Market Outlook: What lies beyond the downturn for airlines?

This story is sourced from Airline Business
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The majority of the December year-end companies have now reported their 2008 results and given their perspectives on 2009. Against this background it is worth spending a few moments on some of the possible outcomes in the near- and medium-term, and to give some consideration to the factors that may determine the ability of the industry to create shareholder value in the next upswing.

Given that we all expect the next 12-18 months to be particularly challenging, there is little to be gained from speculating how bad it is likely to get before we reach the turning point. There are still cases where hope appears to be triumphing over expectation.

While my view has been that 2009, in terms of financial performance, will be worse than 2008, this is not a view that has been universally shared. One thing that has become increasingly evident over the last weeks is that the expected fall in the fuel price will be insufficient to counter the combined effects of the continuing deterioration in the economic environment, the reduction in revenue resulting from the continued fall in traffic, the deteriorating mix and generally lower fares.

Although capacity is being withdrawn and the number of parked aircraft has increased by some 30% over the last year, the real process of adjustment has yet to occur. It is not a question of just hanging on for the bumpy ride the real issue is the size that the industry has to retrench to in order to be able to prosper in the next upswing. Equally important are the factors that may act to prevent this, enabling the industry to generate the returns necessary to create rather than destroy value.

Consolidation has been suggested not only as necessary in the current circumstances but is seen by some as a panacea to the problems of the industry. Unfortunately this is not the case. Turning to the thesaurus, alternative meanings for the verb consolidate are to combine or merge on one hand and to strengthen and secure on the other. We have seen airlines combine and have greater size in the marketplace but they are no more financially secure.

Of course, consolidation can occur through market exit with the remaining participants becoming stronger. The number of airline failures in 2008 was in the order of 30 but this had a negligible impact on the overall ­market. Attention will inevitably focus on whether a large "national" airline will be allowed to fail, given the bailouts that have been arranged for a number of other sectors.

This is one of the great unknowns but it would depend on the industry structure and, ultimately, the local government's view on what are now known as "stakeholder issues". One solution would be for the government to seek to broker a deal with another airline. But it is important to remember that a strong company is not going to emerge from putting two weak companies together, and there is a considerable risk to a stronger company if it acquires or is merged with a weaker company.

There is already evidence of airlines approaching their governments for support. Add to this the view expressed by one industry body that it is the obligation of governments to support their airlines, whether or not they are privatised, and this tends to suggest that public money may be used. While this would distort competition, it will perhaps be the inevitable ­outcome in some countries.

The consequences of macroeconomic and policy objectives being of paramount importance will mean that at least part of the airline industry will enter the upswing with less prospect of generating an adequate financial return than it did in the early part of this decade. While some elements of the downturn are depressingly familiar it looks as if so too will be some of the elements of the eventual upturn.