The outlook for the global airline industry remains strong for the near future. Although air travel demand for the rest of the year is expected to be soft owing to weakness in certain emerging economies and a tepid cargo market in the Asia-pacific region, the next year looks promising on the expected consistency in economic recovery and improved business and consumer confidence.
The International Air Transport Association (IATA) projects overall airline profits of $11.7 billion for 2013, with 3.12 billion passengers in total. The current forecast marks almost an 8% reduction from the previous projection of $12.7 billion. Net profit margin is expected at 1.65%, down from 1.8% estimated previously. However, profitability is expected to increase to $16.4 billion in 2014 backed by a passenger count of 3.30 billion. Net profit margin is expected to grow 2.2% in 2014.
North America: With the world's largest economy improving, the outlook for North American airlines looks brighter for the rest of the year. Consolidation benefits, disciplined capacity, growing travel demand and a number of new and enhanced ancillary revenues also provide an impetus.
The carriers are performing impressively in terms of customer service with on-time arrivals, fewer customer complaints, lower cancellations, launch of newer routes and overbooked flights. As a result, these carriers are expected to generate $4.9 billion in profits in 2013, and $6.3 billion in 2014.
Asia-Pacific: These carriers are expected to post profits of $3.1 billion in 2013, much less than $4.0 billion recorded in 2012. A sluggish regional cargo market and softer air travel demand are primarily responsible for the poor showing. This will be partially offset by the strengthening of China's domestic market and growth of long haul markets owing to upbeat trade flows and business activities. The lingering tepidness of the region's cargo market will have an impact on 2014 profits, which are only expected to increase to $3.6 billion.
Middle East: Per IATA, profits from the Middle East carriers are expected to grow from $1 billion in 2012 to $1.6 billion in 2013 and $2.1 billion in 2014. Cost control measures, joint ventures and product innovations will drive the profitability. The region will likely witness strong traffic growth owing to solid growth in non-oil producing sectors in Saudi Arabia and UAE.
Latin America: The region is expected to swing back to profit, generating an income of $600 million against the $200 million loss suffered in 2012.Profits will further improve to $1.1 billion in 2014. Growing demand and capacity expansion stemming from increased trading and business flows with Asia and North America will likely offset the sluggishness in the domestic scenario.
Europe: As for the European airlines, the IATA expects this year's profit to reach $1.7 billion versus $400 million in 2012. Modest economic recovery, improving consumer confidence and increased manufacturing and export activity would drive traffic demand and support the profit surge. The growth is expected to continue next year, with the regions carrier accumulating a profit of $3.1 billion.
Africa: African air carriers this year are expected to face the same fate as last year, suffering a loss of $100 million, and will remain the same in the following year. Over the last few quarters, this territory has attracted immense attention owing to the untapped business opportunities it offers. However, the opportunities have not yet materialized into any substantial profitability.
Emergence of Several Airways in the Middle East
While the U.S. passenger carriers' steadies after domestic economic sluggishness, several Gulf-based airlines continue to fortify their positions within the global airline industry. Emirates has led the pack by expanding in Europe, Africa and the BRICS thus making Dubai one of the largest international connecting hubs in the world. Emirates' success was followed by the formation of two other Gulf airline superpowers, Etihad Airlines and Qatar Airways, which are trying to emulate their size and stature.
The large scale plane orders only confirm the long-term ambitions of these airlines. The three Middle Eastern carriers already have a much impressive fleet of wide-bodied jets as compared to U.S. carriers. Further, the Gulf giants have placed a staggering order worth $162 billion with The Boeing Company ( BA ) and Airbus, deliveries of which are expected over the next decade.
Emergence of these cash-rich airline companies remains a concern for the legacy carriers including the U.S. ones, which might lose a chunk of their international market as more passengers continue to move through the Gulf.
Underlying Factors for 2014 Profits
In the base-case scenario, there are several dynamics that will act as driving factors for the overall airline profits in 2014. These include:
Passenger & Cargo: Solid air travel demand, stability in emerging markets and economic recovery in Europe and North America would drive growth. The IATA suggests enhanced partnership between carrier and freight forwarder for recovery from the prolonged slump. The IATA projects global airline passenger growth of 5.0%, while cargo business will see an expansion of 3.7%. The average industry load factor is expected at a record level of 80.7%.
Coming to demand-supply balances, demand (measured in traffic) is expected to outpace capacity in 2014. While the projected capacity increase is 5.0%, air travel demand will likely see a 5.8% pickup, resulting in a marginal reduction of 0.5% in passenger yield in 2014.
Fuel Price Effect: Airline profit outlook depends on fuel prices, the major variable component in the industry. For 2014, average oil prices are expected to stay at $105 per barrel, lower than $111.8 per barrel in 2012 and around $109 in 2013 primarily due to stability in oil producing countries and increased fuel supply in North America. Lower fuel prices no doubt cut airlines' operating expenses, but it also indicates a slowing economy and the consequent fall in global air travel demand.
However, despite a soft macroeconomic outlook, if pricing remains stable the carriers will likely experience better profitability. The Association projects fuel cost of $215 billion in 2014, accounting for 30% of the overall operating cost.
Service and Fleet Restructuring: Air carriers at large are scrapping flights in many small and unprofitable airports in order to reduce their cost burden that has increased 55% over the period 2006-2013. The companies continue to replace old and depleted airplanes with new and upgraded ones. Though initially expensive, new and improved aircraft are more fuel efficient than the existing ones and will help in lowering operating and maintenance costs.
Over the next 20 years, global airlines are expected to invest in excess of $4 to $5 trillion in fleet development. Apart from the high demand from the oil rich Gulf nations, a major part of the fleet demand will also be driven by China and the continuous expansion of low-budget carriers around the world. For this, the airlines are banking on top aircraft manufacturers such as Boeing, Embraer SA ( ERJ ) and Airbus.
Over the long run, the carriers aim to replace their old narrow-body jets - A320's/B757-200/300 - with advanced narrow-body airplanes such as A-321, A320 Neo and the B737 Max, for better service and demand-supply equilibrium.
In October, Delta Air Lines Inc. ( DAL ) has announced its plan to purchase 40 new jets from European aircraft manufacturer Airbus in a deal worth $5.6 billion. Delta has ordered 10 A330-300 wide body jets and 30 narrow body A321 aircraft to be delivered between 2015 and 2017. Four A330 will be delivered in 2015, with four more scheduled for the coming years and the remaining two for 2017.
In October, JetBlue Airways Corporation ( JBLU ) entered into an agreement with Airbus to purchase 15 new A321 ceo and 20 new A321 neo aircraft. The carrier has also opted to upgrade the existing order of 8 new A320 ceo and 10 new A320 neo with 8 new A320 ceo and 10 new A321 neo.
Jet Renovation: With passengers demanding comfort and quality service along with proper security, airlines are focusing on aircraft redesigning with new and attractive products and services within the travel plan.
United Continental ( UAL ) is offering premium flat-bed cabin seats on every transcontinental flight between New York's John F. Kennedy International Airport and San Francisco/Los Angeles. Further, the aircraft will have 42 Economy Plus seats with additional legroom. This is in addition to flat-bed seats and personal on-demand entertainment system for its premium cabin passengers of long-route international flights. This will also provide flyers an added level of privacy and comfort along with multi-course meals and complementary wine plus personal staff attention.
Dallas, Texas-based Southwest Airlines ( LUV ) has upgraded 89 of its 737-700 fleet with the new Boeing Sky Interior, and renovating in-flight cabins and decorating interiors (known as Evolve) to improve customer satisfaction and experience.
Hedging Strategies: Hedging strategies are used by airline companies to cope with the rising fuel prices. The carriers use a combination of calls, swaps and collars at varying WTI crude-equivalent price levels to hedge.
U.S. Airlines - 20-Year Projection
The U.S. airline industry is expected to remain profitable over the next two decades given the improving worldwide aviation trend. However, growth may be held back until 2015 due to volatility in fuel prices and economic softness in the U.S. and Europe.
Although U.S. airlines experienced sluggish growth over the last few months, the demand for air travel is expected to nearly double over the next 20 years, as predicted by the U.S. Federal Aviation Administration (FAA). Passenger enplanements are expected to grow 2.8% to 757.2 million in 2014 and about 2.1% in the future, reaching $1.0 billion by 2027 and nearly $1.15 billion by 2033.
The FAA projects air traffic, customarily measured in billions of revenue passenger miles (implying a unit of one mile flown by one passenger), to grow many folds over the same period. Revenue passenger miles will jump from 815 billion reported in 2011 to 1.46 trillion by 2033 at an average annual rate of 2.8%.
International traffic is forecasted to move up at an average rate of 4.1% per year, reaching 402.9 million in 2033. Domestic travel will grow at a more modest clip of 2.8% annually. This projection assumes a steady economic recovery with no major headwinds like a large rise in oil price, changes in macroeconomic policy or financial meltdowns. Further, major North American airlines will raise capacity (available seat miles) at an annual rate of 2.1%,reaching 1.74 trillion by 2033.
Zacks Industry Rank
Within the Zacks Industry classification, airlines are broadly grouped into the Transportation sector (one of 16 Zacks sectors).
We rank all the 260-plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more visit: About Zacks Industry Rank.
As a point of reference, the outlook for industries in the top one-third of the list (with Zacks Industry Rank #88 and lower) is 'Positive,' the mid one-third of the list (between #$89 and #176) is 'Neutral,' while the last one-third ( from #177 and above) is 'Negative.'
The Zacks Industry Rank for the airline industry is currently #16, implying that the outlook remains positive on this sector for the next year backed by a steady surge in air travel demand.
The broader Transportation sector, of which airlines is a part, reflects a stable growth pattern. So far, 100% of the sector participants have reported third-quarter results, which have been fairly good in terms of both beat ratios (percentage of companies coming out with positive surprises) and growth.
Both earnings and revenue "beat ratio" stood at 63.6% in the third quarter. Total earnings for the companies in this sector grew 13.2% year over year on 4.5% revenue growth. Earnings showed a meaningful improvement from 8.3% year-over-year growth in second quarter 2013, while revenue growth was modest in comparison to 2.2% year-over-year growth in the second quarter.
The Consensus earnings expectation, pegged at 16.7% for the fourth quarter of 2013 and 15.8% for full-year 2013. The first quarter of 2014 is expected to register an earnings growth of 16.8%.The fourth quarter revenue expectation is pegged at 4.4% while full-year 2013 growth stands at 3.5%. The first quarter of 2014 is expected to register revenue growth of 4.6%.
We believe industry consolidation and various ancillary revenues will boost the profitability and cost performance of most air carriers going forward. This is a suitable time for companies to consolidate for higher profits and operational efficiency.
Additional Revenue Gains: A number of supplementary revenue streams helped the airline industry gain ground in 2012. Air carriers are adding novel features to their service and introducing products to improve passenger satisfaction and experience. The IATA projects total revenue of $708 billion for 2013 and $743 billion in 2014.
Mergers & Acquisitions: Airline companies unite in order to restore lost profits and broaden their perimeter. This was evident in the past mega mergers within the industry involving Northwest Airlines and Delta Air Lines in 2008, United Airlines and Continental Airlines in 2010,and AirTran Holdings and Southwest Airlines in 2011. All the three companies -- Delta, United and Southwest -- are long-term beneficiaries on capacity and cost fronts. It now seems that the mega mergers are back in the airline industry.
The much hyped impending merger between U.S. Airways Group Inc. ( LCC ) and American Airlines Inc, a subsidiary of AMR Corporation ( AAMRQ ) will create the largest global carrier.
Though the merged entity will have more pricing power and control over a larger number of slots, we believe it will have little effect on the dynamics of the U.S. aviation industry. This is because 80% of the same market will be dominated by the new American, United, Delta and Southwest.
Another leading U.S. airline, Delta Air Lines got the nod from the U.S. Department of Transportation (DOT) to acquire a 49% stake in British carrier Virgin Atlantic from Singapore Airlines. The alliance will hugely benefit customers with a broader network of flights, enhanced connectivity and convenient booking options.
Apart from these major acquisitions, various airline partnerships and alliances are vital to the overall growth of the industry. Low-cost airline JetBlue Airways signed an interline agreement with one of Europe's largest passenger carrier, British Airways. The two carriers will incorporate 18 daily transcontinental BA flights, more than 50 routes within the U.S. and more than 100 BA routes beyond London.
The latest round of consolidation would lead to long-term sustainability of the U.S. airline industry. Apart from having a larger pie of the market, the merged entities will gain from financial and operational synergies, thus creating values for its shareholders.
Expansion: North American carriers continuously strive to increase domestic and international flights. United will launch new daily roundtrip flights from its home base of Chicago to Elmira, Topeka and State College from early next year in addition to a couple of non-stop daily flights between the San Francisco-Atlanta and Los Angeles-Minneapolis routes. To expand its operations in Europe and the Asia-Pacific region United will non-stop flights between Chicago to Edinburgh and San Francisco to Chengdu before mid-2014.
Delta Air Lines is strengthening its position in the western coastal city of Seattle and is building it as an access point to Asia. Meanwhile, Southwest is looking to tap opportunities in the international market with its debut in the Caribbean, Central America, Latin America and Mexican markets by 2015, considering which it is building a new facility in the Houston airport.
JetBlue continues to successfully expand its network in two major growth regions - Caribbean and Latin America - as these comprise almost one-third of the company's total network. Allegiant Travel Company ( ALGT ) announced 18 new non-stop jet services, which include 10 new cities within its network. In an attempt to boost passenger revenues, Hawaiian Holdings Inc. ( HA ) has added 10 new international destinations including one in the U.S.
Technology Upgrades: Air carriers are opting for numerous technology upgrades and system automation for various activities such as airline reservation, flight operations and website maintenance. These upgrades allow the companies to function effectively and efficiently, minimize expenses and render better customer service.
United Airlines has introduced its all new mobile applications that run on Apple Inc.'s ( AAPL ) iOS 7 platform. The new application will offer new features, better functionality and an improved touch friendly design that will allow passengers quick access to information.
Additionally, Cathay Pacific, Malaysia Airlines, KLM, Delta, Qantas and British Airways have made Apple's iPad available to passengers in their lounges, rent them out in the air as well as use them as a self-service kiosk, customer survey tool and food ordering tool.
The major outperformers will be Spirit Airlines Inc. ( SAVE ) and China Eastern Airlines Corp Ltd ( CEA ) that have Zacks Rank #1 (Strong Buy). We also like a few Zacks #2 (Buy) Rank stocks such as Delta Airlines, Bristow Group Inc. ( BRS ) and Alaska Air Group Inc. ( ALK ). United Continental and Southwest hold Zacks Rank #3 (Hold).
Of the many challenges facing the industry, the most crucial ones include slow economic recovery, volatile fuel prices, natural calamities, industry consolidation, government regulation, unionization, airport infrastructure constraints, technological investments and safety concerns.
Pitfalls of Industry Consolidation: Over the last few years, the U.S. aviation industry has seen several consolidations with the most significant one being United and Continental's in 2010. With major and legacy airlines of the U.S. joining hands, the total number of carriers operating within the industry is becoming less. This results in less competition, higher airfares and increased fees, thus affecting the flyers.
Cannibalization: Smaller airlines could also be dominated by their bigger counterparts, which will try to drive them away either via price competition or through strategic acquisitions.
Oil Price Volatility: Fuel price volatility continues to be one of the significant challenges, as fuel costs are largely unpredictable. Airline carriers' ability to pass along the increased costs of fuel to its flyers is restricted by the competitive nature of the industry. Although fuel price is currently hovering on the lower side, even a small change in fuel price can significantly affect profitability.
Unionization: The airline business is labor intensive. Most of the employees are unionized and depend on various U.S. labor organizations. The relation between airlines and labor unions are governed by the Railway Labor Act, which states that a collective bargaining agreement between an airline and a labor union does not expire - instead it becomes amendable as of a stated date.
Failure to amend terms and conditions suitably may lead to work stoppages or strikes, and thereby hamper operations. Similarly, the airline industry in rest of the world is also exposed to labor related concerns - as recently found by Aer Lingus. The Irish carrier's largest trade union is planning to conduct a vote for industrial action after their talks with the company failed to find an opening over a pension related dispute.
Federal Regulations: The airline industry is highly regulated, in particular by the federal government. All companies engaged in air transportation in the U.S. are subject to the regulations implemented by the Department of Transportation (DoT). Further, airlines are also regulated by the Federal Aviation Administration, a division of the DoT, primarily in areas of flight operations, maintenance and other safety and technical matters.
Large Investments: The air carriers are investing a lot of money to enhance their products and services to gain a competitive edge. However, returns from these investments are uncertain.
Technological Failure: Technological investment is a key expense for air carriers. The profitability of airlines could be affected by technology glitches or if the company fails to invest in new technologies.
We expect Republic Airways Holdings Inc. ( RJET ), to underperform the broader market. RJET holds a Zack Rank #5 (Strong Sell).
APPLE INC (AAPL): Free Stock Analysis Report
ALLEGIANT TRAVL (ALGT): Free Stock Analysis Report
ALASKA AIR GRP (ALK): Free Stock Analysis Report
BOEING CO (BA): Free Stock Analysis Report
BRISTOW GROUP (BRS): Free Stock Analysis Report
CHINA EASTN-ADR (CEA): Free Stock Analysis Report
DELTA AIR LINES (DAL): Free Stock Analysis Report
EMBRAER AIR-ADR (ERJ): Free Stock Analysis Report
HAWAIIAN HLDGS (HA): Free Stock Analysis Report
JETBLUE AIRWAYS (JBLU): Free Stock Analysis Report
SOUTHWEST AIR (LUV): Free Stock Analysis Report
REPUBLIC AIRWAY (RJET): Free Stock Analysis Report
SPIRIT AIRLINES (SAVE): Free Stock Analysis Report
UNITED CONT HLD (UAL): Free Stock Analysis Report
To read this article on Zacks.com click here.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.