No surprise if airlines collapse as winter sets in

A storm of hurricane proportions is churning towards the European airline industry and the consequential damage should not be underestimated.

No surprise if airlines collapse as winter sets in

The genesis of this major event is multi-faceted.

The sustained strength in the dollar is one problem.

Airlines across the world have to buy aircraft and insurance in dollars so any shift upwards in the US currency increases costs for carriers.

When those airlines do not have offsetting dollar revenues to soften the blow of higher costs, the effect is amplified.

Since March, the dollar has advanced by 10% against the euro, adding cost for airlines who finance their fleets in the US currency.

However, the most troubling factor currently is the price of oil.

It has increased by 50% since the summer of 2017, and jet fuel accounts for up to 40% of operating costs in an airline.

When you add higher oil prices to a stronger dollar, it equals a whole lot of pain for airline managers.

On top of all that, there is evidence that too much aircraft capacity has been injected into the European air travel system for the coming winter and into 2019.

Strong capacity growth usually requires lower fares to stimulate enough demand to fill the extra seats on offer.

After a few years, when profits have been robust airlines have a habit of being over-confident and ordering more airplanes.

In aggregate, this leads to an industry-wide supply boost that forces fares lower as airlines compete to achieve high load factors, a term defined as a percentage of available seats filled.

These problems are unfolding together in real time across Europe at present.

The stock market can often be the ultimate canary in the coalmine when trying to predict future developments in specific sectors.

The airline canary is now coughing loudly and sweating profusely.

EasyJet, Wizz Air, and Ryanair have had their share prices fall by almost a third in the past 12 weeks as investors begin to assess the consequences outlined above.

High oil prices and evidence of too much capacity are usually the causal factors of significant change in the airline sector.

Just last week a Scandinavian airline, Primera Air, went bust, leaving customers without flights alongside pilots and cabin crew without jobs.

Such failures are relatively small, but they are lead indicators of the pressures evident within the system.

As in times past, it is those airlines with the strongest balance sheets and proven lowest unit costs that can weather this storm best.

In Ireland, the two key airlines —Aer Lingus and Ryanair — are well positioned in that context.

Aer Lingus is now an integral part of the IAG Group, which has the resources and financial strength to manage a period of very low fares and rising costs.

Ryanair’s balance sheet remains among the strongest in the industry.

Despite raising its labour-related costs over the past year it also continues to be the lowest cost carrier in the European market.

While both of these could emerge on the far side of this difficult period stronger than ever, they will be feeling the effects of cost shocks and revenue weakness too.

Ryanair issued a profit warning last week that was tethered to its labour issues, but also noted the effects of higher oil prices.

Winter is usually the time of year when episodes like this are most damaging.

Seasonal demand is lower, so average fares tend to be depressed between October and March.

That reduces revenues in businesses that have high fixed costs due the price of aircraft.

Add in a spike on oil prices, and it is understandable why bankers and investors are fretting at present.

I would not be surprised if more airlines collapse as the winter days get shorter.

Joe Gill is director of corporate broking with Goodbody Stockbrokers. His views are personal.

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