December 9, 2016/FDC
The global aviation market recorded a sub-optimal performance in 2016. It is estimated that full year profits are 5.6%, or about $10.42 per passenger.1 This shows a marginal improvement over the previous year. (It is low when compared to the average profit-ability of industries such as finance and technology with net profit margins of 17.14% and 17.23% respectively.)
Lower oil prices have kept operating costs at a record minimum, and thus helped to increase profitability. This is not the case for the African aviation industry. Although East Africa remains resilient, losses in other regions are too significant to offset gains. Exchange rate depreciations have tempered the advantages of lower oil prices for most of the continent. Thus, the region is expected to lose $500 million in 2016.
The Nigerian aviation industry has borne the effects of the economic downturn. Two factors played a major role in its underperformance: the unavailability of foreign exchange (forex) and the decline in demand for airline services.
Factors facing the Domestic Aviation Market
Foreign airlines have been unable to repatriate revenue. Through repatriation, airlines convert their profit into dollars and then into their local currency (e.g. Euros or pounds, where applicable). The scarcity of dollars has trapped funds in naira, rendering them essentially unusable to airlines who deal with foreign currency.
Funds repatriation is extremely important for day-to-day activities for the airline industry which operates on a thin profit margin. While airlines like Lufthansa and Emirates have reduced flight frequencies, some others (United & Iberia) exited the market entirely due to this problem. Most airlines have been forced to buy a portion of the dollars they need from the parallel market. This is not an effective strategy because it creates an excess forex demand and mounts pressure on the naira.
Additionally, airlines make a conversion loss when using the black market rate. For example, a ticket that costs N250,000 equals $819 at the interbank rate (at N305/$), but only $520 (at N480/$) at the black market rate. To cope, airlines have stopped or significantly reduced the sale of naira tickets to avoid the loss. By forcing customers to pay for tickets in dollars, airlines reduced the risk of conversion losses.
At the end of Q2, some $591 million of non-repatriated funds were trapped. Although airlines got a share of the $1.48bn forward contract settlement at the end of Q3, there is still an estimated $400bn of blocked funds (at minimum).
For domestic players, the forex shortage has led to scarcity of imported aviation fuel. Marketers have complained about the challenge to source dollars to import aviation fuel. There is a school of thought that suggests that oil marketers intentionally import less oil than is needed to meet demand. This creates an artificial scarcity and keeps the price high. Jet A1 fuel prices are approximately 100% higher than they were in Q4’2015.
High fuel prices and landing charges have kept operating costs at a peak. Many domestic carriers have turned to debt financing which, in the current regime of high interest rates, has proved to be a more expensive alternative. The result has been increased flight cancellations, delays and reduced customer satisfaction. The bigger domestic airlines have struggled to stay afloat, despite the increased patron-age from Nigerians who prefer the relative lower ticket fare, naira pricing, and more baggage allowance these airlines offer.
Additionally, the aviation industry has been affected by the paradox of thrift. This is the economic idea that states that people generally spend less and save more in periods of economic down-turn.
This can be traced back to the depreciation of the naira, which combined with rising consumer prices, has eaten away the earnings of the average consumer leading to sharply lower disposable income. Just as basic economics implies, when faced with limited resources, rational economic agents choose between available options. Consequently, the reshuffling of priorities and the change in consumption patterns has prompted a fall in the demand for air travel. Families cancel vacation trips, prospective post-secondary students enrol in Nigerian universities instead of British, American or Canadian Institutions, while business meetings are replaced with conference calls. Thus, in 2016, passenger load factors dwindled by 15% for international and 20% for domestic flights.
These issues have squeezed the profit margins of domestic and international players operating in Nigeria. While International carriers, having profits from other markets, have coped better in the present crisis, the smaller revenue base of domestic airlines has caused them to almost topple over. Thus 2016 saw airlines (e.g. Aero and First Nation) suspend operations, as rising costs, falling revenue and static demand in the industry have caused their balance sheets to bleed.
Outlook: Marginal Recovery Ahead
The future health of the aviation industry is affected by the direction of global economic performance. The global economy will see a growth of 3.4%, higher than the 2011-2015 average of 2.61%. The global aviation sector is expected to reflect this trend and expand marginally.
The domestic market will also record marginal improvements based on the following:
1. Improved forex liquidity: The Central Bank is committed to solve the repatriation crisis by keeping airlines as a top priority for forex allocation. Consistency of dedicated and continuous contact with international airlines is needed to maintain investor confidence. In the medium to long term, when the benefits of effective forex policy and export diversification begin to come to fruition, the problem of non-repatriated funds will disappear.
2. Local production of Jet A1: With the ongoing Dangote Refinery project and revival of the Kaduna refinery, local refining of aviation fuel is not too far off. The oil refining sector grew by 49.19% in Q2. A local refinery with high capacity and output will solve the supply problem. Until then, airlines will need to cope with fuel scarcity and higher prices by looking to neighbouring markets for supply.
3. Regulation and monitoring: The Nigerian Civil Aviation Authority is beginning to take note of the uncontrolled unreliability of Nigerian operators. Thus, the agency intends to impose penal-ties for unnecessary delays and flight cancellations.
4. General economic recovery: FDC Think Tank forecasts a modest recovery in 2017 of 1.6% full year growth, compared to -1.7% in 2016. This will be driven primarily by government spending. The result will be improved economic activity and output, job creation, and an increase in disposable income. All of these will translate into increased demand for air travel.
In summary, the aviation sector is vulnerable to external events and shocks. Thus, its performance in 2017 will be highly dependent on the factors listed above, especially the supply and price of forex and aviation fuel.