Airline industry in recession: European airlines facing a harsh winter

Last month IATA published its 2011 revised estimates, showing an expected 60 per cent decrease in airline industry profits, over 2010. No doubt airlines are in a far worse position in 2011, following a large rebound in 2010. The European and North American sovereign debt crisis, rising fuel prices, turmoil in the Arab world and Japan’s earthquake, all had a negative impact on air traffic growth and on the financial results of European carriers with international route networks. In the first half of 2011 IAG and Lufthansa, two of the largest European airline groups, reported marginal operating profits. Low cost carriers have also experienced the negative impact of an adverse operating environment, with Easyjet reporting a loss for the first half of 2011.

More bad news to follow for the sector, as January 2012 will mark the start of aviation becoming part of the EU Emissions Trading Scheme, resulting in higher costs for European airlines. According to EC DG Clima, direct costs for airlines are calculated to be between €1.50 or $2.10 per passenger each way for a long haul flight from Europe to the US. We believe that this represents an additional cost that airlines are not able to handle during a recession period and passing it on to the passengers could impact demand adversely.

At the same time European airlines are in the process of modernising their fleet, ordering new generation aircraft in order to increase fuel efficiency and reduce their overall costs. As fuel costs represent more than 30% of the airline’s total costs and fuel prices are expected to stay at high levels, fleet modernisation becomes a priority. However, raising cash to finance large capital expenditure projects, as with fleet modernisation, at a time when the European finance industry is in the process of restructuring, is challenging to say the least. This is partly the reason French banks, who for the most part of the last 20 years were the primary lenders to airlines, have retreated from the aviation sector. We firmly believe airlines are set to face a harsh winter that will have a negative impact on their profitability. This is why consolidation will intensify and we will see smaller players exiting this market.