By Bjorn Fehrm
January 5, 2017, ©. Leeham Co: The last two years have seen increased profits for the airline industry. Lower priced fuel gave the industry time to breath and to finally earn a reasonable Return on Invested Capital (ROIC).
Earnings as a percent of revenue for the industry has been increasing from 5% on a worldwide basis in 2014 to around 10% for 2016, Figure 1.
The US and European airlines have been topping the earnings with 18% on revenue for the third quarter of 2016. There are many signs this will not continue in 2017, especially for European airlines.
The European airline landscape
The European airline industry is divided into roughly three segments:
It’s the latter group which brings the profit levels of European airlines to the levels of 18%. Ryanair is one of the world’s most profitable airline, with more than 20% earnings on revenue and 34% on capital. Easyjet operated at about half the earnings on revenue during the 2016 financial year and earned 15% on capital employed.
The legacy flag carriers have been able to turn a profit, but just. Their colleagues further down the road to normal companies are doing better, returning between 5%-10% on invested capital. But this is still miles away from the best-in-class Ryanair with 34% ROIC.
Why will 2017 be tougher?
The primary reason the easy times are over is the return of the fuel prices to higher levels. It has passed $55/bbl and the OPEC policy is that is shall rise further, Figure 2.
The low fuel price gave struggling airlines some time off the hook. Now the reality is gradually returning. The effect is immediate. Airlines like Air Berlin and Alitalia are already in serious difficulty. And so is their major shareholder, Etihad Airways, meaning that there will be no more bail-outs from their major code-share partner.
The major legacy groups, Lufthansa, IAG, Air France-KLM, are all wrestling with how to counter the emerging low cost long haul threat. Norwegian Air Shuttle will fly the Boeing 737 Max 8 from Edinburgh to New York during 2017 with tickets at €65 one way says the company.
IAG will start a low cost long-haul operation, but how is not clear yet. Air France-KLM has announced it will do the same, this time as a new company tied to the group headquarters. Will the powerful French pilots’ union accept that? They haven’t so far.
Lufthansa is expanding Eurowings as fast as their touchy relation with their pilots’ union allows. The question is if Eurowings can operate long-haul successfully. So far they have messed up the destinations they have tried.
Will these low-cost initiatives get airborne and start to cruise? And will they be competitive with Norwegian, Wow Air or the Gulf carriers? This will all pan out in 2017.
With fuel prices returning to higher levels and many airlines having used the grace period inefficiently, 2017 will be a crucial year for these that did not turn the corner during 2015/2016.