Airline

Financials

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One of the most important short-term drivers shaping the airline industry has been the large fall in the price of oil. Capacity decisions, including aircraft retirement, route planning, and pricing were all influenced by the input cost of fuel. The lower price of oil tempts airlines into backsliding on their strategy of disciplined growth, as it reduces the pressure to cut costs and capacity.

The rapid reduction in the barrel price from USD 100 to USD 30 made a massive difference to the shape of the industry; particularly in an industry which typically records such low profit margins.

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Beyond the obvious near-term positive impact on balance sheets and cash flows, there is the ever-increasing threat of overcapacity. The glut of available seats has impacted ticket prices, leading to significant fare discounting. The market became even more strongly stimulated by supply driven growth, in the form of lower air fares that may not be sustainable over the long run.

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The current economic performance of the airline industry is no guarantee of future results. Performance, by definition, is a snapshot of the past. Profits may now erode and gains may be wiped out with rising oil prices, bringing the profitability stake back to the rare and the few.

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Oil Prices vs. Airline Profits

Source: IATA, ‘Economic Performance of the Airline Industry’, June 2018, ‘2018 Average Crude Oil Price Forecast’: World Bank, April 2018
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The ability to shift towards sustainable revenue unit growth, instead of aggressive capacity expansion, is crucial to set the table for margin sustainability in the years ahead as oil price rises and labor unions demand better working rules after years of wage austerity and massive layoffs.

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A three-year long slump in oil price has resulted in a hugely positive financial impact on the airline industry’s costs, but airlines must consider the importance of capacity discipline so that profits can outlast the fuel cycle.

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Competitive cost structure is critical to long-term sustainability. The extent to which rising fuel costs affect profitability in the airline industry depends on the ability to push up unit revenue and, hopefully, margins.

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The airline industry is notorious for its boom and bust cycles and is unforgiving to airlines that are unable to adapt in time. The fluctuations in the marketplace put the carriers under severe pressure to sustain profitability, making fleet optimization critical in a variable business cycle.

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In a high-volume, low-margin environment, it is obvious that a competitive cost structure remains strategically important for business sustainability, but greater control in matching aircraft capacity to market demand results in resilient profit growth with a greater percentage of higherfare passengers, increasing both yields and load factors.

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The single-aisle sector will undergo either a fundamental change or an evolution, once it proves equally inefficient to be deploying larger single-aisle aircraft with more seats than can be profitably filled. Even from an operational point of view, their size means that the number of airports these aircraft can serve today is limited.

The bottom line is that this will be another great year for the industry, but the peak of this particular cycle is behind us. 2018 is expected to be the ninth year in a row of aggregate profitability, but the industry is facing a soft landing.

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The key to sustainability for an airline will be less about adapting its network to its capacity, and more matching capacity to its network. Some of the world’s most profitable airlines today operate numerous fleets and sub-fleets, tailored to various missions. A synonym for complexity can also mean sophistication, and a more diverse fleet, if well-managed, can be a profitable one.