SLOWLY DOES IT

Tom Ballantyne 

	'Losses will diminish, but a recovery to net profit looks unlikely until 2011'
	Brian Pearce Chief Economist IATA

“The global recession presided as an oppressive market reality, driving many carriers to re-evaluate their near and medium-term fleet requirements.” said chief executive, Jim Albaugh. Now, with signs of economic recovery emerging the company was looking forward to better days, he said.

But how long will it take before better days arrive? There is mounting evidence they won’t come any time soon.

“In absolute terms, demand remains well below pre-recession levels,” said Andrew Herdman, director general of the Association of Asia Pacific Airlines (AAPA). “In addition, the aviation industry is still wrestling with the problem of low yields and continuing oil price volatility, so a recovery in airline profitability is still some way off. Overall, market conditions remain extremely challenging.”

The International Air Transport Association’s (IATA) latest estimates forecast that Asia-Pacific carriers, which jointly lost US$3.4 billion in 2009, will lead the recovery this year, but they will still lose a combined $700 million.

The improvement is being driven by an expansion in some of the region’s economies. China’s Gross Domestic Product (GDP), for example, is forecast to grow by 9% in 2010.

Herdman described the region’s latest traffic statistics – in November AAPA member airlines’ freight traffic was up 12% year-on-year and international passenger numbers rose 4.5% - as “only mildly encouraging, in line with the broader economic recovery underway, which was being led by the Asia-Pacific region”.

His warning was echoed by IATA. Speaking in Geneva, IATA director general, Giovanni Bisignani, said while demand on international routes was seeing continued year-on-year improvement, the numbers were deceptive.

International scheduled traffic rose 2.1% year-on-year in November, compared with a gain of 0.5% in October. “However, the improvement trends … are being exaggerated by the sharp fall in demand experienced in the first half of 2008. Adjusting for seasonality, demand actually fell 0.7% from October to November and load factor was 75.4% in November, versus 78% in October,” said Bisignani.

	Hong Kong International Airport: along with airports like Shanghai Pudong and Korea Incheon, Hong Kong is one of several Asian airports leading the world’s recovery in freight traffic

Bisignani pointed out that traffic is still 6% below the peak levels of early 2008, although it is also 6.4% better than the low point in the first quarter of 2009. “We cannot anticipate any significant improvement in yields in the coming months,” said the IATA chief.

Indeed, Bisignani said the airline industry was structurally out of balance. “The precipitous fall in yields will likely never be fully recovered. It is difficult to see how this can be balanced on the cost-side of the equation,” he said.

“After almost a decade of cost-cutting, non-fuel unit cost reductions will be incremental at best. And the risk of rising fuel costs will be constant. There will be some individual airline success stories. But without re-laying the foundations of the industry to facilitate structural change, covering the cost of capital for this hyper-fragmented industry will remain a dream at best.”

That sentiment is echoed by airline chiefs. Cathay Pacific Airways is also experiencing better numbers in business and first class travel, but chief executive, Tony Tyler, continues to emphasise a sustained revival has not yet taken hold. “The structural recovery will probably come when the world economy is on a firmer basis,” he said.

At Singapore Airlines chief executive, Chew Choon Seng, described 2009 as “one that most, if not all of us, would rather forget. The evidence, thankfully, is that we have passed the bottom of the downturn and are now into a gradual recovery - month-on-month if not yet year-on-year.”

	'In absolute terms, demand remains well below pre-recession levels'
	Andrew Herdman Director General AAPA

Air New Zealand chief, Rob Fyfe, also reported ongoing recovery in traffic, but pointed out: “What we’re not seeing is an improvement in yields and ticket prices. I’m not convinced this recovery in demand can be sustained.”

Qantas Airways chief executive, Alan Joyce, said the carrier was now growing capacity. “We are seeing things improving but for international traffic there is still some way to go.”

Nevertheless, there is widespread agreement that recovery, however long it takes, is underway and that the comeback is being led by the Asia-Pacific, particularly China and India.

While the Civil Aviation Administration of China (CAAC) has not yet released official figures for 2009 or forecasts for this year, major Chinese airlines have been recording double digit growth through the final quarter of 2009, in some cases as high as 16% domestically, 10% internationally and 23% regionally (regional flights in China refer to services to Hong Kong and Macau).

Another pointer to good times ahead is a forecast from the China Tourism Academy that the country’s tourism industry will grow 13% and be worth $205 billion this year. Chinese tourists are forecast to make 2.1 billion domestic trips in 2010, up 12%, and 5.4 billion overseas trips, up 16%. The number of inbound trips by overseas tourists is expected to reach 136 million, up 8%.

In India, the country’s civil aviation minister, Praful Patel, has said the coming year holds prospects of stability. “Things are turning for the better, which is borne out by the rebound in air traffic figures from October onwards,” he said.

	'What we’re not seeing is an improvement in yields and ticket prices. I’m not convinced this recovery in demand can be sustained'
	Rob Fyfe Chief Executive Air New Zealand

Air traffic in India for the last three months of 2009 was expected to surpass the previous best, recorded in October-December 2007. Domestic flights have seen a surge in traffic in recent months. “Our statistics indicate that December alone would see an increase of 40% over December last year in terms of airline ticket sales and passenger traffic,” said Ankur Bhatia, managing director of IT and reservations company Amadeus India. 

Kapil Kaul, India head of the Centre for Asia-Pacific Aviation (CAPA) is now predicting India could be the strongest passenger growth market globally for the next 10 to 15 years. He said in a report that India’s private airlines should return to profit – with total income between $250 million and $300 million - in the next financial year after suffering bruising losses in the past few years.

“After a turbulent couple of years, 2010 should be a more positive year for Indian aviation, provided the airlines can remain disciplined on costs, capacity and pricing.”

India’s domestic traffic is expected to grow 15% or more in 2010-11, with international traffic expansion forecast to rise by up to 12%.

But there are concerns in some quarters about the near future prospects for recovery. Industry analyst, Chris Tarry, from London-based Aviation Industry Research and Analysis (CTAIRA), warned that if airlines, which significantly reduced capacity during recession, re-introduce too much of that capacity too soon, markets could end up with too many seats.

“The most recent statements from the manufacturers suggest, for the time being at least, they intend to maintain production rates in the single aisle segment at or close to current rates,” he said. He felt an adjustment in production was necessary. More new aircraft in the system will mean even fewer airlines will be able to achieve investable returns in the next upswing, said Tarry.

Despite the announcement of cost reduction programmes by many carriers, Tarry said fuel was the major swing factor on the cost side of the equation. “For most airlines their ability to reduce unit costs is a function of growth, which enables costs to be ‘grown down’ as fixed costs are spread over more ASKs and ATKs. New aircraft may well be received by airlines that can grow structurally, but as the result of taking traffic from competitors.

	'Without re-laying the foundations of the industry to facilitate structural change, covering the cost of capital for this hyper-fragmented industry will remain a dream at best'
	Giovanni Bisignani Director General IATA

“The near and medium-term effect will be less revenue to share around and this will persist until there is at least a partial withdrawal, and even then the capacity is likely to remain somewhere in the system,” he said.

At least one airline chief executive has a more radical view. Tony Fernandes, head of low-cost carrier (LCC) AirAsia, said the industry was caught in a time warp. “One of the sad things about this recession is that many things haven’t changed. Should airlines have failed? Absolutely. It has been a phenomenally controlled industry. You only have to look at Japan Airlines; that should have gone a long time ago,” said the entrepreneur.

As 2010 began the depth of the damage to airlines and the prospect of a long, hard period of recuperation has become clear. In late December, IATA revised its financial outlook for the year to an expected $5.6 billion global net loss, larger than the previously forecast loss of US$3.8 billion. But it will be around half the $11 billion net loss carriers suffered in 2009.

“We are ending an annus horribilis that brings to a close the 10 challenging years of an aviation decennis horribilis. Between 2000 and 2009, airlines lost $49.1 billion, which is an average of $5 billion per year,” said Bisignani.

“The worst is likely behind us. For 2010, some key statistics are moving in the right direction. Demand will likely continue to improve and airlines are expected to drive down non-fuel unit costs by 1.3%. But fuel costs are rising and yields are a continuing disaster,” he added.

IATA’s assessment of 2009 and the outlook for 2010 is:

• Industry revenues are expected to rise $22 billion (4.9%) to $478 billion in 2010, compared to 2009. However, revenues remain $57 billion (-11%) below the peak of $535 billion in 2008 and $30 billion below 2007 when passenger traffic was at similar levels to what is expected in 2010.

	'The steady improvement of traffic at airports indicates that losses for the year may be softer than originally expected'
	Angela Gittens Director General Airports Council International

• Following a decline of 4.1% in 2009, passenger traffic is expected to grow by 4.5% in 2010 (stronger than the previously forecast 3.2% in September). A total of 2.28 billion people are expected to fly in 2010, bringing total passenger numbers back in line with the peak recorded in 2007.

• Cargo demand is expected to grow 7% to 37.7 million tonnes in 2010 (stronger than the previously forecast 5% in September), following a 13% decline in 2009. Total freight volumes will remain 10% below the 41.8 million tonne peak recorded in 2007. Cargo demand is rising faster than world trade as depleted inventories are rebuilt. Once the inventory cycle completes, growth is expected to fall back in line with world trade.

• In 2009, passenger and cargo yields plummeted by 12% and 15% respectively. Cargo yields are expected to improve by 0.9% in 2010. But passenger yields are not expected to improve from their extraordinary low level. This is being driven by two factors: excess capacity in the market and reduced corporate travel budgets. Capacity adjustments in 2009 were made at the expense of lower aircraft utilization (down 6%). An additional 1,300 aircraft due for delivery in 2010 will contribute to 2.8% global capacity growth, putting continuing pressure on yields. On top of this, corporate travel buyers have adjusted their budgets to reflect lower premium fare levels.

• An average oil price of US$75 per barrel (Brent) is expected in 2010, up considerably from the US$61.8 average expected for 2009. As a percentage of operating costs, fuel will be 26% in 2010. This is considerably lower than the 32% of operating costs that fuel comprised in 2008, but twice the 13% of operating costs that fuel represented in 2001-2002.

• Through 2009, the industry raised at least $38 billion in cash ($25 billion from capital markets and $13 billion from aircraft sale and leasebacks). The ratio of cash to revenues improved for European and North American airlines, but was flat for Asia-Pacific carriers. This will provide a cash cushion for the seasonally weak traffic flows in the first quarter of this year.

In his latest quarterly update on the airline industry’s financial performance in the year ahead, IATA chief economist, Brian Pearce, says the outlook is for more widespread, but still relatively weak, economic growth. 

	'One of the sad things about this recession is that many things haven’t changed. Should airlines have failed? Absolutely'
	Tony Fernandes Chief Executive AirAsia Group

“This is not expected to be strong enough to eliminate excess capacity nor to bring about much recovery in demand for premium seats; so yields will remain weak.  Losses will diminish, but a recovery to net profit looks unlikely until 2011,” he said. 

Pearce pointed out that rising load factors have helped to stabilize yields, but this has been partly achieved by cutting aircraft utilization. “Spreading fixed aircraft costs over fewer hours in the air means that even if higher load factors enable a firming in fares, unit costs will have risen,” he said.

He added that futures markets and consensus forecasts now project average oil prices of $72 a barrel this year compared with $61 in 2009.

IATA’s quarterly business confidence survey of airline chief financial officers and heads of cargo, an invaluable forward-looking view of key financial and demand indicators, suggested their expectations that conditions will improve during the next 12 months have risen markedly.

More than 73% of airline CFOs said profitability in the next 12 months would improve (the sample included major airlines in Asia, Europe and the Americas). That does not mean loss will turn into profit.  It does mean that smaller losses are expected.

The bounce back in cargo traffic, a critical part of Asia-Pacific airline revenue, in the second half of last year will give carriers some reason for optimism.

In January, one of the region’s busiest cargo centres, Hong Kong Air Cargo Terminals Limited (Hactl), announced it handled 2,323,605 tonnes of cargo in 2009, a year-on-year reduction of 8.3%. But after dramatic declines in freight in the first half of the year, the fourth quarter recorded 7.9% growth over the same period in 2008. In December, there was an even more dramatic rise of 38.5% year-on-year.

“Two thousand and nine has been a year full of ups and downs,” said Hactl general manager for marketing and customer service, Lilian Chan. “While we came across difficult moments in the first six months, the global economy has delightfully stabilized from the third quarter and has picked up faster than expected. We do not have a crystal ball to predict market conditions, but we are expecting a more stable year in 2010.”

Evidence the cargo market has turned the corner is underscored in AAPA results.  It’s latest statistics, for November, showed the month saw the first growth in cargo traffic in 18 months. Freight traffic of AAPA members grew 12% over November 2008, the month when business fell into near free-fall amid the meltdown of global financial markets.

The growth also marked a sharp acceleration of the halting gains the carriers had seen in previous months as freight forwarders in Hong Kong, Shanghai and other major gateways reported strong demand and serious backups during the holiday shipping season, said the AAPA.

At the same time, air freight capacity was almost flat in November, slipping just 0.9%, a sign the airlines had halted their two-year effort to reduce capacity following falling demand. For the first 11 months of 2009, average cargo capacity for AAPA carriers was down 13.2% from the same period a year ago, almost equal to the 13.7% drop in freight traffic in the same time.

Although the AAPA does not report yields, the 71.1% average freight load factor in November was 8.2 percentage points ahead of last year and even two percentage points higher than October, suggesting the carriers had very strong demand for any freight space available.

The bottoming out of the recession appears to be industry wide. Airports are also witnessing an upturn.

Airports Council International (ACI), which represents the world’s airports, last month reported “strong positive growth” in both passenger numbers and freight tonnage in November.

“The steady improvement of traffic at airports indicates that losses for the year may be softer than originally expected,” said Angela Gittens, ACI’s director general. “In the first quarter 2009 airports registered an alarming downward spiral yet since mid-year we have witnessed the return of demand, first for domestic and now for international travel. 

“For sure, we are comparing November 2009 against November 2008, the month which had the biggest traffic losses in that year.  Nonetheless, positive passenger growth in all categories – overall global, international and domestic – indicates that the industry remains on track for a rebound.”

November was the first month since March 2008 in which all regions registered positive passenger traffic growth and December was expected to show further growth across all regions. Gittens said the global 2009 decline in passenger traffic may possibly be less than 3%, much less than expected.

The airports reported that China, India and Brazil continue to lead domestic passenger traffic recovery and that international traffic growth is being dominated by the Asia-Pacific and Middle East regions.

Among airports recording the largest growth in November were Singapore (up 10%), Kuala Lumpur (up 21%) and Bangkok (up 35%). On the freight front the Asia-Pacific again dominated recovery with several of the region’s key hubs among the top performers. They included Shanghai Pudong (where cargo throughput was up 31%), Korea’s Incheon (up 22%) and Hong Kong (up 16%).

ACI’s assessment is in line with preliminary full-year figures for 2009 from the International Civil Aviation Organization (ICAO). It reported last month that the year’s passenger traffic decline was 3.1%, the industry’s largest annual fall on record.

It is predicting a “moderate” increase of 3.3% this year and a “full recovery” of 5.5% in 2011.