An Investor’s Quick Guide to Understanding the Cost Structure of Airlines

The airline industry can be a challenging one to operate in as it is highly competitive and capital intensive.

As such, it could be important for any investor interested in the airline industry to have a grasp of the cost structure of airlines. In here, I thought I’d use Singapore Airlines Ltd (SGX: C6L) as an illustrative example.

The table below shows the costs for Singapore Airlines’ airline business only in 2015/16 (fiscal year ended 31 March 2016) and 2014/15:

Source: Singapore Airlines’ 2015/16 annual report

There are a few observations we can draw.

First, fuel costs are the single most important cost in an airline business. Given the sharp fall in oil prices over the past two years, many airlines – Singapore Airlines included – have benefitted from lower fuel costs.

Second, a significant chunk of the airline’s costs – fuel costs, staff costs, depreciation, rentals on leased aircraft, handling charges, and aircraft maintenance and overhaul costs – are mostly fixed in nature. From this, we can see how important it is for an airline to maintain a high load factor for its flights so that it can spread out its fixed costs among more customers.

A Foolish conclusion

From the above, we can see that an airline business has significant operational gearing since the business has significant fixed costs in its cost structure. In general, the higher the operational gearing, the more operating risk a company has to bear.

When high operational gearing is combined with other uncontrollable factors such as competition, fuel prices, high capital investment needs, and currency risks, you can see how running an airline can be challenging!

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Lawrence Nga doesn’t own shares in any companies mentioned.