This week’s Capital Agenda Blog comes from Amanda Blackhall O’Sullivan, a partner in our Restructuring team.
Some of the strongest headwinds that have battered the travel sector in recent years are easing, but new challenges are always emerging and many go deeper than temporary shifts in overheads and demand. Airlines and tour operators in particular will need strong balance sheets to ride out further storms and to compete in a sector seeing the fastest rate of technological disruption.
In this week’s Capital Agenda Blog, I’ll discuss the challenges facing airlines and tour operators in 2019 and explore how they can stay ahead of the curve.
In the last two years, four UK-based airlines – Monarch, Primera, Cobalt and Flybmi – have gone into administration. This is in addition to the further insolvencies, debt restructurings and distressed sales across the broader UK and global travel sector. In the UK, the FTSE Travel & Leisure sector issued its highest number of profit warnings for sixteen years in 2018..
Why has this been an especially tough few years for UK-based airlines and tour operators? We’ve identified four common economic and political themes that struck from around 2016.
Rising fuel costs
Whilst not reaching historic highs, oil prices more than doubled between January 2016 and mid-2018. IATA figures show that jet fuel costs rose to 23.5% of airline industry operating expenses in 2018, up from 20.8% in 2016.
With most airline purchases made in dollars and most tour operator purchases made in Euros, sterling’s post-Brexit weakness from mid-2016 added to the cost pressures of UK-based companies. This has been compounded by rising operating costs elsewhere, such as further increases in air passenger dut
Airline overcapacity has created fierce Europe competition between lower cost carriers (LCC) and legacy airlines, with 41% of cross-Europe capacity operated by LCCs. Meanwhile, tour operators contended with a significant demand shift following the 2015 terrorist attacks and 2016 Turkish coup, which put significant pressure on Spanish and Portuguese capacity. Meanwhile, companies exposed to Turkey and Tunisia saw bookings sharply fall away.O
To add to the pressures building by summer 2018, trade union disputes also disrupted schedules, whilst many holiday makers stayed at home due to the warmer European weather.
Are we nearly there yet?
Many of these headwinds are easing in 2019. Oil prices have fallen, with hedging, improved fuel efficiency and the stronger pound/weaker dollar also taking the edge off fuel prices. Capacity is falling in the airline sector, which should help ease competitive pressures. The European Travel Commission reported a 22.3% increase in travel to Turkey in 2018, taking the pressure off Spanish and Portuguese capacity. It’s unlikely that we’ll see a summer as warm and dry as 2018 for a while!
But stacked up against these positives are new challenges. UK consumer spending power is growing on aggregate, but UK consumer confidence and economic growth is weakening – as it is across major European markets. In previous downturns, households have prioritised holidays, but they have spent less or travelled closer to home. The industry isn’t totally immune to economic disruption.
This fall in confidence and economic outlook is in part due to Brexit, which will change the dynamics of UK travel most significantly and dramatically if the UK leaves without a deal. The travel sector has made extensive preparations and the UK and EU have put in mitigating measures to ensure travel continuity on 29 March 2019 in the event of no deal, but these are not unconditional or indefinite.
Oxford Economics estimates that no-deal Brexit could cause a 5% fall in overseas travel and tourism trips by Britons in 2020.
A changing climate
Moreover, even though the ‘weather’ might improve in 2019, the underlying climate for travel companies is changing. Business travel has always been vulnerable to the impact of economic downturn. But, even in an expanding economy, the growing popularity and ease of video calls (e.g. Skype & FaceTime), web based seminars and video conferencing all provide the means for companies to cut their business travel budgets.
Technological disruption is a two-edge sword for the sector. The Travel and Leisure sector saw the fastest rate of technological change, according to the latest EY Disruption Index™ with Artificial intelligence (AI), virtual reality (VR) and the internet of things (IoT) helping the sector to personalise its service to customers, increase customer numbers and improve efficiency.
AI can be used to predict customer travel choices, to provide customer assistance and analyse feedback. AI can help reduce the seasonal uncertainty through improved accurate demand predictions, resource planning and pricing.
VR provides tours of rooms and help visitors create virtual itineraries, encouraging holiday makers to book.
IoT reduces the headcount needed to maintain a hotel by allowing for central visibility of the entire property’s key indicators. Hotels are also increasingly offering guests IoT voice-activated devices, mirroring the spread of smart-home devices
All of which presents significant opportunities for the sector. But staying ahead of the curve requires investment, when many companies are still struggling with day-to-day commitments.
Finding the balance
Thus, while some headwinds will ease in 2019, it remains a challenging environment to achieve profitable growth. Companies without the strong balance sheet and buffers necessary to ride out weaker demand and inevitable ‘one-off’ events will increasingly struggle. Not least because they’ll be unable to invest in new technologies that enable them to attract and retain customers and increase their operating efficiency. One the other hand, those with strong balance sheets will be in a good position to invest to build market share and possibly consolidate their markets, if regulatory conditions allow.
Air travel is also a market where size increasingly matters. It is getting harder for small regional carriers to survive, especially those without connecting flights at major hubs and limited bargaining power. This in turn makes smaller regional airports vulnerable. Smaller airports often heavily reliant on one or two airlines, leaving them exposed to airline failure or relocation. Airline consolidation is a hot topic and we’re likely to see larger airlines continue to buy-up smaller operators; but larger tie-ups are likely to raise competition issues given than many European routes already exhibit a high level of concentration.
Tour operators can still operate in niche markets, where having the access to quality experiences and the right destinations will attract loyal customers. Although a lack of diversity can leave companies vulnerable to sudden shifts in demand– as we saw with the collapse of demand in Turkey. Indeed, size, brand and regulator protection can provide consumers comfort in turbulent markets. But it can take larger operators longer to react to market trends. In parallel with retailers, many are still struggling to adjust the size of their legacy retail operations, whilst needing to invest to create online and omnichannel offerings that create a customer centric experience.
What’s vital across the whole sector is a culture of continuous cost control and cash flow management. Margins are so skinny that management teams must stay on top of costs and their cash flows with regular reports and forecasts. This is one of the toughest times of the year for tour operators in particular, who are only just starting to get deposits in for summer holidays. But airlines too need to keep close eye on cash. Brexit may not directly impact travel plans, but if it hits confidence and delays bookings to later in the season, cash flows will wane. It’s also making it harder to raise finance in parts of the sector. These are still testing times.
Edited by Kirsten Tompkins