The crunch bites flights

Monday, October 20

The credit crunch is adding to the woes of the airline industry, particularly in the United States. While the aerospace manufacturing sector appears to be more resilient, a deep recession would dramatically undercut the profit outlook for all but the largest global firms.

The decline in the price of oil to under 70 dollars per barrel has given the hard-pressed airline industry some respite, allowing carriers such as British Airways (BA) and Virgin Atlantic to cut their fuel price surcharge on long-haul economy flights. However, with average ticket prices still some 50% higher than in 2007, the sector will struggle to eke out profits this year. Moreover, with the economic downturn beginning to bite heavily in the United States and Europe, and spreading to Asia, the outlook for traffic is poor. Even Asian traffic fell 0.5% in July and cargo slumped by 6.5%. Airlines in the region are beginning to follow their European and US counterparts into the red, with a collective loss of 207 million dollars during the first half of 2008.

 

Aerospace: good in parts

The prospects for the global aerospace industry are more mixed:

Defence Defence companies have accumulated large cash reserves thanks to high levels of government spending over the last decade.  However, as governments struggle to fund financial bailouts and to contain spending, the outlook will turn increasingly poor. In particular, the projected growth of US spending on social entitlement programmes, and the cost of Washington's overseas commitments, will have an impact on new procurement programmes. The next administration may increase operational spending, but outlays on new weapons systems are likely to decline. In Europe, both the United Kingdom and France, the EU's big defence spenders, will struggle to maintain existing levels of defence spending. London is already seeking to cut 2 billion dollars from its planned budget, with likely reductions to tactical helicopter and combat aircraft programmes.

Civilian aviation The civil market is more vulnerable than the defence sector, as demand falls and orders begin to slow:

• Production plans. Airbus has already curtailed plans to increase production. This adjustment comes as Airbus opened a new production line in China, which will serve the expanding Chinese market and help the company meet predicted worldwide demand over the next decade. Costs in China will initially be higher, but over time the new plant will help to mitigate some of Airbus' exchange-rate risk (aircraft are priced in dollars, but most of the company's manufacturing costs are incurred in euros).

• European makers. The dollar's rise against the euro is helping European manufacturers. However, if the current adjustment is only a short-term correction  European aerospace companies will struggle to compete.

• Business jets. The most vulnerable segment seems to be regional and business aviation. Executive jet factional leasing may be less vulnerable to the downturn, but outright purchases are likely to fall. Business jet manufacturers have huge backlogs, but most are already revising their forecasts downwards.

• Supplier problems. While cash-rich major manufacturers, such as Boeing and Airbus, are weathering the crisis relatively well, their smaller suppliers face lean times. Funding new products and production is very difficult for these companies, in the context of rising credit costs.

A difficult business environment may ultimately accelerate necessary processes of consolidation and restructuring for the airlines, allowing surviving firms to return quickly to profitability. Cash-rich global manufacturers appear well positioned to ride out the current crisis, but they may need to provide more help to their suppliers in order to maintain production.