Air Traffic is pointing to additional economic activity weakness

"Rashness belongs to youth; prudence to old age." - Marcus Tullius Cicero 

A regular economic activity and deflationary indicator we have been tracking has been Air Cargo. It is according to Nomura a leading indicator of chemical volume growth and economic activity:

"Over the past 13 years’ monthly data, there has been an 84% correlation between air cargo volume growth and global industrial production (IP) growth, with an air cargo lead of one to two months (second graph). In turn, this has translated into a clear relationship between air cargo and chemical industry volume growth" - source Nomura:

"Our air cargo indicator of industrial activity came in at -7.4% (y-o-y) in April, following -3.8% in March and -7.8% in February. As a readily available barometer of global chemicals activity, air cargo volume growth is a useful indicator for chemicals volume growth." - source Nomura

Air cargo volume growth vs global industrial production growth, y-o-y, % - source Nomura:

In addition to Air Cargo trending down, as far as Air Traffic is concerned, demand growth remains weak as indicated by CreditSights in their April 2013 European Airlines Traffic Review. YTD demand in Europe has been flat and April demand was only up by 1% for Air-France-KLM, whereas April 2012 had been up by 5%. Overall demand by regions including Americas was up 2% in April 2013 against up 3% in April 2012 for this European operator. It was worse for IAG, the combined British and Spanish operator (British Airways and Iberia) with Spanish demand particularly weak in April in its domestic market, down 16% whereas it had been up 3% in April 2012. Iberia's traffic is down by 19% due to the weak Spanish economy sapping the demand.

Looks like we are indeed moving more into a soft patch...just saying.

"It's not what you look at that matters, it's what you see." - Henry David Thoreau 

Stay tuned!

Yogurts, European Consumer Confidence and Consumption

"Consumption may be regarded as negative production."
Alfred Marshall - Economist

Looking at European company Danone's profitability warning leading to a drop in the share price in conjunction with a dismal German investor confidence Zew index (ZEW institute reported that its monthly confidence index dropped by 27.7 points to a level of -16.9 points — its strongest decline since October 1998) has made us reflexionate around Yogurts, European Confidence level and Consumption.

Danone share price taking a beating - source Bloomberg:

As reported by Dermot Doherty in Bloomberg, Danone, the world's biggest yogurt maker cut its profitability forecast as Spanish consumers switch to less expensive products and raw-material costs rise, sending the shares down the most in three years - Danone Cuts Profitability Goal on Southern Europe, Costs:

"Danone is losing market share in dairy in Spain, where about one in four people are unemployed, and will take measures such as cutting costs and introducing new products to react. That will reduce profitability in southern Europe, Chief Financial Officer Pierre-Andre Terisse said today.

“The competitive environment in Spain is a lot tougher, so they’re having to invest more in promotion and pricing,” said Martin Dolan, head of equity research at Espirito Santo in London. “This is very Danone-specific rather than sector wide because of milk raw-material costs, and Danone’s exposure to Spain is far greater at about 8 percent than for other big food companies.”

Danone also indicated in relation to consumer spending in the same article:

"The French yogurt maker in April said it expected consumer spending to remain “under pressure” this year in western Europe. European companies are wrestling with the fallout from a drop in consumer spending as the sovereign debt crisis rocks the region’s economies. Carrefour SA, the biggest European retailer, last week said it would withdraw from Greece and carmaker Fiat SpA said it would cut investment in the region by 500 million euros ($630 million)."

In similar fashion to the trend in shipping with shipping giant Maersk is in fact shifting its business away from Europe (Shipping is a leading deflationary indicator) while Airlines are benefiting from growth outside Europe where traffic to the Americas have been the biggest beneficiary (Air Traffic is a leading deflationary indicator), Danone said sales growth target of 5-7% was unchanged; with robust performance in Asia, Americas, Africa, Middle-East, CIS offsetting pressure in Western Europe.

Leading us to an interesting exercise, plotting Danone share price against the gauge for consumer sentiment which last came at minus 19.3 (from minus 19.9) at the end of May 2012: Danone share price versus European Consumer Confidence since 2006 - source Bloomberg:

At the end of May Consumer Confidence in Europe fell to a two and half year low, following the previous inconclusive Greek elections, Spanish woes and fears of a euro break up.
Yogurts matter as an indicator? One has to wonder...

As austerity bites consumer spending and with Italy and Spain in recession, companies have been forced to lower cost to protect earnings so far. End of May the ECB also indicated that loans to households and companies in the euro zone grew at the slowest pace in two years as the on-going crisis curbed demand for credit.

We already discussed the difference between the growth differential between the USA and Europe (Growth divergence between US and Europe? It's the credit conditions stupid...), which continue to improve in the USA for now as indicated by my friends at Rcube Global Macro Research:
"The private sector credit growth (one of the most reliable Fed Fund leading indicator) has spiked(15% yoy).
The % of US commercial banks reporting stronger commercial & industrial loan demand is back to 2004 levels."

"As a result, US commercial banks will adjust balance sheets to the rising demand for loans, buying fewer Treasuries in the process. Their stock of government securities has risen from less than 10% of total assets in Q4 2009, to 15% today. While the incentive to do so was large over the last 4 years (extremely steep yield curve, falling inflation, broken credit channel), it is less so today. Their pace of purchase has already slowed from 25% YoY in Q3 2009 to less than 10% today, and should weaken further."
- source Rcube Global Macro Research - 18th of June 2012

As far as European Staples are concerned, according to a recent study by Morgan Stanley, impact of private consumption in Europe could be very significant in "European divorce" scenario playing out  - "European Consumer Testing Defensiveness – Downside Case Priced In?" - 14th of June 2012:
"Better prepared for an even worse scenario? In a “European divorce” scenario, the impact on private consumption in Europe could be worse than in 2009 due to the reduced scope for fiscal and monetary policy and higher unemployment. On the positive side, the Consumer Staples sector could see less of a relative de-rating because a) financial leverage is lower, b)inventory levels are generally at more manageable levels, c) commodity inflation is lower, and d) many companies have also expanded their lower-price point offerings. The relative re-rating has also been more measured this time, as the PE premium (60%) has not yet reached the peak from Nov 2009 (80%)."

It isn't only Danone facing similar exposure to weakening consumption levels in Western Europe with a slowdown in consumption levels in peripheral countries such as Spain. Heineken, L'Oreal, Reckitt and others are also exposed to similar trends as indicated by Morgan Stanley in their recent note:

"Within the region, Southern Europe only accounts for less than 10% of group sales on average across the sector. Imperial Tobacco is the most exposed to the region (Spain accounts for around 2/3 of its sales in Southern Western Europe). It is followed by Diageo and Heineken with more than 15% of group sales in the region (mostly Ireland and Spain for Diageo, and mainly Spain and Italy for Heineken). In Food, Danone has the largest exposure to Southern Europe, as Spain (~14% of group EBIT) is its most profitable market." - source Morgan Stanley - "European Consumer Testing Defensiveness – Downside Case Priced In?" - 14th of June 2012

No surprise Morgan Stanley's conclusion:
"Mix is Key
Our Bear case analysis illustrates the importance of having diversified portfolios and geographic exposures. Geographic mix (which we define as higher-margin regions growing faster than the group average and vice versa for lower-margin regions) plays a crucial role in determining the magnitude of downside risk in our Bear case scenarios."

In regards to European Consumption trends, CreditSights in their recent Euro Consumer Takeaways from the 18th of June made the following interesting points:
"-Italy: Confidence has fallen to its lowest level ever as of May; minus 38.6. Spending had already fallen by 2.4% in the 12 months to the first quarter, which is as large as the fall in the 2009 recession. Consumer spending can only fall so far before households fall back on subsistence levels, and prolonged declines in spending are rare. As such they believe that full-year spending decline will be less negative than the 2.4% fall in the year to the first quarter, but we are still expecting to be at least 1% lower over 2012 as a whole in real terms.
-Households debts in France, Germany and Italy are much lower versus national income; compared to the UK (96% down from 103% of GDP in 2009); respectively 55%, 60% and 45% of those country’s annual GDP. Household debt-to-GDP for the Eurozone as a whole is 65%. But while households in France, Germany and Italy are less encumbered by debts and do not, therefore, have to divert income to servicing that debt, low interest rates should still act as some motivation to bring forward spending by borrowing. They believe that is especially the case of borrowing costs are barely any more than households expect their salaries to grow by.
-Consumer borrowing costs , adjusted for wages, in Germany are roughly in line with the crisis low in 2007 at 2%. However, at 4% in France and 6% in Italy, the interest rates on unsecured debts are well above the lowest rates they reached in the 2000s. Additionally, these lower real borrowing costs have not obviously generated greater increases in household debts.

Wealth holdings – the “housing” conundrum:
"In the UK most peoples’ primary provisioning for retirement is their house, that tends to mean that changes in house prices are closely associated with changes in spending. Therefore the stabilisation in UK house prices is good in that falls are not actively undermining spending any more, but in their view it will be a long time before rampant house price appreciation once again drives a boom in consumer spending.
In Germany and France, house prices have, since 2009, been growing strongly. Prices were not over-inflated by a bubble in mortgage lending in the pre-recession years. And to some extent that growth may feed through to a greater willingness to spend in those countries. But their UK contemporaries and so while booming prices in Germany may provide some inclination to spend less, they believe that more consistent income growth and falling unemployment (leading to greater job security and consumer confidence) will be more important drivers of any increases in household spending.
In contrast to France and Germany, Italian house prices have been falling for some time. And falling incomes, tax-induced increases in prices, rising unemployment and worries about the government’s fiscal position are all likely to ensure that spending by Italian households remain depressed with or without the additional impact of house price declines."

UK wise:
"The government’s attempt to tighten its belts at the same time as the private sector is also cutting spending will not only be self-defeating for the government’s fiscal position but is prolonging the period that it takes UK consumers to reduces their debts and feel confident once again about the outlook for their incomes. They expect UK household spending to be centered around the 0% range this year."

With consumer confidence and investor confidence in the doldrums, in conjunction with struggling Southern Europe no wonder yogurts are taking a beating...

"The shelf life of the average trade book is somewhere between milk and yogurt."
Calvin Trillin

Stay tuned!

Air Traffic is a leading deflationary indicator

"He who rejects restructuring is the architect of default." - Macronomics.

Following on the theme of deflationary indicators (see our conversations "Shipping is a leading credit indicator" - "Shipping is a leading deflationary indicator"), we thought this time around we would venture towards Air Cargo and Airlines, given that on June 5 the Lex Column in the Financial Times asked an interesting question in relation to Europe and Airlines: "How many airlines does Europe need? Certainly not 40, providing 8.5 per cent more seat  capacity in 2011 compared with 2007. One theory says that the region could live with three flag carriers (Lufthansa, International Airlines Group and Air France-KLM), a couple of budget airlines (Ryanair and easyJet) and perhaps, a few niche players. But while consolidation talk is plentiful, the actual pace of airline rationalisation remains fairly stately."

As we posited in our "Shipping" conversations, as far as Airlines are concerned, in similar fashion, it is as well a global game of survival of the fittest.

In fact Lex Column concluded their 5th of June EU consolidation conversation by the following:

"Ultimately, though, credit withdrawal pressures may be required to achieve rationalisation. Last year, these pushed Malev and Spanair out of the skies. It could be an even tougher winter ahead."

We already know from our various credit conversations relating to 2011 issues, namely access to dollar funding, that many European banks have in fact scaled back from dollar-funded businesses such as aircraft financing. In similar fashion to shipping we believe credit withdrawal will accelerate the pace of rationalisation in the European skies.
As a reminder:
Last year issues surrounding liquidity issues and difficulties in accessing dollar funding mean most European banks are paring back on their Structured Finance Operations: Definition of Structured Finance business - source Credit Agricole CIB:
"The Structured Finance business consists in originating, structuring, and financing operations involving large-scale exports and investments in France and abroad, often backed by collateral security (e.g. aircraft, ships, corporate real estate, or commodities), as well as complex and structured loans.
The Structured Finance division comprises nine finance segments: aviation and rail / shipping finance / tax-based leases / natural resources, infrastructure and power / real estate and lodging / export and trade finance / acquisition finance / transactional commodity finance / structured finance advisory."

So in our Air Traffic conversation we will first look at Air Cargo as a leading deflationary indicator then at the ongoing issues plaguing Airlines which will lead to consolidation.

According to a note by Nomura published on the 12th of June, Air Cargo is a leading indicator of chemical volume growth and economic activity:
"Our air cargo indicator of industrial activity came in at -7.6% (y-o-y) in May, following -7.8% in April and -4.3% in March. As a readily available barometer of global industrial activity, air cargo volume growth is a useful indicator for chemical volume growth."

It has also been a very reliable indicator in relation to industrial production according to Nomura:
"Over the past nine years' monthly data, there has been an 85% correlation between air cargo volume growth and global industrial production (IP) growth, with an air cargo lead of one to two months. In turn, this has translated into a clear relationship between air cargo growth and chemical industry volume growth."

Nomura’s proprietary air cargo indicator shows a high correlation (85%) with global industrial production:

Moving on to the ongoing issues plaguing the Airlines industry, as recently as yesterday IATA (the International Air Transport Association) has almost doubled its 2012 loss forecast for European airlines and said the continent's debt crisis could wipe out an expected global profit according to Bloomberg - IATA Doubles Loss Forecast for Europe Airlines on Crisis:
"Carriers in Europe may lose $1.1 billion this year, compared with a March forecast for a $600 million loss, the airline body said today at its annual meeting in Beijing. It reiterated a forecast for a $3 billion global profit. The worldwide estimate could be reduced if the European economy worsens more than expected, the group said. “If there’s a full-blown crisis, all bets are off,” Tony Tyler, head of IATA, which represents about 240 carriers, said in a Bloomberg TV interview yesterday. “It will have a big impact on the world economy and a huge impact on airlines.”
Global profits are already set to fall from $7.9 billion last year, as recessions in the U.K., Spain and other European countries damp demand and erode gains from lower fuel prices. Deutsche Lufthansa AG (LHA), Air France-KLM (AF) Group and International Consolidated Airlines Group SA (IAG), Europe’s three biggest full- service carriers, have all announced plans to cut staff or restructure operations following first-quarter losses."

Although the recent fall in fuel costs could been seen as good news for Airlines, in the 1st quarter of 2012, soft pricing and high fuel costs had already meant losses for European airlines due to weak price elasticity for European carriers as indicated by Bloomberg on the 26th of April:

"Most European airlines will record losses in 1Q, according to consensus expectations. Load factors improved on depressed air fares, which rose 6% on average during the period, barely enough to cover the 400 bps to 500 bps of margin loss due to higher fuel costs. Substantial hedging should alleviate some, not all, of the pain." - source Bloomberg

In fact given that many carriers hedge more than 70% of fuel consumption, it is highly unlikely that the recent fall in fuel prices will make a big difference to their difficult situation:

"European airline fuel hedges could alleviate the effects of a 1Q fuel price increase. Jet fuel prices rose 16% yoy and 9% sequentially. The effect of high fuel prices could be damped as many carriers hedged more than 70% of fuel consumption for the period. Hedges are typically most effective when prices rise significantly sequentially." - source Bloomberg, 26th of April.

So as we posited in our conversation - "Growth divergence between US and Europe? It's the credit conditions stupid...", same apply to US Airlines versus European Airlines, its the credit conditions stupid given, as indicated by Bloomberg in their article - IATA Doubles Loss Forecast for Europe Airlines on Crisis:
"IATA raised its profit forecast for North American carriers to $1.4 billion from $900 million. The airlines will boost earnings from $1.3 billion last year as they refrain from adding many flights amid a 0.5 percent growth in demand, the slowest pace worldwide, the group said."

As far as traffic is concerned, in similar fashion to shipping (see our previous posts), traffic to the Americas have been the biggest beneficiary as indicated by Bloomberg in April:

"Lower airfares boosted international demand and improved load factors for European carriers in 1Q. Traffic to the Americas saw the best improvement, probably aided by depressed U.S.-to-Europe air fares. Asia-Pacific region traffic, the second-biggest market, also improved during the period on lower fares." - source Bloomberg, 26th of April.

As far as Europe consolidation is concerned, the game of survival of the fittest is truly on. For instance, Air France-KLM in the first quarter of 2012 took market shares to its rival IAG (the British Airways and Iberia company formed in January 2011) as reported by Bloomberg on the 26th of April:

"Domestic load factors improved in 1Q for the top full-service European airlines, though they remained weak at about 67 on average, on a 3.6% traffic gain and with capacity unchanged. Air France added capacity and increased traffic, improving load factors and gaining market share from IAG, which cut capacity during the quarter." - source Bloomberg.

Europe has already seen some airlines collapse this year, including Hungary’s Malev and Spain’s Spanair as a matter of fact.

When it comes to low cost airlines, the fight is as well truly on, in a weak pricing environment where Ryanair's loss in the 1st quarter was, as reported by Bloomberg, EasyJet's treasure:

 "Ryanair's 2.3% capacity cuts weighed on low-cost European airlines' domestic capacity growth (3.4%) in 1Q amid weakness in pricing. EasyJet countered Ryanair's contraction by adding 7% capacity during the period, increasing market share. Domestic load factors were unchanged for European low-cost carriers on a 1% increase in traffic." - source Bloomberg 26th of April.

Although US Airlines have been benefiting from European woes, according to Bloomberg, American, United Airlines are most exposed to a potential fall in Latin America Airfaires:

"Non-premium airfares for U.S. to Latin America travel fell for the second straight month in May, by 3%, while premium fares fell sharply by 28%, indicating Latin America passenger yields may slow. American Airlines and United are the most exposed to demand changes to the region because they are the biggest carriers to Latin America by traffic." - source Bloomberg, 17th of May.

But in this global deflationary environment, it is not only affecting American and European carriers facing potential headwinds such as pricing issues, weak earnings and consolidation threats. Australian airline Qantas predicted a 91% drop on the 5th of June 2012 leading to an 18% slump in its share price on the day:

"Qantas Airways Ltd., Australia’s largest carrier, plunged to a record low in Sydney trading after
saying annual profit may fall as much as 91 percent because of losses on overseas routes and higher fuel costs.
The carrier, which listed in 1995, slumped as much as 18 percent, the biggest drop since February 2009, to as low as A$1.16 at 1:52 p.m. in Sydney as the benchmark S&P/ASX 200 Index
rose 1 percent. Credit-default swaps rose to an eight-month high.
Underlying profit before tax may be A$50 million ($49 million) to A$100 million in the year ending June because of a A$700 million increase in fuel bills and a doubling of losses at Qantas International, the airline said today. The Sydney-based carrier could also lose its investment-grade credit rating at Standard & Poor’s following the profit warning, said National Australia Bank Ltd." - source Bloomberg

On the 5th of June Qantas 5 year CDS  jumped 15 bps to 365, their highest since October 2011,
according to CMA data. S and P downgrading the carrier from BBB is likely and a two-grade two-grade cut to a non-investment level is an “outside possibility,”  according to National Australia Bank said in a research note as reported by Bloomberg.

In similar fashion to Wilbur Ross planning shipping expansion as industry distress grows for shipping (which we discuss in our recent shipping conversation), the sharks are circling the stricken airline industry as well, with Qantas shares jumping 11% today, their biggest gain in more than 5 years as reported by Bloomberg. This jump has led Qantas to hire Australian bank Macquarie Group Ltd to ward-off the predators - "Qantas Hires Macquarie for Takeover Defense After Slump":
"Qantas may be more attractive to bidders after its stock slumped to its lowest levels on record last week after forecasting the first annual net loss since a 1995 initial public offering. The airline, which can only legally be controlled by Australian investors, is battling rising losses on international services as rivals from the Middle East and Asia lure passengers."

Similar to the shipping industry, consolidation, defaults and restructuring are going to happen no matter what, in the Airline industry in our on-going deflationary game of survival of the fittest.

"The first thing you have to do is accept that decay sets in and there's nothing you can do about it."
Francesca Annis

Stay tuned!