Mona Lisa’s smile – the many different aspects of the aviation industry

A recent article in The Economist noted how the current global economy revealed what was known as the Mona Lisa effect. Like the smile on Mona Lisa’s face, every time you look at her, the smile looks a little different. Similarly, every time we look at what’s going on in the world economy, the picture seems to change – these include the impact of higher interest rates on growth in the world’s leading economies, the pace of China’s recovery and further developments on the geopolitical front (Ukraine/Russia, China/Taiwan). Add to the mix the impact of the US’s regional banking crisis and the recent drama before the US (finally) raised its debt ceiling and you have a few more takes on the Mona Lisa’s smile.

The smile on Leonardo da Vinci’s famous portrait seems particularly apt in a discussion about the aviation sector. Not only is Rome’s leading airport named after da Vinci, but he was possibly the first person to conceptualise the idea of an aircraft, hundreds of years ago.  And his famous subject’s multifaceted smile is a good metaphor for the challenges (and opportunities) that the sector faces right now.

This environment makes it difficult for the key stakeholders in the aviation sector to forecast and plan. At the start of the year, the prognostications were generally bullish: as the world continued to emerge from the Covid-19 pandemic, IATA expected airlines to return to profit for the first time since 2019 and passenger and freight volumes to continue to pick up this year, as the pent-up demand for travel after the pandemic continued to play out. 

Air travel demand rebounds

According to the 2023 ‘Global Commercial Aircraft Market - Annual Review & Market Outlook’, global air passenger demand is projected to grow by almost 3% from its pre-pandemic level by the end of this year.

This will be driven in particular by China’s lifting of restrictions at the start of the year, and airlines and airports benefiting from the normalisation of the conditions that caused bottlenecks of mid-2022 – as well the growing trend towards spending on experiences, such as travel, overspending on goods.

According to Fitch Ratings, deliveries of large aircraft are forecast to rise by 10% this year from 1,140 aicraft in 2022 to 1,250 in 2023, with production rates also expected to rise over the year. Aftermarket sales and maintenance, repair and overhaul servicing should also increase this year, to close to 2019 levels.

In January this year, revenue passenger kilometres were up 67%, while overall air travel numbers were 84% of their pre-pandemic levels in January 2019.

Meanwhile, IATA says that commercial aircraft deliveries are forecast to exceed pre-pandemic levels this year, up by 24% compared to 2022 with North America (primarily the US) forecast to receive 33% of deliveries, followed by Europe (27%) and Asia Pacific (24%; mainly China and India).

Inflation challenges

But a further glance at the Mona Lisa reveals different aspects. High inflation and rising interest rates are starting to take their toll and many economists are expecting a recession within the next 12 months, which could have an impact on demand.

Up to now though, airlines have been able to hike prices above inflation. A recent article in the Financial Times, ‘Air fares soar above inflation as carriers cash in on travel demand’, noted that airfares across 600 major routes rose by 27.4% in the 12 months to February, well ahead of inflation rates in the world’s leading economies.

While pent-up demand has certainly contributed, the usual suspects are the main drivers of steep rises in ticket prices, as airlines face rising costs.

Bradley Gordon, head of Aviation Finance at Investec in South Africa, says that the biggest of these is fuel.

“In December 2019, the Brent crude oil price was US$60/barrel, and for most of last year this was anywhere between US$80-100/barrel. While Brent may have reduced now to US$75/barrel it still remains above pre-pandemic levels.”

But other costs have also risen. Base global interest rates (LIBOR, which has been phased out and its replacement SOFR) have increased from near zero to over 5%, which has increased financing costs and insurance costs have also increased.

“Inflation has driven all costs through the supply chain including spares, maintenance, insurance and salaries higher, while a strong US dollar has also added to cost inflation for most airlines,” adds Gordon.

While inflation appears to have turned the corner in the major economies, it remains to be seen if rates will come down before a recession kicks off. China’s economic recovery meanwhile has been unconvincing, with manufacturing, imports and retail sales falling short of forecasts.

African airlines back on track

Looking specifically at Africa, Gordon says African capacity, as measured by available seat kilometres (ASKs) is at 103% of its 2019 level according to data provided by IBA.

“So capacity in the market is back to where it was. Connectivity has largely reopened and there is a return of leisure and business travel into the African market – the demand is there,” says Gordon.

On the financing side, orders and deliveries in Africa took a dip since 2020 but have gradually started to recover, says Gordon. “Orders however seem to be concentrated amongst a few names, largely Ethiopian Airlines and then carriers in West Africa across Nigeria, Gabon and Cote d’Ivoire,” he says. 

“For consistently profitable carriers in Africa, as with elsewhere, financing will always be available, and we see the large African carriers such as Ethiopian having similar access now to financing as before. Margins and lease rates remain competitive even though base rates have increased significantly with the US Federal Reserve and European Central Bank all raising rates significantly over the last year,” he adds.

However, airlines without a consistent track record of profitability, in Africa and elsewhere, will always face a more challenging task in getting access to financing. Those that have the benefit of explicit government support via sovereign guarantees will likely have access to supported financing through export credit agencies, non-payment insurance or multilateral DFI-supported financing, operating lessors and could have access to commercial financing.

“But for airlines without a track record of profitability and explicit government support, financing is likely limited to DFIs and operating lessors, with limited commercial financing available in that space,” he adds.

Returning to the enigmatic Mona Lisa, we should never forget that it is, after all, a smile that keeps us so intrigued. On this note, we should remember the many things there are to be positive about in the aviation sector. These include: a number of new airlines launching in Africa, many of which are successfully fulfilling their business plans; the solid growth prospects for the African continent, based on the long-term outlook for commodity prices; Africa’s more youthful demographic (when compared with many other developed markets) and growing middle class; and the promise that the Single African Air Transport Market (SAATM) can bring to the continent.

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