In a major turnaround, the airline industry recorded $16 billion in profits last year, after losing $16 billion in 2008 and $9.9 billion in 2009. But 2010 was most likely an earnings peak, as a host headwinds have come together to bring down industry profits.
The International Air Transport Association (IATA) expects 2011 profits softening to the level of $8.6 billion from its previous expectation of $9.1 billion. The factors weighing on earnings include the escalating fuel prices, weak traffic volumes and the March 11 catastrophe in Japan, which are expected to suppress demand for air travel.
Worldwide air freight volumes rebounded in 2010 to the 2008 peak level. This rebound was particularly apparent in Asia, where volumes were well above previous peak levels established in 2007. Air freight is expected to be unchanged in 2011 due to excess capacity and yield pressures as demand softens.
As stated by IATA, Asia-Pacific is expected to generate $3.7 billion in profits in 2011, the highest in the industry, outstripping other regions. However, the region's profits would be down substantially from the 2010 level of $7.6 billion. Despite the strong economic growth, aggressive inflation measures in China are weakening the demand for air travel in the country.
North American carriers are facing challenges from rising fuel prices. Profits in the region will likely fall to $3.2 billion from $4.7 billion reported in 2010. Growth in Europe is also lagging due to the ongoing banking and government debt crisis. European airlines' profits are expected to drop to $500 million in 2011 from $1.4 billion in 2010.
The African air carriers are expected to break even in 2011 compared to profits of $100 million made in the prior year. Strong economic growth and high demand for air travel will be offset fully by intense competition from Middle Eastern carriers. Middle East air carriers reported 2010 profits of $1.1 billion. The IATA expects this profit to slide to $700 million in 2011, owing to political instability in that region. Latin American carriers' profits are also expected to decline to $300 million from $1 billion in 2010.
Persistently rising fuel prices since last December have surfaced as a major headwind to the airlines industry. Crude oil prices are currently trading around $110 per barrel, representing the steepest rise in more than two years. Oil prices have already risen more than 21% this year due to the ongoing economic unrest in the Middle East.
Following the massive earthquake and Tsunami in Japan on March 11, air carriers introduced drastic cuts in their capacity. Fears of flying to Japan are increasing, owing to the still-unsettled nuclear situation, and the demand for air travel in the country is dropping, hurting the overall airline profitability.
However, the carriers will likely be able to handle this situation as conditions stabilize in Japan. In all probability, the capacity cuts are temporary, and should last only for the next two–three months. Also, the carriers are combating rising fuel prices with higher fares and extra fees.
We believe industry consolidation and various ancillary revenues will boost profitability and cost performance of most air carriers going forward. This is an opportune moment for companies to consolidate in order to regain their lost profits post-recession and operate more effectively.
Ancillary Revenue: A number of supplementary revenue streams helped the airline industry gain ground in 2010 after two years of drought. The airline companies are enforcing fees on baggage, reservation change, pet travel, food and beverage to add to their revenue streams. These are expected to enhance revenues in 2011. The IATA projects total revenue of $594 billion for 2011, up slightly from $565 million reported in 2010.
Consolidation: Airline companies are consolidating in order to restore profits. The first consolidation in the industry was Delta Air Lines' (NYSE: DAL) successful acquisition of Northwest Airlines in 2008. The merger catapulted Delta to the position of the second largest airline in the world, generating significant cost savings for both.
In October 2010, United Airlines merged with Continental Airlines and formed a new company -- United Continental Holdings Inc.(NYSE: UAL). This merger created the world's largest airline, overtaking Delta Air Lines.
The third merger, between the discount leader Southwest Airlines (NYSE: LUV) and fellow discounter AirTran Holdings (NYSE: AAI) announced in September 2010, is underway. The acquisition of AirTran represents a unique opportunity for Southwest to expand its presence in key markets. Southwest will gain a valuable market presence in Atlanta, the busiest airport in the U.S. The transaction is expected to complete in the second quarter of this year.
Technology Upgrades: Air carriers are involved in numerous technology upgrades and system automation for various activities such as airline reservation system, flight operations system, website, maintenance and in-flight entertainment systems. These upgrades enable companies to perform better, lower costs and enhance customer service.
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