Leasing remains the most important form of finance in the aircraft sector. According to research commissioned by CIT, 54% of respondents revealed that more than 50% of their fleets are leased, and they expect this to remain fairly consistent over the next five years.

Support funding from manufacturers (51%) ties with bank loans as the second most important form of aircraft finance followed by export credit loans (39%), secured bonds (28%), government loans (25%) and tax leases (24%). Islamic (Shariah) leasing makes an appearance at some 11% in terms of funding importance.

Chart 1 Leasing is the most important form of financing

A rough ride through the recession

The past few years have been very hard on global airlines. Not surprisingly, leading airlines have shifted rapidly into survival mode.

For example, more than a quarter of respondents in the CIT report, Challenges of an ever-changing industry, which was prepared in conjunction with Forbes Insights, indicated their companies had grounded more than 10% of their fleets during the height of the recession, with larger airlines more likely than smaller ones to be grounding part of their fleets. The post-recession percent of planes grounded is lower.

Chart 2 Percent of fleet grounded

As a fleet executive with a major European airline explained: “We implemented a survival plan soon after we detected the downturn. Today the action continues, as we recognize that the downturn uncovered a number of shortcomings which we now intend to address for the long term.”

This airline’s program centers on developing a more cost-conscious culture. He added: “We want to strip working capital and general operating costs as much as possible, and that requires getting more people involved. People need to understand the issues and the urgency. Performance metrics, for example, are being retooled to include greater emphasis on the cost of capital as well as costs in general. They are putting teeth into the cost measures.”

In addition, the program includes paring the size of the airline’s fleet, postponing or canceling orders, reducing cruising speeds to save fuel, and consolidating routes.

The company also took moves such as cutting back on workforce hours and is now actively trimming the ranks through attrition. And though economic conditions today are improving, “they are not back to normal,” said the executive. Moreover, “regardless of the extent of the recovery, we’ve learned valuable lessons in this crisis—and we will not go back to our old habits.”

Challenging fuel costs

Even with the recession easing, many fleet and finance executives reported that their companies face a significant number of their pressures to their bottom lines. In particular, respondents cited the risk of higher fuel costs and heightened price volatility as a top challenge.

Chart 3. What are the most significant challenges your company will face over the next two years?

Generally, the consensus is that fuel prices will rise over the long term. Still, according to a senior executive from a large US-based carrier, there is much less certainty in the short- to mid-term, a development that has made it quite difficult for the airline to plan effectively.

A quarter of respondents said they were concerned about the impact regulatory actions—such as those related to carbon emissions—will have on fuel prices.

As a European fleet executive explained, costs related to regulation can create an even greater challenge. “We can hedge fuel prices, and we do, anywhere from six months to 24 months ahead depending on our forecasts and risk tolerances.” However he added, “we have no standard capital market options for hedging regulatory actions which are a de facto fuel price increase.”

The promise of fuel-efficient technology

One operating hedge against both higher fuel prices and associated regulatory actions may be to improve fleet fuel efficiency. Accordingly, 83% of respondents said their companies are likely to acquire or lease fuel-efficient technology.

Chart 4. How concerned is your business about fuel supply and costs?

As the US airline executive explained, “we’ve got orders in place for (a significant number) of 787 Dreamliners, which are extremely energy efficient. In addition, most of the group’s existing turbine aircraft are outfitted with winglets, while its regionally focused turboprop fleet uses advanced technology fan blades.”

Meanwhile, as Ryanair CFO Howard Millar explained, “given the role of fuel costs, we would be very interested in more fuel-efficient aircraft.” However, he added, “anything really interesting is probably still a long way off—to at least 2020.”

Even with this pent-up demand for increased fuel efficiency, and with some airlines itching to place orders, many airlines appear to be taking more of a “wait-and-see” approach. Just 32% of survey participants said their airlines would be among the first to acquire or lease such next-generation aircraft, while 68% indicated they wanted to wait to see how the new aircraft perform.

Why the hesitancy? There may be too many unknowns related to how or when the major aircraft manufacturers will have more fuel-efficient aircraft available. For example, Airbus COO John Leahy told Bloomberg at the 2010 Berlin Air Show that “the real game-changing technologies in airframes, systems, and engines will come around 2025 to 2027.”

Delays related to the Airbus A380 and A350 and Boeing 787 Dreamliner may be causing some airlines to postpone their orders. Moreover, with technology changing at a rapid rate, many airline executives may be concerned that any investments they make in these new aircraft could be overtaken by engine and airframe models that are significantly more fuel-efficient.

Chart 5: How likely are you to acquire or lease newer, fuel-efficient aircraft within the next five years?

Cost drives consolidation – and consolidation drives competition

Airlines must also contend with shifts in the competitive landscape driven by both the emergence of stronger carriers and the increasing amount of consolidation.

As they look ahead to the next two years, increased competition from low-cost and charter airlines is second only to fuel costs in respondents’ list of concerns, cited by 38% of executives. Meanwhile, 27% said they’re concerned about increased competition from airlines similar to their own.

A key driver of competition is consolidation. According to the US airline executive, consolidation is necessary “in order to trim overcapacity.” This has certainly been the case in North America, where, owing to a slew of mega mergers and acquisitions, the industry has shifted from relatively fragmented to relatively concentrated. In 2010, Continental merged with United, Delta merged with Northwest, and Southwest Airlines purchased AirTran.

Consolidation is also occurring outside the US. In Europe, British Airways and Iberia announced plans to merge, and in Latin America, Chilean carrier LAN Airlines will merge with Brazil’s TAM Airlines. Among alliances, the Star Alliance gained several members in 2010, including TAM, Greece’s Aegean Airlines and Olympic Air, Ethiopian Airlines and Columbia’s Avianca-TACA.

What’s pushing this consolidation? Clearly, costs are a primary driver. Growth in mergers and acquisitions and other forms of consolidation are being set in motion by a need to optimize costs and capacity. And mostly, there is a sense that consumers can only be loyal to a handful of carriers. In fact, more than half (54%) of respondents indicated marketing synergies through more routes and stronger brands was what would power this consolidation trend.

Chart 6: What do you believe will be the principal drivers of consolidation activity in the airline industry over the next five years?

The imperative to contain costs

Knocked down by the global recession and the resulting dip in air travel, airlines had to look closely at their operations to find areas where inefficiencies and costs could be pared. Today, those tough decisions continue, as airlines look to revitalize their businesses in the face of fluctuating fuel prices, volatile consumer demand, and an unpredictable regulatory environment.

For many, this means improving their overall efficiencies. This is taking the form of building fleets with new, more fuel-efficient technologies, optimizing labor costs, and increasing industry consolidation, all while dealing with the effects of greater global competition.

It’s not easy. But they believe that they need to put all these parts in place to move to a period of sustainable growth.

“Challenges of an ever-changing industry”: a 2011 Global Aerospace Outlook compiled by Forbes Insight in association with CIT.

http://www.forbes.com/forbesinsights/Aerospace_Outlook_2011/index.html

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