A major airline predicting lower profits in the coming years and cutting back on capacity growth certainly lends credibility to the theory that the European airline market has peaked. That’s why Friday’s update from BA owner International Airlines Group (LSE: IAG), downgrading its EBITDAR targets from €5.6bn to €5.3bn annually and lowering predicted annual capex from €2.5bn to €1.7bn through 2020, is a big deal.
Now, these are not drastic cuts and IAG is still maintaining high targets for operating margins and free cash flow. However, the fact that the airline is scaling back expected capacity growth should worry investors in all European airlines. That’s because this isn’t an industry-wide plan to throttle capacity in order to maintain profits, but rather one airline essentially admitting that demand growth is faltering and that storms are on the horizon.
Turning bearish
This is backed up by the latest data from the International Air Transport Association (IATA), which shows slowing demand growth from passengers. Bullish IAG shareholders can validly point out that IATA is also forecasting total global passenger numbers to double in the next twenty years. The bad news is that IATA is not exactly an unbiased observer, given that it’s basically a trade association. Likewise, four of the top five growth markets, measured by additional passengers, are expected to be in Asia, which is far removed from IAG’s Trans-Atlantic breadbasket. Adding further salt to the wound, IATA is predicting Europe to be the slowest growing market through 2035, with meager annual growth measuring just 2.5%.
None of this means that IAG is a poorly run company. Rather, it should simply illustrate that the airline industry is a highly cyclical one in which even great companies suffer during the downswings. Contrarian investors may well find any potential downturn a stellar opportunity to snap up shares at a bargain price. But, with management and trade groups turning bearish on their medium term outlooks, I wouldn’t pull the trigger just yet.
A peaking market
The weak pound, faltering Eurozone economic growth and fear of terrorism have all played their role in weakening air travel demand in Europe. While IAG can at least fall back on highly profitable US-UK flights, Thomas Cook (LSE: TCG) has no such buffer. The aforementioned headwinds led to poor Q3 results for the package holiday provider as revenue dropped 8% year-on-year and posted a £25m operating loss.
The company is attempting to expand long-haul offerings to the likes of the US, but they have thus far failed to compensate for problems in core markets such as Turkey. The company is in the midst of a multi-year turnaround but high levels of debt and very low margins are enough to make me wary of the company to begin with. Add what appears to be a peaking market for air travel and Thomas Cook becomes one company I won’t be owning anytime soon.
