Airline Finance 5th Edn

AIRLINE FINANCE
Revised and updated in its fifth edition, this internationally renowned and respected
book provides the essentials to understanding all areas of airline finance. Designed
to address each of the distinct areas of financial management in an air transport
industry context, it also shows how these fit together, while each chapter and topic –
for example, aircraft leasing – provides a detailed resource that can also be consulted
separately.
Supported at each stage by practical airline examples and recent data, Airline
Finance examines the financial trends and longer term prospects for the airline
industry as a whole, contrasting the developments for the major regions and airlines
together with critical discussion of key issues that affect the industry as a whole.
Important techniques in financial analysis are applied to the airlines as well as their
investors such as banks and other financial institutions.
Thoroughly amended and updated throughout, and expanded with the addition of
two new chapters, the fifth edition reflects the many developments that have affected
the industry, such as the impacts of the banking and sovereign debt crises on the
airline industry, signs of re-nationalisation of airlines that have emerged in Europe,
and the substantial changes that have occurred in connection with rating agencies
and LIBOR. New start-ups and bankruptcies are covered for the first time in a new
chapter, joined by airline mergers and acquisitions (M&A), both playing a role in
airline concentration. Reflecting their status as a permanent feature, fuel hedging and
fuel surcharges now also have their own chapter. The medium- to long-term future in
terms of further concentration and government intervention (or the lack of it) and a
shift in aircraft financing towards capital markets are discussed in the final chapter.
The book is written for employees of airlines, airports and their suppliers, and
investment bank and other analysts. It is also popular for use by universities and
in-house courses on air transport management, within both academia and industry.
Peter S. Morrell graduated in economics from Cambridge University and subsequently

gained a master’s degree in air transportation from the Massachusetts Institute of
Technology, where he worked on NASA-sponsored research into airline forecasting
and profitability. He has a doctorate in airline capital productivity from Cranfield
University. He initially worked with merchant bank Lazard Brothers, in the City,
before joining the Association of European Airlines in Brussels as an economist in
1971. He worked as an air transport consultant from 1978 to 1991, when he joined
Cranfield’s Department of Air Transport, retiring in 2011.
He is a former head of the Department of Air Transport at Cranfield University,

where he had a chair in air transport economics and finance. He is now an independ-
ent aviation advisor and a visiting professor at Cranfield University, and is on the
editorial board of the Journal of Air Transport Management and Tourism Econom-
ics. He is the author of Airline Finance (the fifth edition of which will be published
in 2021, and a Chinese edition in 2007), Moving Boxes by Air: The Economics of
International Air Cargo, second edition with Thomas Klein (2018), and has written
many papers for both academic and industry journals.
AIRLINE FINANCE
5th Edition
Peter S. Morrell
Fifth edition published 2021
by Routledge
2 Park Square, Milton Park, Abingdon, Oxon, OX14 4RN
and by Routledge
605 Third Avenue, New York, NY 10158
Routledge is an imprint of the Taylor & Francis Group, an informa business
© 2021 Peter S. Morrell
The right of Peter S. Morrell to be identified as author of this work
has been asserted by him in accordance with sections 77 and 78 of
the Copyright, Designs and Patents Act 1988.
All rights reserved. No part of this book may be reprinted or
reproduced or utilised in any form or by any electronic, mechanical,
or other means, now known or hereafter invented, including
photocopying and recording, or in any information storage or
retrieval system, without permission in writing from the publishers.
Trademark notice: Product or corporate names may be trademarks
or registered trademarks, and are used only for identification and
explanation without intent to infringe.
First edition published by Ashgate in 2002
Fourth edition published by Routledge in 2013
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the British Library
Library of Congress Cataloging-in-Publication Data
Names: Morrell, Peter S., 1946– author.
Title: Airline finance / Peter S. Morrell.
Description: 5th edition. | Abingdon, Oxon ; New York, NY :
Routledge, 2021. | Includes bibliographical references and index.
Identifiers: LCCN 2021001549 (print) | LCCN 2021001550 (ebook) |
ISBN 9780367481414 (hbk) | ISBN 9780367481384 (pbk) |
ISBN 9781003038191 (ebk)
Subjects: LCSH: Airlines—Finance.
Classification: LCC HE9782 .M67 2021 (print) | LCC HE9782
(ebook) | DDC 387.7/1—dc23
LC record available at https://lccn.loc.gov/2021001549
LC ebook record available at https://lccn.loc.gov/2021001550
ISBN: 978-0-367-48141-4 (hbk)
ISBN: 978-0-367-48138-4 (pbk)
ISBN: 978-1-003-03819-1 (ebk)
Typeset in Sabon
by Apex CoVantage, LLC
CONTENTS
List of figuresxi
List of tablesxiii
Prefacexvii
1 Industry financial performance 1

1.1 Government regulation of airlines: the
‘level playing field’ 2
1.1.1 Air Services Agreements (ASAs) 3
1.1.2 Taxes 3
1.1.3 Subsidies 4
1.2 World airline financial results 4
1.3 Factors affecting financial results 10
1.3.1 Asset and labour efficiency 12
1.4 Key financial issues 14
1.5 Financial implications of environmental measures 16
1.6 Conclusions 18
2 Airline financial statements 20

2.1 Introduction 20
2.2 Profit and loss account (income statement) 23
2.2.1 Cathay Pacific Airways Ltd 23
2.2.2 American Airlines 27
2.3 Cathay Pacific Airways and American Airlines
compared: income statement 27
2.4 Lufthansa Group and other airlines: income
statement 28
2.5 Balance sheet 31
2.5.1 Assets 33
2.5.2 Liabilities 39
v
C ontents
2.6 Balance sheet comparison: Cathay Pacific versus

American Airlines 42
2.7 Cash flow statement 44
2.8 Value added statement 48
2.9 Cash value added 49
2.10 Progress towards greater accounting
standardisation 52
Appendix 2.1 Frequent flyer programme award
accounting 53
Appendix 2.2 Accounting for finance and operating
leases 57
3 Airline financial ratios 61

3.1 Performance/earnings ratios 62
3.1.1 Operating ratio 62
3.1.2 Net profit margin 64
3.1.3 Return on invested capital (capital
employed) 64
3.1.4 Return on equity 65
3.2 Risk or solvency ratios 67
3.2.1 Interest cover 67
3.2.2 Debt/equity ratio 68
3.3 Liquidity ratios 70
3.3.1 Current ratio 70
3.3.2 Acid test/quick ratio 71
3.4 Stock market ratios 71
3.4.1 Performance 71
3.4.2 Value 74
3.4.3 Other ratios 77
3.5 Inter-airline comparison of financial ratios 79
3.5.1 Operating ratio 81
3.5.2 Return on equity 81
3.5.3 Debt to equity ratio 81
3.5.4 Interest cover 81
3.5.5 Cash as a percentage of operating
revenues 82
3.6 Interpretation problems 82
3.6.1 Distortion of comparative data 82
3.6.2 Differences in accounting treatment 82
vi
C ontents
3.6.3 Ratio analysis used to assist judgement 83

3.6.4 Window dressing 83
4 Airline valuation 85
4.1 The valuation of intangible assets 85
4.1.1 Route or traffic rights 85
4.1.2 Factors determining the value of traffic
rights 88
4.1.3 Rights to airport slots 89
4.1.4 Valuation methods 91
4.2 The valuation of tangible assets 95
4.3 The valuation of the airline as a whole 96
4.3.1 Discounted cash flow (DCF) method 97
4.3.2 Ratio method 97
4.4 Aircraft valuation 101
4.5 Ratings agencies 102
5 Sources of finance 106

5.1 Sources of internal finance 110
5.2 Sources of short-term external finance 111
5.3 Sources of long-term external finance 111
5.3.1 Shareholders’ equity capital 111
5.3.2 Preference share capital 113
5.3.3 Bonds/debentures/unsecured loan stock/
ABS 113
5.3.4 Convertible bonds 116
5.3.5 Equipment Trust Certificates 117
5.3.6 Term loans 117
5.3.7 Leasing 122
5.3.8 Manufacturer’s support 123
5.3.9 Islamic finance 124
5.4 Institutions involved in aircraft finance 125
5.4.1 Banks 125
5.4.2 Export credit agencies 126
5.4.3 Operating lessors 130
5.4.4 Governmental financing organisations 134
Appendix 5.1 Term loan repayment, book profit, and
manufacturers’ prepayments 137
vii
C ontents
6 Equity finance 141

6.1 Share issues 141
6.2 Equity finance for start-up airlines 144
6.3 Foreign ownership limits 147
6.4 Share trading and stock market listings 149
6.5 Initial public offering (IPO) 156
6.6 Mergers and cross-border investment 159
6.6.1 Air France-KLM 162
6.6.2 Lufthansa-Swiss 162
6.6.3 Lufthansa-Austrian Airlines 163
6.6.4 Lufthansa-BMI 163
6.6.5 British Airways-Iberia 163
6.6.6 British Airways-BMI 164
6.6.7 LAN (Chile) and TAM (Brazil) 164
6.6.8 Qatar Airways and minority stakes 165
7 Airline privatisation 167

7.1 Introduction 167
7.2 Previous airline privatisation case studies 169
7.2.1 Full privatisation through flotation – British
Airways 170
7.2.2 Full privatisation through trade sale and
flotation – Qantas 173
7.2.3 Gradual privatisation – Lufthansa 176
7.2.4 Partial privatisation – Kenya Airways 178
7.2.5 Full privatisation and trade sale –
Iberia 181
7.2.6 Gradual privatisation and acquisition – Air
France 181
7.3 The results so far by region 184
7.3.1 North America 184
7.3.2 Caribbean 185
7.3.3 Central and South America 185
7.3.4 Europe 186
7.3.5 Africa/Middle East 188
7.3.6 Asia/Pacific 188
7.4 Re-nationalisation 190
7.4.1 Alitalia 190
7.4.2 TAP Air Portugal 190
viii
C ontents
8 Airline financial planning and appraisal 193

8.1 Budget preparation and control 194
8.2 Working capital management 198
8.2.1 Current assets – stocks 199
8.2.2 Current assets – debtors or receivables 200
8.2.3 Current assets – cash and marketable
securities 201
8.2.4 Current liabilities 202
8.3 Financial planning 202
8.3.1 Cash flow forecasts 202
8.3.2 Decision criteria 205
8.3.3 Discount rate calculation for NPV 208
8.3.4 Which criterion to choose? 210
8.3.5 Risk and uncertainty 212
8.4 Start-up airline business plan 213
9 Risk management: Foreign currency and interest rates 219

9.1 Exchange rate volatility 219
9.2 Airline trading exposure to currency movements 223
9.3 Airline balance sheet exposure to currency
movements 228
9.3.1 Example 1 229
9.3.2 Example 2 229
9.4 Airline foreign exchange risk management 230
9.4.1 Do nothing (Strategy a) 231
9.4.2 Hedge with forward purchase
(Strategy b) 232
9.4.3 Hedge with call option (Strategy c) 232
9.5 Interest rate exposure 234
10 Risk management: Fuel prices 237

10.1 The need and means to hedge fuel 239
10.2 Examples of airline fuel hedging practice 245
11 Aircraft leasing 251

11.1 Finance lease 254
11.1.1 Japanese leveraged leases 255
11.1.2 US leveraged leases 257
11.1.3 European leveraged leases 257
ix
C ontents
11.1.4 Extendible operating leases 257

11.2 Operating lease 258
11.3 Japanese operating lease (JOL) 261
11.4 Wet lease 261
11.5 Sale and leaseback 263
Appendix 11.1 Lease rental calculations 264
Appendix 11.2 Lease versus buy decision 266
12 Aircraft securitisation 270

12.1 Equipment trust certificates: ETCs and EETCs 271
12.2 Securitisation 274
12.2.1 ALPS 92–1 securitisation 274
12.2.3 Airplanes 96 securitisation 275
12.3 Early securitisations (2003–2008) 277
12.4 Conclusions 279
13 Airline new entry and bankruptcy 281

13.1 Airline new entry 282
13.2 Airline exit – bankruptcy 283
13.3 Airline consolidation – mergers and acquisitions 285
13.4 North America – Chapter 11 bankruptcy 287
13.5 Latin America 291
13.6 UK/Europe 292
13.7 Australasia 295
13.8 Summary 297
14 Industry financial prospects 299

14.1 World airline traffic and financial forecasts 300
14.2 World airline capital expenditure projections 302
14.3 World airline financial requirement forecasts 303
14.4 The prospects for cross-border mergers 306
Glossary of terms and abbreviations 307

Bibliography 316
Index 320
x
FIGURES
1.1 International Air Transport Association (IATA) scheduled

airline traffic (RPK) growth versus world GDP growth 6
1.2 IATA scheduled airline financial results 7
1.3 IATA scheduled airline financial results as per cent revenues 7
1.4 Operating result as per cent revenues by region of airline 8
1.5 Passenger load factor trends by major world region 9
1.6 Airline return on invested capital (ROIC) 9
1.7 Actual and breakeven load factor for global airlines 11
1.8 Stock index vs top share indices, 2008–2019 15
1.9 EUA spot market trends, beginning 2012 to end 2019 18
4.1 Income statement valuation ratios for selected airlines
by region 99
5.1 Per cent of total and Boeing deliveries with ECA support
(2010–2019)128
6.1 Ryanair Dublin versus Nasdaq (ADR) share price 149
7.1 British Airways share price trend versus UK market 174
7.2 Qantas Airways share price trend versus Australian market 176
7.3 Lufthansa share price trend versus German market 177
7.4 Air France share price trend versus French market 182
7.5 Air France-KLM post-merger interim structure 183
8.1 NPV versus discount rate: A330–300 versus B777–200 211
9.1 Key currency exchange rates versus US dollar, 2009–2019,
and South African rand 222
9.2 Selected Asian exchange rates versus US dollar, 1997/1998 228
9.3 Cost of hedging versus eventual spot rate 233
9.4 Twelve-month US$ LIBOR from the beginning of 1990 to
the end of 2019 235
10.1 US Gulf Coast spot kerosene prices 238
10.2 Jet fuel and crude prices and refiner margins 238
xi
F igures
10.3 Percentage of fuel costs covered by fuel surcharge for

typical long-haul flight 242
10.4 Trend in refiner margin (‘crack spread’), 2000–2019 246
10.5 Per cent hedged for H1, 2019, as at November 2018 248
11.1 Lessors financing of new aircraft from Boeing, 2012
and 2019F 253
xii
TABLES
1.1 Employment share of airlines vs others involved in world

aviation sector (2018) 2
1.2 Gross Domestic Product (GDP) contribution of world
aviation sector (2018) 2
1.3 World airline productivity 14
2.1 Cathay Pacific Airways Group consolidated income account 25
2.2 Cathay Pacific Airways’ turnover by origin of sale 26
2.3 American Airlines’ consolidated statement of operation 28
2.4 Lufthansa Group consolidated income statement 29
2.5 Cathay Pacific Airways Group balance sheet 33
2.6 CX Non-current liabilities: property, plant, and
equipment (Note 8) 34
2.7 Airline depreciation example 36
2.8 Depreciation rate comparison for 2019 37
2.9 Cathay Pacific Airways’ Group non-current liabilities 39
2.10 Balance sheet comparison; assets, FY ended 31
December 2019 43
2.11 Balance sheet comparison; liabilities, FY ended 31
December 2019 43
2.12 Cathay Pacific Airways’ Group loans and lease finance 44
2.13 Cathay Pacific Airways’ Group cash flow statement 46
2.14 Cash flow statement comparison 48
2.15 Value added statement for Singapore Airlines Group 49
2.16 Cash value added statement for British Airways Group 51
2.17 Weighted average cost of capital calculation for
Lufthansa, 2011 and 2019 52
2.18 AAdvantage Award distribution in 2005 56
3.1 Cathay Pacific Airways Group – operating ratio/margin 62
3.2 Cathay Pacific Airways Group – net profit margin 64
3.3 Return on invested capital (ROIC) for FY2019 65
3.4 Return on equity (RoE) for FY2019 66
3.5 Cathay Pacific Airways Group – interest cover 67
xiii
T ables
3.6 Cathay Pacific Airways Group – debt/equity ratio 68

3.7 Effect of gearing on ratios 69
3.8 Cathay Pacific Airways Group – current ratio 70
3.9 Cathay Pacific Airways Group – quick ratio 71
3.10 Cathay Pacific Airways Group – dividend cover 71
3.11 Cathay Pacific Airways Group – market capitalisation 73
3.12 Cathay Pacific Airways Group – earnings per share (EPS) 73
3.13 Cathay Pacific Airways Group – price/earnings ratio 74
3.14 Cathay Pacific Airways Group – net asset value per share 75
3.15 Cathay Pacific Airways Group – equity value/EBITDAR 76
3.16 β values for selected sectors 76
3.17 β values for airlines 79
3.18 Key financial ratios for major airlines by region,
FY2019/202080
4.1 British Airways valuation criteria 100
4.2 Comparison of S&P and Moody’s rating grades 101
4.3 Selected airline debt ratings, 2001 to 2019 103
5.1 Scheduled world airlines balance sheet long-term financing 108
5.2 Share of fleet by type of financing for major world
airlines for FY2019 109
5.3 Emirates Airlines’ financing share 109
5.4 Hypothetical example of manufacturer’s support for
aircraft finance 124
5.5 Top banks for aircraft export credits, 2009/2010 126
5.6 UK export credit support (maximum liability) to airlines
in 2019 129
5.7 Top ten operating lessors and their fleets – December 2019 132
5.8 European Investment Bank lending to airlines 135
6.1 China Southern Airlines equity shares by type, 2019 142
6.2 Venture capital interests in LCC/start-up airlines, early
2000s146
6.3 Institutional shareholding in European airlines, 2019 147
6.4 International passenger airlines with stock market listings 151
6.5 Major world stock indexes (end 2019) 152
6.6 NYSE ARCA Airline Index (XAL), 2019 153
6.7 Constituent airlines of the MSCI World Airline Index
(March 2012)155
6.8 Exchange-traded funds (ETF) invested in aviation stocks 156
6.9 Airline IPOs taking place between 2000 and 2019 158
6.10 Major airline cross-border investments in other airlines
(2019)161
7.1 Government shareholdings (%) in top ten airlines, 2019 169
7.2 British Airways’ and Laker Airways’ liabilities 170
xiv
T ables
7.3 British Airways privatisation fact sheet (1987) 171

7.4 Initial post-privatisation British Airways share distribution 172
7.5 Qantas Airways’ post-offer share distribution 175
7.6 Qantas Airways privatisation fact sheet (1995) 175
7.7 Lufthansa shareholding – 1996 and 1997 178
7.8 Kenya Airways’ pre-privatisation financial data 180
7.9 Kenya Airways’ post-privatisation results 180
8.1 Route profitability analysis 195
8.2 Typical airline management accounts – budget 2019 196
8.3 Example of airline cash budget 198
8.4 Aircraft investment appraisal cash flow forecasts
(US$ million) 204
8.5 Example of accounting rate of return 206
8.6 Example of payback period 206
8.7 Financial evaluation of alternatives 210
8.8 Start-up airline business plan 215
9.1 Effect of exchange rate depreciation on profits of
exporter airline 224
9.2 Effect of exchange rate depreciation on profits of
importer airline 225
9.3 Turkish Airlines revenue and cost currency breakdown in
1stQ 2020 (%) 226
9.4 Impact of currency changes on Cathay Pacific profits,
FY2019227
9.5 Interest rates on long-term loans (2019/2020) 235
10.1 Fuel surcharges announced by major airlines in 2004 241
10.2 Aviation fuel hedging instrument shares 244
10.3 Aviation fuel hedging: average duration of positions 245
10.4 Fuel hedging profits and losses: Southwest versus
Singapore Airlines, 2003–2019 247
11.1 Operating leased aircraft shares by jet aircraft category
(2019)254
11.2 Typical operating lease terms 259
12.1 Virgin Australia EETC 273
12.2 ALPS 92–1 aircraft portfolio 275
12.3 ALPS 92–1 bond amounts and interest rates 275
12.4 Airplanes securitisation – aircraft numbers and values 276
12.5 Airplanes securitisation – bond amounts and interest rates 277
12.6 ALS II – initial lessees 278
13.1 Start-ups August 2015–August 2016 282
13.2 Start-ups August 2015–August 2016 282
13.3 Airline exits, August 2015–August 2016 284
13.4 Key US airline Chapter 11 entry and exit 289
xv
T ables
14.1 World air traffic and GDP forecasts 300

14.2 Air traffic forecasts by region: Airbus versus Boeing 301
14.3 Commercial jet aircraft delivery/retirement forecasts
(2019–2038)303
14.4 Boeing airplane demand by region (2010–2030) 304
xvi
PREFACE
The purpose of the book is to provide, as far as possible, a broad under-

standing of all areas of airline finance. It is targeted to the non-specialist,
although bookkeepers and qualified accountants moving to an airline or
working for one will find it useful. While there are obviously numerous
financial management, corporate finance, and related texts available, none
of these provide explanations, as this book does, for some of the quirks
of the airline industry (e.g. the accounting treatment of frequent flyer pro-
grammes or the various aircraft leasing options available). Furthermore,
none of them provide worked examples based solely on the air transport
industry.
It is hoped that each area of airline financial management will be discussed
in sufficient depth to satisfy both those in the industry without any financial
background and newcomers to the industry perhaps with some knowledge
of finance. No prior knowledge is required of, for example, accounting,
economics, or statistics to gain considerable benefit from the book. In a few
cases, notably in the chapters on investment appraisal and aircraft leasing,
mathematical formulae have been used, but in such cases they are based on
relatively simple compound interest concepts and generally confined to a
separate explanatory appendix at the end of the chapter.
The opening chapter describes the financial trends for the airline industry
as a whole, with developments for the major regions and airlines contrasted.
It also provides an introduction to the impact on the airline industry of the
global financial and banking crisis that began to unfold over 2007 and 2008
and was further impacted by the sovereign country problems over 2010–
2012. This was followed by a recovery over the next four to five years with
a slowdown starting to be evident by 2019, just before Covid-19 struck.
The majority of international airlines now report their annual data based
on the 12 months to the end of December. Thus, the latest available annual
audited financial statements were 2019 but only published on their websites
from April 2020 onwards. The very first reported Covid-19 infection was
in China at the beginning of January 2020, only peaking in most countries
in spring/early summer. Given such a cataclysmic impact and taking into
xvii
P reface
account the availability of data, it was decided to exclude any attempt of

analysis after the end of 2019.
As with the past few editions of this book, Cathay Pacific was chosen for
many of the worked examples because of their position as a key airline in a
fast-growing region, with financial links to mainland China. It also presents
its published financial statements in English, and in both Hong Kong and
US dollars; thus, it offers sufficient clarity and detail for the reader to obtain
a good understanding of an international network carrier. Other airlines’
accounts are also introduced to contrast different approaches, especially
American Airlines (an airline that is somewhat larger than Cathay Pacific)
and, in some cases, Lufthansa, to compare financial performance and ratios.
The role played by hedging and derivatives in the airline industry is intro-
duced in the next two chapters, again supported by actual airline examples.
Fuel price hedging has been further expanded with its own chapter (10) in
this edition. Interest rate hedging is introduced to complete the major areas
of financial uncertainty. Leasing is examined in some detail in Chapter 11,
covering the new regulations on the treatment of operating leases on the
balance sheet and other financial statements, and aircraft securitisation is
separated off from leasing to its own in Chapter 12 to reflect its growing use
by non-US airlines helped by the Cape Town agreement and availability of
insurance. Finally, a new Chapter 13 will deal with market entry and exit
as well as discussion on alliances and their implications on competition and
capacity.
It would be impossible to mention all those who have contributed, know-
ingly or otherwise, to the book. Over the past years, MSc students of air
transport management at Cranfield University have made numerous valua-
ble comments, pointed out errors, and generally provided the motivation for
the development of much of the material presented here. A growing number
of students choose airline finance as a thesis topic. And some of these are
published in academic journals. Special thanks must also be extended to
senior airline industry experts who have given up their precious time over
the past years to contribute to courses (and my understanding of the indus-
try) – in particular, Ian Milne, formally of British Airways; Alan Robinson
of ALM; and Andrew Lobbenberg, a former colleague, now the chief airline
financial analyst with HSBC.
I am also grateful to all my former colleagues in the Cranfield’s Depart-
ment of Air Transport (now the Centre for Air Transport Management),
especially Rigas Doganis, head of the department, friend and colleague, at
Cranfield University over many years and subsequently.
xviii
1
INDUSTRY FINANCIAL
PERFORMANCE
This first chapter will provide a broad picture of the state of the airline
industry at the end of the second decade of the 2000s, but first the degree to
which regulation has changed and the degree to which governments distort
competition. The latter is discussed in terms of Air Services Agreements
(ASAs), subsidies, and taxes. This is followed by airline financial perfor-
mance and then the factors that have affected that performance.
The focus of this book is the airlines, wherever based and wherever they
fly, but with an emphasis on international operations. Table 1.1 gives an
idea of the size of the airline industry in relation to the total aviation sector
in terms of employment (27%).
Table 1.1 also shows that the majority of employees are from other non-
airline activities such as ground handling, retailing, car parks, catering, and
so on. The other on-airport service providers are often closely involved with
airlines and sometimes even acquired ground handling or duty-free busi-
nesses. Airports have traditionally been involved themselves or through
separate companies in some of the aircraft-related services such as ground
handling, but this is now more usually supplied by third-party specialists.
Table 1.2 gives an idea of the size of the commercial aviation sector in
terms of GDP contribution with the total impact US$2.7 billion a year in
2018. The industry’s indirect impacts include employment and economic
activity generated by suppliers to the aviation industry: aviation fuel sup-
pliers, construction companies that build airport facilities, suppliers of sub-
components used in aircraft, manufacturers of goods sold in airport retail
outlets, and a wide variety of activities in the business services sector (such
as call centres, information technology, and accountancy).
The induced spending of those directly or indirectly employed in the avia-
tion sector supports additional jobs in other sectors such as retail outlets,
companies producing consumer goods, and a range of service industries (e.g.
banks, telecommunication providers, and restaurants). The catalytic contri-
bution comes from many other industries that rely on effective air transport
links; thus, a part of their increased productivity should be attributed to
1
I ndustry financial performance
Table 1.1
Employment share of airlines vs others
involved in world aviation sector (2018)
Direct employment
Other on-airport 55%

Airlines 27%
Aircraft manufacturers 11%
Airport operators 5%
Air navigation services 2%
Total aviation sector 100%
Table 1.2 Gross Domestic Product (GDP) contribution

of world aviation sector (2018)
Aviation GDP US$ billion
Direct 704
Indirect 638
Induced 454
Tourism and catalytic 897
Total 2,693
Source: International Civil Aviation Organisation (ICAO)
www.icao.int.
aviation. The same occurs with tourism, some of which depends on frequent
and cheap air services.
1.1 Government regulation of airlines: the

‘level playing field’
In spite of widespread liberalisation and deregulation, airlines still meet
with some barriers to entry. Competition still faces obstacles through cer-
tain aspects of their ASAs, and subsidies to airlines had not been entirely
removed.
With widespread privatisation of national airlines, government subsidies
have all but disappeared for larger airlines with the exception of alleged
payments to certain Middle East-based airlines as well as for the Italian
national carrier (formerly Alitalia). These issues will be discussed later, first
addressing ASA liberalisation, followed by subsidies (at least where they
have direct impacts on financial flows). Finally, airline-specific taxes will be
examined, before reviewing financial aspects of the air transport industry
over the last decades.
2
1.1.1 Air Services Agreements (ASAs)

ASAs, in the past 20 years or so, have been gradually more liberal, especially
within regional blocs. This has opened up most third, fourth, and fifth free-
dom traffic rights as well as some sixth and seventh. However, the ASA still
exists for designation of airlines and, in particular, still restricts flights from
airlines that are not majority owned by shareholders resident in their coun-
try. Richard Branson’s Virgin Group proposal to start a US-based airline
had to surmount numerous obstacles, before services could start within the
USA. These were principally to do with the requirement that Virgin America
is less than 25% owned by foreign or more than 75% US nationals.
Almost 30 years ago, the European Commission appointed a committee
in 1993, which included five airline representatives (out of 12) as opposed to
the US Commission’s two (out of 15). In their early 1994 report, the European
‘Committee of Wise Men’ made the following financial recommendations:1
• The EU should work towards easing the ownership and control restric-
tions in bilateral agreements.
• The EU should try to maintain and improve the access of European
airlines to credit insurance.
• The European Commission should try to expand the number of financ-
ing options available to airline management.
By 2020 restrictions on ownership and control had been lifted for intra-
EU routes, and some progress had been made, but EU/US and other EU
ASAs still capped ownership of foreign designated carriers at 49%. Many
countries will now accept airlines that have up to 49% of foreign owner-
ship and control – for example, a UK designation of Virgin Atlantic Air-
ways that was 49% owned by Singapore Airlines (and is now 49% owned
by the US carrier Delta Airlines). Their last recommendation had to a large
extent been achieved by the private sector providing bond and leasing
finance to airlines. The bilateral ownership clause makes airline mergers
much more difficult, although they have been possible both in the USA and
within the EU.
1.1.2 Taxes
Over the past ten years or so, governments have been imposing taxes on the
sale of airline tickets. Increasingly, these are stepped up in terms of length of
haul, and often they are justified as environmental taxes. They might also be
considered as a fuel tax on international flights, something that is exempt by
international agreement and enshrined in ASAs. Since January 2012, Euro-
pean airlines have been required to participate in the EU emissions trading
3
scheme (EU ETS), and so there is now an element of double counting in

some countries.
1.1.3 Subsidies
Subsidies have always been widespread, especially by way of grants and
loans on advantageous terms. The recipients of these subsidies have gener-
ally been state-owned airlines. Many of these airlines were substantial Euro-
pean airlines. Subsidies approved by the European Commission for payment
to just five European airlines (Olympic Airways, TAP Air Portugal, Iberia,
Air France, and Aer Lingus) between 1992 and 1997 totalled US$8.94 bil-
lion, or almost 17% of the sum of the airlines’ three previous years rev-
enues.2 On the basis that they were paid in equal instalments over the five
years, 1992–1997, this would have amounted to $1.8 billion a year. Since
then, the European Commission has taken an increasingly tough stance on
subsidies and ensured a level playing field for all. By 2012, three of those
airlines benefitting from subsidies in the 1990s had been privatised, and
a fourth radically transformed into a profitable airline that was partially
privatised in 2006. The last, TAP, was finally part privatised in 2015, with
the state left with 45% of the shares and a group of private equity investors
taking control (see also Chapter 7). More recently, ‘The Partnership for
Open and Fair Skies’3 still maintains that billions were given as subsidies by
various Middle Eastern states, in particular by the UAE and Qatar, to their
government-owned airlines, Etihad, Emirates, and Qatar Airways under-
mining fair competition.
These direct subsidies paid to airlines were not the sole way of provid-
ing financial support. The absence of any tax on fuel used for international
flights is also described as a subsidy (Goessling et al., 2017). Other ways are
guarantees on loans to airlines by governments, loans at less than market
rates of interest, tax breaks, and reduced or zero airport charges. Support
may also come indirectly – for example, airports giving marketing support
or landing fee reductions to some low-cost carriers (LCCs) in Europe in
return for new services to their airport. Aircraft and aero-engine manufac-
turers have also received large subsidies that they can pass on to airlines.
So the very obvious and direct support to airlines in the 1990s has been
replaced by less visible means of subsidy. However, the focus of support has
moved from Europe – and, to a much less extent, from the USA – to the
Middle East and Asia.
1.2 World airline financial results

The airline industry has over the years been buffeted by both economic
cycles and threats from war, terrorism, and most recently epidemics.
Seven years of good profitability that stemmed from a relatively long
4
world economic upswing from the emergence of the banking crisis to

2018/2019. An indication of the end of the cycle came in 2019 with a turn-
down in GDP and trade. The pandemic struck at the beginning of 2020
and all that can be said at this stage is that its impact will far exceed pre-
vious pandemics such as SARS. The past five years up to 2019 generated
good profits for many world airlines and restored their balance sheets to
more acceptable levels (Figure 1.2). This highlights the cyclical nature of the
industry, with the subsequent slower recovery over a longer period, with ten
years from the banking crisis up to the Covid-19 at the time of writing. Since
1970, there have been five cycles varying from eight to 11 years in duration.
Clouds appeared on the horizon in 1999, with the price of jet fuel jumping
from 40 cents per US gallon a barrel to 75 cents in January 2000. This led to
a drop in operating profits, although net profits were maintained largely due
to the sale of aircraft and non-core investments such as holdings in IT and
communications companies. The dollar price of fuel in 2001 was still well
below its high in 1981. At that time fuel expenses rose to just under 30%
of total airline operating expenses. In 2000, they were still only 12% of the
total, even after recent sharp increases. This has been helped by substantial
advances in fuel efficiency. For example, British Airways has reduced its
average fuel consumption in terms of grams per revenue tonne-km from
around 440 in 1990/1991 to 345 in 1999/2000 (or by an average of 2.6% a
year) and more than met its target of 306 grams by 2010.
As stated previously, the fuel price started increasing alarmingly in early
1999; a further advance occurred at the end of summer 2000 to a high of
107 cents, before the price fell back to around 75 cents by the end of 2000.4
The next period of instability was in 2004, when prices ranged from a low
of 92 to a high of 157 cents per US gallon. In the following year, the range
ratcheted up to between 119 and 223 cents, and the 2005 high of 223 cents
was again reached in August 2006. This was repeated in 2008 when high
demand and instability pushed the jet fuel price to a new high of 305 cents.
This level was again reached in 2011, but the period 2012–2019 was one
of lower prices.
Some economists link any sudden and substantial rise in fuel prices to an
economic recession about 18 months later. This appeared to be happening
in 2001, as the downturn in the US economy began to have a serious effect
on Asian exports, and again in 2009. The impact of declining GDP for the
major world economies such as the US, the EU, and Japan has in the past
led to a downturn in traffic (Figure 1.1).
The first ever decline (as opposed to a large reduction in growth rate) in
world air traffic growth in 1991 was due to the combined effects of the Gulf
War and the world economic recession, with a second in 2001. Measures
of economic activity such as GDP have by far the largest impact on traffic
growth and profits, much greater than pressures on costs such as oil price
spikes. Economic recession leads to a combination of reduced traffic and
5
10
8
Percent change from previous year
-2
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Global RPK growth Real GDP growth
Figure 1.1 International Air Transport Association (IATA) scheduled airline traffic

(RPK) growth versus world GDP growth
lower yields, far outweighing any cost instability. It should be added that
GDP is a relatively crude measure of economic activity: personal travel is
more driven by ‘discretionary’5 income, while business travel responds to
trade and industrial production indices.
Figure 1.2 shows the cyclical nature of past financial results for the
world’s scheduled airlines. The more significant downturns are often caused
by economic downturns in addition to various crises such as that caused by
the banking industry (Table 1.2).
The difference between the operating and net profit is caused by net inter-
est paid, gains or losses on asset sales, taxes and subsidies, and provisions
for restructuring (Figure 1.2).6 Input prices such as interest rates and fuel
prices have had less of an impact on profits in recent years, particularly the
latter.
ICAO stress that published operating and net results are susceptible to
‘substantial uncertainties’.7 This is particularly the case with the net results,
which are the small differences between estimates of large figures (revenues
and expenses). Just under 15% of revenues and expenses are estimated for
non-reporting airlines.
The operating margin for the world’s scheduled airlines exceeded 5%
only five or six times during past 14 years, all of these being since 2015
(Figure 1.3).8
6
70000
60000
50000
40000
30000
US$ million
20000
10000
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
-10000
-20000
Operang Result Net Result
-30000
Figure 1.2 IATA scheduled airline financial results
10
4
Operang raos %
-2
-4
Operang Result as % Revenues Net Result as % Revenues
-6
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Figure 1.3 IATA scheduled airline financial results as per cent revenues
Figure 1.4 shows the financial margins for the world’s airlines according
to the region in which they are based. It shows that the North American air-
lines were hardest hit by the banking crisis. The least affected by the banking
crisis was those airlines based in Asia and the Pacific.
A similar picture emerged after 9/11 with the North American airlines
most badly affected. The European airlines recovered fairly quickly in 2002
7
20
15
10
Percent
Asia/Pacific Europe North America

-5
-10
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Figure 1.4 Operating result as per cent revenues by region of airline
but were hit in 2003 by the strength of the Euro, the Iraq War, and SARS
on Far Eastern routes.
The best financial results were achieved by the regional airlines, especially
those based in the USA, and LCCs, with the leisure (mainly those European
airlines formerly called ‘charters’) next best. Majors are the network carriers
with annual revenues of over US$2 billion, and these were adversely affected
by some of the large US carrier losses.
Figure 1.5 shows that the US carriers’ passenger load factor was both
the lowest and recovered the most. It is noticeable that load factors have
converged for the airlines of the three major regions, reaching an effective
ceiling, given the nature of the service offered and the variation of demand
by day, week, and season.
Figure 1.6 shows airline return on capital over two five-year periods.
It includes 30 airlines with strong coverage in each region and together
accounting for 64% of the world market. Return on capital is defined as
operating profit after taxes and adjusted for operating leases9 expressed
as a percentage of end-of-year invested capital. The decline from the first
period to the second was most marked for US airlines and to a lesser extent
the European ones. However, none of the regional groups exceeded the
weighted average cost of capital (WACC), which the IATA study assumed to
be 7.5% for the airline sector as a whole.
8
90
88
86
84
82
Percent
80
78
76
74
72
70
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Norwegian Brish Airways

Southwest American
AirAsia Singapore
Figure 1.5 Passenger load factor trends by major world region
12
10
8
6
4
2
Percent
0
-2
-4
-6
-8
-10
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019*
ROIC ROIC minus WACC
Figure 1.6 Airline return on invested capital (ROIC)

Source: IATA Economics Briefing No. 04, December 2019; * estimate.
9
1.3 Factors affecting financial results

Airline financial results are highly sensitive to small changes in either costs
or revenues because of the histor ically high level of operational gearing that
has prevailed. Once the relatively high interest charges have been covered,
increases in revenues or reductions in costs flow through to large improve-
ments in net results and vice versa. Financial gearing might be expected to
decline somewhat in the future, as more assets are financed by operating
leases, rather than with debt.
Airlines also display high operational gearing. This is caused by the fixed
nature of operating expenses and relatively small margins on sales; this
results in large swings in operating results, in the same way as described
earlier for net results. The degree to which operating costs are fixed depends
on the timescale, and three periods can be identified:
(a) The medium term: Once the schedule has been determined, the costs
associated with operating flights are relatively fixed – that is, aircraft-
related costs (capital), flying, technical, and other skilled staff and gen-
eral overheads.
(b) The short term: Once the airline has committed to operate the flight, all
the medium-term costs are fixed, as well as airport charges, fuel, air traf-
fic control charges, and certain flight-related variable costs (e.g. wear
and tear on landing gear and tyres).
(c) The very short term: Once the airline has committed to carry passengers
on the flight, additional costs become fixed – that is, ticketing materi-
als, in-flight food, agent commissions, and fuel required to lift extra
payload.
The additional costs in (b) are often described as variable costs, while
the additional costs in (c) are marginal or incremental costs. As long as the
flight is not full, traffic and revenues can be increased at very little extra
cost, but once additional flights need to be scheduled, costs start to escalate.
Conversely, when there is an unexpected reduction in demand, induced by
an economic recession or an event such as the Gulf War, airlines find it dif-
ficult to shed costs: aircraft cannot be sold, and staff contracts are difficult
or expensive to break.
Many airlines have recently been trying to reduce this fixed cost burden
by outsourcing and hiring part-time staff to meet traffic peaks. This allows
them to return some aircraft to lessees and adapt staff to levels of demand.
There may be a trade-off in paying more for contracted-out services dur-
ing periods of traffic growth (and lower profits) against lower costs and
reduced losses or higher profits in periods of recession. Variable costs have
10
also tended to increase as a share of the total through large increase in fuel
costs, reducing the weight of fixed costs, and reducing operational gearing.
World airline financial results reflect the difference between the breakeven
and actual load factors. The former can be described as the ratio of unit
costs to unit revenues (yields). This ratio remained surprisingly constant at
around 58% over the whole of the 1980s, dipping only in 1987 to just under
57% as a result of reduced fuel costs. In the 1990s, both yields and costs
declined, but the faster reduction in the latter at least until 1998 resulted in a
gradual fall in breakeven load factor to just above 56% in 1998. The contin-
ued decline in yields in the face of increased fuel costs pushed the breakeven
point up above 60% in the first half of the 2000s (Figure 1.7). The cause
of declining yields was both increased competition and overcapacity that in
less regulated industries might be removed by consolidation or market exit.
A recent look at an EU country that experienced new competition on
both short-haul and long-haul routes: the United Kingdom. Shorter routes
had, at least until 2018, competition for British Airways/Iberia from large
established LCCs and from leisure airlines, or what was remaining of the
85
80
75
Percent
70
65
60
55
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Weight load factor % Breakeven load factor %

Passenger load factor %
Figure 1.7 Actual and breakeven load factor for global airlines
Source: IATA Airline Industry Economic Performance (December 2019 and 2015).
11
‘charter’ airlines. In 2018, British Airways was operating 172-seat aircraft

on average across all European Economic Area (EAA)10 flights compared
with 172 seats for easyJet and 218 for the leisure Thomas Cook Airlines.
Passenger load factors were 83%, 89%, and 91%, respectively. Thus, not
much differentiation and potential for lower costs from larger, more filled
aircraft except perhaps for the leisure operators, which were also operating
over longer sectors.11
On long-haul, Norwegian Airlines started transatlantic services from
London in July 2014. These used high-density B787 aircraft, initially from
London Gatwick and later to London Heathrow in 2019. It is difficult to
see how Norwegian can get lower costs than network carriers operating
the same aircraft since it had similar aircraft utilisation and passenger load
factors: in 2018 the airline’s small network of flights from the UK to North
America operated at an 85% passenger load factor compared to British Air-
way’s 82.5%; it carried only 3.6 tonnes of cargo per flight versus 6.6 tonnes
for British Airways (and 8.9 tonnes for Virgin). Norwegian (and Virgin)
both had longer flights than British Airways. So Norwegian’s longer sectors
and higher load factors, and thus less cargo payload, reduced its capacity to
carry as much air cargo.
Overcapacity can be alleviated by grounding uneconomic aircraft. Some
of these are subsequently brought back into service, but others are eventu-
ally broken up for spares or scrapped. The number of parked aircraft dou-
bled to around 1,000 in the year following the Gulf War, as traffic declined
and deliveries accelerated. This figure included a certain number that are
parked even in good years on a short-term basis, either between operators
or for major refits. It also included some brand new aircraft that went into
storage direct from the factory. There were still 730 aircraft parked at the
end of 1995, but, of those, 45 were stage 1 and 230 stage 2 aircraft, neither
of which were likely to enter service because of the cost involved in hush-
kitting them to meet current, more stringent, noise requirements.12 A simi-
lar pattern emerged after 9/11 with 668 aircraft, or 6% of the total IATA
member airline fleet, parked by 2005, down from 2002.13 The average age
of parked aircraft in 2005 was 23.6 years, suggesting that many of these
aircraft (such as B727s and early B737s) will never return to airline service.
1.3.1 Asset and labour efficiency

The airline industry appears to be a relatively labour-intensive one in terms
of the share of labour costs in total operating costs. These are between 25%
and 35% for the major scheduled airlines in North America and Europe,
while capital costs, including depreciation, rentals, and interest charges,
amount to just over 15%. This is not surprising, since it is a service indus-
try that requires a substantial number of customer contact staff, particu-
larly on the passenger side of the business. Over the past decade, many
12
customer contact jobs have been outsourced to ground handling and pas-
senger services.
However, the industry could also be described, at the same time, as capital
intensive. A new Airbus A380 aircraft cost just under US$200 million at
the end of October 2019 (list price) and a Boeing 787–10 around $150 mil-
lion,14 and an increasing quantity of capital is required in the form of com-
puters, component test equipment, ground handling automation, and in
other areas.
ICAO reported net fixed assets (after depreciation) of US$262 billion in
2004 for the world’s scheduled airlines, compared to around $60 billion
in 1985. One dollar of fixed assets produced 2.2 revenue tonne-km (RTK)
in 1985, but this had fallen to 1.75 RTK by 2002, increasing somewhat to
1.88 RTK by 2004. The data included in this section is both from IATA and
ICAO publications, but these are no longer published (Table 1.1).
Based on an estimated 1.3 million staff employed by the world’s airlines,
the average net assets per employee was US$183,000 in 2002. This had
increased from about $50,000 per employee in 1986, or by over 8% a year,
compared to the US consumer price index increase of 3% a year. Between
1999 and 2002, net assets per employee advanced by 4% a year versus the
general price index rise of 2.6% a year. Inclusion of operating leased aircraft
(at 7.5 times annual rental expenses) would increase the rate of growth
between 1995 and 1999 and reduce it slightly between 1999 and 2002. On
this basis, it is clear that the industry is becoming more capital intensive
although increasing less rapidly than in the early 2000s. This is caused by a
combination of reduced staff numbers, increasingly expensive aircraft, and
investment in new technology. It is also due to the outsourcing of the more
labour intensive airline activities – for example, ground handling and cater-
ing. Investment and outsourcing together led to strong growth in labour
productivity of 5.3% a year between 1985 and 1999, but only 1.2% a year
from 1999 to 2005 as output declined following the 9/11 downturn. On the
other hand, fuel efficiency gains have been fairly constant over the whole
period at around 1.5% pa, apart from the four years to 1999. This was in
contrast to staff productivity that was almost unchanged (Table 1.3).
The average size of aircraft operated has been largely unchanged from
1985 to 2010, both for international services (36 tonnes) and domestic and
international services combined (26 tonnes). However, the aircraft have
been operated over longer sectors such that aircraft productivity in terms
of available tonne kilometres per aircraft has increased in line with average
sector length.
The average price of aircraft has increased at an average of 8% a year
between 1970 and 1995, based on the 1970 price of a B737–200 of US$4 mil-
lion and the 1995 price of the equivalent B737–500 of $28 million. This was
faster than the rate of inflation of consumer prices in industrial countries
and has provided the stimulus for airlines to increase the utilisation of their
13
Table 1.3 World airline productivity
RTK per RTK per litre of Aircraft hours

employee (000) fuel (index*) per year
1985 144 187 2,179

1995 258 213 2,790
1999 295 213 3,031
2010 375 251 3,391
2019** 379 224 n/a
% change 2019/2010 1.1 10.8
Source: IATA World Air Transport Statistics.
* 1965 = 100.
** Estimate.
aircraft. However, the price of a new B737–500 only increased marginally

to $30 million by 2000, reflecting increased competition from Airbus and
the slower increases in the consumer and producer price indexes. Heavier
discounting of new prices was evident in the period immediately after major
downturns. The list price of the A319 aircraft types was $35 million by 2019,
with these aircraft providing a similar role to the B737 in terms of seats availa-
ble. This suggests that aircraft prices scarcely increased over the past 20 years.
Average aircraft utilisation for the world’s airlines increased from just
over 2,000 block hours per aircraft in 1985 to 3,000 hours in 2002, or by
1.9% a year (Table 1.3). However, a small dip occurred at the beginning
and end of the 2000s, as a response to the unexpected drop in traffic and
a situation of overcapacity during these two sharp downturns. Since 2010
average aircraft utilisation has been fairly static for network carriers (such
as Cathay Pacific Airways) and hardly increased for LCCs such as easyJet
(staying around 11 hours per aircraft per day).
1.4 Key financial issues

As the industry approaches a catastrophic 2020/1 downturn, it will be inter-
esting to see if the same issues are as relevant as previously or whether they
were overshadowed by events. Certainly, many more airlines are now pri-
vately owned (see Chapter 7) and thus might not be expected to receive the
amount of state aid that they were given in the early to mid-1990s. However,
airlines most likely to survive will be given large cash injections by govern-
ments in the form of cash grants and, to a lesser extent, low-interest loans.
It can be argued that this is necessary to re-establish quickly at least a rapid
return to a basic network of air services. Thus, exit does not seem quite as free
yet as other industries, and the track record of existing airlines and other hur-
dles do not seem to deter new entrants unduly, at least for charter and LCC
14
types of operation, which can operate on a regional basis without owner-

ship restrictions (see Chapter 13).
Figure 1.8 shows how the major quoted airline stocks have performed
against the world stock indices. The former Morgan Stanley Capital Inter-
national World index of 25 international airlines outperformed the world
indexes in the initial period between January 2009 and around 2014 (in
line with the recovery from the banking crisis) when the major indexes
did better, apart from the Japanese Nikkei. The returns to shareholders
should also include dividends paid, which are not reflected in these trends.
Since airlines on the whole do not pay dividends and major industrials
do, the comparison tends to overstate the airlines’ performance. Some air-
lines do pay dividends (e.g. IAG, Cathay Pacific, and the large Chinese
airlines). The US majors also started paying dividends during the past dec-
ade, encouraged by their much better profits, but it could be argued that
more should have been retained to reduce debt further or to build cash
balances to survive massive turbulence. This leads to the question of how
much should be retained to meet the very low future probability of global
pandemics or similar events.
The key financial issues of access to capital markets and provision of
finance at reasonable cost remain high on the list of airline priorities. Almost
all debt and other forms of borrowing are at either fixed or variable rates;
variable rates have been adjusted over time using an indicator of short-term
market interest rates, the most common being the London Interbank Offer
FTSE100
250
Nasdaq 100
Nikkei 225
Index: Jan 2008 = 100
190
MSCI Airlines
130
70
10
01/2008
04/2008
07/2008
10/2008
01/2009
04/2009
07/2009
10/2009
01/2010
04/2010
07/2010
10/2010
01/2011
04/2011
07/2011
10/2011
01/2012
04/2012
07/2012
10/2012
01/2013
04/2013
07/2013
10/2013
01/2014
04/2014
07/2014
10/2014
01/2015
04/2015
07/2015
10/2015
01/2016
04/2016
07/2016
10/2016
01/2017
04/2017
07/2017
10/2017
01/2018
04/2018
07/2018
10/2018
01/2019
04/2019
07/2019
10/2019
Figure 1.8 Stock index vs top share indices, 2008–2019
15
Rate or LIBOR. LIBOR was and still is based on overnight and short-term
borrowing in different currencies. These were actual rates where possible,
but judgement was also used when there was no borrowing activity. The
problem was when no information was available on actual deals, some
banks started to use ‘judgement’ to favour their deals. Hence, the agreement
to phase out LIBOR and similar benchmarks by the end of 2021. Some of
the proposals for a new benchmark will be discussed in Chapter 4, and the
management of variable interest rate risk will be examined in more depth
in Chapter 9.
1.5 Financial implications of environmental measures

One of the key issues that were growing in importance over 2019 was the
environment. By then few thought that voluntary measures were sufficient
and that market-based measures (MBM), applying the principle of ‘polluter
pays’ would be needed, and airline flights were identified as very polluting.
The European Union had introduced a MBM, emissions trading scheme
(ETS), and this was expanded to include air transport in 2012. Up to then
the EU scheme was applied to industries such as power stations and indus-
trial plants. The airline ETS was still running, albeit reduced in scope in
2019; the approach chosen by the EU was capping emissions at a level that
was based on an RTK (revenue-tonne-km) benchmark, averaged over the
past three years. This was applied initially to all flights to/from and between
EU airports. Strong complaints, notably from the USA, and the introduc-
tion of a more global ICAO scheme named Carbon Offsetting and Reduc-
tion Scheme for International Aviation (CORSIA) led the EU to reduce its
application to intra-EU flights only. Carriers such as British Airways ben-
efitted from no longer needing to account for emissions by its considerable
number of EU/non-EU flights; EU airlines like Ryanair, on the other hand,
had 84% of its emissions subject to the EU ETS. Considerable uncertainty
now (in 2019) exists as to the future of the EU ETS once CORSIA is fully
running, which, as things stood, looks like towards the end of the 2020s.15
Ryanair emitted 11.01 million tonnes of CO2 in 2018, which equated to
0.085 tonnes of CO2 per passenger. At a market price of even €50 per tonne
of CO2, the impact is not large (Ryanair, annual report 2019). According to
Wizz Air’s annual report and accounts for the year-to-end 2020, Wizz had
the lowest CO2 emissions per passenger-km (57), followed by Ryanair (67),
easyJet (77), Air France-KLM (80), IAG (90), and Lufthansa (92). There
was a large difference between the high load factor and new fleet LCCs and
the network carriers. The main parameters agreed for the EU ETS were:
• To include aviation in the existing scheme for greenhouse gas (only

CO2) emission allowance trading
16
• First year 2012

• All flights to/from European Union airports
• Various exemptions, including smaller aircraft, military, training, and
rescue flights
• Cap based on actual emissions averaged across calendar years 2004,
2005, and 2006
• Cap set at 97% of baseline in 2012, and 95% for 2013–2020
• Emissions allocation based on a benchmark
• Initially 15% of allowance to be auctioned
In short, every airline operating on the routes included will have to find
enough allowance to offset its CO2 emissions. Some of this allowance is to
be given without charge, the remainder bought at auction or purchased in
the secondary market:
• Trading directly with other companies covered by the system

• Buying or selling from intermediaries – for example, banks and special-
ist traders
• Using the services of a broker
• Joining one of the several exchanges that list carbon allowance products
Most airlines are likely to be short in emissions allowances, essentially

because their air traffic and fuel use are growing faster than their ability to
reduce CO2 emissions. An ETS provides incentives to reduce emissions at the
lowest cost. However, care needs to be taken to avoid schemes that merely
transfer wealth between taxpayers and emitters or between emitters in some
parts of the world and those in other regions. The latter danger applies par-
ticularly to aviation and is relevant to the present EU reduced scale scheme.
Figure 1.9 shows how low EUA allowance prices have moved little above
€5 since mid-2017. This was because of the generous number of free emis-
sions that the other ETS members had been given. However, this was tight-
ened up, and more of the other emitters such as power plants had to buy
more EUAs in the market. A high point was reached in July 2019 of €28,
even higher than the levels of €20–30 between 2008 and 2012. An even
higher level just below $35 was reached in January 2021. The global meas-
ure agreed through ICAO, CORSIA, does not need any trading in allow-
ances, as it is not based on cap-and-trade, but rather, on reducing airline
emissions by offsetting its additional emissions above a baseline in 2018
(changed to 2019/2020). This will be achieved by investing the value of its
requirement – purchase verified carbon reduction units – using the spot and
futures market (according to its spot/futures EUA price) in green projects.
In terms of accounting, the submission of both the free and paid-for allow-
ance will be entered as a cost in operating costs. The paid-for allowance will
17
30
25
EUA Price in Euros
20
15
10
0
01/2012
05/2012
09/2012
01/2013
05/2013
09/2013
01/2014
05/2014
09/2014
01/2015
05/2015
09/2015
01/2016
05/2016
09/2016
01/2017
05/2017
09/2017
01/2018
05/2018
09/2018
01/2019
05/2019
09/2019
Figure 1.9 EUA spot market trends, beginning 2012 to end 2019
Source: www.investing.com; Note: 1 EUA equals one tonne of CO2.
be transferred from inventories as and when required. Buying allowance in

the market will increase inventories and not be treated as financial deriva-
tives. Emissions costs could be passed on to the passenger or shipper in the
same way as fuel surcharges, but that seems unlikely unless existing fuel
taxes are first removed.
1.6 Conclusions
Cash balances and lines of credit have been growing in importance, as the
industry is buffeted by more frequent downturns,16 aircraft delivery peaks
remain, and opportunities arise for acquisitions. Ratios such as debt/equity
have been improved by many major airlines, as financiers impose stricter
covenants. Hedging is much more widely practiced by airlines, covering
mainly fuel price, foreign exchange, and interest rate risks.
The control of costs and the price of new aircraft are largely economic
issues and not covered in depth in this book, although the financial aspects
of fleet planning are (Chapter 8). Access to capital markets is considered
in Chapters 5–7 and 11, while foreign exchange and interest exposure are
covered in Chapter 9 and fuel price exposure in Chapter 10.
For this, and many of the other topics discussed earlier, an understanding
of airline financial statements and ratios is required, and these are addressed
in the next two chapters.
18
Notes
1 Expanding Horizons. A report by the Comité des Sages for air transport to the
European Commission, January 1994, pp. 29–31.
2 Single Market Review 1996: Impact on Services – Air Transport (1997), pub-
lished by Kogan Page for the European Commission, Cranfield.
3 A US lobby consortium consisting of American and United Airlines along with
the pilots and other unions. www.openandfairskies.com/subsidies/
4 Lufthansa Cargo website (2001), ‘www.lufthansa.com’, average of spot jet fuel
prices for Rotterdam, Mediterranean, Far East Singapore, and US Gulf and West
Coast.
5 Discretionary income is what is left after paying taxes, social security, private
insurances, accommodation, and other regular payments.
6 Airlines, especially in the USA and, to a lesser extent, in the EU, tend to deduct
from profits large amounts for restructuring in bad years (i.e. when profits are
already bad); once the worst case doesn’t materialise, some of these can be added
back in later years, leading to large swings in net profit.
7 ICAO Journal, July/August 1996, p. 18.
8 Airline Business (2001), Financial Analysis: The Airline Rankings, September,
p. 62.
9 The interest component of operating leases is removed from aircraft rental
expenses and added back into EBITA.
10 Flights within the EAA.
11 Thomas Cook’s lower costs were offset by even lower fares, and the airline went
bankrupt in September 2019.
12 Boeing (1996), Current Market Outlook, Boeing Commercial Airplanes, Seattle,
WA, p. 4.
13 IATA World Air Transport Statistics, 2003 and 2006.
14 Aviation Strategy 250, November 2019.
15 The EU has extended the suspension of its rules to international flights until the
end of 2023, contingent on the successful implementation of CORSIA.
16 And above all, the huge impact of the Covid-19 virus where the survival of all
airlines was at stake.
19
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4 This is still the case in Asia but rare in North America and Europe.
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6 The Economist, 29 June 2006.
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36 Airline Business, August 2000, p. 21.
37 Airline Business, April 1995, pp. 54–57.
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7 https://en.wikipedia.org/wiki/HIBOR.
8 Airline Business, February 2012, p. 41.
9 The Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed
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10 Allegis Corporation (1988), Addressing Airline Issues, 1987 Annual Report.
11 Continental Airlines, Annual Report, 1995, p. 25.
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14 Ian Verchère (1994), The Air Transport Industry in Crisis, EIU Publications,
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15 Airfinance Journal (1994), Guide to Export Credits, p. 32.
16 Aircastle’s presentation to the Credit Suisse Aerospace and Defense Conference,
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17 Financial Times, 13 May 1993, p. 24.
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19 World Bank Development Report, 1994.
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9 From World Federation of Exchanges website, www.world-exchanges.org.
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AIRLINE FINANCE

Peter S. Morrell graduated in economics from Cambridge University and subsequently

He is a former head of the Department of Air Transport at Cranfield University,

1 Industry financial performance 1

2 Airline financial statements 20

2.6 Balance sheet comparison: Cathay Pacific versus

3 Airline financial ratios 61

3.6.3 Ratio analysis used to assist judgement 83

5 Sources of finance 106

6 Equity finance 141

7 Airline privatisation 167

8 Airline financial planning and appraisal 193

9 Risk management: Foreign currency and interest rates 219

10 Risk management: Fuel prices 237

11 Aircraft leasing 251

11.1.4 Extendible operating leases 257

12 Aircraft securitisation 270

13 Airline new entry and bankruptcy 281

14 Industry financial prospects 299

Glossary of terms and abbreviations 307

1.1 International Air Transport Association (IATA) scheduled

10.3 Percentage of fuel costs covered by fuel surcharge for

1.1 Employment share of airlines vs others involved in world

3.6 Cathay Pacific Airways Group – debt/equity ratio 68

7.3 British Airways privatisation fact sheet (1987) 171

14.1 World air traffic and GDP forecasts 300

The purpose of the book is to provide, as far as possible, a broad under-

account the availability of data, it was decided to exclude any attempt of

Other on-airport 55%

Table 1.2 Gross Domestic Product (GDP) contribution

Aviation GDP US$ billion

1.1 Government regulation of airlines: the

1.1.1 Air Services Agreements (ASAs)

scheme (EU ETS), and so there is now an element of double counting in

1.2 World airline financial results

world economic upswing from the emergence of the banking crisis to

Global RPK growth Real GDP growth

Figure 1.1 International Air Transport Association (IATA) scheduled airline traffic

Figure 1.2 IATA scheduled airline financial results

Asia/Pacific Europe North America

Figure 1.4 Operating result as per cent revenues by region of airline

Norwegian Brish Airways

Figure 1.5 Passenger load factor trends by major world region

ROIC ROIC minus WACC

Figure 1.6 Airline return on invested capital (ROIC)

1.3 Factors affecting financial results

Weight load factor % Breakeven load factor %

‘charter’ airlines. In 2018, British Airways was operating 172-seat aircraft

1.3.1 Asset and labour efficiency

Table 1.3 World airline productivity

RTK per RTK per litre of Aircraft hours

1985 144 187 2,179

aircraft. However, the price of a new B737–500 only increased marginally

1.4 Key financial issues

types of operation, which can operate on a regional basis without owner-

Figure 1.8 Stock index vs top share indices, 2008–2019

1.5 Financial implications of environmental measures

• To include aviation in the existing scheme for greenhouse gas (only

• First year 2012

1 Industry financial performance 1

2 Airline financial statements 20

3 Airline financial ratios 61

5 Sources of finance 106

6 Equity finance 141

7 Airline privatisation 167

8 Airline financial planning and appraisal 193

9 Risk management: Foreign currency and interest rates 219

10 Risk management: Fuel prices 237

11 Aircraft leasing 251

12 Aircraft securitisation 270

13 Airline new entry and bankruptcy 281

14 Industry financial prospects 299

Glossary of terms and abbreviations 307

3.6 Cathay Pacific Airways Group – debt/equity ratio 68

7.3 British Airways privatisation fact sheet (1987) 171

14.1 World air traffic and GDP forecasts 300

Table 1.2 Gross Domestic Product (GDP) contribution

Figure 1.1 International Air Transport Association (IATA) scheduled airline traffic

Norwegian Brish Airways