Airlines must be savvy to avoid past blunders

A diorama of the plane that Wilbur and Orville Wright first flew from Kitty Hawk, North Carolina, in December 1903

As airline industry margins recover, the industry will need discipline to avoid repeating the busts of the past.

By Hall Greenland

The airline industry’s unpleasant secret is that, since 1966, its earnings have never covered the cost of capital invested. Reflecting on this, canny investor Warren Buffett once quipped: “If there had been a capitalist at Kitty Hawk, the guy should have shot down Wilbur [Wright].”

Recent years have been kinder to airline investors. The global industry has had repeated profits after the losses caused by the global financial crisis. Aviation research group CAPA expects figures for 2015 to show margins at historic highs of 5.9 per cent, up from 2014’s 4.6 per cent, with 2016 slipping only slightly to 5.2 per cent.

Capacity under control

Buffett’s doubts have merit, though. The airline industry is notorious for blowing its profits by investing huge sums in pricey aircraft just as traffic volumes turn down. So far this century, CAPA says, airlines have exercised “capacity discipline”, with fleet growth in 2015 estimated to be about 3.9 per cent, well below the historical average of 4.5 per cent.

Passenger numbers up ...

Growth in revenue passenger kilometres (RPKs), the key airline demand metric, closely tracks overall economic growth – and global growth estimates by the International Monetary Fund (IMF) and others have been heading down for many months.

Nevertheless, CAPA expects demand will grow more strongly than supply, bolstered by surging Asian demand. It forecasts RPKs to grow by 6 per cent in 2016 and by 7.1 per cent in 2017. That should fill up some planes.

... and fuel costs down

The other major factor in airline profitability is the cost of fuel. Jet fuel accounts for between one-quarter and one-third of airline costs, and plummeting prices have been a tailwind for the industry.

CAPA warns, though, that the benefits of cheaper fuel could be cancelled out if global growth falls too far too fast and leads to declining passenger numbers.

Indeed, while airlines are now enjoying good earnings weather, CAPA believes it is the top of the cycle and that some descent is only a matter of time.

History suggests CAPA – and Warren Buffett – are right.

Climate control

Flying causes 3-5 per cent of global CO2 emissions, with emissions from air travel more than doubling since 1990. The industry has pledged to stop increasing emissions by 2020 – an ambitious target in view of projections of rising passenger numbers.

US$247 billion

Value of Apple’s brand, according to consultancy Millward Brown’s latest global brand value assessments.

Of Millward Brown’s 15 most valuable brands:

  • All of the top four are technology brands - in order, Apple, Google, Microsoft and IBM – and nine of the top 15 are in technology or telecommunications.
  • All of the top 15 are US-based except for three Chinese companies – Tencent (11th), Alibaba (13th) and China Mobile (15th).

Be true to yourself?

“The last thing a leader needs to be at crucial moments is ‘authentic’ – at least if authentic means both being in touch with and exhibiting their true feelings.

In fact, being authentic is pretty much the opposite of what leaders must do. Leaders do not need to be true to themselves. Rather, leaders need to be true to what the situation and what those around them want and need from them.”

– Stanford Graduate School of Business’s Professor Jeffrey Pfeffer in his new book Leadership BS

Airline ups and downs

“Legend has it that the Greek king Sisyphus was forever condemned to rolling a boulder up a mountain, only to see it roll back down again every time he neared the top. As the world’s airlines near the top of the margin cycle, will they be able to prevent the boulder from rolling back down?”

Global Airline Forecast, CAPA - Centre for Aviation

This article is from the February issue of INTHEBLACK.

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February 2016
February 2016

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