The Airline Credit Crunch

9 July 2008 (Last Updated July 9th, 2008 18:30)

Oil prices continue to rise and airlines around the world are beginning to buckle under the pressure. Elizabeth Clifford Marsh reports.

The rising cost of fuel is impacting all aspects of life, resulting in higher petrol costs, rising fares and the increased cost of consumer goods. Combined with the credit crunch, which has resulted in tightened lending conditions squeezing home owners, while governments around the world raise interest rates, the rising price of fuel has resulted in consumers cutting back on unnecessary spending – leisure travel being near the top of the list.

Earlier this year the International Air Transport Association (IATA) director general Giovanni Bisignani told the association's AGM the global airline industry could suffer a loss of $6.1bn if oil prices remain around the $135 mark. Even if oil dropped to $107, the industry would still lose $2.3bn in 2008.

STORMY OUTLOOK

In its annual report, IATA said a combination of high fuel prices, a US economic downturn and accelerated deliveries of aircraft ordered at the peak of the economic cycle, but delivered during the slowdown, meant the outlook for 2008 was 'clouded by the perfect storm'.

At least 24 airlines have stopped operating or have gone bankrupt in the last six months – resulting in the loss of close to 22,000 jobs in the US alone. This said, growing volatility in the industry is making air traffic figures more difficult to predict.

According to IATA's forecast, a slowdown in worldwide air traffic growth is likely in 2008. In March 2008 real international passenger traffic demand rose 4% year over year, continuing the downward trend that began in December 2007.

All this adds up to difficult operating conditions for airports – which by their very nature are highly dependent on the airline industry. Fewer flights mean fewer passengers – which equals less income – not only from departure taxes, but also from consumer spending in the terminal.

Dependence on the airline sector is a weakness for airports in general, especially when compared with gas and water utilities, which benefit from a highly diversified client base. In its report on airports' credit quality, investment analyst Standard & Poor noted: "airports are typically capital-intensive and, hence, a fixed-cost business; therefore, a decrease in traffic can rapidly affect cash generation, especially when rising inflation and commodities are affecting costs such as personnel and energy.

"We expect the robust pace of airport traffic growth achieved in the past few years to slow in the next 12 months as some consumers rethink air travel in the wake of weaker economic conditions and higher fares. What's more, the fallout from a deepening global economic slowdown is likely to dampen growth in load factors and aircraft movements in several regions," the report said.

FUELLING THE FLAMES

"Fuel prices are placing the most pressure on airlines, and therefore will have the biggest effect on airport revenue. Airlines have a limited ability to recoup lost profit margins though hedging, ticket pricing and fuel surcharges, which will pose a huge threat to already ailing airlines. However, larger airports should not notice too much of an impact as passenger demand behaviour is increasingly resilient to external shocks," S&P said.

"At least 24 airlines have stopped operating or have gone bankrupt in the last six months."

"Fuel costs typically represent about 40% of the operating costs of an airline. As such, there is a massive competitive advantage in having modern aircraft with significantly lower fuel burn and maintenance costs. One main difference with the past oil shocks is that a significant part of traffic growth is now driven by the low-cost carriers (LCC). A key question is can the LCC business model sustain durable high oil prices?

"LCCs have been able to capture traffic and generate new volumes through aggressive pricing strategy that is sustainable if costs remain under control. LCCs normally have more recent and fuel-efficient airplanes that should help them in the current oil price environment," the report said.

In order for an airport to survive the increasing fraught financial environment, it must remain flexible. Although airports are a fixed-cost business, margin can be maintained by seeking out flexible refinancing agreements and, where necessary, delaying expansion programmes.

"A slowdown – not to mention a fall – in traffic can rapidly affect cash generation, especially when rising inflation, commodities and rising security costs are impacting on costs such as personnel and energy.

"Airports that maintain strong cash reserves, have improved revenue diversity, or retain flexibility to cut discretionary expenses are better positioned to absorb shocks and maintain their credit quality," S&P said.