The second reduction in anticipated profitability of the airline industry by IATA in the space of only just over four months points to continued market uncertainty, contrasting with the effects of the credit crunch that has the potential to force lease rentals higher. The International Air Transport...
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The second reduction in anticipated profitability of the airline industry by IATA in the space of only just over four months points to continued market uncertainty, contrasting with the effects of the credit crunch that has the potential to force lease rentals higher.
The International Air Transport Association (IATA), the industry funded organization, has now indicated that airline profitability for 2008 is expected to amount to $4.5 billion - still a profit. This contrasts with a September 2007 prediction of $7.8 billion and the revised December 2007 forecast of $5.0 billion. The fall for such a short term projection - residual value projections are sought for 20 years but are generally expected to remain unchanged from one year to the next - is significant and has the potential to impact aircraft values. The IATA rationale for the near halving of the profit forecast is due to the sustained rise in fuel prices, the credit crunch which has affected consumer confidence, the inability of operators to further cut costs and the difficulty that operators will face in undertaking asset sales. In 2007 alone IATA cite the contribution of $15 billion worth of asset sales to airline balance sheets. The economy is expected to slow to 2.6 percent while oil prices will average $86 a barrel. Fuel now represents 32 percent of operating costs with a total bill of $156 billion per annum.
The effect of the anticipated slowdown by IATA is expected to be exacerbated by other factors. The number of aircraft deliveries continues to rise while demand, at least outside of North America, continues to wane. As with previous downturns new aircraft will increasingly be used to replace existing equipment rather than act as growth. Yields, adjusted for inflation and the weakness of the dollar, are still expected to decline by more than four percent for 2008 compared to 3.2 percent for 2007. Moreover, the Open Skies agreement between the EU and the U.S. is anticipated to see further competition, depressing fares.
IATA has seen North America taking the brunt of the reduction in profitability levels falling from the 2007 forecast of $2.8 billion to the $1.8 billion of today. Europe is down by 15 percent and the Middle East by 30 percent. Forecasts for other regions, notably Asia-Pacific, remain largely unchanged. The reduction in the forecast is North American- centric, a factor that has to be noted when reviewing overall demand. Finally IATA expects that consolidation is inevitable for an industry that sees only a profit margin of only one percent in the good times.
The problems facing the industry are severe and values of aircraft are already being negatively impacted. Aircraft being grouped for sale by lessors are expected to face something of a discount due to the uncertainty. Yet this contrasts with the experience of lease rentals. The credit crunch is driving up the cost of borrowing despite the drop in interest rates. Lessors are inevitably anxious to pass on any additional costs and therefore while asset values may be under threat the pressure on lease rentals is positive. The weakness of the dollar continues to play a role in offsetting the effect of any higher rentals though the inability of the U.S. airlines to enjoy such benefits underline why IATA has found it necessary to change its forecast.
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