Airlines Mired in ‘Crisis’ as Margins Shrink

Airline profits forecast to total $28 billion in the three years through 2012 may be unsustainable as over-capacity and looming regulatory costs weigh on margins, the head of the IATA industry association said.

Airlines will generate net income equal to 0.8 percent of revenue next year, a margin that may shrink further if economic growth slows to less than 2.4 percent, Tony Tyler, chief executive officer of the International Air Transport Association since July 1, said in an interview in London.

“The natural condition of the airline industry is crisis,” Tyler said. “Occasionally, we’ve had short periods where the conditions are quite benign and everything goes quite well, and the danger is to believe that’s normal -- and that’s wrong.”

IATA’s forecast that airline earnings will drop almost 30 percent next year to $4.9 billion may prove to be too optimistic should the global economy slow further, said Tyler, who was CEO at Cathay Pacific Airways Ltd. (293), Asia’s No. 1 international carrier, for almost four years. The industry has lost money in seven of the past 10 years, even as global sales doubled to almost $550 billion.

“We’re assuming world economic growth will be just marginally down for next year,” Tyler said in the interview in London. “If we’re wrong with that then all bets are off.”

AMR Slumps

American Airlines parent AMR Corp. (AMR) yesterday tumbled the most since 2003, triggering automatic trading halts, on growing concern the third-largest U.S. carrier may be forced to seek bankruptcy protection. Deutsche Lufthansa AG (LHA), Europe’s second- largest airline, last month scrapped its full-year profit forecast after August’s results were worse than expected.

Figures released yesterday show growth in passenger traffic at IATA’s 230 member airlines slowed to an average 4.5 percent in August from 6 percent in July, including a 0.3 percent slump in U.S. domestic travel. Cargo demand, which is usually tracked by the passenger market, dropped 3.8 percent in the month versus a year earlier, more than double the pace of July’s slide.

“We are in a time now of declining profitability,” Tyler said. “The latest traffic figures would reinforce this and possibly point to risks, if anything, being on the downside.”

The industry’s precarious position is illustrated by the predicted margin of just 1.2 percent this year, even after seat occupancy reached 81 percent in August and premium traffic rose 8.2 percent over the first seven months, allowing many carriers to raise fares, the CEO said.

Carbon Costs

In addition to the global slowdown, airline profitability is being further jeopardized by the European Union’s plans to include aviation in the world’s largest cap-and-trade system for carbon dioxide emissions, Tyler said.

The plan, due to be implemented in January, is “misguided” because it’s not global and creates market distortions while infringing national sovereignty, Tyler said, citing opposition from countries including the U.S., China and India.

Program costs will amount to about $1.2 billion next year, IATA reckons, while estimates of the bill for the first decade of implementation range from $26 billion to as much as $85 billion -- more than double the $36 billion in net income from the industry’s three profitable years in the past decade.

“Airlines will try to recover it,” the executive said. “But it’s naive to think they will.”

While the industry itself needs to do more to eliminate excess capacity and regain control of yields, a measure of revenue per passenger that has been shrinking for decades, national sensitivities about the importance of flag-carrier airlines remain an obstacle to mergers, Tyler said.

Capacity Conundrum

“It would be a good thing for the financial health of the industry to have a more consolidated, less fragmented industry, but the big question is will it happen?” he said. “I’m skeptical. I think it will be a long and very slow process.”

Carriers also struggle to limit seat supply when markets begin to pick up, as they did earlier this year, Tyler said.

“We do better as an industry when there’s capacity constraint,” he said. “But it’s only when the whole market really tanks that everybody says ‘Ok, I give up.’”

U.S. airlines have shown most restraint, partly because the industry there has been consolidating and also because of its “terrible financial straits.” Often, the concern of missing out on a rebound overrides other concerns, Tyler said.

“The difficulty when you’re running an airline is that you’re worried all the time that if you cut, the other guy won’t,” he said. “Airline managers are actually rational, but added together the effect is that they look irrational.”

To contact the reporters on this story: Steve Rothwell in London at srothwell@bloomberg.net; Mathew Carr in London at m.carr@bloomberg.net

To contact the editor responsible for this story: Chad Thomas at cthomas16@bloomberg.net Stephen Voss at sev@bloomberg.net

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