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Frost & Sullivan Market Insight Published: 7 Jun 2010

Airlines: Out of Gloom toward Recovery


Date Published: 7 Jun 2010

By Kunal Sinha, Aerospace & Defense Consultant, Frost & Sullivan

Recovery in Sight

The recently published fourth-quarter results of the European and Asian airlines succinctly tell the recovery
story. The results showed that about $1.65 billion of the net airline losses were wiped off compared with the
same period last year. Still, the carriers collectively raked up a net loss of more than $900 million. Of the total
loss, Asia Pacific carriers accounted for just about $5 million. This reinforces the widely held view that the
region will remain the most profitable one in 2010, while Europe will endure the biggest losses. A further
probe into the results shows that the vast majority of the European sector losses are accounted by network
carriers. If low-cost carriers are left behind, then almost $870 million of the total losses are accounted by the
network carriers, perhaps showing how tough the journey was for the European network carriers in 2009.

The faster than anticipated recovery in the Asia Pacific, as compared to other regions, has created a market
climate where Asian economies are leading the pace of aviation recovery, while those in Europe and North
America are lagging behind. Asia Pacific's prospects are improving faster than other regions. Globally in 2009,
while developed countries' industrial production was down by 10 percent, Asia's (barring Japan) was up by 13
percent. The market for airline services is highly geared to the economic cycle. The World Bank forecasts of
Asian economy growing by an average of 6 percent in 2010 translated into roughly 12 percent growth in the
demand of air services. Hence, while European and North American airlines will struggle, the Asian players
will reap the benefits of a sharp recovery. The cargo business has shown an equally buoyant growth. Asia is
one of the major hubs of the air freight business and is spearheading the cargo business growth.

In spite of the green shots in the economy, players have maintained a cautious and conservative approach.
The scars from the past two years, in which the airline industry raked up a collective loss of $28 billion
(including $11 billion in 2009), are perhaps too deep to fade early. Moreover, the uneven course of the global
recovery and the lingering doubts about the durability of global recovery are not making things any better for
the beleaguered airlines industry.

Underlying Risks

Though there was improvement in the Q3 and Q4 of 2009, revenues and yields remain below the levels
experienced prior to the downturn. The sustainable global recovery is still not perceptible to many. Some of
the key challenges that the airlines industry is facing today are higher fuel prices, lower yield, and higher airline
capacity.

With the improving economic conditions, IATA has raised the expected average fuel price to $79 per barrel
in 2010. This marks an increase of $17 per barrel on the $62 price for 2009. High fuel prices were the
dominant factor in the losses of 2008 and continued to haunt some in 2009 because of fuel hedging. In
2009, prices were volatile and roughly doubled since the start of the year. The expected broader economic
recovery in 2010 will raise the fuel price further. There is a genuine risk that fuel price will increase higher
than economic growth. This, combined with the weak macro environment, will make it increasingly difficult
for airlines to levy surcharge, resulting in lower yield.

Q4 of 2009 saw the passenger numbers growing and the yields rising marginally. Though traffic picked up,
yields remained below 2007 levels. Currently, there is no upward pressure on the airfare nor sustained
improvement in the premium passenger demand. Premium traffic was hit hard by the recession, and its
yields were down almost 20 percent compared to 2008 levels. In 2010, the passenger demand is expected to
grow by 5.6 percent and cargo by 11 percent, resulting in fractional improvement (3.1 percent) in the air
cargo yield and almost flat growth (2 percent) in passenger yield.

The biggest challenge for the airlines industry remains managing their excess capacity. Though the global fleet
grew in 2009, aircraft utilization still remained poor. A lower utilization rate translates to increased cost per
unit and perhaps explains why even stronger traffic in 2009 has not translated into improved profitability.

In spite of immediate concerns, the picture looks relatively assuring for 2010. World Bank has forecasted that
the World GDP will grow by 2 percent in 2010 and 3.2 percent in 2011. The robust growth seen in Latin
America, Middle East and Asia has been reflected in the profitable growth of the airlines business in these
regions, although the situation remains fragile and economic growth does not always translate into better
airline profits. Airline profitability is still dependent on how much capacity is chasing the elusive demand and
therein lies the biggest risk. Because of lower yields and higher fuel prices, even higher passenger growth can
lead to profitless growth.

Emerging Trends

There is a growing consensus that air freight will swiftly move into the profit segment this year.
Manufacturers and exporters have responded to the recovery by sending huge shipments. Asia is expected to
drive the cargo business, as there is a lot of freight activity in Asia.

Despite projections of a bloodbath, the number of airline failures in 2009 was relatively fewer than in 2008. In
2010, one can expect some consolidation in the form of mergers to take place. The second half of 2009 saw
many mergers, notably British Airways and Iberia. Startups are expected to be in short supply this year.

Given the volatility in oil prices, governments are demanding greater fuel efficiency and alternative fuel
options. With the advent of carbon emissions trading schemes in Europe and, increasingly, around the globe,
the need to track and reduce carbon (and therefore fuel) use will grow increasingly important. Product
manufacturers and integrators will be forced to develop products that meet the needs of this new, greener
future for their customers.

The aircraft leasing market is anticipated to grow from today's $129 billion with more than 5,000 aircrafts
worldwide to reach 7,200 leased airplanes by 2011. The primary drivers for the buoyant aircraft leasing
industry include the rapid increase of LCCs in Asia (primarily India and China) and the growing demand for
wide-body aircrafts in the Middle East.

Airline manufacturing firms like Boeing and Airbus must position themselves for substantial changes to avoid
the "death spiral" of rising costs and decreasing demand. Expensive programs like the Boeing 787 and Airbus
380 have faced large cost overruns, and their scheduling delays are at risk. All elements of cost — direct
labor, material, and overhead — must be addressed in a comprehensive manner to create more affordable
alternatives for customers.

The restrictive travel policies and the archaic bilateral system need to be dismantled to treat the airline
business like any other commercial entity. The recent signing of the US-EU Open Skies Deal is an important
step in liberalizing the airline market and is expected to be embraced by all regions.

http://www.frost.com/prod/servlet/market-insight-print.pag?docid=203614455

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