantages hard to defend Aircraft are a platform to serve many markets Economies of scale in aircraft size but business travelers want frequency and flexibility Few scale economies in fleet size but economies of density in networks OUTCOME: Prices pushed down towards variable costs, But ways need to be found to cover fixed costs: Differential pricing, sequential use of coupons, non-refundable tickets.and now ancillaries Network density economies through merger prevented by bilateral and O&C regulation barriers: Leading to code shares, alliances and now ATI JVs and equity partnerships on international markets
% ATKs Improvement in performance pre-dates fall in fuel costs Breakeven and achieved weight load factors 71 69 Load factor achieved 67 65 63 61 59 Breakeven load factor 57 55 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Source: IATA Economics using data from ICAO, IATA Statistics, IATA forecasts
Airlines are sweating assets as well as improving margins Operating margin, % revenue Capital productivity, revenue/invested capital, US$ Components of return on capital 10 Operating margin 8 1.5 1.4 6 Capital productivity 1.3 4 1.2 2 0 1.1-2 1.0-4 0.9-6 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 0.8 Source: IATA Economics using data from ICAO, McKinsey, The Airline Analyst, IATA forecasts
Wide variety of successful business models EBIT margin, adjusted EBIT/revenue 0.45 0.40 0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00-0.05-0.10 2015 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 0.00 0.50 1.00 1.50 2.00 2.50 Capital productivity ($ revenue per $ invested capital) Source: IATA using data from The Airline Analyst IATA Economics www.iata.org/economics
Billion US$ Billion US$ Ancillaries are changing the nature of the airline product 700 600 Airline revenues, tickets, cargo and ancillaries Passenger ticket revenue (left 120 100 500 400 Ancillary revenue (right scale) 80 60 300 200 Cargo revenue (right scale) 40 100 20 0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Source: IATA Economics using data from ICAO, The Airline Analyst, PaxIS, IdeaWorks 0
Invested capital, $ billion Consolidation important but not simply because of size 45 40 35 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
JVs doing better job than code shares/alliances to get density economies Source: Lufthansa
Protectionism (or the new localism ) is a major threat % of GDP 22 Share of goods trade (exports+imports) in global GDP 20 18 Global financial crisis 16 14 12 10 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Source: IATA Economics using data from Netherlands CPB
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 22000 3.50 20000 18000 16000 14000 12000 10000 8000 6000 4000 2000 Unique city pairs Real cost of air transport 3.00 2.50 2.00 1.50 1.00 0 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Source: IATA Economics using data from ICAO, Boeing, OAG, SRS Analyser 0.50
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!