Airline Profitability Still a Challenge Says New Study

Airline Profitability Still a Challenge Says New Study

By Gretchen Kelly

Travel Pulse
July 01, 2013 10:10 AM

A new study by the International Air Transport Association (IATA) has been published which claims that returns on capital invested in airlines have improved in recent years but are still far below what investors expect to earn. The study, “Profitability and the Air Transport Value Chain,” supported by analysis from McKinsey & Company, points to the fact that although airlines are increasing profitability through efforts like unbundling and more fuel efficient aircraft, the industry as a whole is still challenged when it comes to attracting and keeping the financial investment needed to support growth and global connectivity.

“The airline industry has created tremendous value for its customers and the wider economies we serve. Aviation supports some 57 million jobs globally and we make possible $2.2 trillion worth of economic activity. By value, over 35% of the goods traded internationally are transported by air,” said Tony Tyler, IATA’s director general and CEO. “But in the 2004-2011 period, investors would have earned $17 billion more annually by taking their capital and investing it in bonds and equities of similar risk. Unless we find ways to improve returns for our investors it may prove difficult to attract the $4-5 trillion (1) of capital we need to serve the expansion in connectivity over the next two decades, the vast majority of which will support the growth of developing economies.”

During the 2004-2011 period, returns on capital invested in the airline industry worldwide averaged 4.1%(2). This is an improvement on the average of 3.8% generated in the previous business cycle over 1996-2004(3) but it is not near the average cost of capital of 7.5%, which represents the return on capital that investors would expect to earn by investing in assets of similar risk outside the airline industry. On average, industry returns were just sufficient for the industry to service its debt, with nothing left to reward equity investors for risking their capital.

The study showed that over the past 40 years virtually all industries have generated higher returns on invested capital (ROIC) than the airline industry.  Airlines are the least profitable segment of the air transport value chain while other segments consistently generate good returns for their investors. The biggest cost for airlines today is fuel and companies in this sector benefited from an estimated $16-48 billion of their annual net profits generated by air transport. The most profitable part of the rest of the value chain is in distribution, with the computer reservation systems businesses of the three global distribution system companies generating an average ROIC of 20%, followed by freight forwarders with an ROIC of 15%.

The study pointed to the industry’s fragmented and unconsolidated structure and the nature of competition as a major factor in its continued financial challenges.

“More effective partnerships are required among stakeholders in the air transport industry. Efficiency gains are a win-win for all concerned. We have seen that with the adoption of 100% e-ticketing and the introduction of global self-service standards. Not only did partners in the industry benefit,  but consumers gained great value through more efficient and convenient processes. This study points to the active collaboration needed to find even more such solutions, said Tyler.

Tyler pointed to the fact that “smart regulation is needed from governments around the world in order to maximize the economic benefits of connectivity—jobs and growth. Unfortunately, high taxation and poorly designed regulation in many jurisdictions make it difficult for airlines to develop connectivity.  On top of the cost issues, airlines also face a hyper fragmented industry structure owing to government policies that discourage cross-border consolidation. There is plenty of room for some fresh thinking on all accounts.”