Saturday, October 21, 2017, 1:39 am

Moody’s sees slight contraction in airline industry’s operating profits


DUBAI: Airline industry will remain to have a stable outlook, Moodys’ Investors Service said said in its industry outlook for 2017 released on Tuesday, despite its “ expectations for a decline in the industry›s aggregate operating margin and a slight contraction in operating profit through 2018.”

Moody’s said even with the anticipated decline in aggregate operating margin, it will remain attractive relative to the industry’s historical levels, which will offset the declining trend in earnings over the next two years.

US carriers will continue to maintain the highest operating margins, helped in part by a mature domestic market, a more rational industry structure and their modest exposure to weaker foreign currencies. Legacy carriers in Europe and in increasingly competitive developing markets face greater challenges to growing their operating margins. Low-cost, low-fare carriers will advance their expansion across Europe and in long-haul, sustaining pressure on legacy operators. It will be much the same across Asia as well.

The airline industry outlook now focuses on its expectations for the level and trend of operating profit margin on a reported basis for rated airlines only.

“We expect the aggregate operating margin of rated airlines to fall to about 9.3% in 2017 and to about 8% in 2018, from a projected 10.8% in 2016. These fall within our 3% to 10% range for a stable outlook. We expect the aggregate operating profit of rated airlines to contract by about 11% in 2017 and about 12% in 2018, widening from a projected 1.2% contraction in 2016. These rates of change fall within our -20% to 20% range for a stable outlook.”

Moody’s expect improvement in the rate of change of unit revenues in 2017 in the US due to easier comparisons, slower growth in capacity, stability in demand and modestly higher fuel prices. In the US, flat unit revenues in 2017 would be a good result if fuel prices were to remain steady and unit revenue growth is likely to turn modestly positive for the year if the recent modestly higher fuel prices hold for the full year.

It also expects unit revenue growth to be weaker in Europe than in the US. Low-cost, low-fare carriers across the globe will be growing capacity at meaningfully higher rates than their legacy counterparts in their respective markets. Low-cost, long-haul operations, while in their development stage, will increasingly weigh on economy class fares in upcoming years. A sustained stronger US dollar and a weaker UK pound will help crimp passenger demand on long-haul routes to the US and within Europe. In light of Sterling›s decline following the UK›s June 2016 vote to exit the European Union, Ryanair (unrated) said that it will shift to Europe (particularly Germany and Italy) some of the capacity growth it had previously planned for the UK. This will increase low-fare competition on the continent.

Passenger demand will continue to grow, supported by modest, but steady, global economic growth and growth of air travel in the developing world, where disposable incomes are rising and air transportation regulations have loosened. “We project G-20 real GDP growth of 2.9% in 2017 and again in 2018, 30 basis points higher than our forecast for 2016. We project growth of US GDP of 1.6%, 2.2%, and 2.1% for 2016, 2017 and 2018, respectively.”

The expanding middle class and growing per capita income across Asia should continue to support RPK growth exceeding GDP growth in developing countries, although concerns about the strength of China’s economy could reduce the gap between RPK and GDP growth. We expect RPK growth to decline from an estimated 5.9% in 2016 to about 4.6% to 5.4% in 2017, which compares to IATA›s forecast of 5.1%. According to IATA, RPKs will continue to see mid-single-digit percentage growth on an aggregate basis; however, at a slowing rate. The Middle East and Asia-Pacific will continue to lead among all regions, with RPK growth of 9% and 7%, respectively. However, these rates represent declines of 1.8 and 1.9 percentage points in their respective growth rates. Africa and North America will also see percentage point declines in RPK growth of 1.3 points and 0.7 points, to 4.5% and 2.5%, respectively.

Latin America and Europe will buck the trend, seeing increases in RPK growth of 0.5 and 0.2 percentage points, to 4% and 4%, respectively.

The financial impact of weak oil prices is the main cause of slower growth in the Middle East, while terrorism threats have likely slowed Asian connecting traffic to Europe through these hubs.

Asia to Europe direct traffic has also slowed because of these factors. The growth in Latin America results from relatively stronger currencies, particularly the Brazilian Real versus the US dollar, and the expectation of Brazil exiting recession. The decline in North America reflects expectations for fewer visitors because of the strong dollar and carriers› attention to sustaining strong returns on invested capital (ROIC) and improving unit revenues (fares). This will require more conservative capacity deployment, led by the legacy carriers, and higher fares, which will trim some demand.

“We anticipate that growth in aggregate capacity will outstrip growth in aggregate demand by about half a percentage point. Capacity growth across geographic regions will vary, with the US growing in the low-single digits, Europe in the mid-single digits, and according to IATA, developing markets like Asia and the Middle East growing 7.6% and 10.1%, respectively. Demand growth will modestly trail capacity growth across all markets. Fuel cost pressures will weigh on profit generation, as will inflation of other costs, including labor, particularly in the US. Capacity growth is being spurred by the still relatively low cost of fuel, availability of older aircraft coming off leases, growth of low-cost carriers, deliveries of new aircraft that need to be placed in service (primarily in developing markets and increasingly by low-cost carriers, including in long-haul service).”

According to IATA, Latin America and Europe will be the two regions that grow capacity more in 2017 than 2016. Exceptions in Latin America will include LATAM Airlines Group S.A. and Gol Linhas Aereas Inteligentes S.A. (Caa3 negative), which have taken actions to manage through the region›s challenging economic environment of the past few years.

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