City Insider: Airlines approach inflection point

Dart Group and Wizz Air were two success stories in 2015 but both might face a tougher climate this year, says City Insider David Stevenson

Looking at profit estimates for 2016, the travel and leisure segment – along with most consumer-based sectors – is pencilled in for fairly decent increases in corporate profitability.

For example, HSBC has projected earnings-per-share growth of around 15% for the broad consumer sector in 2016.

That should be good news for the travel industry giants. But I would also keep an eye on the two biggest success stories of 2015 – Dart Group and low-cost carrier Wizz Air.

These two businesses had a fantastic 2015, with both releasing excellent numbers in the autumn and early winter.

Interim results in November saw Wizz increase ticket revenues more than 15% while its underlying net profit stormed ahead 34%, and quarterly results for the year end released in January saw the carrier raise its forecast annual profit to at least €200 million.

Over at Dart, the parent group of the Jet2 brand saw profits power ahead by 65% last year as the business notched up an operating margin of 14%.

No wonder the share price of both businesses shot up. Over the last six months Dart Group shares rose 37% and Wizz 15%.

Yet I have a feeling both businesses might face a tougher climate this year. Both are firing on all cylinders, but can they really hope to keep up the momentum?

Jet2 had its best-ever summer in 2015. Could 2016 realistically go even better – and if it doesn’t, would a slowdown in growth pose a challenge for the airline when its package holidays now account for more than a third of clients?

The carrier’s load factors are already at epic levels at around 94%. Is this as good as it will get as competition intensifies?

Wizz is taking delivery of a whole new fleet of aircraft over the next year or so, with capacity set to grow by 18% in 2016. And this increase is set against a backdrop of declining unit revenues and lower fuel prices feeding into lower air fares.

Jet2 is also increasing capacity, buying 27 new Boeing 737s for delivery from September 2016.

The big story here is that the airline sector is reaching a key inflection point – with potentially major implications for the leading tour operators.

The key low-cost airlines are now ramping up capacity at the same time as they pass on fuel savings to the end customer. A price war is imminent and even the best airlines will struggle to keep increasing unit revenues.

Inevitably, that will result in the airlines looking at higher margin business such as dynamic packaging and running their own tour businesses. Jet2 has already made the transition, as has easyJet.

The transmission mechanism for deflation (falling prices) within the package segment of the market is this move by the airlines.

They will be responsible for increasing capacity as they seek out new ways to make an extra buck from their huge capital expenditure on new aircraft.

The obvious answer to this capacity-expansion challenge is for Thomas Cook and TUI to head upmarket.

The average holiday price at Jet2 is a relatively lowly £625 – but sooner or later even that market will come under attack. Could 2016 be the year in which the capacity challenge re-emerges to bedevil industry prospects?

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