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Uneasy jets: the 9/11 terrorist attacks on the US proved ruinous for many of the traditional long-haul airlines, but low-budget operators are prospering at their expense--for now. As war in the Middle East looms, Cathy Hayward asks the experts what the future holds for an industry still in a state of extreme uncertainty. (Cover Feature The Airline Industry).

Life in the airline industry has been especially turbulent over the past two years. It was almost grounded by the combination of overcapacity, the events of 11 September 2001 and the risk of further terrorism. And the outlook is looking even bleaker. A war in Iraq could push fuel prices to unseen levels and issues such as spiralling insurance costs and the threat of deep-vein thrombosis claims are threatening to send costs sky-high and share prices diving.

Many airlines have blamed the terrorist attacks on New York and Washington as the cause of all the industry's ills, but fundamental weaknesses were there long before 11 September, according to Pearse Reynolds, general manager of corporate travel in the UK and Ireland at American Express. "We started noticing a downturn in the first quarter of 2001 because of overcapacity in the market," he says. "There were simply too many seats, aircraft and airlines for the demand. The attacks just sharpened that decline"

Giovanni Bisignani, director-general of the International Air Transport Association (IATA), agrees: "Before 11 September the industry was showing a net loss on international services of almost 2 billion [pounds sterling]. The impact of 11 September was extremely harsh on an already frail operating environment."

Less than a week after the attack, Continental Airlines made 12,000 employees redundant. Within days, American Airlines, US Airways, British Airways and Virgin Atlantic followed suit, cutting 10 per cent of their workforces. Later in the year Swissair and Belgium's Sabena went bust. In May 2002 BA announced a 200 million [pounds sterling] loss, compared with a 150 million [pounds sterling] profit in 2001. Almost a year after the attacks, US Airways filed for bankruptcy protection after racking up losses of $2 billion. And United Airlines, the world's second-largest carrier, was forced to do the same in December.

But it was not all doom and gloom. In the low-cost sector easy Jet saw its profit before tax rise 78 per cent to 71.6 million [pounds sterling] for the year ending 30 September 2002. And its passenger numbers were up 60 per cent to 11.4 million. These figures include two months of financial data from Go, which Easy Jet purchased in August 2002. Passenger numbers at Irish airline Ryanair increased by more than 40 per cent to 14.5 million last year and it reported record profits of 96 million [pounds sterling] for the first half of 2002. And Virgin Express, the no-frills airline partly owned by the Virgin Group, announced a 50 per cent increase in profit after tax on the previous year in its third-quarter results in November 2002.

How the airlines have fared has depended largely on how they responded to 11 September, according to Toby Nichol, corporate communications manager at easy Jet. "The aviation world reacted in two different ways," he says. "Traditional airlines started crying into their balance sheets and put up fares to deal with the predicted drop in revenue. Low cost airlines reacted in the opposite way. They launched, independently of each other, a 'let's get flying again' campaign and cheap seats abounded in the last quarter of 2001. People were still prepared to travel, but didn't want to pay as much as they had before."

Travel patterns also changed after 11 September. The transatlantic market collapsed as Britons decided to holiday closer to home. Traffic to North America from London's three main airports fell by more than a third, according to the British Airports Authority (BAA), while traffic to other faraway destinations served by Gatwick, Heathrow and Stansted fell by 14 per cent. Airlines such as BA and Virgin Atlantic, which have based most of their profit on long-haul flights, felt the pinch accordingly.

The corporate market also suffered as businesses cut back on travel spending, fearing for their employees' safety. Traditional airlines tended to use business class to subsidise the rest of their operations, Reynolds says. "There has been huge pressure on the front of the cabin. People want to travel business class, but they don't want to pay the differentials."

It wasn't only passengers that the no-frills airlines stole from their competitors. Because of its financial crisis BA was forced to pull its European services out of Gatwick. Easy Jet swooped in to fill the gap and is now the airport's second-biggest user after BA.

The "flag carriers" suffered after 11 September because they buried their heads in the sand, argues Stephen Hobday, national commercial sales manager at full-service regional airline Flybe (formerly British European). "It was a huge challenge and made airlines look at their business models. While the flag carriers panicked, other operators looked at creative opportunities." Flybe, for example, has developed a new partnership with Continental Airlines to sell its flights.

After the initial dip, 11 September has in fact had little long-term impact on passenger numbers: BAA's airports in the UK handled 9.3 million customers in November 2002, an increase of 2.2 per cent on November 2000. The IATA forecasts that traffic will grow by an average of 3.3 per cent a year to 2006. What has changed is that low-cost carriers are now accounting for the bulk of these numbers. Stansted, a base for no-frills operators, recorded the largest year-on-year increase in passenger traffic of all BAA-owned airports at 33.8 per cent. Numbers at Gatwick, traditionally a base for full-service operators, fell sharply after the attacks, but have improved in recent months, albeit aided by the arrival of easy Jet's new budget services.

Some of the traditional operators are now showing some sign of recovery. In November 2002, for instance, BA announced a pre-tax profit of 245 million [pounds sterling] for the three months ending 30 September 2002 and a 12 per cent reduction in costs following its "future size and shape" review, although passenger numbers were still down. But others are still suffering: American Airlines reported a loss of 2.25 billion [pounds sterling] in January and is set to reduce wages in 1 billion [pounds sterling] cost-cutting drive.

No-frills airlines may be in the ascendant, but they are facing unexpected problems that have affected their share prices. In December the European Commission launched an investigation into Ryanair over claims that the government aid it had received to encourage it to use Charleroi airport in Belgium as a continental hub were illegal. Ryanair shares fell 5 per cent on the news. The inquiry is being seen as a test case for similar airport deals, so its outcome may affect other budget operators.

The low-cost airlines are also facing penalties of up to 250 [pounds sterling] for every passenger affected by a cancelled or over-booked flight. Until now there has been no statutory compensation for passengers whose flights have been cancelled, but the European Parliament recently voted in favour of the measure, which is expected to be approved by individual EU governments and become law this year. Ryanair says that this will inevitably force up costs in the sector.

There are also concerns that commercial pressures are forcing low-cost airlines to compromise on safety. In June last year a report submitted to the Confidential Human Factors Incident Reporting Programme, the industry body for the anonymous reporting of incidents, claimed that pilots regularly challenged --and sometimes ignored--air traffic controllers' instructions in order to save time. Easy Jet's shares fell 5 per cent as a result.

And some budget operators are taking a big risk in changing their business model, according to Reynolds. "Many are starting to behave like traditional airlines, and that's where they are facing problems," he says. "Instead of flying to secondary airports, which have a quicker turnaround time and lower costs, and scheduling flights at odd hours, many are now serving primary destinations and so have lower profitability because their aeroplanes stay on the ground for longer."

Ryanair is the purest low-cost model, while easy Jet is increasingly aiming for the business market. "If these airlines want a slice of that market, then there's a trade-off with prime destinations--they'll have to start flying to the right side of Frankfurt," Reynolds says.

But easy Jet believes the future is bright and is predicting growth of 25 per cent this year. "Traditional airlines are obsessed with corporate travel, whereas we are always looking for new markets," Nichol says. "The UK is a crowded market for low-cost airlines, but on the continent the situation is very different. Europe really is the land of opportunity and the runways are paved with gold."

He is even sanguine about the effects of a war: "It could benefit us in two ways. If it's accompanied by a general economic downturn, more businesses will switch to low-cost airlines. And, if people decide not to travel long-haul, which is what happened during the Gulf war, people will tend to retrench and holiday in Europe, our prime market."

Understandably, BA isn't so confident. It recognises the potential loss of business and has set aside 2 billion [pounds sterling] to cover any shortfall in revenue. "We have learnt some important lessons from the Gulf war and 11 September," says a BA spokeswoman. "But at the moment we are dealing with an unknown beast."

The prolonged uncertainty about a war is probably worse than the conflict, Reynolds points out. But the industry would not only be affected by a decline in passenger numbers. A war could push up oil prices, and therefore the price of jet fuel. BA hedges its fuel and it plans to continue this policy.

"Fuel is a large percentage of our costs and it is prudent to have it at set prices that we can budget for. If prices went up dramatically it would have a huge impact on our business," says a spokeswoman.

Easy Jet is sceptical of the benefits of hedging. It bought an insurance policy to protect itself against a substantial rise in fuel prices after 11 September. But, although they spiked later that month, they never reached their anticipated heights. Hedging would have added 6.5 million [pounds sterling] to the company's fuel bill, Nichol says. And, once you start hedging fuel, the market expects this and it becomes increasingly expensive.

The whole industry is facing extra security costs. The British government has announced the presence of US-style sky marshals on commercial flights and, although this itself is not a cost for airlines, measures such as strengthening cockpit doors have affected their profits. BA's share prices also dipped sharply when a Parisian airport worker was arrested on terrorist charges in January.

Insurance against terrorism is another extra burden for British operators. Unlike in the US, where the government is still underwriting all airlines insurance, UK airlines now have to find their own commercial protection.

A possible avalanche of compensation claims from deep-vein thrombosis (DVT) victims is threatening to add to the load. If the airlines are forced to defend a group action, it could cost them millions. Reynolds says the industry is in denial about the issue, but BA claims that it has a major education programme to alert passengers to the dangers and the preventive measures that they can take. At the same time, it insists there is no proven link between DVT and flying.

After a disastrous last quarter of 2001, the industry as a whole has started to recover. But there has been a shift of power away from the traditional, full-price airlines to the budget operators. That trend will continue as long as the terrorist threat and economic downturn persist, according to Reynolds.

He predicts that there will be further consolidation in the industry and more airlines leaving the market because of overcapacity. But other experts are more positive. "Aviation is 100 years old this year," Bisignani says. "It has survived war, depression, recession, regulation and deregulation. Now, as with those previous trials, air transport will learn from its experiences and make a comeback."
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Article Details
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Author:Hayward, Cathy
Publication:Financial Management (UK)
Article Type:Industry Overview
Geographic Code:4EUIR
Date:Mar 1, 2003
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