Airlines pull out of their nosedive

Profits are up as high-premium travellers return, but the aviation industry still operates on wafer-thin margins
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Need convincing that the recession is over and the global economic recovery well under way? Look no further than the aviation industry. Airlines are set for total profits of $8.9bn (£5.7bn) this year, the International Air Transport Association (Iata) said yesterday. Not only is the latest forecast based on revenues of $560bn (£360bn) – only slightly below the pre-bust levels of 2008 – it is also more that treble the $2.5bn (£1.6bn) profits predicted as recently as June. This is thanks to booming demand and the return of the high-yield "premium" business and first-class passengers so vital to carriers' wafer-thin margins.

Many of the larger airlines confirm the positive trend. British Airways (BA) is still on course to break even this year – despite the cost of a series of strikes and the volcanic ash cloud – after suffering record losses in 2009. Airline stocks have outperformed global equity markets twice over in the past year. And in the past month there have been a slew of positive results, including a quadrupling of profits at Air New Zealand and profits up 60 per cent at Air China."The industry recovery has been stronger and faster than anyone predicted," Giovanni Bisignani, Iata's director general of said.

It has been a difficult decade for airlines. The cumulative impact of a series of external factors – the 9/11 terrorist attacks, Severe Acute Respiratory Syndrome, and sky-high oil prices, to name but three – have helped the industry to an eye-watering $50bn (£32bn) in losses. But the biggest shock was the havoc wrought by the credit crunch and the ensuing recession. At the worst point, monthly passenger numbers were down by a staggering 11 per cent, freight by 23 per cent. In 2009 – the worst year of the crisis – airlines had their the largest recorded declines, with passenger demand down by 3.5 per cent, freight down by 10 per cent, and global losses of $10bn (£6.5bn).

This year, however, passenger demand is up by 8 per cent so far, and freight is up by 17 per cent. Although the worst may be over, the future is by no means assured. "This year is as good as it gets for this cycle," Mr Bisignani said.

Worryingly for Europe, the recovery is already geographically uneven. Reflecting the broader economic picture, the sharpest improvements are in the East. Iata is forecasting $5.2bn (£3.3bn) profits for Asia-Pacific airlines this year, which not only easily beats pre-recession records, but is also double the organisation's earlier forecasts. The Middle East and Latin American are also strong growth areas, thanks to regional economic strength. Even North America's carriers forecast $3.5bn (£2.3bn) profits this year, on the back of carefully managed capacity reductions and steady demand improvements.

The odd one out is Europe – facing a $1.3bn (£0.8bn) combined loss this year. One factor is the region's sluggish economy. The weak euro is encouraging travellers into the region, hence the forecast rising from earlier predictions of a $2.8bn (£1.8bn) loss. But stagnant consumer and business confidence has held passenger numbers low. The region is also seeing much slower recovery in high-margin premium traffic, particularly on short-haul routes.

And the market is about to get trickier again. For a start, the current booming numbers are at least in part a reflection of how bad things were before. Traffic statistics show massive growth because the year-on-year comparators are so appalling. Similarly, rising profits reflect the amount of capacity sliced out by the recession. Global demand is expected to shoot up by 11 per cent this year, outstripping a 7 per cent increase in total capacity, giving a boost to average yields – the key industry metric of revenue per seat per kilometre flown. But current yields of 7.3 per cent for passengers and 7.9 per cent for cargo are still below pre-crisis levels. And as capacity increases, margins will start to come down again.

Add in lower government spending, stubbornly high unemployment and weakening business confidence in key economies, and Iata's forecasts for next year's profits are a more modest $5.3bn (£3.4bn). "A reality check is in order," Mr Bisignani said.

In the airline industry, everything comes down to margins. Carriers work on astonishingly tight profit margins – so tight that in the 60-year history of commercial aviation, the sector as a whole has made a loss. Margins have been absolute devastated by the financial crisis, not least because it wiped out as much as a third of premium traffic which, although improving, is still far from a full recovery. Even if profits more than triple, it will only generate a 1.6 per cent margin, far below the level needed to cover the cost of capital, according to Iata.

Consolidation would help. "Aviation is a very tough industry where it sometimes seems as if the abyss is always just around the corner," Gert Zonneveld, an analyst at Panmure Gordon, said. "Margins are so thin, even sometimes negative, so economies of scale can be crucial."

But airlines face national regulations which often mitigate against takeovers. There has been a wave of consolidation, starting before the crisis and including, this year, BA's merger with Iberia and joint venture with American Airlines. There will be more to come, particularly within the growing multi-carrier alliances. But the process is slow, cumbersome and in many places – notably the US – entirely impossible because of foreign ownership rules.

"Aside from the few joint ventures, the airline sector is still highly fragmented," the aviation expert James Halstead said. "It is difficult to see how, in the short term, the industry will get the returns needed to cover the cost of capital – but that has always been the case."

Aviation's spectacular recovery this year may be a perfect poster child for the return of economic growth. But with the worst of the global financial meltdown over, the airline business will simply be back to crisis as usual.