Seating surplus Overcapacity to propel airline industry downward in 2018

Airlines are adding passenger capacity to compete, further straining revenues. Lufthansa can cope thanks to strong margins, but 2018 will be tougher than last year for the industry.
Enjoy the row all to yourself.

Lufthansa has had a skittish start this year: Shares have nosedived 10 percent after more than doubling in 2017 to reach €31.12 ($38.60) on Dec. 28, the highest price in over 25 years. Germany’s flag carrier is suffering from the demur of airline investors everywhere, fearing how rising kerosene prices and a glut of passenger seating could take down the airline industry.

Too much airplane capacity and not enough passengers has long been a looming problem, but now it's getting serious. The insolvencies of Air Berlin, Alitalia and Britain’s Monarch last year have resulted in consolidation, but not reduced the excess supply of seats. “Just a few weeks ago it looked as though the consolidation would slow down the growth in capacity,” said Daniel Röska, an analyst at Bernstein Research. “The last weeks have shown that airlines are continuing to add capacity in the summer flight schedules.”

Mr. Röska has calculated that in Europe alone, the supply of airline seats will increase by 6 to 7 percent in the first half of the year. While airlines for decades have successfully adjusted capacity planning to real GDP growth, many have reverted to a much older strategy of defending market position by expanding capacity, and racing prices to the bottom.

In Europe, Britain’s looming exit from the EU in March 2019 has led players such as British Airways-owner IAG, Easyjet and Ryanair to muscle into Continental markets, including Germany, in pursuit of growth beyond Britain’s shores.

06 p19 The big three in comparison-01

The result will likely be downward pressure on margins. Mr. Röska said Air France-KLM could be among the biggest losers because of its already-thin margins: Just 7 percent in the first 9 months of last year. That compares with IAG’s 12.3 percent and Lufthansa’s 8.5 percent.

Lufthansa and IAG will likely be able to cope with falling prices, even though Lufthansa itself plans to increase capacity significantly by 7 percent this year, largely by expanding its budget unit Eurowings. But Germany’s largest carrier also knows 2018 will be turbulent. “The euphoria from 2017 that was driven in part by the collapse of Air Berlin has died down appreciably, we know that,” said one manager.

A possible takeover of parts of Alitalia is unlikely to provide Lufthansa with the kind of boost that its takeover of Air Berlin gave. Many analysts doubt whether an acquisition would make sense given the Italian airline’s failure thus far to progress in its restructuring.

That’s why Lufthansa’s 2018 focus will be on saving costs. At an investor roadshow in the US in January, managers said they plan to keep on reducing cost-per-available-seat kilometer (CASK) by 1 to 2 percent every year. They didn’t even venture forecasts for 2018, saying only that predictions beyond the first quarter would be difficult.

Rising kerosene prices only exacerbate the situation, with the cost of a ton jumping 30 percent to $630 since the start of January. That’s still far below the $1,000 per ton recorded in 2011 though, and most airlines have cut their running costs to the point where they can absorb fuel price hikes without suffering much. Lufthansa hedges a substantial amount of its fuel requirements, limiting its exposure to rising kerosene prices.

Passengers won't be able to take advantage of cheaper ticket prices in the long run. Airlines are likely to find other ways to make up their profits, such as charging more for services or for services that had been complimentary.

Jens Koenen leads Handelsblatt’s coverage of the aviation industry. To contact the author: [email protected]