While European airlines have been “more restrained” than expected on near-term capacity reductions amid higher jet fuel prices, analysts at Bernstein said they do not think the risk of winter capacity cuts is over, even as fuel prices are up around 70% since the war started.
In fact, the firm anticipates pressures rising during winter, citing two main reasons for this: lower baseline contribution margins and a progressive roll-off of cheaper hedges.
The first of these, lower contribution margins, is the result of higher fuel prices making typically profitable summer flights less profitable.
“Airline profitability is highly seasonal, with higher demand in the summer pushing up unit revenues without a corresponding rise in unit cost,” the analysts explained, though noting that the higher asset productivity during this period could mean summer flights might still be worth operating even at lower margins. However, winter could see flights become “altogether uneconomic.”
As for the second reason, the analysts point out that European airlines typically accumulate fuel hedges over an 18-month period, which helps moderate swings in fuel costs. Over time, however, the cheaper hedges secured before the war gradually expire.
“We dispute the logic that fuel is cheaper by hedging (the derivative is separate; fuel itself costs the spot price), but hedges are, for now, providing a cushion for airlines for strategic (read: unprofitable) flying,” the analysts said, adding that even this cushion can be expected to deflate by winter.
Meanwhile, the cuts are expected to impact short- and medium-haul flying more as costs can be more variable here and contribution margins lower.
Moreover, if the situation gets dire, airlines already struggling may even find they are unable to keep going.
“Airlines, for now, appear inclined to battle for market share. If fuel prices do not improve and / or willingness to pay eases, the weaker ones may be forced to cut… Or fail altogether”.
Meanwhile, airlines like IAG (LON: ICAG) and Ryanair (NASDAQ: RYAAY), with strong unit economics and balance sheets will be best-placed to take advantage of the situation.
source https://www.investing.com/news/stock-market-news/why-airlines-look-set-for-winter-capacity-cuts-4708093
