Blog archive - September 2011

Last week Air France-KLM announced one of the bigger aircraft orders this year, with options for up to 110 long-haul aircraft split evenly between the Airbus A350XWB and the Boeing 787. Apart from the apparent Boeing success in securing orders for the 787 from a French carrier, this deal is clearly not an indication of European traffic growth. Combined with American Airlines’ July order for 460 single aisle aircraft, also evenly split between Airbus and Boeing, it is rather an indication of fleet modernisation efforts in both, Western Europe and North America. Simply put, most Western airlines are in need of modernisation, even though their respective markets will see little growth over the next few years. Comparing that to Air Asia’s Paris Air Show order for 200 A320s; an airline clearly geared for growth. This fact leads to the next big announcement from Airbus, on Monday this week, of their new 20 year forecast for 2011-2030. The forecast is slightly less optimistic than Boeing, in terms of global aircraft deliveries, which according to Airbus will be 28,000 instead of 31,500 expected by its rival. Another, unsurprising, point of difference between the two: Airbus expects double the number of deliveries in the “Very Large” aircraft segment, backing its A380 programme. Nonetheless, the most important take from this forecast is the constrained optimism over economic growth figures. Airbus expects a 3-4 per cent world GDP growth in 2012, with a corresponding air traffic growth of 7 per cent. Once again, so called “mature economies” are the ones which keep the global airline industry from double digit growth. Emerging economies will see a GDP growth of 6 per cent and air traffic growth of 10 per cent in 2012, according to the manufacturer. In turn, the above announcement made way to yesterday’s forecast from the International Air Transport Association (IATA), which once again revised its full year global airline net profit estimates, from $4.0 to $6.9 billion, on the back of better results from European carriers. This is not the first time IATA makes such generous revisions to its forecasts. In fact, these forecasts are good indicators of market sentiment, but rather irrelevant from a macro-perspective. In reality the $4 - $7 billion profit range can be translated into a 50-100 basis point difference in net margins for the industry. The industry will, most certainly, enjoy margins of between 0.5-1.5 per cent this year. Let’s ignore the actual numbers and rather concentrate on the trends. In 2010 airlines saw a rebound from a depressed 2009 air traffic level, while 2011 was a year of positive yet modest results, as European and US airlines witnessed the positive effects of restructuring and negative effects of stagnant GDP, rising fuel prices and political turmoil in the Middle East. Next year airlines will struggle to break-even, on the back of ever increasing jet fuel prices and fears of a contagious European economic crisis. That is true for European airlines but not for their Asian counterparts. In fact European airlines may see a sovereign default giving way to a new recession of European economies, where the only positive outcome will be a devalued Euro currency driving inbound tourism. Perhaps it is not surprising then that Lufthansa issued pessimistic earnings guidance yesterday, even though IATA sees better results from Europe. Lufthansa is one of the few European carriers with aggressive expansion plans; indeed plans that were initiated a bit too early. They are in the position where they need to rid of subsidiaries that provide little benefit (see BMI) and further integrate others (see Austrian, Swiss). To summarise, announcements over the past week seem contradictory, in terms of the state of the industry today. Particularly IATA’s upward revised forecast creates a positive market sentiment. But their forecast is irrelevant from a macro-perspective. Everything is pointing towards a difficult 2012 for airlines.

Frost & Sullivan has been examining future major trends that we expect to occur in the ten to twenty year timeframe. Among these is the creation and growth of MegaCities or Megalopolises. These will have major effects on the way people live and work. One of the more pronounced effects will be on the way that people travel. A subset of that travel issue is the access to business and general aviation aircraft. Many of the larger cities in the US have general aviation airfields near their downtown area. Some of these are former city airfields which have been replaced by larger, more modern airports on the periphery of the city. They now continue to exist as operating locations for business aircraft or as small general aviation airfields. Some are owned by the cities or airport authorities and others are in private hands. Over the last twenty years, these airfields have been challenged to stay in operation. There are a number of reasons for their operations to be challenged. In some cases, the area around the airfield has become a distinctly less desirable part of town. A Learjet operator moved his operation to an airport on the fringe of the city because his wife felt uncomfortable visiting an airport with tagging on every surface and homeless people sleeping against the fences. Other airports have issues with contamination from years of fuel spills and unauthorized dumping. Many private airfields have experienced significant raises in property values and therefore property taxes. Noise complaints have restricted operating hours and traffic patterns to the point that many downtown airports have become inconvenient despite proximity. Probably the biggest threat comes from the cities themselves. Cities see the revenue possibilities as being far greater at their main airports than at the downtown airpark. They care very little about the true GA operations. Those probably are not economically viable on their own. It is the business aircraft traffic that attracts their attention. They see landing fees, parking fees, taxi and rental car revenue, and many other opportunities from business travel. This is especially true when the downtown airpark is privately held. Visiting the NBAA and AOPA websites will almost immediately highlight the top three or four airports at risk of closure. Most of those are targeted for closure by the city. Few have gone as far as Richard Daley in bulldozing Meigs Field, but cities have been using his security and safety refrain as their reasons. The reality is probably much more tied to revenue than either security or safety. The reality is that airports effectively restrict building around them. Noise complaints are expensive to fix, as are other environmental issues. As cities become megacities, the ability to operate fixed wing aircraft near the downtown area becomes impractical due to airspace, safety, environmental and business considerations. So, what happens then? Moving the business aircraft to the suburbs only really works if the businesses have moved there as well. In some cities that has become the norm. However, the existing megacities suggest that the move to the suburbs is a temporary phenomenon. Corporate headquarters in the megacities tend to be returning to city central. If the downtown airpark is no longer viable, what is the corporate travel model? Some would suggest that helicopters would provide the transportation to the next business mode. That next mode could be the main metropolitan airport or a business airport that would likely be even farther from the city’s center. In some very large cities, that travel model is used by a number of large corporations. Several of the larger corporations in Chicago have helicopters that deliver the executives to Chicago Executive Airport, north of Chicago, to meet up with their FalconJets and G5s. However, owning a business jet, a helicopter and the crews to fly and maintain them is clearly beyond the business model for all except the biggest corporations. That brings up the possibilities of helicopter air taxis. That is already a reality in many big cities. Heliports in the downtown area are more sustainable than fixed wing airfields. The question comes down to demand. Why not just take the helicopter to the main city airport? In my judgment, most metro airports are not helicopter friendly environments. Most would need some level of redesign to accommodate routine helicopter operations. The loss of the downtown airpark is likely to seriously affect the future of business aviation. The airlines are doing their utmost to convince us all that business aviation is a better option, but making it more expensive and less convenient to travel via business aircraft may seriously damage business aviation. That may be one of the lasting legacies of the megacity.

Growth years Turkish Airlines (THY) grew rapidly in the period 2006-2010, with passenger numbers up by 16 per cent year on year, while maintaining a 76 per cent load factor throughout. The airline expanded both its Airbus and Boeing fleets, reaching 174 aircraft in 2011 with an average age of only 6.2 years. THY takes advantage of its strategic location in Istanbul, in order to feed traffic to and from Asia, Middle East, Europe and the US, with three quarters of its traffic being transit. A different picture in 2011 Nonetheless, this year’s financial results cast a shadow over the company’s growth strategy. THY reported a USD 342 million net loss in the first half of 2011, compared to USD 152 million in the corresponding period last year. With fuel costs up by more than 30 per cent and higher USD denominated lease payments from a fleet that is 87 per cent leased, operating expenses and short term liabilities have increased substantially. This is primarily the result of a weakening Turkish Lira that now stands at a 2 year low against the US Dollar. Furthermore a 30 per cent increase in capacity, as part of the airlines strategy to expand its network and frequencies across Southeast Asia, Russia and the Americas, was not followed by a corresponding increase in demand and load factors. Revenue per passenger kilometer (RPK) grew only by 19 per cent and passenger load factors were negative throughout the year. What the future holds THY’s current losses may not reflect the last of the airline's worries just yet. With further tension across the Middle East and an upward trend in fuel prices, the senior management team faces even more challenges. Nonetheless, the company’s growth and long-term profitability can be sustained, as part of a well planned strategy. The airline has an increasingly diversified route network and now focuses both on the high growth regions of APAC and Middle East, as well as the relatively flat, yet still very important European market. In this respect, THY joined the Arab Air Carriers Organisation (AACO) in June 2011, with the aim of developing and strengthening cooperation across the region. In addition, while being already part of Star Alliance, THY expanded its codeshare agreements with Asiana Airlines and US Airways. We view these partnerships as positive, showing signs of a company that no longer depends simply on organic growth, while operating in an increasingly competitive market dominated by the likes of Emirates and consolidated European carriers. With cash today standing at almost USD 500 million and many potential acquisition targets in Eastern Europe and the Balkans, THY may also choose to fund growth through M&A. Although there are justified worries following disappointing results during the first half of the year, these highlight the need for better currency and fuel hedging policies rather than redesigning THY's growth strategy.