ôIf the oil price remains at current high levels, the present profitability cycle for airlines which started in 2003 has peaked,ö he said during a presentation to reporters yesterday.
UBS is forecasting a recession in the US in the first half of the year, but positive growth for the full year. But the downturn, according to Horth, will lead to a softening of demand for air travel. This together with higher oil prices will force weaker airlines to restructure or go out of business.
The high price of oil has not mattered much in recent years as the strong global economy gave the airlines a degree of pricing power, which enabled them to offset rising oil prices.
ôNow youÆve got this scary scenario with oil over $100 and the global economy softening. A high oil price is nothing new, but high oil prices in the context of a weak global economy is very new. Everything changes over the course of the next year," he said.
Horth expects big mergers in the US between Delta Airlines and Northwest Airlines and also between Continental Airlines and United Airlines. Mergers have in the past been blocked by opposition from the pilots but higher oil prices will force the pilots to agree eventually. ôWith oil at $107 I just donÆt see how the stand-alone business plans of the US airlines make any sense,ö said Horth.
Outside the US, consolidation is complicated by the Byzantine regulatory regime that airlines face.
Airlines that are particularly vulnerable this year include those that are highly leveraged and those that are focussed on the cargo market. But Horth said that stronger airlines will get stronger. This will include ôthose with strong balance sheets, strong competitive positions and higher marginsö.
But start-up carriers are vulnerable, particularly small airlines with a weak balance sheet and a business plan designed around oil prices at $75-$80 per barrel. When oil prices jump to $107 it hurts two kinds of airlines: small long-haul airlines focused on leisure traffic, which have the least pricing power; and airlines with older aircraft focused on the leisure sector.
Horth said that Hong KongÆs Oasis Airlines will find the present environment particularly challenging since it is a small airline with a relatively weak balance sheet. Since it flies long-haul routes, fuel is a high proportion of its cost base.
He also noted that consolidation in the China aviation market is proving to be highly complex.
ôThe current situation is the worst of all possible worlds û we are in limbo,ö said Horth, referring to the stalemate that followed the defeat of a plan by Singapore Airlines and Temasek Holdings to take a stake in China Eastern Airlines.
With the top three airlines in China accounting for 70% of domestic traffic, compared with 30% in the US, China is already a very concentrated market. This presents the government with the difficult choice of either creating strong airlines and thereby risking the creation of a quasi-monopoly carrier, or opting for competition and bringing in foreign airlines as partners to help the domestic airlines overcome the challenges they face.
ôThat tussle is still playing out,ö Horth said.
The problem for investors is that the regulatory regime in China is unclear, but Horth said he believes the future structure of the industry will be discussed at the ongoing PeopleÆs National Congress in Beijing. If the government comes down on the side of competition and bringing in foreign airlines as partners, one candidate for China Southern which has so far not been linked with a foreign airline, would, according to Horth, be Emirates Airlines.
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