In the first installment of a new regular column, IATA’s Chief Economist Brian Pearce discusses the drivers behind the Association’s industry profit forecast for 2017
Airline profit margins halved in the first quarter of this year, compared to a year ago. Although unit revenues are showing signs of stabilizing and traffic growth is strong, a fierce acceleration of unit costs squeezed margins.
Yet airline share prices were up over 20% year-on-year by the end of May, and financial markets expect an improvement ahead. We agree. Our latest forecast upgraded expected airline profits in 2017 from our previous release at the end of last year.
You can already see the impact of the upturn on demand for air travel and cargo
But why is the outlook better than the first quarter experience?
The most important change in the past six months is that the economic cycle has turned up, which is not what we—and many others—were expecting after Brexit, the US elections, and the potential for political upsets in Europe.
Business and consumer confidence have risen sharply. It looks today like a more business-friendly environment, and that drivers such as fiscal expansion in China were underestimated. Brazil and Russia have emerged from recession, and forecasters like the IMF have revised up their forecasts for global GDP growth this year.
The airline industry typically does better during economic upturns. You can already see the impact of the upturn on demand for air travel and cargo.
Air travel grew by almost 8% year-on-year in the first four months of the year, way above its 5% 20-year trend growth rate.
Cargo has had a miserable time since 2010, suffering from setbacks to globalization, but over the past four months growth has been even stronger than travel, at 9.3%.
The industry is more resilient, and there has been structural change in key markets and with ancillaries
Companies have been surprised by the strength of the economic upturn and have turned to air cargo to restock quickly. We revised higher our 2017 forecasts for air travel and cargo volume growth considerably.
But strong growth in demand has never been enough to guarantee profitability in the airline industry. In fact, the first quarter experience of a squeeze on profits from soft yields and rising unit costs has been a recurring experience in the past.
Why do we think that this time it will be different, and the second half of 2017 better than the first?
Well, we think it will be different to a degree anyway. Industry profits have peaked. Since the first half of last year we’ve seen a decline, albeit from high levels. The industry is more resilient, and there has been structural change in key markets and with ancillaries. Balance sheets are stronger, particularly in the US.
But the industry is still not immune to labor market cost pressures and the openness of most markets to new entry. There has been some erosion of performance over the past year as a result. What is different now is that the economic upturn should provide some relief to those pressures.
A forecast return on capital of 8.8% in 2017 is much better than we had expected
Six months ago we had expected to be in a slowing growth environment, with falling load factors undermining unit revenues and profitability.
It now looks as though demand growth will be really good this year, and faster than airline plans to add capacity.
That’s an environment that should support airline profitability. Still down on 2016, but a forecast return on capital of 8.8% in 2017 is much better than we had expected.