What Could Be The Potential Impact Of Multi-Fold Increase In Passenger Demand On Airlines?

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A recent report by the International Air Transport Association (IATA) forecasts passenger demand for air travel to double over the next two decades, as people “trade, explore, and share the benefits of innovation and economic prosperity.” Growing at a compound annual rate of 3.7% per annum, the number of global passengers are expected to reach 3.7 billion by 2035. This rise in demand can potentially have profound effects on the aviation industry, increasing revenues and subsiding yield headwinds.

The September data released by IATA reinforces the expected trends for the growth in passenger traffic in various regions of the world. After weakness in July and August, passenger traffic grew 7% y-o-y in September. Besides traffic, both capacity (+6.6%) and load factor (+30 bps) were seen to be trending upwards.15113

Where Will The Demand Come From?

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More than half of the forecast increase in global demand in air traffic is projected to come from the Asia-Pacific region, with China and India leading the way. By 2025, China would surpass the U.S. as the largest aviation market in terms of traffic, while India will overtake the U.K., to be the third largest market.

Top Ten Passenger Markets
(million O-D passenger journeys)

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As can be seen in the above graph, growth will also be driven by the smaller developing economies of Indonesia and Brazil. Already, over the last 10 years, the developing world’s share of total passenger traffic has risen from 24% to nearly 40%. The following table gives the region-wise growth that is expected in different regions all over the world.

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What Are The Possible Challenges?

One of the main challenges, going ahead, is the uncertainty around economic policies under the new leadership in the U.S. If the bend of the policies is inwards, we are likely to see increased trade protectionism, which in turn will hamper growth prospects globally. Another factor to consider is a lack in the infrastructure required to handle this demand, like runways, baggage systems, personnel training, and air traffic control. The infrastructure needs to be developed and expanded much faster than the existing pace, with the help of all stakeholders involved. If not, the excess demand may result in a breakdown in the system. The recent restoration of relations of the U.S. with Cuba and Mexico, gave us a glimpse of the possible benefits that can be accrued.

Passenger Growth In Latin America

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However, the severe capacity constraints in Bogotá, Lima, and Mexico City illustrate the region’s airport capacity crunch. In order to fully realize the benefits of a closely integrated world, the forces of supply and demand need to be balanced. One way to achieve this is the possibility of letting the private sector enter the space and develop the needed infrastructure.

Further, it is imperative that this growth is sustainable, with minimum carbon footprint. One major achievement on the path towards sustainable growth, is the agreement between nations, through the International Civil Aviation Organization (ICAO), to offset the environmental impact generated by future air traffic growth.

What Is The Impact On Airlines?

The post-crisis era saw some recovery in air travel demand, however, it remained lower than the highs seen previously. Consequently, a number of airlines not only made losses and built massive debt on their balance sheets, but also went bankrupt. With the crash of oil prices in 2013, the aviation sector got a much needed respite. The savings from lower fuel expenses facilitated paring down of debt, providing shareholders return, upgrading old fleets, and building capacity. As of 2016, most airlines in the U.S. suffered from over capacity. This, coupled with pressure on yields, caused unit revenues for carriers to fall, and go in the negative. Thus, started the process of reducing capacity to manage the supply-demand imbalance and reduce the headwinds on yields. Some analysts went as far as saying that higher oil prices in the future may actually help airlines by enforcing capacity discipline.

However, as the demand for air travel increases, the advantages to the aviation sector are obvious. Increased demand is equivalent to more ticket sales, and consequently higher revenues. Further, as the demand increases, the capacity built in the system also gets utilized more efficiently as indicated by the metric “load factor.” The increase in topline trickles down to the bottomline, benefiting those invested in the airline stocks through growth in earnings and dividends given. The position taken by Warren Buffet in the U.S. aviation sector may further provide confidence to the investors looking at this sector as a possible investment.

 

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for American Airlines

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