Rick Adams asks whether airlines still need to hold on to their money in a recovering global economy
Cash flows

In 2007–2009, when jet fuel prices soared 45% and airlines worldwide lost tens of billions of dollars during the great recession, Calyon Securities warned that “cash positions for each of the carriers and projected cash flows will become more critical as the market tries to evaluate which carriers will survive …”

More than 40 airlines subsequently closed their doors; others have gone down the bankruptcy reorganization and merger routes.

“Stronger airlines managed to have a safety cushion cash balance, and they focused on building that up to levels that give them some flexibility,” says Brian Pearce, IATA Chief Economist. Pearce believes that cash is still king, “but I think people are spending it now.

“We’re seeing jobs increase industry wide,” he adds. “We’re seeing airlines spending on fleets. There’s even increased talk and some action of airlines paying dividends to their shareholders, which has been rare. I think it reflects the change of mood with the improvements we’ve seen the last two years.”

Indeed, Delta announced plans to raise its dividend and spend $2 billion on share repurchases by the end of 2016 while also reducing its debt levels and pension liability.

“The environment is better than it has been and may improve further,” acknowledges Chris Tarry, CTAIRA. “The fundamental issue remains whether this is just a temporary phase or whether it’s a structural change in the permanent state. Airlines have shown clearly since 2007 that they can improve their financial performance.”

Tarry notes, however, that when you ask airline financial directors how much cash they need, the answer is always “more.”

A cyclical business

Richard Forson, Chief Financial Officer for Cargolux Airlines. , agrees that building up cash reserves remains a priority. “Our objective is to have as much in cash reserves as we can afford to cater to the volatile conditions in the airfreight market,” he says.

So few aspects of the business are actually under the control of the airlines that many agree that in better times it is best to be storing up reserves of cash for when life is going to get tougher. Because the one thing that’s certain in the aviation industry is that it will get tougher in the future.

“It’s very cyclical,” Pearce says. “And the sort of shocks we’ve seen in the past for fuel prices, military conflicts, disease—they all tend to hit aviation more than other industries. I think people are right in thinking that risk and potential volatility are still there. That on its own indicates you need a very flexible business model to respond to those shocks. You’ve got to have the kind of cash or credit lines to survive losing money for some time.”

Compared with where airlines were before the financial crisis and recession, air travel has recovered well and is way above where it was pre-recession. The feel good factor hasn’t yet reached air freight, however. It certainly is not on the trajectory it was before the financial crisis.

Protectionism has restricted the growth of cross-border trade and air cargo has suffered as a result. It has affected the Asia-Pacific airlines in particular where air cargo is a significant share of revenue and cargo profits underpin the bottom line. There are signs of life—Chinese manufacturing increased in May and the regions’ airlines posted a 5.6% increase year-on-year for the same month—but there is still some way to go.

Nonetheless, Pearce believes there has been a change in airline behavior since the financial crisis. Airlines are now talking more about return on capital rather than market share and this strategy can be seen in the way aircraft are being utilized. Airlines are flying them for longer hours on average and filling more seats. The end result should be improved profitability.

What are the macro-economic threats to growth? Source: PwC CEO Survey

Fleets and Fuel

One of the areas that many airlines are willing to spend money in is new-generation aircraft. “The high level of fuel prices is encouraging them to replace aircraft with newer, more fuel-efficient aircraft,” says Pearce, “but they’re also spending for expansion as well.”

IATA estimates that commercial airlines will take delivery of more than 1,400 new aircraft worth over $150 billion in 2014. More than half of the deliveries will replace existing fleet.

Boeing reports deliveries of passenger jets rose more than 7% in the second quarter, led by the 787 Dreamliner and including the first 787-9 to Air New Zealand. Through early June, Airbus had delivered 248 new planes in 2014, Boeing 271.

Eastern European low-cost airline Wizz Air, for example, reports it will fund fleet expansion with its own cash; it wants to double its current 52 planes in the next fi ve years. Ten-year-old Etihad Airways recently took delivery of its 100th aircraft, an Airbus A321. Angola-based

TAAG received its third 777-300ER. In four years, half of Virgin Atlantic’s 40-aircraft fleet will be new 787s.

Even Lufthansa, despite a future warning on profits, plans to maintain its current delivery schedule for 261 aircraft on order from Airbus and Boeing valued at more than $40 billion.

In contrast, airlines in Malaysia are taking a more conservative approach to maintain their cash levels, including “delaying fl eet deliveries, disposal of older aircraft, aircraft sale and leaseback fi nancing terms, and possible route rationalization,” according to MIDF Research.

Jetstar Japan is also slowing down deliveries, spreading current orders into next year.

Delta Airlines, which enjoys a very high operating cash fl ow of $4.5 billion against capital expenditures of about $2.5 billion, is taking more of a wait-and-see approach to new-generation aircraft. They’ve been utilizing older aircraft, average age 17 years, and even new aircraft on order are current generation A321s and Boeing 737-900ERs. Delta CEO Richard Anderson has said the Atlanta-based airline wants to give new aircraft designs time to mature.

Stocks of US airlines have been riding high in 2013-2014 with American, Delta, and Southwest all gaining 45% or more. They took about a 10% dip in June though when the renewed crisis in Iraq appeared to threaten oil supplies. Jet fuel represents about 30% of total airline operating costs, and though Jet A1 prices have been stable for the past three years they are stable within a high range. The 2014 estimate is an average $123/barrel.

What the CEO says

A recent report from PwC, conducted with the support of IATA, shows that airlines CEOs are acutely aware of the difficulties in finding the balance between a healthy cash fl ow and investing in a sustainable future.

It reports that 82% of the CEOs surveyed believe that industry revenue will grow over the next 12 months but 85% are still expressing caution, concerned about a slowdown in growth markets and continued slow growth in mature economies.

It would imply that cash remains king. Compelling business cases can generate significant investment by the airlines, which is more than they could afford to do a few years back, but lessons have been learned. Aviation operates in a complex and challenging environment and saving for a rainy day remains a wise course of action.