When you think of the credit crunch you naturally think of the banking crisis. The UK government has spent a colossal £1.5 trillion to date bailing out its banks since 2008. To put this into perspective; in the UK £500bn was spent on the banking rescue plan in the year following the 2008 crisis compared to a measly £193bn spent on health and education. Credit crunch is a term used to describe “a severe shortage of money or credit” and this is certainly not a problem that is confined to the banking sector alone.
The financial crisis meant banks were much less inclined to lend to their customers and the cost of borrowing increased dramatically. House prices and share prices also plummeted. The upshot of this for everyday people is a severe impact on market confidence and a reduction in their disposable incomes. People who have less money to spend are forced to focus their income on essential spending rather than luxury goods. The impact of this on many businesses has been monumental. This is the point at which a crisis confined to the banking industry becomes a wider social issue, the consequences of which continue to be felt today.
The airline industry is clearly feeling the effects. Cathay Pacific, a Hong Kong based worldwide airline, this week announced a dramatic fall in profits. The airline made only 5.5bn Hong Kong dollars in 2011 in comparison to 14bn the previous year; a decrease of 61%. Although rising fuel costs and unexpected weather conditions were drivers behind the drop in profits the principal reason provided by Cathay Pacific was “global economic uncertainty” which had hit passenger numbers. The problem is that in a recessionary climate everyday people are less likely to spend what little money they do have on travel. The problem is not confined to Cathay Pacific alone; their announcement follows similar tales of woe from Air France-KLM, Malaysia Airlines, Air Berlin and Air Asia in the last month. The problem is clearly a worldwide one and one that is probably here to stay.
Economic confidence is at an all-time low especially in Europe where the on-going Euro crisis is damaging people’s disposable income and will limit spending, on non essential items such as flights for the foreseeable future. Widespread unemployment and in particular youth unemployment adds to the problem. Young people are a significant part of that sector that spends their money on flights in order to go on holidays around the world. When you throw these confidence damaging issues together the prospects for the airline industry and the wider business world don’t look good.
The early signals are that the airlines themselves don’t expect the situation to improve. Ryanair, KLM and Qantas have all recently announced they are to cut staff in response to declining passenger numbers. But this is symptomatic of the underlying problems I believe lie ahead for the worldwide economy as a whole; people have less money to spend, so they spend less, so businesses profits fall, in response they cut staff numbers, so more people are out of work with less money to spend. And so the dangerous cycle continues. When a similar situation arose in America in the 1930’s after the Wall Street Crash, President Roosevelt increased government spending on a range of measures including building new schools, roads, dams and agricultural regeneration schemes such as the Tennessee Valley Authority to kick start the economy and get people back to work. Even then his measures only reduced unemployment by approximately 50%. A return to full employment in Europe and the USA only came after the start of World War 2 with its subsequent demands on manpower and war materials.
The roots of today’s problems lie with the financial crisis. The result has been significant damage to people’s ability and willingness to spend. Businesses of all kinds will continue to pay the price.
Considering the tone of your blog you are seriously concerned about the prospects for the airline industry. Do you think Cathay Pacific is in any immediate danger?
ReplyDeleteI am indeed concerned about the prospects for the airline industry as a whole. Fuel prices and customer demand are key in the airline industry. Fuel is by far the highest single cost to the airline industry and demand, like any business, shapes the success of the market participants.
ReplyDeleteAccording to the Bureau of Transportation Statistics, since April 2011 airline fuel prices have averaged $2.91 per barrel. This is close to the 2008 average, at the height of the financial crisis, of $3.06 per barrel. This follows a calmer period in 2009 and 2010 in which prices averaged $1.89 and $2.23 respectively. Meanwhile passenger demand has fallen in recent years due to the uncertain economic outlook which is limiting consumers’ willingness to spend on luxury items like airline travel. Together these issues make the outlook for the airline industry extremely uncertain. These fears were confirmed recently by Tony Tyler, Director General and CEO of the International Air Transport Association, who stated that “The outlook is fragile. Weak economic conditions and rising fuel costs are a double-whammy that an industry anticipating a 0.5% margin can ill-afford.”
Having said that I do not feel that Cathay Pacific is any immediate danger. The drop in profits seem alarming on the face of it, however it is worth recognising that 2010 was a record year for Cathay Pacific which was always going to be difficult to replicate. In addition the latest profit figures are on par with, if not exceeding, results posted prior to the 2008 financial crisis. Furthermore in the airline industry there remains strong demand for long haul premium class travel; that which is the core of Cathay Pacific’s business.
My blog may not be clear enough in its explanation that the dangers lie most prominently with budget airlines. These are hard hit by rising fuel costs and rely on low income people travelling on holidays. In the current climate this is unlikely to grow, or even be maintained, and therefore could lead to the immediate danger of some poorly placed budget airlines. But certainly not Cathay Pacific.
When considering the effects of fuel price increases in comparison to a reduction in passenger demand; which do you think goes further in explaining the fall in Cathay Pacific’s profits?
ReplyDeleteAs mentioned previously fuel is the by far the biggest single cost to airlines and therefore has a major bearing on any changes in profit experienced by airlines. Cathay Pacific’s fuel costs increased by an alarming 44.1% in 2011; this equated to an increase of HK$12.455 billion which goes a long way to explaining the HK$8.5 billion decrease in profits. Meanwhile, as alluded to previously, passenger demand for Cathay Pacific’s premium class travel remained strong in 2011. This would suggest that fuel price increases go furthest in explaining the fall in Cathay Pacific’s profits.
ReplyDeleteHowever in terms of the airline industry as a whole I predict that the opposite will be the case. All airline companies employ active hedging policies to help mitigate the impact of changes in fuel prices helping to offset any potential losses arising from this. This is an activity that has gone on for many years allowing airlines, which are heavily impacted by fuel prices, to effectively survive and even prosper through rising fuel price periods. I therefore believe that if any airlines are to go to the wall it will be due to a reduction in passenger demand which simply cannot be managed in the long term.