Cargo Carriers Expect Slow Recovery

United Parcel Service (UPS) has been adding new aircraft to it's fleet in recent years. Here we see N570UP 747-44AF/SCD (35667/1388) on the ramp at Anchorage, Alaska.

(Photo by Michael Carter)

Air cargo has always been an optimistic industry, and in the second half of 2008, when traffic volumes started to drop, air cargo managers were confident that the downturn would be short-lived. Even in December and January, when year-on-year declines reached 23%, plenty of executives still predicted that there would be a sharp recovery by the third quarter of this year. The optimists expected that once the economy recovered, companies would be caught short with excessively low inventory levels and would rush to use air freight to replenish them. This is what had always happened in previous air cargo downturns.

It is therefore ironic that nine months later, with reports of a fewgreen shoots and definite signs of inventory restocking, air cargo is locked in the worst depression it has ever known. Managers have not just discounted the prospect of a sharp bounce back,they are predicting several gloomy years ahead.

"We think the industry could be in trouble for the next three to four years and donot expect to see the levels we saw in 2007 until 2013 at the earliest," says Ulrich Ogiermann, chief executive of Luxembourg-based all-cargo airline Cargolux. "There will be no peak season this year or next year. I think it will be two or three years before we see a recovery," agrees Robert Frei, head of corporate air freight for global freight forwarder Panalpina.

The initial onset of the downturn is evident in the 2008 Airline Business Cargo Rankings, which show many carriers posting lower year-on-year traffic. And while revenue declined for only a few in 2008, the picture has since crystalised and for many revenue is looking twice as gloomy as traffic.

In the quarter to June cargo revenue at Air France-KLM fell 41.5% based on a 22.7% traffic decline, while those at American Airlines fell by 42.6%, based on 25.1% lower traffic. For the same quarter yields at Singapore Airlines dropped by a third and interim yields at Cathay Pacific fell32.8%. IATA calculates a 40% fall in revenue and 21% fall in second quarter yields for the industry overall.

The reason for these precipitous revenue falls is not hard to find. Ogiermann has a nice phrase for it: "irrational capacity". More charitably, freighter operators have found it hard to cut capacity fast enough to match the slump in demand and, since the slump hit passenger operations six months later than those for cargo, there has also been an overhang of belly capacity. That said, there are signs that in recent months, capacity cuts have caught up with the market. In May, Singapore Airlines recorded a 21.4% year-on-year fall in capacity, compared with a 20.7% fall in traffic. In July, both traffic and capacity at Air France-KLM were down by 17%.

IATA says 227 freighters - more than 10% of the global freighter fleet - are now parked in the desert. Cathay Pacific, which has 24 Boeing 747 freighters, has grounded five and leased another one out. Lufthansa has four Boeing MD-11 freighters parked and says by the end of September it will have reduced freighter capacity by 30% year-on-year.

What undermines these efforts somewhat is that airlines are waiting to take delivery of an unprecedented number of new freighters. Boeing has 63 outstanding orders for its 777-200LR freighter, having delivered eight already, and 78 orders for the 747-8 freighter, which is due to start production next year. Airbus has 65 orders for the A330-200 freighter. To put these numbers in perspective, the entire 20-year production run of the Boeing 747-400F amounted toonly 166 aircraft, including the 400ERF versions.

The credit crunch will almost certainly slow down the roll-out of new aircraft. Bankers such as Bertrand Grabowski, head of aircraft finance at German-based DVB Bank, report that there is almost no finance available for freighter aircraft at present, making it likely that airlines will seek to delay deliveries.

DECISION TIME

But that has not stopped some carriers from making awkward decisions. Cathay Pacific has parked some 747-400 conversions that it has only had in its fleet for a year or two, while at the same time taking delivery of six brand new 747-400ERFs over the past 12 months.

Air France-KLM, meanwhile, has leased four of its factory-built 747-400ERFs to Netherlands carrier Martinair, which itself has grounded four 747-400 conversions. That has still not prevented the group from having to park two more 747-400ERFs, along with two 777 freighters, which Air France has only just received from Boeing as launch customer.

More radical steps could be on the way. In August, it was reported that Japan Airlines was considering a merger with Nippon Cargo Airlines, an unsurprising move when both carriers are in a crisis on the cargo side. In the second quarter, JAL saw a 31.1% fall in cargo traffic and a 56.2% fall in revenue. NCA, meanwhile, has an ambitious order for 14 747-8 freighters to digest.

In late September Air France-KLM was due to reveal its strategy for coping with the downturn. Some indication of the scope of changes under consideration came from Air France chief Pierre-Henri Gourgeon, unveiling second-quarter results for the carrier: "The cargo situation is extremely depressed," he said. "These are terrible figures, never seen before. Air France is losing a lot of money. We are a large operator, and we are trying to reduce our exposure. In cargo, we will have to go on with a steep decrease in our activities."

Lufthansa Cargo, meanwhile, seems to be already thinking the unthinkable. In late August, board member Andreas Otto, sent - or at least drafted - a letter to customers, which was leaked to the cargo press. In it, Otto said: "If current market trends continue, we expect that in the medium termthe majority of the world freighter fleet will have to be permanently grounded because there will simply be no economic justification for keeping these aircraft in service."

Otto went on to announce an across-the-board 25% increase in rates, so the letter could be read as part of a negotiating ploy, but it could also reflect doubts about the future of the cargo business in the Lufthansa boardroom. The industry has been here before. The US majors had substantial freighter operators in the 1970s, but all but Northwest withdrew from the market by mid-1985 due to competition from express carriers and the increased availability of low-priced belly capacity.

Much will depend, of course, on what happens next in the global economy and whether former growth levels will return for air cargo even if the economy does pick up. It is interesting that despite the prevailing mood of pessimism, many carriers do report some green shoots, or a "green fuzz" as one European cargo manager puts it.

GREEN SHOOTS?

Industry figuresinsistthe signs are tentative, however and are reluctant to call it a trend. "We have been wrong so many times this year in our predictions that we have stopped making them," as Ogiermann puts it. And yet Ram Menen, divisional senior vice-president for cargo at Emirates, reports that shipping of clothingis returning, having almost disappeared earlier in the year. "I am not an economist, but I have the gut feeling the market is doing what we expected it to do earlier this year, which is pick up towards the year end," he says. Lufthansa, meanwhile, reports improved consumer confidence in Europe and signs of a pick-up in traffic out of Asia.

Rupert Hogg, director of cargo at Cathay Pacific, says both volumes and yields have started to improve in Hong Kong, albeit from a low base. In July, tonnage at Cathay was only down by 6.7% and load factors were up by 6.6% yearonyear. However, Hogg adds: "Much of the volume improvement appears to be a consequence of inventory replenishment after a period of freeze, so this current phase does not necessarily represent a recovery in fundamental demand."

IATA, in its third-quarter 2009 cargo analysis makes a similar point. Pointing to a 10% recovery in air cargo FTKs from the December low point and a restocking of inventories by air freight at the expense of sea freight, which are typical signs of an economic recovery, it nevertheless notes: "The upturn remains fragile until the economic recovery broadens out from an inventory cycle to stronger consumption and business investment."

In any case, improving figures from airlines and airports need to be treated with caution. Traffic began shrinking in June and July 2008 - gently at first, but much more sharply in September, and then very sharply in November and December. That means year-on-year comparisons are bound to improve as the year goes on and by December, even parity with the 2008 figure will mean a fall of more than 20% over 2007 levels. That would leave air freight with its worst year to date and more or less back where it was in 2000, in traffic terms. This "lost decade" is prompting some to wonder if the optimistic long-term forecasts for air cargo are really valid.

BOOM OR BUST

Bob Dahl, managing director of Seattle-based consultants Air Cargo Management Group, points out that in freighter terms real industry growth came in the 1980s and 1990s. In the 1980sthe freighter fleet doubled and in the 1990sit increased by a factor of 1.5 to reach some 1,700 aircraft in 2000. Today, the total is only 1,948, including grounded aircraft.

The big question, says Dahl, is whether the rapid growth phase of air cargo is over, or will the 6% annual growth so often forecast by Boeing eventually resume? "The question is what will happen to global trade, to globalisation, to consumer trends," he says. "There has been a tendency in Europe and the USA for consumers to spend money they didnot have and that drove air cargo growth. There is no guarantee we will go back to that. Some would argue that we have struggled to have 6% growtheven in the good years of this decade when the economy was robust."

The idea that air cargo may have reached its maturity phase is not a new one, but it was previously regarded as a bit eccentric by air cargo managers. Now it has definitely become more mainstream. Part of this may just be gloom caused by the current situation. As Boeing regional director, cargo marketing, Thomas Hoang points out, when you are in a trough, it is difficult to see the way ahead.

But there is also a longer-term worry that the globalisation of manufacturing is slowing down - or even reversing. A report published byErnst & Young in August suggested that many large companies in Europe and the USA were switching from global supply chains to regional ones, owing to a variety of factors. These include concerns over high fuel prices and their impact on transport costs, a desire to be more responsive to market changes, a need for more regulatory oversight of suppliers and worries about their carbon footprint. None of this is good news for air cargo.

Even if globalisation does not go into reverse, manufacturers may be getting smarter in their use of air freight. Many prefer not to use it at all if they can avoid it and they are getting cleverer at finding those ways. Even arch-optimist Menen concedes this, citing an example from the mobile phone industry, where a product might only have a market for six months before a new model comes along and makes it obsolete. He says: "In the past, that might have meant air freight for the whole six months. Now, the first batch goes by air, the second by sea-air and the third by sea."

LONG-TERM GROWTH

Nevertheless, he remains optimistic about long-term air freight growth, as does Hoang, who notes that air cargo has always grown at about twice the rate of GDP. "And even in the current downturn, GDP forecasts for the next 20 years are still predicting 3% growth per annum," he says, adding that cargo is getting more efficient - with new aircraft and improved processes - and so will be cheaper and thus more attractive to shippers in future.

On globalisation, Hoang believes labour costs in China will continue to remain lower than those in eastern Europe and Mexico, giving the former an advantage. But if Chinese labour costs do go up, so will its consumer power, drawing in imports from Europe and the USA. For all these reasons, Boeing is sticking with its 5.4% annual air cargo growth prediction spanning the next 20 years.

Only time will tell who is right. But in the shorter term, a more important factor for air freight is that bankers seem to be subscribing to the gloomier outlook. Grabowski says potential aircraft purchase backers are wary of freighters because of such longer-term concerns about industry growth. If that makes it harder for carriers to finance freighter purchases, the result could be a capacity shortagewhen the recovery comes. In that case, airlines that can access finance could emerge from this downturn with less competition for their cargo business, better yields and lower costs through more modern equipment.

On the other hand, some pundits point to the big reserve of parked capacity, including relatively new 747 freighter conversions, which could flood the market once an upturn comes, leading to a drop in yields and a return to damaging rate wars. Hogg is at least upbeat, speculating that many parked freighters will never return to service. "Some were parked to defer heavy maintenance and these aircraft would need significant capital investment to reactivate," he says. Meanwhile, Grabowski points out that venture capitalist funds for new start-up carriers will be hard to find.

So a more slimmed down, saner air cargo industry could yet emerge from this crisis. But as Ogiermann points out, now is not the time to make predictions.

(Story by Peter Conway - FlightGlobal.com)