ANALYSIS: Can the air cargo market bounce back?

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The air cargo industry is once again anxiously scanning the skies for signs of an upturn, but as so often in the past few years, the signs are tentative and inconclusive.

IATA was able to take comfort from a 1.2% rise in cargo traffic year on year in both June and July, comparing it with just 0.9% in May and 0.1% for the first half of 2013 as a whole. But given that Asia-Pacific carriers saw a 1.8% fall in traffic in June and 1.4% in July, while North America saw drops of 1.2% and 1.1%, the figures were hardly convincing.

More optimistic, perhaps, was the news that Lufthansa Cargo was planning to increase its capacity by 5% in the fourth quarter, boosting freighter flights to Shanghai, Hong Kong, Africa, the Middle East and Mexico. However, it is still planning to phase out two Boeing MD-11 freighters early next year following delivery of the same number of Boeing 777Fs in October. The new freighters had originally been intended as an expansion of its fleet.

Whether or not a convincing recovery does kick in, a good deal of uncertainty will remain about the shape and size of the air cargo business in the years ahead.

Since 2008, a number of cherished air cargo beliefs have taken a knock – that air cargo always grows twice as fast as world trade, that a downturn is always followed by a sharp bounce-back, and that air cargo is a faster growth business than passenger.

The latter factor is perhaps one of the most painful for cargo to deal with. Used to being regarded as something of a poor relation within the airline industry, cargo departments nevertheless used to comfort themselves with the thought that they were at least the more dynamic of the two businesses.

However, now some in air cargo are ­questioning that self-image.

Stan Wraight, executive director of consultants Strategic Aviation Solutions International and a former chief executive of Russian cargo airline AirBridge Cargo, contrasts a passenger airline business that has revolutionised itself in the past decade and still managed to grow even in a depressed economy, with a declining cargo business.

“Air cargo needs to get smarter,” he says. “It is all about how you present your product to the market. The question is why is passenger growing while cargo is in decline? Who is going to be the EasyJet or Southwest or ­Ryanair of air cargo?”

Excessive complexity

Wraight highlights two key failings in air cargo. One is its glacial progress in automating its processes – in particular the sluggish IATA-sponsored e-freight initiative to remove paper documents from air cargo.

“I am going to Canada tomorrow and I have just booked a flight and a hotel online by myself in 15 minutes,” he says. “If I wanted to book a shipment to Amsterdam it would take me all day. That is the complexity we need to get out of this business.”

His other criticism is of the prevailing view that what freighter operators charge is the proper rate for air cargo and that belly operators who charge less are dumping capacity on the market. “It infuriates me when I hear this,” he says. “If a belly carrier is selling below cost, then that is his folly. If he knows his costs and is making a 5% margin, then he cannot be faulted just because he charges less than you do. What you are saying is that he has lower costs and you don’t.”

The lower costs of belly cargo has been a perennial issue for air cargo, but it is becoming even more intense due to the expansion of widebody passenger fleets globally. It is not just the sheer numbers of aircraft due to be delivered, but the fact that the new generation of aircraft have much more belly capacity.

Neel Jones Shah, who until July 2012 was head of cargo for Delta Air Lines, and who is now looking for his next industry role, points to examples such as Japan Airlines replacing 747-400s with 777-300ERs, or United Airlines replacing 767s with 787s. In both cases, he says, there is a near doubling of cargo capacity.

“United is not purposefully trying to increase cargo capacity, but that is what is happening. If you are flying two or three times a week on a route, then the extra capacity can be the same as adding a freighter. Think about the profit and loss on that.”

Or how much less risky financially the belly capacity is when compared to freighters. Wraight does a rough calculation of the costs to a belly carrier flying from Shanghai to Frankfurt, and reckons 40-60 cents per kilo of cargo for extra fuel, 30 cents for handling and 30 cents for other overheads. On that basis a rate of $2.50 is producing a 50% profit. “With a 100 tonne freighter on the same route, $2.50 a kilo would be $250,000: could you pay all the costs of a freighter with that? The answer is no.”

Shah agrees: “If you are a combination [belly] carrier, you are sitting pretty. Maybe you won’t get the same upside in a boom, but you are protected from a very large downside.” Based on his experience at Delta, when he rapidly disposed of the 14-strong 747 freighter fleet that had been inherited from the merger with Northwest Airlines, Shah also thinks the transition can be effected with very little loss of business. “We kept five freighters for a while to meet customer commitments and to get them to transition over to belly capacity, but in the end, we managed to replace all the freighter revenue and profitability tripled. If you are a combination carrier you look at that and think: ‘Wow. Do I really need to be in freighters?’”

It is not just the sheer amount of belly capacity that is changing the economics of freighters, but where it is being deployed. One argument for all-cargo operations has always been that in developing countries ,cargo flows outstrip passenger demand. However, as carriers in these countries expand their fleets, that argument is weakened.

Wraight gives examples. “Four or five years ago, Vietnam was a hotspot for freighters, with rates of $4-5 a kilo. Then Vietnam Airlines bought 777s and Emirates started flying there and now, it is not so attractive. Or take Chengdu: now British Airways, KLM, Emirates are flying there with passenger aircraft, so even that niche market is going away.”

Not everyone is so downbeat about the future of freighters, however. Oliver Evans, chairman of the International Air Cargo Association has presided over an extremely successful belly cargo business at Swiss International Air Lines, and he concedes that the freighter’s share of cargo will probably decline or at best stagnate over the next few years.

A crucial role

However, he points out that the share is still close to 50% and sees plenty of markets and niches in which to deploy freighters. Including on routes where A380s (with their much reduced belly cargo capacity) have been deployed; in response to peak seasons, on main trade routes with reasonably balanced demand in both directions, and for humanitarian flights.

Freighters also play a crucial role in feeding cargo into routes with large amounts of belly capacity or vice versa. Examples include the high frequency networks that several of the Gulf carriers have into India, which generate cargo that can be forwarded by freighters on to Europe or the USA, or British Airways using 747-8 Freighters to feed cargo from India and China into its transatlantic passenger flights.

Karl Ulrich Garnadt, chairman of Lufthansa Cargo, believes this is the only sustainable model for non-express freighter operators. “You need a regular, reliable passenger network, and then to use freighters wherever belly capacity is not sufficient or to places with no passenger network,” he says, adding that he does not expect the current 50/50 balance between belly and freighters at Lufthansa Cargo to change.

Rather, he thinks the significant trend in freighter operations is that higher fuel prices are forcing freighter operators to invest in new freighters or exit the business. “Older aircraft are no longer feasible and for cargo that is ­certainly a big change,” he says. “In the 1990s, fuel burn did not play such a decisive role and noise emissions were not an issue. But now they are both important, so converting retired passenger aircraft into freighters does not make sense.”

Perhaps not surprising, given that it has taken delivery of eight 747-8 Freighters, European cargo airline Cargolux also sees a strong future for freighters. “When the upturn comes, everyone will be scrambling for capacity again,” says Richard Forson, its interim chief executive. He also says the nose cargo door of the 747-8F – something only it and factory-built 747 freighters have – is a huge advantage in industries such as oil and gas – and he praises the 747-8F’s cubic capacity too. “There is a continuing trend for cargo to get less dense, and you can’t optimise a 777 Freighter with less dense cargo.”

Forson does concede that the era of easy pickings for freighter operators has ended: “The days when you could fly them to Asia purely based on the revenue on the return leg are over.” However, he sees plenty of other opportunities for a nimble, entrepreneurial cargo operator. Also, it has to be said that in the parts of the air cargo business that are still growing despite the downturn, the passion for freighters seems unabated. Silk Way of Azerbaijan signed an MoU in March with Boeing for four 747-8Fs and has since made two of those orders firm. Air China Cargo is disposing of eight converted 747-400Fs but will replace them with a similar number of new 777Fs, and China Southern is also taking two 777Fs this year and four next.

Puzzling increases

In the Middle East, Qatar Airways took its fifth 777F in June and has also replaced three A300-600Fs with larger A330-200Fs. Etihad has added a leased 747-8F to a fleet that now includes three 777Fs, two 747-400Fs and three A330-200Fs. It saw cargo tonnage rise 23% in the first half, after 19% growth in 2012. Gulf bellwether Emirates has doubled its cargo tonnage since 2007.

Working out the reason for the continued growth of Middle Eastern carriers, in particular, is a puzzle. Throughout the downturn, they have managed double digit rises in cargo traffic and in the first half saw an increase of 11.2% according to IATA. The usual explanation is a geographical location close to many of the emerging growth markets, and excellent airport infrastructure – Qatar Airways touts its new cargo centre, for example.

Saudia Cargo, which saw a 4% rise in tonnage during the first half, and has also rapidly expanded its freighter fleet in recent years, cites an increased focus on sales in Europe and a more flexible approach to where it flies its freighters on the continent, plus the growth in trade from China to Africa. The carrier says a recent increase in freighter frequencies to Hong Kong was almost entirely on the back of growing traffic from China to West Africa.

Turkish Airlines also continues to grow its freighter fleet, adding two A330-200Fs to its existing five in recent months, but Sukru Nenem, its vice-president cargo commercial, stresses that it is still mainly a belly operator, carrying 70% of its cargo by this method, and citing the “high profitability” of cargo carried on passenger aircraft. However, he says with only 18% of its passenger fleet consisting of widebodies, Turkish has many routes with good cargo potential that cannot be satisfied by belly cargo. Examples where freighter services have recently started include Tehran, Entebbe, Kigali, Kuwait and Karachi.

Despite such examples, there does seem to be a trend for many carriers to become increasingly focused on belly capacity, and one question is how this will affect the standing of cargo within airlines. Shah says that many airline chief executives do not really understand the role of belly cargo in making routes profitable, and says a culture change is needed to give cargo a seat at the table.

Evans thinks that is happening as cargo-friendly passenger widebodies are rolled out.

Meanwhile, any executive who can come up with new ways to fill belly space looks set to have a promising career. “We need to adopt new sales techniques to generate more volumes by air,” says Wraight. “The big question should be: How are we going to justify all this new capacity we have brought in?”