On Monday, the International Air Transport Association (IATA) raised its 2013 forecast for airline industry profits to $12.7 billion from $10.6 billion previously. More efficient use of assets (aircraft utilization) is credited as the main driver behind the increase, and we point to higher load factors (occupancy) as the primary reason for that.
According to the IATA, the industry passenger load factor is expected to average a record high of 80.3% in 2013 (meaning that 4 out 5 seats on every plane are filled, on average). The record number is roughly 6 percentage points above that achieved during the doldrums of 2006, and the first time in history it is expected to average above 80%. The group is also expected to benefit from slightly lower average crude oil prices during 2013 ($108/barrel, was $111.80/barrel in 2012), offsetting moderately lower economic growth forecasts (led by the Eurozone).
Does this improved performance mean that the airline business is finally a good one?
Absolutely not!
One thing Valuentum members know more than anything is just how poor the structural characteristics of the airline business are (click here for a refresher). Tony Tyler, the IATA’s Director General and CEO had some pretty amusing comments about the industry’s miniscule net margins:
“This is a very tough business. The day-to-day challenges of keeping revenues ahead of costs remain monumental. Many airlines are struggling. On average airlines will earn about $4 for every passenger carried—less than the cost of a sandwich in most places.”
If the “sandwich” comparison isn’t enough to scare investors away from this highly leveraged business—small changes in load factor or pricing (yields) drive large changes in profits—the $12.7 billion profit represents a return on invested capital of just under 5%. We peg most airlines’ cost of capital north of 10% (well above the IATA’s average industry estimate of 7%-8%). What does this mean? Well, even during improving (record) times such as this year, airlines are destroying economic value (the industry’s ROIC less WACC is negative).
In the coming years, the group will have to see even more improvement to operating performance in order to generate sufficient returns on the burgeoning aircraft order books at Boeing (click ticker for report: ) and Airbus–which drive our very bullish outlook on commercial aerospace (not airline) shares.
Global Airline Sector Constituents: Alaska (ALK), Allegiant (ALGT), China Eastern (CEA), China Southern (ZNH), Copa (CPA), Delta (DAL), Gol Linhas (GOL), Hawaiian Holdings (HA), JetBlue (JBLU), Lan Airlines (LFL), Republic Airways (RJET), Ryanair Holdings (RYAAY), SkyWest (SKYW), Southwest (LUV), Spirit Airlines (SAVE), United Continental (UAL), US Airways (LCC).