Robust demand underpins the recent upgrades of our five highest rated European airlines.   Ryanair Holdings PLC, easyJet PLC, International Consolidated Airlines Group S.A., British Airways PLC and Deutsche Lufthansa AG (see table 1) are all benefiting from air travel bookings that show no sign of slowing. That is despite a European economic backdrop marked by persistently high inflation, interest rate rises, and pressure on disposable incomes. The upgrades and mostly stable outlooks also reflect the airlines' strong recovery, following a high number of negative rating actions during the COVID-19 pandemic (when all our European airline ratings were downgraded between one and seven notches).

Nevertheless, all but Ryanair (which is in line with its pre-COVID 19 rating) remain one or two notches below pre-pandemic levels. This is typically due to higher leverage, accumulated during the pandemic, and elevated capital expenditure on new aircraft, following delays during COVID-19. Many airlines' capacities remain constrained.

We expect our strongest rated European carriers, and those more highly exposed to domestic and short-haul flights for leisure purposes, to fare well this year, particularly if operational issues experienced in 2022 can be avoided during the peak summer season. We assume similar trends at the largest U.S. airlines (see "The Big 3 U.S. Airlines Are Poised For Credit Recovery Amid Looming U.S. Recession", Apr. 06, 2023).

Chart 1

The negative outlooks on the ratings of four of our European airports is anchored by a slower recovery of credit metrics.  Throughout the COVID-19 pandemic we downgraded the airports we rate by only one or two notches (on a stand-alone credit profile basis), leaving them all at investment grade (see table 2). European airports started the pandemic with high levels of leverage, typical of capital-intensive infrastructure assets, which increased in 2020 and 2021 as the majority of the rated airports were cashflow negative. Also, some airports may now face a backlog of capital expenditure that was delayed over the last three years. The need to make up for that underspend is likely to delay a credit quality recovery at our rated airports, which is expected to be more gradual than among the airlines we rate.

Our rated issuers also include some relatively unique cases, such as Aeroports de Paris , where a negative outlook reflects the unsolicited sovereign rating on France; and NATS (En Route) PLC, where the negative outlook relates to a regulatory review of its remuneration over 2023 to 2027.

Chart 2

The Outlook For 2024

Robust demand, particularly for short-haul leisure trips, and tight capacity on European networks will continue to characterize the market.  The result is likely to be still high ticket prices over 2023, which should serve to continue to offset inflationary pressures on airlines' cost-bases. Discretionary spending on travel is supported by Europe's low unemployment levels, accumulated savings, and pent-up demand following COVID-19 (particularly for high-end travelers).

We believe that traffic will continue to grow over the crucial summer period in 2023, unless economic or geopolitical conditions deteriorate unexpectedly and sharply. The industry has taken steps to prevent a repeat of the staff shortages and capacity constraints that hurt operations in 2022, but similar issues could still cause some delays over the peak summer period. Our forecasts envisage a steady recovery in air travel and rational capacity deployment by operators. That should underpin the ability and willingness of the sector to continue to pass cost inflation to passengers through higher airfares.

International travel will continue to lag domestic travel's near-complete recovery.   We expect 2023 will be the first post-pandemic year that is almost free of COVID-19 related mobility restrictions (with China reopening at the beginning of the year). Whilst we understand that domestic travel has almost fully recovered across the globe, The International Air Transport Association (IATA), an airline trade body, recently reported that international connectivity is about 87% of 2019 levels in Europe and North America. We consider it unlikely that most of our rated European airports, which are highly exposed to international flights and in several cases suffering from congestion issues, will see passenger numbers return to pre-pandemic levels in 2023.

Airlines are still, on average, deploying lower capacities with downsized fleets post-pandemic (with notable exceptions, such as Ryanair and Wizz Air). We understand that short haul capacity in Europe is about 5% lower than pre-pandemic capacity, but this is expected to improve throughout the year. Furthermore, business travel remains around 70% of pre-pandemic levels (although premium economy is proving profitable), and could still be about 15%-20% lower in 2024. Corporate spending on air travel remains under economic and environmental pressure, and we believe there has been a structural shift in air passenger profiles to some extent.

Airlines, unlike airports, continue to benefit from elevated airfares.   Airline revenues have soared for our strongest rated airlines, supported by high ticket prices. We think that yields will remain high in 2023. However, we expect continued revenue gains will be largely absorbed by growing fuel bills (as lower-priced hedges roll off) and other forms of cost inflation, such as staff costs. Airlines' capacity deployment decisions will likely have a meaningful impact on the evolution of airfares, as will rising carbon costs (see "Europe's Airlines To Bear Highest Carbon Costs", April 3, 2023).

Passenger volume growth at airports relies heavily on increased capacity from airlines.   Available Seat Kilometers (ASK), which is a measure of passenger carrying capacity, at European airlines recovered to 92% of pre-COVID levels during the first quarter of 2023--domestic capacity fully recovered while international capacity was 8% down (IATA figures) impacted by the Ukraine war and limited air space capacity. During the pandemic, many legacy carriers significantly shrank their fleets. Delays to new aircraft deliveries (mainly from the two key suppliers Airbus and Boeing) have further restrained capacity growth. We forecast 2023 passenger volumes at our strongest rated airlines will remain just shy of 2019 levels, with the notable exception of Ryanair (where volumes in fiscal 2023, ending March 31, already exceed 2019 levels).

European air passenger traffic should return to pre-pandemic levels in 2024, up from 85%-95% of 2019 levels in 2023.   Airlines and airports with significant exposure to domestic and short-haul traffic could record volumes toward the upper end of the forecast ranges, and perhaps beyond. Groups with a greater exposure to long-haul and business traffic are likely to end the year at the lower end of the ranges. Going forward, we will likely discontinue referencing 2019, reflecting our view that a new normal has been reached post the COVID-19 pandemic. Although the recovery in air traffic has been impressive, particularly given the huge strain the industry was under during the pandemic, traffic levels are still well below where they were expected to have been if COVID-19 had not occurred (the industry expected annual growth in the low- to mid-single digits).

Table 1

Risks Over The Medium- To Long-Term

The affordability of airfares may test travel appetite.  Airfares increased materially throughout 2022, driven by strong cost inflation and capacity constraints. At the same time, pressure on disposable incomes grew due to soaring inflation and increased interest rates (see chart 3). We understand that airline bookings remain solid and have not showed signs of weakening ahead of the crucial summer season. Travel could, however, come under pressure in 2024 if the weak macroeconomic environment persists, so we are closely monitoring booking trends.

Chart 3

Flying across Europe is likely to become more expensive.  Aviation's effort to reach net zero by 2050 centers on the development of sustainable aviation fuel (SAF), a type of biofuel with a lower carbon footprint than conventional jet fuel. Railway and road freight will also rely on biofuels on their way to net zero. SAF supplies are limited and, coupled with growing demand, the fuel is likely to remain much more expensive than conventional fuel. However, using such fuels can mitigate increasing carbon costs that airlines will face over the next few years. We expect a structural increase in European airfares over the longer-term. Long-haul volumes may prove more resilient to that cost increase, compared with short-haul, which competes with a greater number of alternative transportation options.

Investment in European airports is likely to become more complicated.   Airports sponsors can expect greater scrutiny of new airport projects, such as new runways and terminals. This is not just due to budgetary pressures, but also because of environmental factors, such as noise, carbon emissions, and local community interests. The delays to the approval of Schiphol's airport at Lelystad, which has been ready to open since 2019, are an example of these pressures. Increases in airfares may also impact long-term growth in Europe and affect investment decisions. Airports' fixed locations mean they have fewer options than airlines to make adjustments, such as rerouting capacity, in order to boost profits.

Some European airports are likely to target expansion in riskier jurisdictions to support revenue growth.   Aeroports de Paris and to a much lesser extent Flughafen Zurich AG , for example, have invested overseas, particularly in India, and will likely continue that strategy. European airports adopting this strategy could expose themselves to a degree of foreign exchange risk and greater EBITDA volatility due to riskier cash flows--particularly given the stability of existing assets that are mature, located in stable countries, and operate under resilient regulatory frameworks. From a credit worthiness perspective, this volatility would need to be compensated with lower leverage. Hence international expansion, should it materialize, and depending on its contribution to earnings and required investment, would be a key element in our determination of an issuer's credit quality.

Related Research

• The Big 3 U.S. Airlines Are Poised For Credit Recovery Amid Looming U.S. Recession, Apr. 06, 2023
• Europe's Airlines To Bear Highest Carbon Costs, Apr. 3, 2023
• SLIDES PUBLISHED: EMEA Infrastructure: Handbook, Jan. 24, 2023
• Industry Top Trends 2023: Transportation, Jan. 23, 2023
• Industry Top Trends 2023: Transportation Infrastructure, Jan. 23, 2023