Aviation Strategy Issue No: 42 April 2001 Recession time? CONTENTS uddenly a global recession threatens. In the US consumer con- Sfidence seems to have evaporated with the collapse in the price Analysis of new technology companies on the NASDAQ. Europe with less exposure to the stock markets is mostly unaffected as yet, but Asian economies, having recovered strongly from their regional crisis, are Preparations for recession 1-2 starting to look wobbly again. While the portents are ominous, it shouldn't be assumed that a SAir: putting together a recession is inevitable. The economic fundamentals remain sound rescue plan 3-4 - the OECD forecast produced at the end of last year predicted 2- 3% real GDP growth for most in the developed economies includ- ing the US - and the bursting of the e-commerce financial bubble Seattle’s sonic tonic 5 should have come as no surprise. With inflation still well under con- trol, the US Fed has the opportunity of boosting the economy with Has BA’s downsizing another half-point cut in interest rates. The Japanese, meanwhile, strategy worked? 6-9 are desperately trying to kickstart their economy by cutting interest rates to zero. However, assuming that some form of recession reduced global traffic growth to 2.4% this year and 4.2% next year (compared to around 6.5% in the past two years) then a serious surplus in the air- Briefing craft market emerges. This is illustrated by the graph on the next Iberia: a new version of page, which is based on calculation made by ESG. the Air France story? 11-14 As usual the traffic slowdown coincides with a period of peak deliveries (and we have excluded the 400/year RJ deliveries from the chart). The result is that the aircraft surplus (defined as the dif- US Regionals: well ference between jet supply and the number of jets required at opti- positioned for mal utilisation) leaps from about 540 last year to 930 this year and a downturn? 15-19 to over 1,300 in 2002. In relative terms the surplus will peak at about 7-8% of supply compared to 10% in the early 90s. 20-21 This suggests a softer airline recession compared to the col- Macro-trends lapse of the early 90s. There are other important differences as well. 22-23 First of all, there is an obvious way to dissipate the surplus this Micro-trends time round - through the scrapping or sale to the Third World of the remaining non noise- compliant 727s and 737s; nearly 500 of these types are currently available for sale or lease. Generally, the major airlines have become much more adept at managing capacity over the past decade through conservative fleet addition strategies, downsizing, rightsizing and greater reliance on operating leases. The key to survival in this recession may come down to what proportion of an airline's costs are fixed and what pro- portion are variable. PUBLISHER The leasing companies were blamed, probably justifiably, for contributing to the extent of the supply demand imbalance and arti- Aviation Economics ficially inflating asset values. This time they are being seen in a James House, LG, more positive light, as providing a means of smoothing the cycle by 22/24 Corsham Street facilitating the movement of aircraft between regions in line with demand fluctuations. London N1 6DR Lessors have two ways of looking at the impending recession. Tel: +44 (0) 20 7490 5215 Fax: +44 (0) 20 7490 5218 www.aviationeconomics.com e-mail: [email protected] Aviation Strategy Analysis On the one hand, in a reces- % TRAFFIC GROWTH MOSTLY EXCEEDED sion the credit ratings of air- 10.0 CAPACITY GROWTH DURING THE 1990s lines tend to fall markedly while those of the leasing com- 8.0 Traffic growth panies, backed by financial giants like Gecas and AIG, 6.0 remain solid, so improving the attractiveness of their product. 4.0 Capacity growth Aviation On the other, they will have to Strategy 2.0 is published 12 deal with slumping asset val- ues and distressed clients. times a year by 0.0 Aviation They may be forced into run- 90 91 92 93 94 95 96 97 98 99 00 01 02 Economics ning airline operations (Awas, -2.0 on the first of for example, has its own each month AOC). -4.0 A recession will be the acid Editor: Keith McMullan test for two contrasting and currently relative- bution from its DOS phase to its Windows ly successful strategies - rapid expansion of phase, according to its owners. (Its detrac- Associate Editor: capacity and traffic around a hub system à la tors say it's nothing but a conspiracy of the Heini Nuutinen Air France and downsizing, total business US majors.) focus à la BA. Early indications from the US In Europe and the US, a recession will Subscription are of a clear downturn in business travel, in afford the low-cost carriers the opportunity to enquiries: terms of business class seats sold and also gain market share from their full-service Keith McMullan Tel: +44 (0) 20 in terms in business volumes as teleconfer- rivals, both because of their cost advantage 7490 5215 encing and other e-communications become and because of the greater price-sensitivity more sophisticated. of passengers. Unless, of course, the low Copyright: Although e-commerce financing may cost carrier has the wrong strategy or weak Aviation have precipitated this recession, the full financing, in which case it will go bankrupt. Economics All rights reserved impact of e-distribution on the airline busi- Bankruptcy is a real prospect for a dis- ness has yet to be felt. Greater use of the turbing number of European and Asian flag- Aviation internet will help keep selling costs down, carriers in a recession. Governments again Economics saving which are likely to be passed onto the will face the invidious choice of bailing them Registered No: passenger via lower fares, which should out or facing the social and political conse- 2967706 (England) hopefully boost traffic volumes. Orbitz now quences. However gruesome the prospect, Registered Office: due for launch in June could be a major the EC will have to re-open some of its state James House, LG break-through, representing a shift in e-distri- aid files. 22/24 Corsham St London N1 6DR VAT No: 701780947 Units LONG-TERM CYCLES Surplus as 1,000 0.0% ISSN 1463-9254 % of fleet 900 The opinions expressed in 2.0% this publication do not nec- 800 essarily reflect the opinions Deliveries of the editors, publisher or 700 (excluding contributors. Every effort is 4.0% made to ensure that the 600 RJs) information contained in this publication is accurate, but 500 6.0% no legal reponsibility is 400 accepted for any errors or 8.0% omissions. 300 The contents of this publica- 200 tion, either in whole or in 10.0% part, may not be copied, 100 stored or reproduced in any format, printed or electronic, 0 12.0% without the written consent 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 of the publisher. Source: ESG. April 2001 Aviation Strategy Analysis SAir - and now the rescue plan Air has announced one of the most legal proceedings. The strategy could centre Sspectacular financial results in European on selling some assets, such as the Nice aviation history - a net loss of Sfr2.9bn operation, where Air Littoral has a good ($1.7bn) on revenues of Sfr15bn, with position, and/or the long-haul routes to the Sfr2.4bn of the loss related to write-offs on French Caribbean, then restructuring the its airline investments. network, with the aim of providing feed to an SAir, until recently thought of as one of alliance partner. An immediate problem is Europe's financially robust airlines, is now that Air Littoral, to whom Sair has cut off looking very fragile with a debt/equity ratio of funding, would only command a distress 6/1 on its balance sheet. Its share price sale price now. plummeted another 30% of announcement Perhaps the French government will of the results at the beginning of April, and intervene - the first instance of state aid to a Moody's downgraded its credit status from non flag-carrier. A3 to Baa3, one grade above junk bonds. Having just pumped €250m into Sabena SAir, under the new leadership of Mario (see Aviation Strategy, March 2001), SAir Corti, formerly head of Nestle, is now faced has little choice but to stick with this airline. with putting together a turn-around strategy Here the strategy will have to be old-fash- for the whole Group. He has at least the ioned asset stripping. Cash could be raised comfort of knowing that the Swiss govern- from the sale of parked A340s and other mental bodies, which retain a 13% stake in assets. The network could be severely the company, will probably not let the core trimmed as well, with transatlantic services airline go bankrupt. State aid, in some form being an obvious target, but agreements or another, may be necessary, which should with the unions which themselves are con- be permissible given that Switzerland is out- tributing to Sabena's rescue plan may limit side the EU and the European Economic SAir’s scope for action. Airspace Agreement. LTU has yet to see any benefits from tour operator Rewe's purchase of 40% of this Painful exiting charter last year (SAir is stuck with 49.9%).