Signs of a structural improvement in airlines financial health? February 2016 Brian Pearce Chief Economist International Air Transport Association
% growth in traffic and ROIC as % invested capital Structural not cyclical gains (or just cheap fuel)? % growth in GDP Global GDP growth, airline industry ROIC and air traffic growth 14 12 10 8 6 4 2 0-2 -4-6 Growth in air travel and cargo volumes Airlines' return on capital Growth in global GDP (right scale) 1995 2000 2005 2010 2015 Source: ICAO, McKinsey, EIU, IATA www.iata.org/economics 2 8 6 4 2 0-2 -4
Passenger revenue, US$ billion Cargo revenues, US$ billion Travel business very strong, cargo very weak 800 Airlines revenues from passengers and cargo 90 700 600 500 400 300 200 Revenue from tickets and ancillaries Revenue from cargo 1995 2000 2005 2010 2015 80 70 60 50 40 30 Source: ICAO, IATA
Index ratio, 2005 equals 1 Not all structural change is good 1.2 International trade compared to global industrial production 1.1 1.0 0.9 0.8 0.7 0.6 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Source: Netherlands CPB www.iata.org/economics 4
% of invested capital Airline investors paid a normal return for 1 st time 10.0 8.0 6.0 Return on capital invested in airlines Cost of capital (WACC) 4.0 2.0 Return on capital (ROIC) 0.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: McKinsey, IATA www.iata.org/economics 5
US$ billion Ending decades of investor capital destruction (?) 15 10 5 0-5 -10-15 -20-25 -30-35 Difference between investing in airlines and investing in similar assets elsewhere -40 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Source: McKinsey, IATA www.iata.org/economics 6
And awful relative performance Source: McKinsey Software and services Pharma, biotech, and life sciences Household and personal Healthcare equipment and services Media Food, beverage, and tobacco Tech hardware and equipment Communications and professional services Semiconductors and equipment Telecom Postal/CEP Retailing Consumer services Consumer durables and apparel Bus Capital goods Food and staples retail Energy Contract logistics Materials Freight forwarding Rail Shipping Transportation & logistics Automobiles and components Trucking Utilities Airlines Annual return on invested capital, 2004-2013 0 20 40 60 80 100 www.iata.org/economics 7
Debt finance markets still sceptical of change AA+/- A+/- BBB+/- BB+/- B+/- ANZ, Qantas, Lufthansa, Ryanair, Southwest, Alaska, Westjet Delta, American, United, Allegiant, Spirit, BA, Turkish, LATAM Air Canada, Hawaiian, JetBlue, Avianca, GOL, SAS, Virgin Australia Investment grade Source: S&P, Airfinance Journal December 2015
2016 forward P/E ratio As are equity markets 20 18 16 14 12 10 8 6 4 2 0 US transportation sector 43% Legacy airlines LCCs Trucking Rail Integrators Logistics Source: Datastream www.iata.org/economics 9
10 9 8 7 6 5 4 3 2 1 0 ROIC improvement in 2014 was narrowly based Number of airlines in ROIC band -20-16 -12-8 -4 0 4 8 12 16 20 24 28 32 36 40 % ROIC 2014 Q1-3 Source: The Airline Analyst, IATA Economics 37 airlines: ROIC>WACC 38% of industry capital
ROIC>WACC concentrated mostly in US in 2014 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% ROIC as a % invested capital, 2014 Average cost of capital N America Europe Asia Pacific LatAm ME Af Source: The Airlines Analyst, IATA Economics
But last year ROIC improvement spread Number of airlines in ROIC band 10 9 8 7 6 5 4 3 2 1 0 47 airlines: ROIC>WACC 60% of industry capital -20-16 -12-8 -4 0 4 8 12 16 20 24 28 32 36 40 % ROIC 2015 Q1-3 Source: The Airline Analyst, IATA www.iata.org/economics 12
Returns rose in US, Europe and spread to Asia 45% ROIC as % invested capital, 2015 Q1-3 annualized 40% 35% 30% 25% 20% Average cost of 15% capital 10% 5% 0% -5% -10% -15% -20% N America Europe Asia Pacific LatAm ME -25% Source: The Airlines Analyst, IATA Economics
US$ billion Unprecedented FCF in the US 30 25 Cash flow from operations, 2015 Q1-3 Capex, 2015 Q1-3 20 15 10 5 0 N America Europe Asia Pacific L America Source: The Airline Analyst, IATA Economics
Adjusted net debt, US$ billion Allowing significant balance sheet repair for some 2014 free cash flow and adjusted net debt 30 25 20 15 6 airlines could repay all debt in next 5 years 10 5 Median airline $3 billion net debt -3% FCF/net debt 0-50% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50% Free cash flow as a % of adjusted net debt Source: The Airline Analyst, IATA www.iata.org/economics 15
US cents per ATK % return on invested capital It s not just cheap fuel Fuel unit costs and airline return on capital 30 25 20 15 10 Airlines return on capital Fuel unit cost 10 8 6 4 2 5 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: ICAO, McKinsey, IATA www.iata.org/economics 16 0
% ROIC Suppliers mostly generate much better returns 30% Return on capital across the air transport supply chain 25% 20% 1996-2014 2007-2014 15% 10% 5% 0% Source: McKinsey for IATA www.iata.org/economics 17
But this is not the main issue for airline earnings Average yearly economic profit, USD billion, 2007-2014 2.0 (0.7) - (2.0) 0.4 0.7 0.3 (2.5) 0.8 Estimate (19.4) 0.5 0-2.0 1.2 (16.7) (18.0) Manufacturers Lessors MRO Ground Catering Airports ANSP Airlines CRS GDS Travel Agents Freight Forwarders TOTAL Source: McKinsey for IATA www.iata.org/economics 18
Number of unique city-pairs US$/RTK in 2014US$ Most of the value created ends up with consumers 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 - Unique city-pairs and real transport costs Unique city pairs Real cost of air transport 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Source: ICAO, Boeing, OAG, IATA www.iata.org/economics 19 3.5 3 2.5 2 1.5 1 0.5
% ATKs Step change in airlines asset use since the GFC 68 67 66 65 64 63 62 61 60 59 58 Breakeven and achieved load factor (LF) Achieved LF Breakeven LF 2000 2002 2004 2006 2008 2010 2012 2014 Source: ICAO, IATA www.iata.org/economics 20
And the productivity of capital is improving Operating margin, % revenue Capital productivity, revenue/invested capital, US$ 10 8 6 4 2 0-2 -4 Capital productivity Operating margin 1.2 1.0 0.8 0.6 0.4 0.2-6 2000 2002 2004 2006 2008 2010 2012 2014 Source: ICAO, McKinsey, IATA www.iata.org/economics 21 0.0
% revenues Still driven primarily by the US 15% Operating profit margins by region, 2016 vs 2010 10% 2010 2016 5% 0% -5% N America Europe Asia Pacific Middle East Latin America Africa Source: ICAO, IATA www.iata.org/economics 22
Only a few generated economic profits consistently Ryanair Easyjet Emirates COPA Aeroflot Westjet Spirit Allegiant Wizz Alaska Vuelling Aegean Economic profit, cumulated 2005-2014 Average ROIC 12.5% 11.8% 10.0% 12.5% 10.5% 9.6% 12.1% 24.1% 12.4% 7.6% 7.3% 8.7% Source: McKinsey for IATA 0 500 1000 1500 2000 2500 Economic profit ((ROIC-WACC)*IC), US$ million www.iata.org/economics 23
What differentiates the few? Route network with time advantages/high QSI A brand that consumers value in some way Cost advantage versus key competitors Less capital? Shorter-haul? www.iata.org/economics 24
Are we measuring the right thing? Economic losses persisted for 70 years No apparent shortage of capital Operating cash flow covers leasing cost/depreciation Are aircraft really capital? Is WACC overstated? Are airlines doing better than we think? www.iata.org/economics 25
BACK UP SLIDES www.iata.org/economics 26
% change over previous year Wide variation in travel growth by country 25 Economic and passenger growth in 2015 to date 20 15 10 5 0 GDP Pax -5 India China US Eurozone Brazil Russia Source: Datastream, IATA Statistics www.iata.org/economics 27
Equity markets not always a good signal Index (January 2005 = 100) 500 450 400 350 300 250 200 150 100 Bird flu outbreak Shanghai composite share Domestic China air passenger trips (seasonally adjusted) Int'l air passenger trips to/from China (seasonally adjusted) 50 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Datastream, IATA www.iata.org/economics 28
Partly driven by major exchange rate shifts 130 120 110 100 90 80 70 60 50 40 Jet fuel price index (Jan 2014 = 100) 30 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Source: Datastream www.iata.org/economics % changes in jet fuel prices since Jan 2014 Russian ruble: -23% Brazil: -40% Euro: -54% Indian rupee: -60% Chinese yuan: -61% US dollar: -63% 29
Premium slowing yield decline in some markets North And Mid Pacific Europe-Asia South Atlantic North Atlantic Europe-Southern Africa Europe-Middle East Within Asia Asia-Southwest Pacific Within Europe North-South America Each route's share of industry-wide premium revenues 12.4% 14.7% 3.2% 24.6% 4.4% 5.8% 8.4% 3.3% 4.2% 2.9% -7% -6% -5% -4% -3% -2% -1% 0% 1% 2% Change in premium's share of revenues (Nov'15 vs. Nov'14, %-point) Source: PaxIS+, IATA www.iata.org/economics 30
Still vast potential in air travel marketes Air passenger journeys per capita (2014, log scale) 10.0 1.0 0.1 0.0 Jordan Oman Iraq Iran Saudi Arabia UAE Kuwait UK Zoomed portion of chart US Germany Norway Qatar Air passenger journeys per capita (2014, log scale) 10.0 0.1 $0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 GDP per capita (2014, US dollars) 1.0 'Normal' line B)...but a much bigger increase in trip frequencies is possible if the Iranian air market 'normalizes' over the coming years. Iran A) The expected increase in living standards in Iran now that sanctions have been lifted will underpin a rise in the average number of air journeys taken each year... 0.0 $0 $2,500 $5,000 $7,500 $10,000 GDP per capita (2014, US dollars) www.iata.org/economics 31 B A