ANALYSIS: Should airlines invest in full freighters?

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Are freighters in decline in the air cargo business? This might seem an odd question to ask at a time when an unprecedented number of new all-cargo aircraft - 230 widebodies in the next four years - are rolling off the production lines. This is supposed to be a golden age for freighters, when airlines have finally made long-term commitments to buy new fuel-efficient capacity such as the Airbus A330-200F, Boeing 747-8F and Boeing 777F.

Instead, the air cargo industry is suffering a crisis of confidence in all-cargo aircraft. Carriers that have invested in them seem to be struggling to make a return on capital, and those that have gotten rid of them seem to suffer no ill effects. So are airlines better off without them?

It is certainly possible to put forward a negative case, as does Larry Coyne, chief executive of Coyne Airways, a specialist air cargo operator that has no freighters of its own but charters capacity from other carriers. "The real problem is that the upside in the freighter business is not that big, but the downside is very big," he says.

"In the last 10 years or so, we have seen constant upheaval in air cargo, which is a problem for carriers who have to fly freighters 14-16h a day to justify the purchase price. If I was the chief executive of a combination carrier, I would see freighters as a bit of a headache."

Meanwhile Stan Wraight, executive director of consultants Strategic Aviation Solutions International, and a former chief executive of Russian cargo airline AirBridgeCargo, describes freighters as "expensive to operate and now expensive to buy too. And with cargo prices at passenger belly operator levels, the revenue will not return to pay for them."

This sentiment is in stark contrast to the 1990s, when operating a freighter was the sign that a carrier was "serious" about cargo. Freighter fleets grew rapidly and the widely-cited Boeing forecast reckoned that they would double in size over the next 20 years. But in fact since 1999 the fleet has barely grown at all - from 1,676 aircraft in the Boeing 2000-2001 World Air Cargo Forecast to 1,740 in the 2012 Current Market Outlook.

FLEET SLIMMING

It is certainly easy to call to mind major carriers that have eliminated or slimmed their freighter fleets. In 2005, Japan Airlines and Northwest had 12 747 freighters each; now both fleets have disappeared entirely. Meanwhile Singapore Airlines has gone from 16 747-400Fs in 2005 to 13 today, and the three airlines that now make up Air France-KLM-Martinair Cargo have gone from 26 widebody freighters in 2005 to 16 today. Jade Cargo International, a joint venture between Lufthansa Cargo and Shenzhen Airlines, exited the market in December 2011, and - as Karl Ulrich Garnadt, chairman of Lufthansa Cargo, admits - the market did not even notice that its six 747-400ERFs were no longer flying.

Other major carriers have increased their fleets somewhat, although all seem to be questioning just how big those fleets should now be. Lufthansa had 14 widebody freighters in 2005. It now has 18, as well as a share in eight 777Fs operated by AeroLogic, its joint venture airline with DHL, and five more 777Fs on order, the first of which are due to arrive later this year. Those five aircraft were planned as expansion for the fleet, but Garnadt says they may now be used as replacements instead.

Meanwhile Cathay Pacific has risen from 20 widebody freighters in 2005 (including Dragonair, which it later took over) and now has 21, but that is after disposing of a number of older freighters in the past few years, some of which it initially expected to operate alongside its eight new 747-8Fs. It has two more 747-8Fs and eight 777Fs to come, but its director of cargo Nick Rhodes admits to a great deal of uncertainty about how big the fleet might be in future.

What is making carriers doubt the viability of freighter operations? One factor is certainly the state of the global economy. Thomas Crabtree, regional director of airline market analysis for Boeing and one of the key people behind its freighter forecast, compares the current era to the 1929-1939 depression.

RECOVERY WORRIES

Then, he points out, it took two years - until 1931 - before cargo traffic began to fall, and in the next three years, it saw a 25% fall, only recovering to 1929 levels in 1939. Air cargo seems to be in a similar trough, with negative growth in four of the last five years, although IATA is predicting a 1.4% recovery in 2013 after a 1.5% decline in 2012 and a 0.6% fall in 2011.

The big question is whether everything will go back to normal once the economy recovers, with air cargo resuming the vigorous growth it saw in the 1990s. Boeing essentially says that it will, predicting 5.2% growth over the next 20 years in its 2012 forecast, although many expect this year's update to predict a reduction in that figure. "Do the last 12 years reflect the next 20? We don't think so," says Crabtree. "We expect the end of this year to see a slight recovery - low single digits - and then to see a return to trend, or above-trend, growth."

What if growth does not come back so strongly? Or what if a structural change is underway in the air cargo business? Air cargo executives worry about various nightmare scenarios: that companies are changing the way they ship goods to make more use of sea freight; or that the traditional strong Asian peak from September to November - a key time for freighter operators to make money - is a thing of the past. But the biggest concern is about the rise of belly capacity, which is seen as squeezing freighters out of more and more markets.

The concern here is that while the cargo business has been moribund, the passenger business has continued to grow, particularly for long-haul widebody aircraft which are friendly to belly cargo. Wraight calculates that there are 2,300 such widebodies on the order books, equivalent to 450 777Fs.

The great thing about belly capacity is that its costs are largely - and in some carriers almost entirely - paid for by the passenger side of the business, with cargo only having to carry extra fuel, sales and handling costs.

Wraight reckons that profitability is between 30% and 60%, while consultants Seabury Group has put it at as much as 65%."The more reality settles in with airline chief executives of the tremendous earning potential beneath their passenger fleet, the more it will be hard for freighters to earn the income they need to sustain operations," Wraight says.

Air France-KLM-Martinair Cargo certainly came to that conclusion some years ago. Catherine Colbus, its senior vice-president of revenue management, market and network, praises the 777-300ER for which Air France was effectively the launch customer.

"It can carry an impressive amount of cargo on very long distance flights, for example carrying 25t on top of more than 300 passengers from Paris to Tokyo," she says. "Every time you replace a 747 with a 777-300ER you double the cargo payload."

BELLY EROSION

She adds that the average load factors of passenger bellyholds is less than 50%, leaving significant potential for further development: "So our conclusion at Air France-KLM-Martinair Cargo is that our motto should be 'bellies first'.

At Cathay, Rhodes also says the rise in belly capacity is making the carrier "think very carefully" about how many freighters it should have. "I should stress that as a carrier based in the heart of Asia, we will always need a freighter fleet to fly to destinations where passenger aircraft don't fly and to lift the specialist cargo that doesn't work below deck. But the question remains - how many freighters do we need and of what type?"

As it happens, Wraight identifies China as one market which will certainly continue to need freighters. But he sees belly capacity already eroding the key transpacific market, and feels as much as 80% of cargo that is currently carried by freighters could fly in passenger bellies. "With 2,300 passenger planes on their way, carriers had better start to rethink their strategies," he says.

Is the fear about belly cargo overstated, however? At Boeing, Crabtree has a chart which shows that the percentage of air cargo carried on freighters has remained more or less constant at 60% (a figure which includes the volumes of the big four express operators). It was 56.9% in 2000 and actually rose to 60.2% in 2003, declined to 58% in 2009, and recovered to 59.4% in 2011. Boeing's forecast is for 60.9% in 2016 and 60.2% in 2021.

In other words, the shift to belly capacity is barely perceptible. "How is this possible when Boeing is delivering cargo-capable 777-300ERs? Because shippers still by and large prefer freighter capacity where their needs are not subordinated to the passenger business," Crabtree says. "In difficult times like these it is easy to say that freighters are in retreat, but in fact it is not true."

He admits that it got the overall figures in its 2000 freighter forecast wrong, but interestingly one key component was fairly accurate. This was the forecast that widebody freighters - those over 40t payload - would rise to 999 freighters by the close of 2009. The actual figure was 926, which is not a huge shortfall.

Why then, was the overall figure so wrong? The answer lies in narrowbody freighters, of which Boeing predicted 1,100 would be in service by 2009, while the actual figure was 650. "What we missed here was the rise in fuel prices, which forced express operators to drive unit costs down. There was a big diversion to trucking in North America and Europe as a result of that," Crabtree says.

If the number of widebody freighters has risen since 2000, but major airlines have been reducing their fleets, where have the new freighters gone? Crabtree has a big list of carriers, including China Southern, China Cargo Airlines, as well as secondary Chinese carriers such as Yangtze River Express which did not exist in 2000. Russian cargo operator AirBridgeCargo is also new since 2000, as are Qatar Airways and Etihad. The latter has six freighters already and will add three this year.

NEW CHALLENGERS

Meanwhile Saudia has boosted its widebody freighter fleet from two aircraft in 1998 to 12 today, with two 747-8Fs due to join the fleet this summer, and carriers such as Ethiopian Airlines, Turkish Airlines and LAN Cargo have become major all-cargo players in their regions.

There is another category of long-haul freighter operators which are often forgotten by the conventional air cargo industry but have had a big impact. FedEx, UPS and DHL have all put in place significant long-haul freighter networks in the last few years - FedEx, for example, now has 23 777Fs, while DHL is estimated to have 29 long-haul freighters flying.

Nearly all of this capacity has been added since 2005, and although its primary purpose is to move express items, in practice about 40% of it is filled with general cargo. This is for the simple reason that an express operator must have capacity available for any shipments that turn up on the day, so traditional cargo will always be a key buffer to enable the freighters to fly full.

It may be, then, that growth in freighter fleets has simply shifted from traditional airlines to new challengers, and with fuel prices set to stay high, that trend can only accentuate. That is because fuel costs have eliminated older, inefficient freighters - hitting the freighter conversion market hard - and forced carriers to choose between making a big capital investment in new freighters or exiting the business.

In strong manufacturing economies like China, Germany or Turkey, or for carriers with geographical advantages like those in the Middle East, that investment may still make sense. For big express operators, with their high yields and money-back guarantees to customers, it certainly will. But for other carriers, given the attractions of belly capacity, it could be a lot harder to make the figures stack up.