SubscribeThe financial viability of the world's airlines has been subject to some sharp shocks over the past two years. The events of 9/11 were the first, followed by SARS and the Iraq War, and most recently fuel price escalation.
Many of the major US airlines were showing signs of declining profits even before 9/11. This paper looks at the post-9/11 financial fortunes of the airlines, focusing on the financial years 2002 and 2003.
The two financial ratios used here to gauge the financial health of the industry are operating margin and net margin. These measure the airlines' success in generating sufficient revenues to cover costs both before and after the so-called non-operating items such as interest charges, the profit from sales of assets and other provisions or adjustments.
However, without positive operating and net results airlines cannot generate sufficient cash to meet financial commitments and reduce the high borrowing that many of them have amassed over the past few years.
Clearly, the financial strength or weakness of airlines is also reflected in a number of areas that cannot be covered in this paper:
- Balance sheet structure and ratios such as debt/equity
- Future firm orders or commitments to purchase or lease aircraft
- Average age of fleet
- Management of risks such as fuel price and foreign exchange
A fuller understanding of airline finance and chance to discuss these key issues can be obtained by attending the Cranfield University course (Airline Finance: Appreciation and Issues) on the campus between 28 February and 4 March 2005. This has been successfully run annually over the past 12 years:
http://www.cranfield.ac.uk/soe/cpd/atm-finance.htm
Figure 1 shows the cyclical nature of world airline results, with severe downturns in the early 1990s and 2000s. The first was induced both by economic recession and the first Gulf War. Declining GDP led to lower traffic and overcapacity, lower yield, increased costs and falling load factors. The fear of taking trips by air further compounded these negative trends.
The second downturn was caused more by terrorist attacks and threats as well as health threats in Asia than economic factors. The second Gulf War also led to less flying, and many corporations suspended air travel for a period, as well as downgraded travel entitlements.
Figure 1 also shows that even in the better years, the operating ratio did not reach 6%, well below targets that many larger airlines have in place, for example British Airways' current target of 10%.
Figure 1: ICAO Scheduled airline financial results (1988 to 2003)
The difference between operating and net results is largely the interest paid on bank loans (less a much smaller amount of interest received on bank deposits). However, many airlines have sold and leased back aircraft recently, as well as disposed of non-core assets, for example in GDS service providers, handling or catering companies. This was principally to generate much needed cash, but it may also have produced some positive benefit to the net result.
Airlines, like other private corporations, also have a tendency to make large provisions in years when they are already in loss. This means that all the bad news can be reported together, and, if the provisions are overly pessimistic, a positive add-back can be taken in future years. The most common type of provision is for staff redundancy, but network rationalisation might also be allowed for, as well as write-downs on obsolete aircraft.
Operating margin by region
The global view of airline profitability disguises some interesting regional trends. The worst hit areas in 2002 were North and Latin America, the latter suffering indirectly from the North American downturn. Low cost competition and declining yields led to continuing problems for the US majors in 2003: Four of the largest US airlines, American, United, Delta and US Airways, collectively returned a negative operating margin in 2003 (-6%). If these carriers were removed from the total, the 2003 world operating margin would have been 2.1% in 2003, rather than the 0.9% reported.
Figure 2: Operating margins by region of airline for FY2002 and FY2003
Northwest and Continental also had negative 2003 margins, but low cost airline Southwest produced a positive 8.1%, as did recent LCCs JetBlue 10.4% and AirTran 10.9%.
In Asia, the high 2003 margins of Thai (13.2%), Cathay (7.5%) and Singapore (7.0%) were offset by the low margins returned by the Chinese airlines, Malaysian, ANA and Asiana. Japan Airlines was the only major carrier from the region with a negative margin (-3.5%).
In Europe, the highest 2003 margins from network carriers came from British Airways (5.4%), followed by Iberia (3.5%), with Air France (1.1%), KLM (2.0%) and Austrian (2.8%) scarcely above breakeven. Airline Business (the source of the above data) reported the SAS result for 2003 to have been 6.5%, but this was before lease and depreciation costs. The SAS Group (including hotels and other subsidiaries) true operating margin after deduction of those two items should have been -3.8%, and SAS Airline as -4.0%. On the other hand, Lufthansa Group's negative result (-0.9%) was distorted by a large loss from its catering subsidiary (and also a loss from its leisure airline and tour operator company), with the passenger airline subsidiary reporting a positive margin of 3.3%. Alitalia's troubles are clear from its -8.8% operating margin, as were those of Swiss (-12.8%).
The European average was pushed up by Ryanair's very healthy margin of 23.2%, with easyJet only 5.2%, with the other more recent LCCs not reporting their results, but unlikely to have been profitable (especially, flybe, germanwings, Air Berlin, bmibaby, dba, and the now bankrupt Volare, which make up a significant share of the rest).
Large airlines such as Saudia and Egyptair did not report profitability to Airline Business, but the largest airline based in this region, Emirates, earned a high margin of 13.2% in 2003. South African and El Al were close to breakeven, while Gulf was still making an operating loss, although their margin had improved from -8.5% in 2003 to -3.4% in 2003.
The largest Latin American carriers were the Mexican airlines owned by Cintra, with a negative result (-4.4%), and Varig (5.1%), Lan Chile (6.8%) and TAM Brazil (6.1) which all improved their results significantly from 2002 (TAM in particular which had a negative margin of 27.5% in 2002).
Operating margin by type of carrier
It is also interesting to distinguish between the type of carrier and focus of operations. This is shown in Figure 3, taking only the top 150 airlines from the Airline Business survey.
The number of cargo airlines reporting profits was small, and it is doubtful whether those such as UPS separated out their air transport operations from system results. The leisure airlines were part of travel groups such as MyTravel, or independent charter airlines. However, the Airline Business survey did not include the larger airlines such as those in the TUI group (the former Britannia) or Thomas Cook. Thus it is likely that profitability was over-estimated, since many of these were losing money or little above breakeven.
The surprise from Figure 3 was the regionals. This were composed mainly of North American airlines such as ATA, SkyWest, Mesa and Air Wisconsin, combined with a few Europeans such as Eurowings and Air Nostrum. All these except ATA reported operating margins in excess of 10%, with the best from Air Wisconsin (13.2%). The The operating margin for the US regionals as a whole was 11.5% in 2003, up from 6.2% in the previous year.
Figure 3: Operating margins by type of airline for FY2003
The high margins of the low cost sector have already been commented on, and in 2003, many of the European start-ups such as germanwings had not yet reported results. In 2004 margins are expected to be significantly down on 2003, with the inclusion of the start-ups and greater competition in the marketplace. In the US, low cost airlines AirTran, America West, ATA, Frontier, JetBlue, Southwest and Spirit together made a profit of US$0.8 million in 2003, compared to a $4.8 billion loss by the legacy carriers.1 The two groups of airlines' respective 2003 operating margins were +6.9% and -4.6%.
'Flag carrier' was defined as mainline national carriers, while the majors were those airlines having a turnover of greater than US$2 billion. The latter would thus just include Asiana, China Southern and the Virgin Group. The flag carrier return in 2003 was clearly depressed by the results of the US majors.
Net margin by region
The full impact of the serious financial state of the industry is shown in Figure 4. Even allowing for some exaggeration in provisions, the net margins were far from those required to pay dividends and provide an adequate return to investors.
Only airlines in the Asia-Pacific region showed a positive net result, although this declined to close to zero in 2003, following the SARS outbreak. These carriers did well to have a positive result in 2003, and did so against a drop in annual revenues of 7-10% for the majors. Cathay remained in profit, with a net margin reduced from 12.0% to 4.4%. This was managed with the help of voluntary staff support through reductions in pay and hours worked. For Singapore Airlines the decline in margin was lower, and both airlines were helped by an improved contribution from cargo.
Figure 4: Net margins by region of airline for FY2002 and FY2003
Conclusions and more recent developments
The US majors have had a disastrous two years following, but not solely due to 9/11. Low cost competition has accelerated, staff costs have been difficult to control, pricing has become more transparent, and business travel budgets have come under continued pressure. Similarly trends have affected European network carriers
The year 2004 was expected to be one of breakeven or better for the US carriers, having cut more than US$20 billion from costs since 9/11. However, the Air Transport Association of America President estimated that they would lose around US$ 6 billion, or a net margin of around -5%.2
Only Delta, United and US Airways, of the US majors, have reported operating losses for the first nine months to date of FY2004. For this period, Delta's operating margin was -9.0% (up from their margin of -7.9% for the same period in 2003), United -2.4% and US Airways -4.3%. Both American and Northwest had changed from a nine-month loss in 2003 to just above breakeven in 2004.
Investment banks are expecting all of the larger EU network carriers except SAS to make an operating profit in FY2004, in spite of higher fuel costs. Air France and Lufthansa should increase margins, with little change for British Airways and Iberia. Swiss came back into profit in the second quarter of 2004, and secured sufficient finance to last into 2005.
The two largest LCCs, Ryanair and easyJet are predicted to make somewhat lower profits on considerably increased turnover. They are facing some pressures on yields, and will find it hard to sustain their low cost levels. They will also face increasing competition from new low cost airlines based in continental Europe, some with deep pockets. Further consolidation may occur, but the business model looks likely to become established, with many of its features copied by the network carriers.
The European charter or leisure sector should be more immune to events in the US, Asia and the Middle East, but margins there are low or negative, and traffic growth has been well below trend. Later bookings and some switching to de-packaging of holidays (sometimes using low cost airlines) has not helped the charter and tour operator airlines' fortunes, even after quite considerable consolidation within Europe. They are also flying more longer haul services to destinations that could be subject to greater risks of health scares and political instability.
Most of the larger Asian airlines achieved significantly higher profits in the April to June quarter of 2004. The majority should achieve a profit overall in 2004, with perhaps the exception of Japan Airlines.
The International Air Transport Association (IATA) forecasts their members to make a loss of US$4 billion in 2004, after their pre-fuel price escalation estimates of breakeven (IATA website, 30 November 2004). IATA also report that this loss will take total industry losses for the past four years to US$35 billion.
This latest loss forecast equates to a negative margin of between 3-4%, little changed from 2003. For 2005, IATA expect that the industry will breakeven at an average oil price of $36 per barrel, with a $1.2 billion profit if prices fall further to average $34 per barrel.
Footnotes
1 These definitions are those used in a recent GAO Report (GAO-04-837T). The US legacy carriers are the majors excluding America West and Southwest.
2 Perry Flint, in Air Transport World, November 2004.
