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Strong recovery for the airline industry despite capacity constraint concerns

Strong recovery for the airline industry despite capacity constraint concerns

Strong recovery for the airline industry despite capacity constraint concerns

The most recent results of major airlines focused on the UK market show an extraordinary level of positivity. Profits at British Airways owner, IAG in Q2 2023 soared by 400% and broke previous records for that quarter. EasyJet has announced a $30bn order for Airbus planes as part of setting an ambitious annual profit before tax target of £1bn as compared to the current level of £460m. Ryanair announced record profits of over €2bn for its latest six months’ trading and will start paying regular dividends to shareholders for the first time in its history.

The facts behind these stories reveal an industry worldwide which is succeeding not despite its operational challenges, but because of them.

Demand is closing in on pre-pandemic levels

According to a recent report by ING, global passenger travel volume in 2023 is expected to end up close to 90% of its pre-pandemic levels, driven mainly by short haul and domestic travel rather than international flights. This recovery is uneven regionally, with the USA already ahead of 2019 and Europe at around 92% in June 2023, but Asia-Pacific still only at two thirds.

Leisure vs. business travel

Leisure travel is booming, particularly certain sectors including the premium market, international long haul and domestic first class bookings. Business travel has also picked up post-pandemic, but not to the same extent. The aviation analytics firm Cirium reported earlier this year that it had only reached 75% of pre-pandemic levels, with notable weakness on short haul routes.

Strong ticket price rises drive higher revenues

ING also predicts that the key measure of Revenue Passenger Kilometer (RPK) will grow by 25% in 2023 compared to 2022, although this will moderate in 2024. Despite the cost of living crisis, people are prioritising previously postponed trips. Rapid recent rises in pay rates are key to this. Just 10% of the global population in the upper middle and higher income classes are responsible for almost 90% of air passenger traffic.

Upward cost pressures almost across the board

Lower aviation fuel costs are almost the only bright spot amid a sea of inflation-linked cost uplifts. Labour costs have soared in an historically tight market. Consultants AeroDynamic Advisory estimate that airlines will spend $110bn on maintenance in 2023, equivalent to 14% of revenues, compared to historic levels between 8% and 10%. Most other costs are higher.

Profitability is rising despite cost pressures

Current market dynamics are expected to generate a return to profitability for many airlines, with revenue growth outpacing cost increases. According to IATA, the average operational profitability (earnings before interest and tax) of the airline sector should recover to 2.8% in 2023, with bottom line profits marginally above 1%. Good as these figures are by comparison with the recent past, they demonstrate exactly how vulnerable airlines are to sudden changes in their business model.

Supply-side capacity constraints

Coupled with soaring demand, capacity restriction has the effect of driving up fares and is the most significant of the factors underlying improved profitability for airlines. The sources of this constraint are many, including:

  • Significant aircraft delivery delays, especially of the high-demand narrow body specification units;
  • Issues with new generation engines;
  • Labour shortages, whether for pilots, cabin crew, security, ground handling and air traffic control staff;
  • Limited maintenance capacity.

Sustainability and carbon neutrality is an ongoing challenge

In October 2021, IATA members passed a resolution committing the industry to achieving net zero by 2050. This target is focused on delivering maximum reduction in emissions at source, through the use of sustainable aviation fuels, innovative new propulsion technologies, and other efficiency improvements (such as improvements to air traffic navigation).

Much of this will be a long term and difficult project, but in the short term, the delays to the delivery of more modern and efficient planes will not only delay any reduction in emissions, but leave airlines less efficient and its fuel costs higher. New generation aircraft are usually between 10% and 25% fuel efficient.

What next for the airline industry?

2023 and 2024 may prove to be a high water period for profitability, as passenger demand continues to drive revenues higher than costs. If demand growth and ticket price insensitivity turn out to be less durable than capacity constraints, then the industry will have to find ways to deal with a fundamental truth about its business model. Without growth, how can it drive down its unit costs? Without falling unit prices, how can it be profitable if travellers once more become price sensitive or if demand reduces?

There are also global events to live with. The pandemic and the Ukraine war caused huge disruption to aviation, now there is the threat of regional conflict in the Middle East. What other Rumsfeldesque unknown unknowns might be coming at us through the tunnel of uncertainty?

 

Read our latest Travel Sector Report to find out more about the sector as a whole


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