State of the Industry:

Transcript

Peter Harbison:Hey, it's good to be back. It's great to see so many smiling faces, and I guess you're sort of happy to be out of the dungeon as well. It's been a very interesting 2 years, hasn't it? I did have a lot of difficulty tying my tie this morning, which I really found Quite, not the most attractive thing to be wearing, but anyway, you have to do it, don't you? But welcome back. It's great to be here. It's great to be talking with such a distinguished group of people about what's going on in the industry, and I hope you enjoy the next couple of days. I've been spending most of my time on the beach over the last 2 years, so it might be a bit, I might be a bit rusty in getting to the details, so. Thank you, Peter. Don't hesitate to correct me if I get it wrong. I'm gonna run through, we've got a great panel coming up after this, and I'm gonna sort of do a prelude to that by, sorry, let me just get the doodah, by running through a lot of the issues, a lot of different points that I'll make. I'm not gonna try and cover everything because there is just too much, but I think change is what we're talking about fundamentally. And I asked that question to start with, I mean this, I've been in this industry for a long, long time and I seriously don't think we've been confronted by quite so many issues ever in the history of modern aviation anyway. We've still got another year to go probably before we get through to 2019 levels globally. We're coming into that era with a massive debt from— for the airlines, with interest rates going up, with stagflation around the corner, and the share markets fortuitously have held up pretty well over this period. Will that last? High fuel costs, of course, are the, the most recent cherry on the cake, as it were, which are really very much an unwelcome development. And then of course the airlines are confronting a whole lot of costs and the airports of course and thanks to Ken and MAG for sponsoring this. But that's going to mean costs, getting new aircraft, buying SAFs at a higher price and paying for offsets in the meantime. There's a great need to invest in new technology. Tech is where the industry really hasn't been very good. and where really there do need to be a lot of changes made, which again involves expenditure and a whole change in thought processes in the industry. There are supply chain issues, resources are not always there for the aircraft manufacturers but also for the industry itself. Now all these things aren't necessarily bad, I'm talking about change. The long-haul narrow-body aircraft that are coming through, which I'm going to talk about a bit, The change in the role of lessors, the changing role, the growing role of lessors. There are dozens of new entrants coming into the market at this time, and then of course we've got a tyrant who's threatening to change the world order, which has a lot of impacts for aviation, as everything does. Everything that changes in the world affects the aviation industry. So with that to kick off, as I said, it's not all bad, but it's change. And the industry is resilient, it's always been able to change. It's going to need to change a lot. This is the part that's a bit more difficult, what passengers are going to want to do. I'm not going to get into a discussion about business travel, but it will be reduced, and it does have a fundamental impact on, particularly on long-haul operations. It is going to be down at least 20%, maybe not 50% like some people with vested interests in online operations might suggest, but things like ESG, the desire of companies to save costs on travel, which are a big thing, are all those factors which will go into that mix. And for passengers themselves, for travellers, are they going to want to stay closer to home? Are they going to want to go back to the way they used to be? And things like visiting friends and relatives in a divided world, we find this a lot in Australia now, people saying, well, you know, I moved to Australia because I thought I could go back to wherever every year. If that's not going to be the case in future so easily, maybe we start looking differently at it. And of course that does affect the frequency of VFR operations, travel. And behind all this, of course, tourism, the tourism industry itself has been hit dreadfully hard. So there's a lot of absence perhaps of more familiar territory for tourists to go to. And I think there is still a concern, probably most of us have, I'm about the only one wearing a mask, I think, at the moment, but I— obviously we don't know, but the concern is there. It's a— it's an unknown, and that's not always welcome. So how will I behave short-term, long-term? That big thing coming through the door, the whole world welcoming me, am I ready for it yet? It's a big ask. And I think that's sort of in the back of a lot of people's minds. This is from OAG, just very quickly to look at it. On the left is the change in domestic seat bookings versus 2019, and on the left of the line is the different regions in terms of the shortfall from 2019. The only ones, domestic ones, that are positive are Central Western Africa, Upper South America, South Asia, i.e., India particularly, and Central America. Everything else is negative. And then if you look at international, of course, which is on a scale of 100% right across to the left, Asia-Pacific lags dreadfully, but there's almost nothing on the right, nothing at all on the right. of that vertical line. In other words, every market pretty much is below. And then the graph on the right is just an aggregation of those 2. But obviously international has a long way to go before it comes back to anything like even 2019. From IATA, this, the blue line is domestic bookings, the period through January last year to, to February. The red line is international. We saw them coming up towards the end of last year, December '21, and then the Omicron wave hit, decline again. And this goes up to about where the Russian invasion of Ukraine occurred, so we don't really know yet on these data just what's happening, but it does show that COVID is still there ready to leap out and slow things down. This one was a bit more interesting because, just to make it interesting too, they changed the colours. So domestic is the higher one, it's down 26% in— at the end of January. Oh, And international is down 62%, the blue line. If you just go back to the previous one, international is down 45% in terms of passenger ticket sales, but the RPK levels are down 62%. So it does suggest, and I think it's probably pretty logical, that the average journey is much shorter because you've got fewer RPKs per booking. Yeah. Whether that's a longer-term trend or whether it just sort of reflects where the air services have come back a bit more. And as I said, I won't debate that issue, but it is going to have an impact. I'm just going to run through each of the markets. These are graphs taken off our website where we use the OAG data. So on the left, we're looking at April 2019, and these are aggregated schedules of all the different airlines. On the right, we're up to September '22, but where the little box is, is about now. So that Asia-Pacific-West Europe market has only recovered to about 30%. The leader in that by a long way is Singapore Airlines, obviously, which is Still operating and nonstop operations easily enough. But then if you go to Middle East Asia Pacific, just to say, these are point-to-point schedules so that anything that goes through the Middle East to Europe, you have to aggregate Middle East Asia Pac and Middle East Europe, which is what I've done here. So Middle East Asia Pac has recovered to about 80%. And similar gross numbers to the Asia direct. And Middle East-Western Europe has recovered to about 60%. So what's happening is a lot more traffic is flowing proportionately through the Middle East, through the Gulf. Similar impact for Middle East-North America where we've seen a great revival. The blue line there is— the blue bar is Qatar. And then on the left end, we see Emirates, which is the second largest in terms of operations at both ends of that scheme. Where we have seen recoveries, Latin America to North America, particularly Latin America, including the Caribbean, it's up above where it was in 2019. A lot of that is short-haul traffic through to Mexico particularly and the Caribbean. Within Africa, obviously very small market but is pretty much where it was before. And Africa to Europe, again, pretty strong. Small numbers but interesting that they have managed to stay there. And overall the North Atlantic was looking good anyway. This goes up to, as it says there, the escalation of conflict. So we're talking about prior to the invasion. So whether that red and blue line, the blue line being US to Eastern Europe, and the US to Western Europe is the red line. I suspect the blue line has gone down somewhat since then, but it does suggest there is a lot of resilience in that market. And it is coming back to decent levels. It's up to about 72% in terms of capacity at the end of April, or at the beginning of April this year. Largest carrier on that route at the moment is United, the blue line there at the top, on the bottom, sorry, on the right on the bottom list, on the bottom graph. Thank you. But this, again, this isn't unknown, any surprise to anybody. The slow recovery, if you can even call it a recovery, of Asia-Pacific is really holding things back. Broadly speaking, in 2019, there were 3 relatively equal slices of that pie. Whereas now Asia-Pac is down to under 20%. And where China will go is another issue. It doesn't look like opening up at all. So the question is then, who is going to survive in this environment? And there is a hangover typically when you do have these sort of dramatic events, financial events and other events, It takes a while to filter through and actually you see departures from the market. Will it be the smaller airlines, smaller— will we see smaller major airlines? Will there be fewer of them? How do we respond to passenger preferences? And it does seem inevitable lower costs are really going to be the key to driving growth again. And with fuel prices, for example, that's not easy. I'm not going to talk a lot about low-cost carriers, but obviously that is a new ingredient in terms of its significance probably in the future markets. And the narrow-body revolution, which as I said I'll talk about a bit more, the ascendancy of the Middle East, It does seem quite likely, and I'll show you some numbers on that. And then getting to the airline model, are we going to see alliances? Every time something happens of any size, people start saying, well, where will the alliances go? Will the alliances save us? Will they change? Is this the end of alliances? There does seem to be a consensus now that alliances are going to be important. for the future? And one that's dear to my heart is, will that start to involve equity? Will there get some— become some rationality in the industry where we can see some form of merger or at least getting closer? And I'm going to finish by just a quick word on the traditional model and what role governments might play. Fuel. So I've said this, we're talking about about $165 a barrel for jet fuel when you see that blue line go up. The problem is very much that not only have fuel prices gone up, oil prices gone up, but we've seen this disconnect between oil prices and jet fuel costs. So where oil was up to about $115, it's down to about $80. $102, I think, today, Brent crude. You've got this great disparity with the jet fuel split so that you've got probably $165 a barrel there, which really does undermine any prospect of real low-cost operations because, of course, the proportion of fuel in a low-cost operation is that much greater. What happens? Well, you need higher yields. Can we get higher yields back? Will consumers pay higher prices? We have yet to see. But for the time being, getting people back in the air is actually meaning a lot of discounting. And what is the profile of the airline that survives? in this new environment. This— when I said the cherry on the cake before, it's a pretty ugly cherry. So when IATA suggests that it'll add $97.9 billion to the 2022 fuel bill based on an average of only $122, which is the average to the this time of the year when we saw that in fact jet fuel prices were over $160. Even at that price, the industry's got to absorb another $50 billion just on fuel in this coming year, assuming prices stay up, and I think most of us assume that prices will stay up. And this is an industry that in a good year has made less than $40 billion profit. In the best year ever, has made less than $40 billion profit. So it is a— I don't want to be too negative in this. It's hard to be too positive. I'm just trying to get through some of the issues that, which go to the heart of what we want to discuss in the panel, which is never waste a good crisis, and I fear that we might be. doing just that. So against this, it's an attractive market for new entry. 57 new airlines, this is IATA's chart of the week last week. 33 exits going across the green bars, which are 2021, and then dormant airlines, 69. Of those going back to the left, Of those 57 new carriers, interestingly, 12 of them are all cargo operators. So there is an opportunity here for a new— newly invented airline perhaps to make profits in this market. I mentioned lessors. I've forgotten it was May last year. We had Steve Hazy on CAPA Live last year. And he was talking about— we were talking about the debt issues that the airlines have. And going on to this, the next graph I'll show you, just suggesting that the lessors, of course, who do have effective business models and have many— in many cases been making profits throughout this entire period because they do have credit ratings which most airlines don't. suggesting that the lessors will be in a much better position to be buying aircraft in future. And that's reflected in this, the growth of lessor ownership of aircraft. Last year, even more. Something like 65% of all new orders last year were from lessors. Now, it's not quite as, as you know, not quite as black and white as that because some of them are already committed, but— Yes. That is— looks very much like the story for the future. When you've got the sort of debt levels we've got and the failure of credit ratings for the airlines, who buys the aircraft? The lessors. Now, that's not just a simple statement on its own because it filters through to a lot of things. Most of those orders, I think something like 90% of them, were for narrowbodies. the new generation narrowbodies. And I won't bore you with all the details of why they're effective, but they're up there. The point I do make there, though, is that lessors prefer these aircraft now. Lessors will be buying the aircraft. Lessors prefer the narrowbodies because they're very versatile. They know at the end of a lease they can switch them over if they have to pull the aircraft. they can place them more easily. So there's a lot of pressure to move towards the new narrowbodies, not just for good operational reasons. And in turn, that probably affects the options for travellers. If they do prefer to stay closer to home, if they do prefer nonstop operations, well then you've got this— this additional pressure that says, well, actually, that's the main choice you have. So that's really going to influence your whole thought process. And then that coincides too with reduced revenues likely, the reduced yield levels as a result of business travel not being there, at least for several years. What does that do? Well, it makes longer haul, as I mentioned before, longer haul conventional wide-body network operations less viable. I'm talking generally here. Obviously, there are major exceptions to these. But what we have is lower frequency, fewer routes, just throwing a lot of these things into the basket, and the process of transition to narrowbodies, which are coming into the market relatively slowly because you can only produce so many at a time, but it's been accelerated very much by COVID. Today, this is from our website again, over half of the aircraft, just over half of the aircraft in the world's fleet is narrowbodies, the blue bar there, the blue part of the pie. and about 17% widebodies. These are the orders. The red bars are narrowbodies. On the left are the so-called unassigned, they're not committed to any particular region or airline. And then going across from the left, Asia-Pacific, no surprise there that we've got a lot of orders and perhaps some of them might even come through into completion. Over on the right, Latin America, North America, and Europe. Now most of those Asia-Pac ones will be staying in Asia-Pacific because of the size of the region, because of the growth demands there. Likewise, most of the European ones, and look at the scale, the difference between the red bars and the yellow bars which are wide-body. It used to be 50 to 20%. These are much more than 50 to 20%. Most of those will work in Europe or across the Atlantic. Most of the North American ones and the Latin American ones will be used domestically and in that American market. The Middle East one is interesting though because the profile there has been very widebody until now, as you're well aware. There are a lot of narrowbodies coming in now. And when you look at some of the numbers there, this is why I want to sort of make a bit of a stronger mention about the Middle East role. Just take a moment to digest that, but these are the major carriers and I've included Turkish as a superconnector. Large fleets already. And median age of the fleets is relatively young, which is relative— which is important in the context of looking at why the new orders coming through. It means they're not all just replacements, they're in terms of expansion as well. Most of the orders are narrowbodies, most of the— and this is a great transition, great transformation from say 5, 10 years ago. Emirates is staying with the widebodies. Etihad has got a mix. Turkish is predominantly narrowbody. And Qatar is all widebody, of which 34 of that 120 are 777 freighters. Interesting development. But then you've got what's happening in Saudi now. Saudi's civil aviation strategy And like a lot of strategies, they don't necessarily always come to fruition. But Saudi has a lot of money, and Saudi has a massive program to develop tourism and travel through that country. It's the biggest country in the Gulf by a long way, and it really has been very much a sleeper in terms of global operations. It wants to move from 100 today to 330 million passengers in the next 7, 8 years, of which 10% will be transfer, they want. Now put that into context. That's about what Qatar carries at the moment. So they're talking a big, big change. 250 destinations. The Saudi Group, Saudi and Flyadeal, have 168 aircraft, again, Quite a young median age, 60 narrowbodies on order. There's a new airline coming in Saudi to be based in Riyadh along with a new airport. And Flynas, the independent low-cost carrier, is talking about up to 250 new narrowbodies. That means a lot of change. Now, I'm going to conclude with having a quick look at the the airline model that really has been so gloriously unsuccessful over the last 75 years. It doesn't make money. And it's based around buying and flying aeroplanes. It's very close to the national heart, creates jobs, countries want them. It provides a brand, And almost inevitably requires a lot of government support. I'm not just talking about the rest of the world, I'm talking about America as well, where the major airlines have been bailed out 3 times this century to the tune of hundreds of billions of dollars. So it's not just a non-US issue. So the question is, is there— well, do we focus a lot more on the non-flying elements? The bits that make money. Let's have a look at American, for example. As you're probably aware, American used its frequent flyer program as a backing for a $10 billion bond sale. It estimated its frequent flyer program value at somewhere between $20 and $30 billion. It also has a fleet of nearly 900 aircraft, of which it owns about half. with a book value of about $13 billion. So add that up, give you, even modestly, gives you a total of about $30, $33 billion. Last Week has a market cap of $12 billion, less than even the fleet valuation, but it does suggest that the value is in the frequent flyer programme, not in the airline. American's got some problems, but Delta's not that different. It's got a total book value on that basis of $32 billion, and its market cap is about $7 billion less as of today. That says a lot, I think, about the airline model. Just concluding almost now. As I said before, one of the issues that always arises when we talk about change is what will happen with alliances? Do we need them? And there are a lot of reasons this time, I think, for a pretty broad consensus that alliances will become more important. The question is, what will the nature of those alliances be? Will they be reinforcing the the 3 big ones? Will there be much more bilateral, regional, global? And the key underlying that, if we want to see change in the industry, is will we some— at least start to get some form of significant equity exchange in that process across borders, which is always— Excuse me. Which has always been so difficult. I doubt it from the top down anyway. The whole process has really survived because governments have kept it that way, and there's a great will at the moment to restore what we had before, which is why I say it's only going to change from the bottom up. Governments aren't going to come together and say, oh yeah, we renounce our nationalism, we renounce all our national interest, let's get some logic in the industry. No, it's this hybrid operation that really doesn't make commercial sense as things stand. So when I say from the bottom up, I'm talking about things like AirAsia and its transformation in Asia where it established cross-border joint ventures where governments then sort of looked the other way and said, okay, we can accept that. We didn't actually come together as governments to agree it as an operation, but it technically seems to conform to the rules of substantial ownership and effective control. That's where I think changes will perhaps happen if the need is great enough and if the desire is there. Hopefully it will be. But I don't know, I've been banging away at this for years and nothing much seems to change. Let's try not to waste this crisis. Then of course I haven't talked about this because it is that great big elephant sitting here, but decarbonisation is going to be a massive issue for the industry as we all know. As we all know. And that one ain't going to go away. So we do have to respond to that very effectively. That ends my presentation. Thank you for that. Thank you, Peter.

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