The airline industry is on a roll and Air New Zealand is a major beneficiary of the improved outlook.
The national carrier, which is 73.6 per cent directly owned by the Crown, recently upgraded its pre-tax profit guidance for the June 2013 year to a range of $235 million to $260 million, compared with just $94 million achieved in the previous year. The impressive upgrade was due to a number of company and industry factors.
The latest International Air Transport Association (IATA) forecasts, which were published in March, paint a reasonably optimistic picture for the airline sector. They predicted that total industry profits for the 2013 calendar year will be US$10.6 billion ($12.4 billion), compared with US7.6 billion in 2012. By comparison the airlines sector reported combined losses of US$26.1 billion in 2008 at the height of the global financial crisis.
IATA predicts that the Asia-Pacific region will be the best performer in terms of total profitability and operating margins. The region's ebit (earnings before interest and tax) margin is expected to be 5.3 per cent this year, compared with a worldwide ebit margin of 3.3 per cent.
Air NZ had an ebit margin of 3.5 per cent for its June 2012 year and 7.2 per cent for the first half of its current year. Based on its recent guidance upgrade the carrier should achieve an ebit margin of around 7 per cent for the June 2013 year, well above the 5.3 per cent predicted for carriers in the Asia-Pacific region.
IATA notes that the outlook for the global economy and the airline industry improved during the first quarter of 2013. Listed airline companies outperformed sharemarket averages during this period, partly because of structural as well as cyclical factors.
• An increase in passenger numbers.
• A modest upturn in cargo volumes, particularly in the Asia-Pacific region. Air freight delivers higher margins and profitability for carriers.
• A significant improvement in traffic to and from emerging countries.
• Traffic growth is increasing at a much greater rate than capacity and this is boosting load factors and underpinning profitability.
• Mergers, joint ventures and code-sharing agreements that have boosted efficiency and profitability.
• New aircraft are more fuel efficient and IATA believes that the industry will report similar profits to 2006 in the current year even though oil prices are US$40 a barrel higher.
Nevertheless fuel prices remain an extremely important variable, with IATA predicting that the industry will spend US$216 billion on fuel this year, representing 33 per cent of total operating costs, compared with only US$44 billion 10 years ago.
There are three listed airline companies in Australasia - Air NZ, Qantas and Virgin Australia, with Air NZ owning 20 per cent of Virgin Australia. The good news is that Air NZ is performing much better than either Qantas or Virgin Australia at present.
Air NZ has a much higher ebit margin and is the only company to currently pay a dividend. The company carried 13.2 million passengers in the 2012 calendar year, representing three times the country's total population, whereas Qantas carried 47.7 million passengers over the same period, which is just over twice Australia's population.
Air NZ reported normalised net earnings after tax of $99 million for the six months to December 2012, compared with $23 million in the previous corresponding period. Chairman John Palmer wrote in the interim report that the company's performance was "a strong profit growth story against the backdrop of a sluggish economic recovery and ongoing challenges facing our industry".
Palmer added that the 3c interim dividend "reflects the strength of the company's balance sheet, a strong cash position, positive earnings outlook and the board's belief in the organisation as it moves into a new phase under the leadership of chief executive officer Christopher Luxon".
On April 24 Air NZ released its March operating statistics report, which showed that passenger numbers and load factors were well ahead of the same month in the previous year. Included in this report was the profit upgrade for the 2013 year.
Broker analysts are forecasting adjusted net profit after tax of around $180 million for the full June 2013 year and further profit increases in the 2014 and 2015 years.
However, airline profit forecasts are notoriously unreliable and any change in market conditions, particularly jet fuel prices, could have a major negative impact on the carrier's performance.
Qantas reported an underlying profit before tax of A$223 million for the six months to December 31, 2012, compared with A$202 million for the previous corresponding period.
The latest result included a A$125 million compensation payment from Boeing because of the late delivery of 787 Dreamliner aircraft.
Chief executive Alan Joyce said that the company's transformation programme, which includes major cost reductions, was ongoing but the external environment remains complex and hostile and "for this reason we have not provided specific guidance for the second half".
Analysts are forecasting adjusted net earnings after tax of around A$180 million for the June 2013 year and further significant improvements in the following two years. Dividend payments are expected to recommence in either the June 2014 or 2015 years.
Qantas owns 100 per cent of Jetstar New Zealand which carried 918,000 passengers in the six months ended December 2012. This gave the Qantas subsidiary 22 per cent of the NZ domestic market compared with 19.9 per cent in the corresponding period of the previous year.
Virgin Australia reported a reduction in adjusted net earnings after tax for the first half of its June 2013 year, mainly because the company benefited from Qantas' industrial problems in the first half of the previous year.
Chief executive John Borghetti said: "The group has delivered a solid result in a difficult operating and economic environment, reflecting the significant progress we have made in diversifying our revenue base and improved cost control".
Virgin Australia had this to say about the full June 2013 year: "Consistent with the guidance provided at our annual general meeting on November 20, 2012, while we currently expect an improved underlying profit before tax in financial year 2013 compared to financial year 2012 (excluding the impact of the proposed Skywest Airlines acquisition and Tiger Australia joint venture), the uncertainty in economic conditions and the competitive environment precludes us from providing a profit guidance for the year."
These cautious guidance statements from Qantas and Virgin Australia demonstrate that they are much less confident about their earnings outlook than Air NZ, partly because the outlook for the New Zealand economy is more positive than that of our Tasman neighbour.
Nevertheless analysts are forecasting that Virgin Australia will achieve strong increases in earnings in both its June 2014 and 2015 years although no dividend payments are anticipated.
The outlook for the airline industry has improved and investors should keep a close watch on the sector, particularly as there are likely to be more Air New Zealand shares available as the Crown is proposing to reduce its stake to 51 per cent.
However, investors should never forget that the airline industry is highly volatile and the outlook can change quickly and dramatically from positive to negative, particularly if fuel prices rise and there is a downturn in consumer confidence.
• Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management which holds Air New Zealand shares on behalf of clients.