The economics of airline

financial performance
and wider economic
benefits
6th April 2018, Paris
Brian Pearce,
Chief Economist, IATA
www.iata.org/economics
Outline
• Why is the airline industry suddenly profitable?
• After decades of investor capital destruction
• Is the change widespread?
• Have the underlying economics of the industry changed?
• Why is the emergence of protectionism such a threat?
• How does air transport bring economic benefit?
• Users
• Wider economic benefits
• Come from the people, goods, capital and ideas we carry between cities
• Rather than the jobs required to run the service (with some exceptions)
 Airlines have suddenly become profitable (for their equity investors)
Return on capital invested in airlines and their cost of capital
12.0
Return on capital
10.0 (ROIC)
8.0
% of invested capital

6.0
Cost of capital
(WACC)
4.0
2.0
0.0
1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
Source: IATA Economics using data from McKinsey, The Airlines Analyst, IATA forecasts
 After decades of investor value destruction
Difference between investing in airlines and investing in similar assets elsewhere
30
20
10
0
US$ billion

-10
-20
-30
-40
1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
Source: IATA Economics using data from McKinsey, The Airlines Analyst, IATA forecasts
 And widespread airline failures
Iceland Express
European LCCs
Air Finland
Flying Finn
snowflake Norwegian
Planet Nordic
Thomsonfly
airlink
flyglobespan Ryanair
nexus FlyMe Jet2
flyforbeans.com AerArann
Viking
GetJet mytravellite Aerlingus Monarch
Sterling Cimber
jetmagic Kiss duo Go easyJet
Maersk Air flybe Transavia airberlin
Debonair buzz SkyExpress
Air Wales Hamburg airlines
EUjet Basiqair VBIRD centralwings Eurowings
VirginExpress Air polonia
flywest HLX
flyeco LTU GermaniaSmart Wings WIZZ
dba Skyeurope
Aeris
Helvetic flybaboo
Airclickair
Turquoise Volotea
air lib express vueling
myair
Clickair Volareweb
Pegasus
fly gibraltar
Atlas-blue WindJet
Failed Survived
Source: HSBC report early 2014 situation. Since then Monarch and airberlin have failed
 But improvement has been very uneven across the industry
Return on invested capital
20%
EBIT adjusted for operating leases as % invested capital

18%
16% North America
14%
Europe
12%
10% Industry average
Latin America
8% Asia Pacific
6% Weighted Average
Middle East Cost of Capital
4%
2%
0%
2010 2011 2012 2013 2014 2015 2016
Source: IATA Economics using data from IATA and The Airline Analyst
 Balance sheet remain highly leveraged in some regions
Adjusted net debt/EBITDAR
8
7
Debt adjusted for operating leases/EBITDAR

Latin America
6
Middle East
5 Asia Pacific
4 Industry average
Europe
3
North America
2
Investment grade
1
0
2010 2011 2012 2013 2014 2015 2016
Source: IATA Economics using data from The Airline Analyst
There has always been a paradox at the heart of air transport
2015-18: 9.7%
Source: McKinsey presentation to IATA
Technology continues to cut costs dramatically
Source: Lee
Typically airlines pass all gains through to consumers
Unit cost and the price of air transport
4.0 7.0
Boeing 707
3.5 6.0
US$ in 2013 prices to fly a tonne kilometer

US$ in 2013 prices per tonne kilometer

3.0
5.0
1973
2.5
oil
crisis 4.0
2.0 US deregulation
3.0
1.5
EU deregulation
2.0
1.0 Unit cost
(US$/ATK)
0.5 1.0
Price
(US$/RTK)
0.0 -
1950 1960 1970 1980 1990 2000 2010
Source: IATA Economics using data from ICAO and IATA Statistics
In fact prices have fallen further than costs forcing up breakeven loads
Breakeven and actual load factors
70%
Load factor achieved
65%
60%
% ATKs

Breakeven load factor +15%

55% points
50%
45%
1970 1975 1980 1985 1990 1995 2000 2005 2010
Source: IATA Economics using data from ICAO and IATA Statistics
 Have industry economics changed or is it just low fuel costs?
Airline industry ROIC and jet fuel prices
12.0 160
Return on capital
(ROIC)
140
10.0
120
ROIC, % of invested capital

Jet fuel price, US$/barrel

8.0
100
6.0 80
60
4.0
Jet fuel price 40
2.0
20
0.0 0
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Source: IATA Economics using data from McKinsey, Platts and own forecasts
The underlying economics of air transport
• Perishable
• Fixed costs high
• Barriers to entry low
• Competitive advantages hard to defend
• Aircraft are a platform to serve many markets
• Economies of scale in aircraft size but business travelers want frequency and flexibility
• Few scale economies in fleet size but economies of density in networks
OUTCOME:
• Prices pushed down towards variable costs,
• But ways need to be found to cover fixed costs:
• Differential pricing, sequential use of coupons, non-refundable tickets and no ancillaries
• Network density economies through merger prevented by bilateral and O&C regulation barriers:
• Leading to code shares, alliances and now ATI JVs and equity partnerships on international markets
 Improvement in performance pre-dates fall in fuel costs
Breakeven and achieved weight load factors
71
Load factor achieved
69
67
65
% ATKs

63
61
Breakeven load factor
59
57
55
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Source: IATA Economics using data from ICAO, IATA Statistics, IATA forecasts
 Airlines are sweating assets as well as improving margins
Components of return on capital
10 1.5
Operating margin

Capital productivity, revenue/invested capital, US$

8 1.4
6
Operating margin, % revenue

Capital productivity 1.3

4
1.2
2
1.1
0
1.0
-2
-4 0.9
-6 0.8
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Source: IATA Economics using data from ICAO, McKinsey, The Airline Analyst, IATA forecasts
Wide variety of successful business models
2015 ROIC = adjusted EBIT/revenue * revenue/invested capital
0.45
EBIT margin , adjusted EBIT/revenue

0.40 Jazeera Increasing return

0.35
Spring Ryanair on capital (ROIC)
Spirit Allegiant
0.30 Mesa
0.25 Volaris Alaska
PFIZER Hawaiian
Southwest
0.20 JetBlue
Delta
Air China AMR JAL
0.15 United Easyjet
Aeromexico
Air Canada
0.10 PIA IAG Qantas Lufthansa
Cathay SIA ANA
0.05 LATAM Comair
Korean GOL AF-KLM WALMART
0.00
-0.05
-0.10 Thai
0.00 0.50 1.00 1.50 2.00 2.50
Capital productivity ($ revenue per $ invested capital)
Source: IATA using data from The Airline Analyst IATA Economics www.iata.org/economics
Ancillaries are changing the nature of the airline product
Airline revenues, tickets, cargo and ancillaries
700 120
Passenger ticket revenue (left
600
100
500
Ancillary revenue 80
400
(right scale)
Billion US$

Billion US$
60
300
Cargo revenue 40
200 (right scale)
20
100
0 0
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Source: IATA Economics using data from ICAO, The Airline Analyst, PaxIS, IdeaWorks
 Consolidation important but not simply because of size
Return on invested capital versus invested capital, 2016
45
American
40 Emirates
(2015)
Invested capital, $ billion

35 United
30 Qatar Air China Delta
25 (2015) China Southern
China Eastern
20 Singapore Lufthansa
Cathay Southwest
15 AF-KLM Fedex
Korean TurkishLATAM IAG
10 Ryanair
5 Alaska Allegiant
Icelandic
-
-10% 0% 10% 20% 30% 40% 50%
Return on invested capital, %
Source: IATA Economics using data from IATA and The Airline Analyst
JVs doing better job than code shares/alliances to get density economies
Source: Lufthansa
Protectionism or the new localism is a major threat
Share of goods trade (exports+imports) in global GDP
22
20
Global financial
18
crisis
% of GDP

16
14
12
10
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
Source: IATA Economics using data from Netherlands CPB
 Benefits to consumers (and economy) arise from cheap city connections
Unique city-pairs and real transport costs
22000 3.50
20000 Unique city pairs
18000 3.00
16000
Number of unique city-pairs

2.50

US$/RTK in 2014US$
14000
12000
2.00
10000
8000
1.50
Real cost of air transport
6000
4000 1.00
2000
0 0.50
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
Source: IATA Economics using data from ICAO, Boeing, OAG, SRS Analyser
Wider economic benefits
• Often measured by the jobs and GVA in the supply chain, through I-O models
• Economic footprint is a useful description
• But it measures cost not benefit
• Do labor productivity gains really mean lower wider economic benefits?
• Economic benefits generated by connecting cities at lower cost
• Air transport network is an infrastructure asset, a bridge between cities
• Boosting the productive capacity of an economy
• Generating flows of people, goods, capital, ideas, competitive pressure
• Raising productivity through agglomeration, gains from trade
• Higher GDP from the supply-side, in economies close to full capacity
• Demand-side/spending flows do matter where economies/regions under-developed
• More research and evidence required!