Where are the opportunities in international markets?Print
These are exciting times to be in the airline business in North America. After more than a decade of “traumatic” restructuring, North American airlines are finally reaping the benefits, topping the worldwide charts for profitability by a sizable margin. In 2014, North American airlines generated more than 50% of worldwide airline profits (~$13 billion), a feat which seemed unattainable just a few years ago.
Although only 20% of North American capacity is deployed internationally, international flights contribute about 40% of overall revenues. In general, long-haul traffic grows faster than short haul traffic by 1% per annum. But how will this growth change international markets?
It is fair to say that while North American carriers were busy restructuring in the past 15 years, foreign carriers used this period to expand their operations into North America. Today, more than 50% of wide body aircraft serving North America are operated by foreign carriers.
Now, North American carriers have the cost base and financial stability to be more aggressive internationally. However, there have been some recent concerns about declining revenues and overcapacity on international markets: revenues and yields have been trending downwards the last couple of months, raising the question, “what are the most promising markets?”
Emerging markets are key to international growth
According to Airbus’ Global Market Forecast (GMF), most of the growth will come from emerging countries. Traffic between emerging countries will grow at 5% worldwide– twice the rate as traffic between mature economies (2.6%). North American carriers can tap into this growth by focusing on emerging markets such as Asia-Pacific and Latin America.
Solid growth in Asia, India and China champion growth
In a nutshell, in terms of traffic growth to and from North America, China and India will lead the way with 9% and 8% respectively over the next 10 years. [Source: Airbus internal study. Add chart from YCR presentation]. China will become the second largest international market after the UK, ahead of Germany and Japan. India will move up to 5th place, overtaking markets like France and Italy.
Concentration around large Asian hubs
How will this growth materialize in concrete terms? There will be some new route openings, but historically traffic growth across the Pacific has been centered on the large Asian hubs. Nearly 80% of the route expansion across the North Pacific in the past five years has occurred at hub airports, where onward connections are readily available. There are good reasons to believe that this trend will continue. For example, there is a slot scarcity at the main Chinese airports, and U.S. carriers are are already using all their traffic rights to primary Chinese cities. The best way to grow in these circumstances is through up-gauging to large aircraft on existing major routes. Expanding frequencies beyond daily frequencies entails significant risk; up-gauging mitigates this risk and is seen by many airlines as the more efficient way to grow.
Aircraft size trending up
Following the 2008 global financial crisis, average aircraft size dropped on the transpacific market, mainly driven by 747 retirements. This trend has been reversed in the last few years, now trending up towards 300 seats. Larger twin-aisles (A350-900 and A350-1000) will be the predominant aircraft type on the market. The major Asian cities such as Tokyo, Shanghai, Seoul or Sydney will require larger aircraft such as the A380.
The number of aircraft serving these markets is expected to grow by more than 50% to 529 aircraft in 2023. North American carriers today only represent 40% of this fleet, a position that they can now start improving thanks to their more competitive cost base. For comparison, North American carriers operate 53% of aircraft flying to Europe, and 70% of all aircraft flying to Latin America.
Latin America – boost by emerging middle class
Although Latin American countries are not present in the top 15 international destinations from North America, Latin America as a whole will remain the second largest international market for North American carriers, with a solid 4.4% growth rate. Latin America’s fast growing middle class will boost premium traffic to grow 1% faster than economy traffic, a lucrative opportunity up for grabs. As noted above, North American airlines already account for 70% of the aircraft operated between the two continents, but Latin American powerhouses such as LATAM or Avianca are stepping up their game with very modern fleets and will try to claim a larger piece of the cake; a space to watch.
European destinations will remain the largest market
With all this focus on emerging markets, it could be easy to forget that nine out of the top 15 International destinations will still be in Europe, albeit with smaller growth rates. Competition intensifies on the Atlantic, but so far new entrants like Norwegian are not commanding large market shares. M&A activity and JVs further influence the market. New aircraft types like the A321LR will de-risk route openings across the Atlantic, an opportunity which a variety of airline types from Low Cost Carrier to network carrier are likely to exploit in the mid-term.
What about the Middle East?
North America-to-the-Middle East is a strong growth market with an attractive 6.4% growth rate for the next 10 years. But it will remain a niche market. No Middle Eastern market is in the top 15 destinations, and overall traffic volume will just slightly surpass traffic between Africa and North America in the next 10 years. UAE and Qatar both will grow at roughly 10% over the next five to10 years, but to put things into perspective, their combined traffic volume in will only be one-fifth of the traffic with China.
Orderbooks not yet poised to tap into growth
So there are many lucrative opportunities out there for North American airlines to tap deeper into international markets. But to do so they need to think about their wide-body order books. With current order books North American carriers would reduce their capacity by 18% in 2023 compared to today’s wide body fleet, which stands in stark contrast to order books of their international competitors.