The airline industry - in serious financial trouble
by Lida Mantzavinou
15 June 2012
Weaker airlines cannot compete in a hostile economic environment and may be forced to declare bankruptcy - writes consultant
The airline industry globally is expected to see its net profits reduced by more than $5bn, compared to 2011, but still remain marginally positive. This is nothing new. During a period of nearly 70 years, airlines' net profit margins have rarely exceeded 3 per cent, making carriers the worst performers in the air transport chain. However, with the looming threat of a major breakdown in the eurozone area and with fluctuating fuel prices that will remain at above $100 per barrel - positive results could easily turn into losses by the end of the year.
Furthermore, the European Emissions Trading Scheme is an added burden to airlines. It is expected to add 1 per cent to an average return air fare. Intensifying price competition does not allow carriers to pass on the cost to the passenger. Fears of a full blown trade war between foreign and European Union aviation authorities are exaggerated and negotiations for horizontal agreements that would liberalise the industry have been blocked - until a consensus is reached through the International Civil Aviation Organisation. All these issues put pressure on the European Commission to postpone implementation of the ETTS up to 2013, when the ICAO will take control of the matter during its assembly.
The use of alternative fuels in aviation, regularly discussed and with multiple flight trials around the world, is still in its infancy. Biofuels are currently, as they have been proven, an unsustainable source and an expensive alternative; competing with oil prices at $125 to $150 per barrel. According to industry's estimations, this is a level at which the airline industry incurs losses. To date, biofuel trials have been conducted by airlines - such as Lufthansa - with the financial support of governments. With limited and unsustainable production, high prices and an apparent lack of future government funding - biofuels will remain on the fringe for the foreseeable future.
Meanwhile, European airlines reported $1.7bn in net losses in the first quarter of 2012. The number is not so striking, as traditionally the first three months is the worst performing quarter for airlines. Although with expectations of a full blown eurozone crisis, the future is bleak. At the same time airlines come better prepared, having already started major restructuring programmes. Lufthansa and AF-KLM, two of the three largest airline groups in Europe, are now implementing ambitious cost-reduction programmes. The fact that the behemoths of European air travel are in trouble should be both worrying and positive for the industry. It is worrying because weaker airlines do not have the same tools to compete in a hostile economic environment and may declare bankruptcy. But positive, as for the first time airlines are being proactive and have a long-term view in their restructuring efforts.
We expect that in 2012 and 2013, many weaker European airlines will be forced to close down. Others will become acquisition targets for foreign investors, willing to provide a lifeline in exchange for expansion opportunities through valuable route networks. We know that EU regulations do not yet allow full ownership or taking effective control of European airlines by foreign investors and this is still a deterrent to foreign direct investment. Nonetheless, restrictive bilateral agreements and congested European airports make small shareholding stakes increasingly attractive. Over the past couple of years Etihad acquired stakes in both Aer Lingus and Air Berlin, while Turkish Airlines invested in Bosnia's flag carrier. Similarly, Air China has expressed an interest to acquire a stake in LOT; while TAP Portugal and Scandinavian SAS are still 'in play' as acquisition targets.
To conclude, the European aviation market is still very inefficient and we expect industry restructuring and consolidation to intensify in the next couple of years. Consolidation allows the creation of synergies, cost efficiencies and economies of scale. At the same time, the implementation of major restructuring programmes is also key in achieving sustainable profitability. Restructuring should concentrate on cost-cutting, fleet modernisation and a streamlining of route networks and revenue management systems - among other measures.
Lida Mantzavinou is an analyst for the Frost & Sullivan consultancy group
The airline industry globally is expected to see its net profits reduced by more than $5bn, compared to 2011, but still remain marginally positive. This is nothing new. During a period of nearly 70 years, airlines' net profit margins have rarely exceeded 3 per cent, making carriers the worst performers in the air transport chain. However, with the looming threat of a major breakdown in the eurozone area and with fluctuating fuel prices that will remain at above $100 per barrel - positive results could easily turn into losses by the end of the year.
Furthermore, the European Emissions Trading Scheme is an added burden to airlines. It is expected to add 1 per cent to an average return air fare. Intensifying price competition does not allow carriers to pass on the cost to the passenger. Fears of a full blown trade war between foreign and European Union aviation authorities are exaggerated and negotiations for horizontal agreements that would liberalise the industry have been blocked - until a consensus is reached through the International Civil Aviation Organisation. All these issues put pressure on the European Commission to postpone implementation of the ETTS up to 2013, when the ICAO will take control of the matter during its assembly.
The use of alternative fuels in aviation, regularly discussed and with multiple flight trials around the world, is still in its infancy. Biofuels are currently, as they have been proven, an unsustainable source and an expensive alternative; competing with oil prices at $125 to $150 per barrel. According to industry's estimations, this is a level at which the airline industry incurs losses. To date, biofuel trials have been conducted by airlines - such as Lufthansa - with the financial support of governments. With limited and unsustainable production, high prices and an apparent lack of future government funding - biofuels will remain on the fringe for the foreseeable future.
Meanwhile, European airlines reported $1.7bn in net losses in the first quarter of 2012. The number is not so striking, as traditionally the first three months is the worst performing quarter for airlines. Although with expectations of a full blown eurozone crisis, the future is bleak. At the same time airlines come better prepared, having already started major restructuring programmes. Lufthansa and AF-KLM, two of the three largest airline groups in Europe, are now implementing ambitious cost-reduction programmes. The fact that the behemoths of European air travel are in trouble should be both worrying and positive for the industry. It is worrying because weaker airlines do not have the same tools to compete in a hostile economic environment and may declare bankruptcy. But positive, as for the first time airlines are being proactive and have a long-term view in their restructuring efforts.
We expect that in 2012 and 2013, many weaker European airlines will be forced to close down. Others will become acquisition targets for foreign investors, willing to provide a lifeline in exchange for expansion opportunities through valuable route networks. We know that EU regulations do not yet allow full ownership or taking effective control of European airlines by foreign investors and this is still a deterrent to foreign direct investment. Nonetheless, restrictive bilateral agreements and congested European airports make small shareholding stakes increasingly attractive. Over the past couple of years Etihad acquired stakes in both Aer Lingus and Air Berlin, while Turkish Airlines invested in Bosnia's flag carrier. Similarly, Air China has expressed an interest to acquire a stake in LOT; while TAP Portugal and Scandinavian SAS are still 'in play' as acquisition targets.
To conclude, the European aviation market is still very inefficient and we expect industry restructuring and consolidation to intensify in the next couple of years. Consolidation allows the creation of synergies, cost efficiencies and economies of scale. At the same time, the implementation of major restructuring programmes is also key in achieving sustainable profitability. Restructuring should concentrate on cost-cutting, fleet modernisation and a streamlining of route networks and revenue management systems - among other measures.
Lida Mantzavinou is an analyst for the Frost & Sullivan consultancy group
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