Airlines fasten their seatbelts as profits dive

By Associate Editor David Stevenson Aug 29, 2008

David Stevenson
Aeroplanes parked at an airport

Fuel-price hikes could see some airlines grounded

How strapped for cash are airlines?

Very. The latest International Air Transport Association (IATA) report at the end of June said that the outlook for airline profitability had "deteriorated substantially" since previous findings in March, when business travel started to fall. A major problem, as you might expect, is fuel costs. "Significant" net losses are expected for the industry this year, of between $2.3bn and $6.1bn, depending on whether oil prices fall in line with the 'consensus' of more than 60 experts, to below $100/barrel, or return to highs of around $140/barrel. At present, oil prices are in the middle of this range, but "the revenue cushion that allowed the fuel cost surge to be absorbed in the four years to 2007 has gone". And fuel prices aren't the only issue. The recent tragedy in Madrid, in which a Spanair MD82 crashed off the airport runway, killing 154 people, has put the focus on another rising expense: maintenance costs.

How far have maintenance costs risen?

A recent cost index compiled by the US Air Transport Association found that maintenance expenses were up 20% for the first quarter of 2008 compared with 2007. This was driven by higher material costs, more inspection and repair expenses and new safety mandates. Even for those US carriers where cost increases were below average, they've still been a major concern. Southwest Airlines' maintenance costs grew by just 14% year-on-year in 2008's first half, but the airline's vice president of maintenance and engineering, Jim Sokol, admits the group has "seen additional maintenance demands". The Federal Aviation Administration (FAA) "recently issued a number of airplane inspection, safety and repair requirements following concerns about cracks in Boeing airplanes", reported the Silicon Valley/San Jose Business Journal this month. "And earlier this year, the FAA slapped a $10m fine on Southwest for flying airplanes that missed a specific inspection." Meanwhile, US Airways and American Airlines both saw much higher maintenance costs in the first half of 2008, seeing annual increases of 23% and 24% respectively.

Were maintenance costs an issue at Spanair, too?

Certainly, Spanair – which incurred an operating loss of about €30m last year – has faced similar problems to the rest of the industry. "Spain's second-largest airline is to cut about a quarter of its workforce and its fleet in an attempt to combat high fuel prices, fierce competition and a sharp downturn in its domestic market," reported the FT just over a month ago. And fearing a drop in Spanish passenger demand, Spanair said it would also drop nine routes, as well as loss-making domestic services, to cut €90m from its 2009 cost base. The crash came just hours after pilots and staff at Spanair had threatened to strike over these plans. It could be several weeks before an investigation into the causes is complete. However, until the crash, the MD82 had "a very strong safety record", says Teal Group analyst Richard Aboulafia, while the BBC reports that "Spanair insists the plane was fit to fly, and that there were no short cuts taken".

Are higher costs due to ageing fleets?

"Younger aircraft are easier to maintain and more fuel efficient," says London aerospace analyst John Strickland. The Western-built airline fleet, excluding Russia, has an average age of 14 years, unchanged from 2007, says this month's survey from Flight International of the world's airliners. A recent study by Airfleets.net of 35 American and 30 European airliners found that the average age of an American aircraft is 10.4 years, compared with 9.5 years for Europe. Now rising costs are ensuring that this gap is set to widen further: "American carriers have curtailed their orders for new vessels as financial conditions become increasingly difficult", says Forbes. American carriers have ordered only 18 out of the 386 new fuel-efficient Airbus S350 jets booked by manufacturer EADS this year.

Will things get any better for the industry soon?

Hardly. Just 10% of respondents to the IATA survey expect profits to rise over the next year, while 70% expect a further dip. A year ago, none expected a decline. While fuel prices were the main issue, the number of airlines reporting softening demand and more competition also rose. "Airlines' reaction to this deterioration is clear," says IATA. "For the first time since the survey started, employment is expected to fall." Even top-notch Australian airline Qantas is suffering, slashing 1,500 jobs. But outgoing CEO Geoff Dixon has rejected criticism that cost-cutting was behind a series of recent safety incidents, including a mid-air blast that damaged a fuselage, causing an emergency landing in Manila. Qantas did not cut back on safety, customer service, or training, he says.

How safe is air travel?

Flying is now more than five times safer than 30 years ago, says Harvey Elliott in The Times. "If you travel by air for a lifetime, you have a 1 in 2.5 million chance of being killed. Use the train and that drops to 1 in a 50,000 chance. On the road that becomes a 1 in 200 chance". Last year, 2,946 people died in road accidents in Britain, says the Department of Transport; there hasn't been a fatal crash by a UK-airline owned jet for nearly 20 years. And there doesn't seem to be a gap between budget and flag carriers. "Qantas is one of many airlines with fatality-free records in the modern era, and easyJet and Ryanair have unblemished histories", says Simon Calder in The Independent; flying is, he says, "astonishingly safe".

Published in Stock markets | More articles by David Stevenson

Related articles

FREE - MoneyWeek's daily investment emailJohn Stepek

Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.