Formulating aircraft strategy in an economic downturn

The current economic downturn has resulted in intriguing approaches towards airlines’ aircraft acquisition strategies.

Some airlines have shown inclination towards fleet expansion during the financial crisis, while others have opted for introspection and adopted a more cautious approach.

One group which has stood out for its positive decision-making is AirAsia. Its low-cost long-haul affiliate AirAsia X recently confirmed an order for 10 Airbus A350 XWB aircraft. According to the group, the move “is set to seal the airlines’ vision to be the world’s first long-haul and short-haul low cost airline”.

On the other hand, the likes of Qantas, which consider the current global downturn to be a crisis for the aviation industry, are delaying their orders.

Qantas reached a mutual agreement with Boeing to defer the delivery of 15 B787-8 aircraft by four years and cancel orders for 15 B787-9s scheduled for delivery in 2014/2015.

Qantas’ CEO Alan Joyce, for whom the current scenario is certainly the worst environment he has seen in his 21 years in the airline business, said the changes to the Group’s B787 orders were appropriate in the current climate; and that discussions with Boeing, which commenced some months ago, had not been influenced by the announcement of a design issue and further delay to the aircraft’s first flight.

Prior to its decision to defer B787-8 aircraft, Qantas had mentioned that it has financing facilities in place to cover its aircraft purchase obligations till October 2010.

“We have strong liquidity with more than $3 billion in cash. So we are well prepared if the economic ‘glimmers of hope’ turn out to be false dawns, and the downturn extends for some time. And we are positioning ourselves to grow and prosper when things do improve,” Joyce had said in May this year.

Other than financial considerations, the decision-making is also dependent upon several other factors.

For instance, Qantas categorically says it does not have the advantages that some of its competitors enjoy.

“We are not government owned. Our activities do not form part of a national strategic agenda. Australia is not an aviation hub,” Joyce had said.

Among others, Virgin Blue group’s chief executive & co-founder Brett Godfrey said, “In order to achieve desired reduction in overall planned capacity growth, we have slowed down – but not stopped – the delivery schedule of aircraft we have on order, Embraer e-Jets operated by Virgin Blue and also B777-300ER aircraft operated by our long-haul international carrier, V Australia.

“However, it is also important to note that Virgin Blue has taken up options for five additional B737-800’s to take our total aircraft on order of this type to 15. The first of these aircraft are due to be delivered in the third quarter 2013. It has not yet been determined if these will be additional aircraft to the fleet or replacements for lease returns.”

The Cathay Pacific Group, which operates 128 passenger aircraft and 25 freighters, with firm orders of 39 aircraft for delivery from now to 2013, stated that there is no plan to cancel its aircraft orders. “But we will continue to discuss with the aircraft manufacturers for delivery deferrals,” said the spokesperson.

Trends
The most visible trend in aircraft acquisition programs, according to CA Advisors’ managing principal and president Jahan Alamzad, indicates the move to smaller-capacity aircraft and away from large, long-haul aircraft, particularly in the Asia Pacific region that has been hit hard by the economic downturn. 

“Financing of wide body aircraft has proven to be more difficult. The general tendency in a difficult economic time is to lower the cost structure by lowering the capacity, which leads to using smaller aircraft,” said Alamzad.

He added, “Airlines are doing everything they can to postpone aircraft delivery for expansion. Unless the new aircraft have been slated for replacing the older, less efficient aircraft, airlines prefer to put off receiving the previously-ordered aircraft. Certainly, options are being looked at as a way of deferring aircraft deliveries."

Japan Airlines (JAL) will focus on downsizing to small and medium-sized aircraft that are more fuel-efficient while retiring its older ones.

JAL plans to operate smaller aircraft with increased frequency on certain routes to give customers more flight-timing options.

“Operating aircraft with higher fuel efficiency will also lead to lesser fuel consumption which in turn lowers fuel cost, and at the same time it can reduce JAL’s environmental footprint. JAL targets to decrease its CO2 emissions by 20 per cent by financial year 2010, compared to the 1990 levels. Thus far, we have already achieved up to 15 per cent reductions, and using more fuel-efficient aircraft will take us closer towards this goal,” said Atsuo Takazawa, director corporate planning, JAL. 

He added, “We will be introducing 18 new airplanes (777, 767, 737 and E170) and will retire 23 (747, 767, 737, MD81 etc) in financial year 2009.”

The driving forces in the marketplace, coupled with competitive reasons, compel fleet-renewal programs to take place, even during the downturn when that’s not the most ideal time to do so from the airline’s perspective. For that, the forecast (when the downturn ends) becomes one of the most crucial items, says Alamzad.  
“Airlines strive to have the right fleet once the downturn ends so that they can capitalise on the market opportunities. Tactical decisions, such as delivery deferral or grounding, help to cope with the unpleasant impact of traffic downturn.

If done correctly, the airline will be in a position to have the right fleet once better times arrive,” said Alamzad.

Virgin Blue group’s Godfrey said, “Our aircraft redeployment and capacity reduction program has been in the public arena since June last year, when it was implemented as a response to exceptionally high fuel costs. In short, we have redeployed aircraft from underperforming routes and introduced services on routes not already serviced by other carriers and where we see good potential for growth. This approach has continued this year as the impact of the global economic crisis began to impact the economies in the countries which our airlines serve.”

Combating short-term downturn
Airlines are looking at progressively making their fleets younger, greener, more efficient and easier-to-maintain, besides offering the latest generation in-flight product.

JAL aims to adjust capacity to meet demand more closely.

“In terms of our fleet and route plans, we will be reducing frequency and suspending under-performing domestic and international routes for short-term periods or altogether, based on more conservative projected demands and profitability. We have announced the suspension of eight international routes for the period from July 2009 to October 2009,” said Takazawa.

JAL will not overly rely on a recovery in the economy that is still shrouded with uncertainty, but is going to look within the company and enforce cost-cuts where possible.

“In our financial year 2009 Management Plan announced on May 12, we laid out a cost-reduction plan aimed to save up to 53 billion yen in nine fields within the company. This will continue until we have streamlined and made more-efficient, the processes of each unit and thereby rebuild our business model to be one that is lean and that can withstand the sporadic threats of unforeseen crises such as the current pandemic,” explained Takazawa.

Qantas has decided to defer aircraft orders and freeze capital expenditure.

Joyce said the cancellation of 15 B787-9s would reduce the group’s aircraft capital expenditure by US$3 billion based on current list prices.

After the order changes, the Qantas Group will jointly remain the biggest airline customer for B787 family aircraft.

The changes will see Qantas Group firm orders reduced from 65 to 50 aircraft, comprising 35 B787-9s and 15 B787-8s; with the Group’s first 15 aircraft (B787-9s for Jetstar’s international operations) delivered from mid-2013, around three years later than planned. Then 15 B787-8s are to follow over 12 months from the fourth quarter of 2014 for Qantas’ Australian domestic operations (to retire the remaining Qantas B767-300 fleet).The remaining deliveries (20 B787-9s for both Qantas and Jetstar international operations) are to take place from the fourth quarter of 2015 through to 2017. And Qantas will retain the ability to purchase up to 50 additional aircraft.

“Delaying delivery, and reducing overall B787 capacity, is prudent, while still enabling Qantas and Jetstar to take advantage of growth opportunities and market demands, both domestically and internationally,” said Joyce.

Cathay Pacific says it has committed to 30 Boeing 777-300ER and 11 of them have already been delivered.

“Our new aircraft are very fuel efficient and this is particularly important in this operating environment.

The777-300ER is 22 per cent more fuel efficient per payload tonne than a 747-400. We are bringing forward the retirement of the remaining Classic freighters by August this year. Meanwhile, we have taken delivery of six 747-400ERFs, which is 16 per cent more fuel efficient than the retiring Classics; while the 747-8F (we have ordered 10) is 22 per cent more fuel efficient than a Classic and 12 per cent more than a 747-400F,” said Cathay Pacific’s spokesperson.

Market deterioration
Market conditions have deteriorated and, for some. especially in their international business. Airlines are experiencing significantly lower demand, particularly in premium classes. This, too, has posed major challenges for airlines.

The long-haul, international routes, particularly for the premium classes, demand service, which is needed in order to compete effectively, said Alamzad.

“An airline must be able to offer the services that its competitors provide if it wishes to remain competitive in this market segment. For that, the in-flight amenities, including those that the latest manufactured flight equipment offers, are the key component of the service offerings. Even if the decision is to retain the older aircraft, those aircraft must be retrofitted to be equipped with the latest in-flight amenities,” he added.

From JAL’s perspective, Takazawa said, as with all other airlines, erosion of demand in high-yield premium traffic is causing a decline in revenue.

“However, looking beyond this current financial crisis, JAL will maintain our high level of service in the premium category and have no plans to convert any aircraft to mono-class (economy) configuration,” he said.

JAL recently introduced the latest seats in first class, the JAL First Class Suite, and in executive class the JAL Shell Flat Neo – an improved version of its executive class,  JAL Shell Flat Seat on the Tokyo-San Francisco and Tokyo-New York City routes.

“We plan to fortify our premium services and will be introducing these seats and the premium economy cabin class, on more routes (to Chicago and Los Angeles in November this year),” said Takazawa.

Virgin Blue Group’s response to deteriorating domestic demand has included strategic rearrangement of capacity to enter new and uncontested markets where new demand is emerging.

“Across fleet, our total seat capacity dedicated to premium classes – premium economy and business class (VAustralia) is significantly lower as a percentage of seat capacity compared to our competitors. So, we are less exposed to any lessening demand for premium class travel,” said Godfrey.

“We have also deferred the delivery of VA’s fifth and sixth aircraft,” he said.

Referring to the operations of VA, Godfrey added, “We operate brand new aircraft. Our business class and premium international products are second to none in terms of their high quality and comfort – and we are seeing significant interest from guests who have had to pay far higher prices with the incumbent carriers. And domestically, Virgin Blue’s premium economy product is developing a following given that it offers essentially the equivalent of our competitor’s domestic business class product but at a fraction of the price. Due to the tough economic times we are seeing a shift in the corporate sector with companies seeking better value for money for their corporate air travel needs.”

In China, the airline industry is also expected to continuously face challenges such as a decrease in international market demand and an overcapacity in the domestic market this year.

In its annual results, China Southern Airlines stated that the group had capital commitments of approximately RMB78,481 million. Of such amounts, RMB75,639 million related to the acquisition of aircraft and related flight equipment and RMB2842 million for other projects.

By the end of last year, the group had on order 217 aircraft and certain flight equipment, scheduled for deliveries in 2009 to 2015. Deposits of RMB13,441 million have been made towards the purchase of these aircraft and related equipment.

Overall, the group said they had a fleet of 348 aircraft, consisting primarily of Boeing 737 series, 747, 757, 777, Airbus 320 series, 300, 330, McDonnell Douglas 82, 90 etc. The average age of the group’s registered aircraft was 6.3 years as at the year end of 2008.

The group’s debt to equity ratio remains high at 685 per cent at 31 December 2008 (2007: 420 per cent) because of the acquisition of aircraft during the current and prior years.

Value-based models
Low-cost carriers like AirAsia and Jetstar have underlined that such business models can combat adverse external environment.

Referring to its recent deal, AirAsia says by buying the Airbus A350, AirAsia and AirAsia X have now got their strategy fixed all the way to 2020. The vision of creating the world’s first long-haul and short-haul low cost airline is complete.

AirAsia X has selected the A350-900 variant for its fleet, which will be configured to seat 425 guests in a two-class layout.

Valued at a list price of US$ 2.2 billion, the deal comes with an option of another five A350 aircraft.

Deliveries are scheduled between 2016 and 2018, which will further complement AirAsia X’s fleet of A330s. The airline has ordered 25 A330s that are due to be delivered through 2015, of which two aircraft have beendelivered so far since October 2008.

Tony Fernandes, who is also director and founder of AirAsia X, said, “Under the current great uncertainties in the global economy where legacy airlines are cutting routes and grounding staff and aircraft, AirAsia and AirAsia X are determined to fulfil and realise our potential. The economic downturn presents AirAsia, as Asia’s largest low cost carrier, an unprecedented opportunity to gain market share with our low-fare, high-quality business model.”

The purchase indicates AirAsia X’s ambition to fly further afield and to serve more destinations than it currently serves that include London (UK), Melbourne, Perth and Gold Coast (Australia) and Tianjin and Hangzhou (China).

Chong Phit Lian, CEO, Jetstar Asia Airways, said Jetstar Asia has been fairly resilient to the effects of the global financial crisis as value based models tend to hold steady at this time as many travellers “trade down”.

“Jetstar Asia is also holding up well and will add new capacity with a daily service to Penang in Malaysia (from July) and double daily from 1 October. Jetstar Asia will also add an additional daily service between Singapore and Bangkok, rising to triple daily from 24 September 2009. Down-trading in the airline industry is encouraging new travellers to Jetstar and Jetstar Asia.  Jetstar Asia in particular is experiencing higher numbers of business travellers and corporate travellers. Jetstar Asia currently has 380 corporate clients alone representing significant growth in the last 12 months,” she said.

Young fleet
In terms of fleet investment, Jetstar Asia operates a very young fleet of Airbus A320 aircraft with an average age of four and a half years. Jetstar Asia pointed out that the A320 has the lowest fuel burn, emissions and noise footprints of any aircraft in its class.

Jetstar Asia currently has seven aircraft, with three new A320 aircraft to be added to the fleet over the next 12 months.

Jetstar Asia/Valuair is part of the Jetstar Group of airlines which operates an existing fleet of 40 wide and narrow body aircraft serving Australia, New Zealand and the Asia Pacific region. Jetstar has orders for 65 A320 family aircraft over the next eight years and options for 40 additional aircraft.  The Jetstar Group now consists of Jetstar in Australia, Jetstar in New Zealand, Jetstar Pacific in Vietnam and Jetstar Asia/Valuair based from Singapore.

In India, Jet Airways India currently operates a fleet of 86 aircraft, which includes 10 Boeing 777-300 ER aircraft, 12 Airbus A330-200 aircraft, 50 classic and next generation Boeing 737-400/700/800/900 aircraft and 14 modern ATR 72-500 turboprop aircraft. With an average fleet age of 4.53 years, the airline says it has one of the youngest aircraft fleets in the world. 

Virgin Blue Group’s Godfrey said, “We already have a young and highly fuel efficient fleet. The average age of VAustralia’s aircraft is less than one year and Virgin Blue/Polynesian Blue’s fleet aircraft less than four years. We have also had in place for some years an internal team charged with the task of constantly improving fuel efficiency. We are also working closely with the Sustainable Aviation Fuel Users Group and also with Airservices Australia towards improvements in air traffic management practices to achieve greater efficiency of aircraft operation.”

Leasing
Earlier this year, Jet Airways shared that, under its on-going route re-structuring and cost saving program, the company has entered into agreements with Gulf Air Company G S C Bahrain for the lease out, on a wet lease basis, of four B777-300 ER Aircraft for a period of six months each commencing from March, 2009 (three aircraft) and May, 2009 (one aircraft). At the end of this term, the wet lease arrangements will migrate to a dry lease arrangement.

The airline also entered into two agreements with Oman Air for the lease out, on a wet lease basis, of A330-200 aircraft for a period of six months each, with effect from May 2009, under the on-going route re-structuring and cost-saving program undertaken by the company. (Wet Lease means that the operational control and maintenance responsibility remains with the company; the aircraft remains on the  Indian registry and is operated with the company’s crew.)

Referring to leasing of aircraft from the airlines fleet to another operator, Alamzad said that this can be viewed as another tactical move to benefit the airline during the downturn.

“The key factor is the expectation for when the downturn ends so that the lease terms are reflective of that, and those aircraft are returned once the airline is in need of expanding its schedule,” he said.

JAL’s Takazawa said leasing can increase the flexibility of fleet planning and make it easier for JAL to re-structure its route plans.

“Also part of our consideration is that, although leasing fees are high, there is no risk in terms of residual value to the airlines as a lessee,”  he said.