Will the commercial airplanes being financed today become the real estate problems of the 1990s?
The answer is a resounding no. A turnaround is already at hand.
One doesn't need to search far these days to uncover bad news about the aviation industry. Problems in the world's airlines are the result of recessions in several key world markets, the Persian Gulf crisis, high fuel costs, and too much overhead.
In fact, the aviation industry is expected to lose up to $3 billion this year, after suffering a $2.7 billion deficit in 1990.
Tough on Financing Companies
It follows that the financial services companies active in the airline business should be suffering major downturns in their profit performances. In fact, many of them are.
Fitch Investors Service Inc., the major U.S. rating agency, even issued a report recently comparing aircraft loans and leases to the depressed real estate and highly leveraged transactions that have caused so many problems lately for banks and other financial institutions.
Obviously, airlines are not a financing opportunity for the faint of heart. But are Fitch and other rating agencies with similarly negative views correct?
No.
A History of Rebounds
The aviation industry is unique, with market fundamentals different from those of most other industries. And it has a history that seems to continually repeat itself.
Today's commercial aircraft market is quite similar to the market we saw in 1981, when the recession and concerns about terrorism resulted in low traffic demand and decreasing aircraft values.
As in today's market, great concern was expressed then about the survival of the carriers and the performance of the banks and other financiers of aircraft stock.
But what happened? Soon, the industry ascended from the depths to the heights, resulting in a boom market that lasted from the early 1980s to the end of the decade. During that period, commercial aircraft values reached record levels.
Shortsighted Analysis
Aircraft industry analysts in 1981 based their mistaken projections on what they observed during an industrywide downturn.
The ensuing boom took them unawares.
It seems to me that today's doomsaying analysts and other less-than-optimistic observers of the aircraft industry may be falling into the same trap, a trap created by shortsighted thinking.
Given today's depressed economy and an airline industry with a string of losses and as many as 850 planes on the world market until recently, with few reported buyers, it's difficult to be optimistic.
But there are tumultuous changes occurring in the world that make it likely that the commercial airline industry will soon leave the doldrums behind.
Too Many Planes
Today's industry is awash in overcapacity. There simply aren't enough travelers to fill the huge number of available seats. The airlines are reacting to this dilemma by slashing fares in the hope that this classic marketing strategy will entice passengers.
However, while they slash fares, the airlines are cutting capacity at the wholesale end of their business by returning leased aircraft, retiring older planes, and delaying or canceling new plane deliveries.
Despite these tactics, the aircraft market remains out of balance, with supply exceeding demand.
Needed: Two Good Years
According to my calculations, a 1% change in airline traffic means 80 more or fewer average aircraft are needed. Therefore, what the industry needs is about two years of back-to-back growth in air travel at a level of 8%.
This would remove the current overcapacity in supply, and bring the market into equilibrium.
Unfortunately, the world's airlines are enduring a period in which at least a 1% fall in traffic is anticipated.
It is this substandard performance that has led many outside observers of the aircraft industry to voice concern about the future of the entire industry.
When one looks at the market from these depths, it's difficult to foresee a bright future.
A New World in the Making
However, the world has changed a lot over the past year. Predictions must take into account the new world order that is evolving with the demise of communism, the federalization of Europe, the rise in economic power throughout Asia, and other extraordinary developments.
Consider that until recently the aviation marketplace was neatly divided between the U.S., with 50% of the market, Western Europe with 30%, and the rest of the world responsible for the remaining 20%.
However, the spectacular growth in some Asian markets over the past five years has shifted the world marketplace's dynamics.
I believe that, as the result of the dramatic geopolitical changes that are taking place, demand for air travel will undergo a greater development in the near future than we have seen at any time in the past.
Potential Customers Unleashed
Consider this: A major portion of the world's population has been living under political regimes that greatly restricted travel.
With their new freedom, many of these people will seize opportunities to travel by air for business and personal reasons.
In parts of Asia, Africa, Central America, and South America, formerly dormant economies are awakening to the benefits of the free market. This evolution inevitably will increase demand for travel and other use commercial aircraft.
If one looks beyond the industrially developed world, there are at least four billion potential consumers of air travel on the horizon.
Granted, not everyone in the developing markets will be able to afford air travel, but with each passing year there will be millions more willing flyers.
When these new consumers are considered along with the increased demand that will emerge in the developed countries as economic conditions improve, the overall impact on the aviation market is bound to be tremendous.
Lessors, Manufacturers Bullish
In fact, Guiness Peat Aviation, the world's largest aircraft lessor, predicts that the world airline industry is about to bounce back with a growth rate anywhere between 5% and 9% in 1992.
Boeing, the world's largest manufacturer of commercial aircraft, is predicting a 5% growth rate annually for the rest of the 1990s.
Some analysts have taken both companies to task for being overly optimistic. These cautious souls believe that a growth rate of 20% is more realistic.
However, given the current pent-up demand for air travel, I believe that Boeing and GPA are far closer to the truth than are the gainsayers. The only question is when will the increase in demand begin.
The answer is becoming apparent. Almost all of the U.S. carriers reported increases in their October traffic. British Airways reported good yields and profits for its second quarter.
Moreover, the number of available airplanes on the world market tell to 790 in September. That number is probably closer to 750 today.
We at Concord Group predict 3.5% traffic growth in 1992 and 5% annual growth through the decade.
At this rate, the markets will return to equilibrium by 1993 and the industry's survivors will move forward - bloodied, but wiser.
(From a financial services standpoint, those who actively supported the newer wide-body aircraft should be satisfied. Those who financed older narrow-body aircraft will suffer - but even they will probably avoid disaster.)
Another Schedule
That's the scenario I support. But there's an alternative scenario supported by other knowledgeable people.
In 1992, they believe, the world's airlines will continue to slash costs and capacity because of low demand and constraints of the balance sheet. But starting in mid-1992, demand will increase- and start to accelerate at a faster rate than the airlines believed possible.
In 1993, so the scenario goes, demand will spike as the international fconomy begins to take off. But having cut capacity severely, the airlines will be unable to react quickly enough to meet burgeoning demand. New airlines will sprout up in response, and aircraft values will rise dramatically. These bullish developments will lead investors back into the aircraft market, precipitating another boom period.
A Long-Term Industry
To those who object that I may be highlighting long-term developments to explain the airline industry's chronic problems, I would like to point out that in an industry in which the average asset life runs between 25 and 35 years, an economic downturn of 12 to 18 months is decidedly short term.
Of course, one can't subscribe to this view unless one believes that history repeats itself. As far as the aircraft industry is concerned, history did exactly that in the 1960s, 1970s, and 1980s.
Mr. O'Hanlon is president and chief executive officer of Concord Group, the Norwalk, Conn.-based leasing and commercial finance subsidiary of Hongkong and Shanghai Banking Corp.
