End of year review for 2023
As has now become traditional, for my final post of the year I will look back at the year just ending and look forward into next year.
Given how much AI dominated the news headlines in 2023, some at least of you will be pleased to hear that the subject is not going to be making an appearance in this round up of the year. That’s not because I don’t think it is an important topic that will have big implications for aviation. Its just that I think it deserves its own blog post. But I couldn’t resist using an AI generated image, complete with some weirdly malformed aircraft.
Let’s get started on looking at how well my predictions for 2023 did with the benefit of hindsight.
Disaster bingo
In last year’s post, I set out a “bingo card” of potential risks for 2023. I’ve shown it again below, with an emoji assessment of how things turned out in each of these potential risk areas.
Uppermost on most people’s worry list at the start of the year was the risk of recession and financial crisis, with the consequent impact on aviation demand. I argued last year that pent up demand and supply constraints would be supportive of continued aviation revenue growth, even if the economic environment was soft. And as we’ll see later, revenue was indeed stronger than anyone expected. But in truth the resilience of demand to an economic downturn wasn’t really tested during the year, since the much predicted recession didn’t materialise. I think the Economist put it well in their round up of the year.
“Almost everyone expected a global recession in 2023, as central bankers raised interest rates to cool inflation. The consensus was wrong. Global GDP has probably grown by 3%. Job markets have held up. Inflation is on the way down. Stockmarkets have risen by 20%.”
The next topic is the question of exchange rates. For European airlines, the most important rate is the euro dollar. All European airlines generate less dollar revenue than they incur in costs, and they also have significant dollar denominated liabilities and capital commitments. So when the euro is weak against the dollar, both profitability and balance sheets come under pressure. Given how weak the euro was in 2022, I thought last year that this was more of an opportunity than a risk going into 2023 and that turned out to be true. On average for the year, the euro was 3% stronger against the dollar and finished the year 4% stronger than at the start. There was some volatility during the year, but overall the exchange rate environment was reasonably calm and slightly helpful.
Interest rates did rise as expected, but as I pointed out last year, most airlines make heavy use of fixed rate financing so this hasn’t proven to be a big problem, so far at least. In fact, given that the large cash balances held by many airlines are generally deposited at floating rates, a higher interest rate environment may actually have been helpful for profits in the short-term.
2023 was not of course a good year for war and terrorism. The war in Ukraine dragged on as expected, without either side making any decisive progress. Last year I warned: “There are plenty of other border disputes in the world and no shortage of aggressive countries who might seek to take advantage of the resources and attention of Russia and the West being focused on Ukraine”. Whether the attack on Israel and subsequent war in Gaza was related to Russia and Ukraine is hard to know, but for airlines with significant exposure to the region, there was the inevitable hit to demand and revenue. That impacted some individual airlines, but the general strength of demand and shortage of supply meant that most airlines were able to mitigate the impact by redeploying capacity elsewhere.
Perhaps the most remarkable thing is that despite the events in the middle east and the continued war in Ukraine, global energy prices did not see big spikes in response and the overall fuel price environment for airlines has been better in 2023 than 2022. The average spot price of jet fuel of just under $900/tonne was 20% lower than the average in 2022. Different airlines will have been affected in different ways, depending on their hedging policies and decisions, but overall fuel price was supportive of airline profitability in 2023.
Source: eia, US Gulf Coast jet fuel prices
I skipped over the bingo card item of volcanoes, earthquakes, fires and floods. We might as well also cover severe weather at the same time. We had plenty of all of these during the year and the consequences for people directly affected were of course tragic, but I’m not aware that any of these caused major issues for the industry in general during 2023.
We should deal with the topics of supply chain disruption and aircraft technical issues together I think, since the main supply chain issues were aircraft and engine related. Highest profile were Pratt & Witney’s problems with the GTF engine, but Rolls Royce continues to have problems too with the Trent and these issues were compounded by ongoing difficulties in the maintenance supply chain. Neither Boeing nor Airbus have been covering themselves in glory when it comes to on-time delivery of aircraft either. Whilst these issues have caused problems for affected airlines, those were generally offset by supplier compensation payments. And the impact on aircraft availability has I think been helpful for the overall supply/demand balance for airlines.
When it comes to pandemics, as I’d hoped this time last year, COVID has ceased to be an important issue affecting demand. The last of the travel restrictions in Asia have been lifted. There are lingering effects on travel demand of course, with Asia still in recovery mode and business traffic remaining down on pre-COVID levels. That’s especially true for short-haul and for corporate travel, but I think that has more to do with the sustainability agenda, with the pandemic having served as an accelerator of change.
The final four areas were government regulations & tax hikes, environmental protests, labour shortages and disputes and ATC & Airport disruptions. There have been some issues in all of these areas, with perhaps the ongoing attempts by the Dutch government to reduce flight numbers at Schiphol being amongst the most noteworthy. But despite the impact that individual incidents had on airlines, it is hard to say that at an industry level these were materially worse than what counts for normal these days. My worst fears of ATC meltdowns and major industry-wide disruptions due to labour disputes did not materialise.
Demand and pricing
Last year I stuck my neck out with some specific predictions for volume and yields for the European carriers:
Overall I’d bet on a substantially better Q1 for European airlines against a soft prior year comparator, maybe as much as 30% in volume terms with higher yields. Summer 2023 should be up 10% in volume terms versus 2022, perhaps with some downwards yield pressure.
Let’s look first at passenger volumes. Here are the figures for the big six Western European airline groups. My prediction for volume growth in the first quarter of “maybe as much as 30%” was exceeded by all six, with all achieving growth of 40% or higher. For the summer period (Q2 & Q3), my 10% prediction was closer to the mark, although IAG and Wizz both exceeded it.
Reality also outperformed my expectations when it came to yields. I thought they would be higher in Q1, but would be flat or showing softness in Q2 and Q3. There were big increases in both Q1 and Q2, although some signs of softening were becoming evident by Q3. Nevertheless, they were still mostly up on the prior year except at the fast-growing Wizz.
My final prediction was that traffic for European airlines would get back to 90-95% of 2019 levels, with unit revenues 10-15% better. This post is already getting rather long, so I won’t show any more charts here and will just give you the overall headlines. Over the first nine months of 2023, these six airlines in aggregate hit 100% of 2019 RPKs and collective passenger revenues per RPK were 14% higher than 2019. Again confirming the robustness of the demand and yield environment during the year.
Profitability
My final predictions last year were for the profitability of Europe’s airlines. I looked at IATA’s forecasts which had just been published and said they looked too pessimistic. IATA was forecasting a 2 point improvement in margins compared to 2022, with net profit only just scraping into positive territory, compared to a $6.5 billion profit in 2019. How do things look now, one year later?
The first thing I’d say is that IATA don’t seem to be good at estimating profits even for the current year. Only one month before the end of 2022, they estimated European airline profitability for that year at a loss of $3.1 billion. The actual outturn was a profit of $4.1 billion, according to their own numbers published earlier this month.
For 2023, this time last year IATA were forecasting profits of $0.6 billion and an operating margin of 0.6%. I said I thought it was possible that European carriers could get back to 2019 levels of profitability (net profits of $6.5 billion and an operating margin of 4.8%, according to IATA). IATA now estimates that 2023 net profits hit $7.7 billion, with an operating margin of 6.5%, in both cases above 2019 levels.
On the chart below, I’ve shown IATA’s numbers from last year (in blue) and this year’s update (in red). As well as showing the upward revisions in IATA’s estimates for 2022 and 2023, you can see the new forecast for 2024 of $7.9 billion, just ahead of their revised estimate for 2023.
Here is the same chart, but showing the operating margin figures this time.
Before commenting on the outlook for 2024, I decided I needed to check IATA’s figures for 2023, given that they didn’t do such a good job of assessing current year performance last time.
Building our own estimate of profits
We don’t actually know which airlines IATA includes in its regional profit numbers, but they claim to include “all commercial airlines”, using figures from “The Airline Analyst”. That’s a data service provided by AirFinance Journal, which unfortunately I don’t have access to. I’ve therefore had to assemble my own numbers from published data. Not every European airline publishes numbers, but almost all of the ones of any size do, plus a number of the smaller ones. The 19 airlines and airline groups I included accounted for 83% of European airline capacity in 2023. The biggest airlines that I couldn’t include due to lack of data were TUI, Air Europa, Condor and LOT. I also left out Jet2, since like TUI, its revenue is mostly holiday packages.
In terms of net profit figures, my sample of airlines replicates the IATA figures for 2019 and 2022 relatively well. For both years my figures were $0.5 billion higher than IATA’s. For interest, here is the breakdown of the $4.6 billion of European net profits for 2022 that I calculated. The most striking thing about these figures is that Turkish Airlines alone accounted for more than half of the total profits of the region. They’ve undoubtedly been one of the beneficiaries of the war in Ukraine, with European airlines being unable to overfly Russia and Türkiye being one of the few places in Europe still open to Russian travellers.
In my attempt to replicate IATA’s numbers, I had less success when it came to the EBIT/operating margin. In both the years I checked, my figures were about two percentage points above IATA’s. I’ve no idea what is driving this. Perhaps IATA includes the full results of the tour operators, like TUI and Jet2. That would bring in a lot of non-flight revenue and perhaps dilute margins. But the scale of that potential impact couldn’t come close to explaining the gap. It is more likely due to some difference in definition of EBIT. The only thing I can think of is that perhaps the figures from AirFinance Journal are “lease adjusted” in some way, for example treating all operating lease payments as operating costs, rather than splitting them into their depreciation and interest elements in the way the accountants now do in published accounts.
In any event, I’ve also done estimates for 2023. Most of the big carriers publish quarterly results and so we already know the performance for January to September. We don’t have any 2023 figures for ITA, Virgin or Luxair, but the following chart shows the nine month totals for the others. You should know that Aeroflot’s actual reported net profit for the year was $1.4 billion worse than this, due to a $1.7 billion currency loss (pre-tax), which I excluded on the basis that it was a non-cash exceptional. IATA claims to exclude those too. As was the case in 2022, Turkish remains the most profitable of the European carriers, but the other big network airlines have now rejoined the profit party.
For my estimate of 2023 profits, I turned these 9 month figures into a full year number using a fairly mechanistic approach, based on the historic relationship for each company between the first nine months and the full year. I did check that those matched pretty well against analyst consensus estimates, where we have them. For Virgin Atlantic, I assumed they would get close to breakeven for net income. For ITA, I assumed they would repeat the same loss as was reported in 2022, albeit on a significantly larger activity base.
These assumptions give me a much more optimistic figure for European airline profit in 2023 than IATA’s $7.7 billion. In the first 9 months of 2023, the airlines for which we have actual data improved profits by $8.4 billion compared to 2022. Quite how IATA believes that the full year figures will be only $3.6 billion better than the prior year is beyond me. My approach gave me an estimate for 2023 of $13.6 billion, substantially ahead of both 2022 and 2019.
I am more sympathetic to IATA’s view that profits for 2024 will not be much better than 2023. This group of airlines is planning collective capacity growth of about 10% in 2024. That will put some pressure on unit revenues, but I’d still bet on them collectively getting some top-line growth. The bigger question is what happens to margins. Some analysts are expecting profits at the big network airlines to start to fall next year, as capacity growth on the transatlantic drives yields lower. I agree that this is starting to happen, but capacity growth will also help on unit costs and I still think there is quite a bit of scope for airlines to re-optimise their businesses for the post COVID environment, now they’ve had a period of stability. The forward curve for fuel prices of around $800/tonne also suggests that fuel costs should provide some upside. I don’t expect profit growth to keep pace with capacity growth, but the 5% profit growth that I’ve built into my forecast doesn’t seem that aggressive to me.
The following chart shows my figures for EBIT/Operating margins, compared to the IATA numbers. As was the case for the net income numbers, I am more optimistic. You can also see from the historical numbers that part of the difference seems to be due to some difference in definitions. In terms of year over year trends, IATA thinks that margins will drop a little next year. That may be the case at specific airlines, but I think that overall margins can be maintained for the reasons outlined above.
Other predictions and thoughts for 2024
This has already been quite a long post, so I’ll restrict myself to one further topic, the issue of sustainability.
Last year I said the following:
When it comes to the bundle of issues relating to the environment, I think 2023 will be a year when most airlines start getting serious about the issue. Some have been doing so for a while, but many have focused on publicity stunts (“our first 100% SAF powered flight”) and rebadging aircraft investments which in reality were made in pursuit of growth and fuel cost savings. Supply of Sustainable Aviation Fuel (“SAF”) continues to fall far short of meeting the industry’s stated ambitions. Airlines, airports and fuel suppliers need to start planning for, investing in and reporting on a meaningful scaling up of the production and use of SAF. Governments need to do their part to help, rather than just issuing mandates and applying “the stick”. There is a long road ahead.
Whilst some progress was indeed made during 2023, the pace of change is still glacial. Everything I said last year remains true today. Indeed, the highest profile SAF event in the UK last year was Virgin’s “first 100% SAF powered flight”. Given the huge shortfall in the volume of supply of SAF, it will be decades before there will be any need to use it in pure form, rather than as a blend. Nor any benefit to the environment from doing so.
I’m not sure whether this a prediction or just an aspiration, but I hope that 2024 will a year where airlines move beyond publicity stunts and where increased production and use of SAF starts to have a meaningful impact on aviation emissions. At a minimum, it needs to be a year when a credible and funded plan is put into effect to bring that about. Otherwise the drive to manage emissions by throttling demand with taxation and to constrain growth through direct regulation of flight volumes will only continue to get bigger.
After a year of record profits, at least the industry is in better shape to face up these and other challenges. I certainly hope those profits will continue to flow and wish you all a Happy New Year.
