Airline industry optimism resurges, but flight path to recovery looks bumpy

The embattled global airline industry has been at the forefront of renewed economic optimism in the early weeks of the new year. Rescinded travel restrictions and easing of both oil prices and inflation have coincided with an ongoing recovery in air traffic demand, along with receding fear of recession in Europe and the US, and China’s faster than expected reopening after border curbs were dropped in the world’s second-largest aviation market. However, the industry still faces a raft of legacy headwinds as it navigates a post-pandemic ‘new normal’; 2023 looks to be a year of consolidation. 

This confluence of softening headwinds and modest tailwinds is sufficient to lift the industry back into profitability in 2023 for the first time in four years. The global airline industry is estimated to earn $4.7bn in global annual net profits, based on revenues of $779bn, according to the International Air Transport Association (IATA), the aviation trade body. If realised, this would crystalise a stunning turnaround for a global industry that reported more than $185bn in accumulated losses over the previous three years – $137.7bn in 2020, $42bn in 2021 and $6.9bn in 2022 – because of the financial consequences of worldwide travel restrictions due to the pandemic. In Europe airlines are forecast to deliver a $612m net profit in 2023, reversing a $3.1bn loss in 2022. 

Passenger demand is expected to surpass the four billion mark in 2023 for the first time in four years and reach 85.5% of 2019 levels, according to IATA forecasts, generating an estimated $522bn. Leisure travel is expected to pick up from mid-February into the summer months. Subsequent to these forecasts, the outlook for the reopening of China has improved, which could push up global passenger traffic to 2019 levels by June, predicts Avolon, the international aircraft leasing company. Global air traffic demand is now forecast to recover to 2019 levels in 2024. 

As Covid-19 has increasingly been downgraded to an endemic rather than a pandemic and the world moves further from the lockdowns of the past couple of years, travellers are more comfortable about resuming long-haul international flights. International business and leisure air travel demand recovered in 2022.

Supply and capacity biggest risks to profitability

However, supply remains the biggest threat to the outlook for profitability. The absence of new aircraft is a constraint on recovery as airlines’ financial turnaround is ahead of capacity recovery. Globally, air traffic is 25% below November 2019 levels, while revenues are just 13% lower as airlines flex their pricing power and raise fares, according to Avolon. However, European passenger capacity was better than the global average at 16% below 2019 levels, which is forecast to reduce further in 2023 to 10.9% under pre-pandemic levels, IATA data shows.

Legacy supply chain disruptions and backlogged aircraft deliveries will continue to weigh on capacity in 2023. Boeing and Airbus, the leading global airline manufacturers, are running aircraft delivery backlogs that keep a lid on new capacity and prop up air fares. In its Q4 results, Boeing reported a backlog of aeroplanes valued at $330bn due to production delivery schedules hindered by the pandemic. Boeing confirmed plans to ramp up aircraft deliveries, but the time frame runs up to 2025–26 which is too distant to influence near-term demand constraints. These targets also have quality control risks, and may ultimately prove aspirational. Reuters reported that Boeing’s Chief Executive Dave Calhoun told analysts the aircraft manufacturer still faces “a difficult, difficult supply chain and while average deliveries met our objectives, we continue to face a few too many stoppages in our lines. … Those stoppages, while they are coming down, are not where they need to be.”

There also concerns among some carriers over the number of aircraft in storage, which are constrained by maintenance and repair before aircraft can re-enter service or move between lessees. This issue is compounded by ongoing shortages in skilled labour, while the possibility of renewed industrial action this year cannot be overlooked. It is a reminder that risks to the industry’s ‘new year’ optimism are never far from view. Airlines’ balance sheets are recovering amid tightened financial conditions and still-slowing global GDP growth, which will require vigilant focus to protect and improve on slim margins. 

Flybe collapses into administration for second time

Flybe, which operates passenger flights via 21 routes to 17 destinations across the UK and EU, has collapsed into administration for the second time in three years, placing 277 jobs at risk. “The aviation sector is still adjusting to the ‘new normal’ following the pandemic”, said the Administrators. Flybe had been unable to withstand the impact of the pandemic on supply chains since its relaunch less than one year ago, which led to the late delivery of 17 new aircraft, severely compromising the airline’s capacity and its ability to remain competitive, according to the Administrators. “This has driven significant financial losses and an associated cash drain for the business.”

Trade unions have encouraged workers – those worried pilots, engineers, cabin and ground staff affected by Flybe’s collapse – to consider equivalent roles elsewhere, including at Ryanair and EasyJet. Ryanair, Europe’s largest discount airline, reported a €211m post-tax profit in the fiscal third quarter, compared to €96m a year earlier. In a statement, the low-cost carrier said structural reductions in its peer group’s capacity – due to bankruptcies, fleet and capacity reductions – have created “enormous growth opportunities” for Ryanair. However, its upgraded full-year profit outlook range of €1.325bn to €1.425bn, “remains heavily dependent upon avoiding adverse events in Q4 (such as Covid and/or the war in Ukraine)”.

Airlines must be flexible to manage fluctuating demand and vigilant to changes in taxes, infrastructure fees and costs associated with decarbonisation and the energy transition. While air traffic demand was relatively insensitive to inflationary pressures in the latter half of 2022, this is likely to change if inflation remains elevated for a long time and key markets do enter a recession. In addition, a recession in the US could reverse the weakness in the US dollar in recent months, which would hurt profitability and potentially trigger renewed jet fuel price volatility and softening demand. 

One strategy to improve profitability that would raise airfares and align with improved demand for business travel would be to recalibrate interiors to increase the size of business class and premium economy cabins at the expense of a reduced economy class. 

These reconfigurations are more common on long-haul flights popular with business travel demand. Aircraft utilisation rates also need to be monitored closely to support profitability goals.

With easing energy costs and a brightened macro outlook in the early weeks of the new year, the airline industry has the strongest tailwinds for three years. However, a recovery remains vulnerable to unexpired risks and legacy pandemic disruptions which could rapidly re-emerge. 

If your business, or portfolio company, is directly impacted by the challenges in the aviation sector and would like to discuss your strategic options, do get in touch and let us see how we can assist.