How Will The Brexit Impact US Airlines?
Contrary to market expectations, the United Kingdom (UK) surprisingly voted in favor of leaving the European Union (EU) through a referendum on 23rd June 2016. While the Brexit, or the exit of Britain from the EU, may not have many short term implications, it is likely to significantly impact the economic health of the UK as well as the EU over the long term, largely due to change in trade agreements. Since air travel demand is positively correlated to the economic conditions of a country, the UK air travel sector is likely to take a hit. This was evident from the fact that the S&P Composite 1500 (Airlines) fell almost 7% post the announcement of the exit. In this note, we discuss how Brexit will impact the UK air travel and, in turn, effect the US Airline industry.
Source: Google Finance
The surprising move by the UK, one of the world’s largest economies, has created a lot of uncertainty regarding the future of the country as well as the EU, resulting in a severe volatility in the stock markets. The US Airline stocks fell sharply on Friday after the results, as investors feared a slowdown in the UK economy to hit the international revenues of the US Airlines. The worst loser was American Airlines (NASDAQ:AAL), whose stock dropped almost 11% in a single trading day, as the airline is believed to have maximum exposure to the UK air travel market. According to market estimates, the world’s largest airline (by traffic) has over 6% capacity that is directly related to the UK markets, owing to its partnership with British Airways. The major reason behind this perspective is that the demand for outbound flights from the UK to the US will decline due to weakening of the pound because of slower economic growth in the country.
To illustrate this, we show below the relationship between the UK’s Gross Domestic Product (GDP) and the UK air passengers. Based on the data provided by International Air Transport Association (IATA) [1], the elasticity between a developed country’s income (proxied by its GDP) and the country’s air travel demand is roughly 1.3. This implies that a 1% growth in the country’s GDP could bring about a 1.3% improvement in its air travel demand.
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While there can be a number of scenarios to arrive at the impact of Brexit on the UK’s GDP, based on the latest report, The impact of ‘Brexit’ on UK Air Transport, by the IATA, we expect the UK’s GDP to decline by 2.5%-3.5% by 2020, ceteris paribus. If this scenario comes true, then the UK air passengers are likely to drop by 3%-5% by 2020. Thus, US Airlines which have exposure to the UK markets, will face a dip in their revenue over the long term.
In addition to the decline in air travel demand, the Brexit is likely to result in the weakening of the pound with respect to other currencies. The UK pound dropped almost 11% against the US dollar on Friday post the vote. In addition, S&P 500 downgraded the UK’s credit rating to AA, from AAA causing further fluctuation in the currency’s exchange rate.
Source: www.xe.com
A weaker pound is expected to make outbound trips for UK passengers more expensive, while the overseas visitors to the UK, will enjoy a higher purchasing power. Since currency fluctuations can directly impact customer decisions, the depreciation of GBP against the US Dollar will result in further contraction of air travel demand from the UK.
In conclusion, we believe that the Brexit is expected to result in a slowdown in the UK’s economy, which will indirectly cause a depreciation of its currency, the pound. Both these factors will lead to a contraction in the UK’s air travel demand, which will severely impact the US Airline industry.
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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 Delta Air Lines Limited
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Notes:
- Air Travel Demand by IATA Economics [↩]