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The economic downturn in 2009 and the oil price hike in 2008 had hit the airline industry hard. Now, with a revival in the economy, demand for air travel is improving.
Revenue and profits of U.S. carriers are increasing with a surge in ticket demand, higher fares as well as improved revenues collected from extra fees. Further, airlines are benefiting from industry consolidation, substantial improvement in yields, an upturn in the market and better capacity management resulting in enhanced supply-demand conditions.
The airline industry lost $16 billion in 2008 and $9.9 billion in 2009. Following a turnaround, airline industry would gain $15.1 billion in profits in 2010 as expected by the International Air Transport Association (IATA). However, the month of December affected most of the U.S. carriers yet again with travelers being snowed in across the U.S. and Western Europe. Canceled flights during the month are bound to hurt fourth-quarter revenues and profits of most of the airlines companies. The impact of loses from flight cancellations are expected to continue throughout 2011.
The IATA expects full-year 2011 to be tough and profits to soften to the level of $9.1 billion. Tougher conditions are likely to stem from rising fuel costs, stable yields, weak traffic volumes, slower global GDP growth and increased taxation, particularly in Europe, which are expected to suppress demand for air travel.
Worldwide air freight volumes rebounded in 2010 to the 2008 peak level. This rebound was particularly apparent in Asia, where volumes were well above previous peak levels established in 2007. Air freight in 2011 is expected to be stressed due to excess capacity and yield pressures as demand softens. Air freight rates will likely be stable in the first half of 2011 with strong growth in Asian demand. The second half will depend mostly on the general economic recovery and capacity discipline.
As stated by IATA, growth in Europe is lagging due to the debt crisis, slow economic growth and increased regulation. European airlines are expected to continue to underperform other regions, particularly the thriving Asian market. European airlines’ profits are expected to reduce to $100 million in 2011 from $400 million recorded in 2010.
Remarkably, Asia outstripped North America consecutively in 2009 and 2010. In 2010, Asia generated half of the airline industry’s overall profit of $7.7 billion, turning out to be the best producing region for the first time. Profits form Asia are, however, expected to slump to $4.6 billion in 2011. The downward trend is also expected in North America where 2011 profits are likely to be around $3.2 billion as against $5.1 billion in 2010.
Middle East air carriers reported 2010 profits of $700 million. The IATA expects this profit to slide to $400 million in 2011 owing to lesser demand in the region. Latin American carriers’ profits are also expected to decline to $700 million from $1.2 billion in 2010.
Higher fuel prices might temporarily stall the ongoing recovery in the airline industry in 2011. Nevertheless, we believe airline carriers will be able to pass on the higher cost to customers in the form of increased fares due to tight capacity.
We believe industry consolidation and various ancillary revenues will boost profitability and cost performance of most air carriers going forward. This is an opportune moment for companies to consolidate in order to regain their lost profits post-recession and operate more effectively.
Ancillary Revenue: A number of supplementary revenue streams helped the airline industry gain ground in 2010 after two years of drought. The airline companies are enforcing a number of fees on baggage, reservation change, pet travel, food and beverage to add to their revenue streams. These are expected to enhance revenues in 2011. The IATA projects total revenue of $598 billion for 2011, up slightly from $565 million reported in 2010.
Consolidation: Airline companies are consolidating in order to restore profits. The first consolidation in the industry was Delta Air Lines’ ([url=http://www.zacks.com/stock/quote/dal]DAL[/url]) successful acquisition of Northwest Airlines in 2008. The merger catapulted Delta to the position of the second largest airline in the world, generating significant cost savings for both the airlines.
In October 2010, United Airlines merged with Continental Airlines and formed a new company –– United Continental Holdings Inc. ([url=http://www.zacks.com/stock/quote/ual]UAL[/url]). This is the second merger that has created the world’s largest airline, overtaking Delta Air Lines.
The third merger is underway between the discount leader Southwest Airlines ([url=http://www.zacks.com/stock/quote/luv]LUV[/url]) and fellow discounter AirTran Holdings ([url=http://www.zacks.com/stock/quote/aai]AAI[/url]) announced in September. The acquisition of AirTran represents a unique opportunity for Southwest to expand its presence in key markets. Southwest will gain a valuable market presence in Atlanta, the busiest airport in the U.S. The transaction is expected to complete in the first half of 2011.
Technology Upgrades: Air carriers are involved in numerous technology upgrades and system automation for various activities such as airline reservation system, flight operations system, website, maintenance and in-flight entertainment systems. These upgrades enable companies to perform better, lower costs and enhance customer service.
Overall, we expect the industry to post strong growth in the upcoming years. However, near-term risks remain. These include volatile fuel prices, economic weakness, government regulation, unionization, airport infrastructure constraints and safety concerns. Some of the major risks are discussed below:
Oil Price Volatility: Airline operations are geared toward aviation fuel prices, a major variable cost. Fuel prices, though high currently, remain well below the 2008 levels of over $140 per barrel that had ravaged the airlines industry. Since, airline companies have limited ability to pass on the increased costs of fuel to their customers, they have to absorb the impact on their profits.
Oil prices are expected to escalate in 2011 as global economic growth leads to higher global oil demand. The IATA projects fuel prices to move higher from $79 per barrel to an average of about $84 per barrel in 2011. However, in order to offset the loss from high oil prices, the airlines are considering levying additional fees and charges on customers. Hedging strategies are another profit protection tool, and will be used extensively.
Unionization: The airline business is labor intensive. Most of the employees are unionized and depend on various U.S. labor organizations. The relation between airlines and labor unions are governed by the Railway Labor Act, which states that a collective bargaining agreement between an airline and a labor union does not expire, instead it becomes amendable as of a stated date. Failure to amend terms and conditions suitably may lead to work stoppages or strikes, hampering operations.
Federal Regulations: The airline industry is highly regulated, particularly by the federal government. All airlines engaged in air transportation in the U.S. are subject to regulations implemented by the Department of Transportation (DOT). Further, airlines are also regulated by the Federal Aviation Administration (FAA), a division of the DOT, primarily in areas of flight operations, maintenance and other safety and technical matters.
Currently, we have a neutral outlook on all major airlines –– Delta Airlines, United Continental Holdings, Southwest Airlines and Jetblue Airways ([url=http://www.zacks.com/stock/quote/jblu]JBLU[/url]). If U.S. carriers are able to combat the rising fuel price in 2011, we think most of the airline stocks will see an upside and the industry on the whole will continue to recover.
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