The Meaning and Implications of Aviation Cycles
Despite an “undeserved” reputation as a pessimist, Adam Pilarski, Senior Vice President at AVITAS, is upbeat about aviation’s the short-term prospects, although a downturn is on the way.
At the recent Dublin Airﬁnance conference, a speaker addressing the question as to where we are in the cycle recited a long list of factors supporting the positive long-term prospects for the industry. Most people, though, do not need
to be reminded of our long-term prospects, but they have no doubt that ours is a cyclical business. It is also quite obvious that we are past the peak and nearing a periodic slowdown.
Over the past few years, we enjoyed continuing growth of world economies, good performance of airlines and an apparent order bubble. All these facts do not contradict the prospects of good fortunes still awaiting us, but highlight that changes are coming and those most prepared for them will do better than those competitors which are not planning for a downturn.To assess where we are related to the cycle, we need to make a distinction between different elements of the aviation industry. Airlines are at a different stage than manufacturers, which face a different reality than investors or lessors.
To assess where we are related to the cycle, we need to make a distinction between different elements of the aviation industry. Airlines are at a different stage than manufacturers, which face a different reality than investors or lessors.
To make life even more exciting, each category can be further subdivided into segments that have their own mini-cycle. So, passenger and cargo airlines are not in the same position, same for legacy and low-cost carriers. Manufacturers of jets face a different environment than those of turboprops and similarly large versus regional jet aircraft producers may be at a different phase of the aviation cycle. Even for the two duopolists, narrowbody lines face different realities than their widebody brethren.
So where are we in the timing of the cycle? First, we need to specify assumptions regarding some of the exogenous factors affecting the various segments of aviation. While the US economy is in the fourth-longest expansion period in its history, a downturn will have to happen eventually. The new administration has explicit plans to expand spending, which probably will stimulate the economy for a year or two.
There are no obvious signs yet of an economic disaster looming in other parts of the world, so we can speculate that we still have some momentum towards increased worldwide economic growth and world traffic. New economic realities point towards higher inﬂation rates and the dollar appears to continue staying at historically strong levels. Airlines just had the most proﬁtable year in their history but costs are deﬁnitely going up, both on the fuel price and labour cost fronts. And the high value of the dollar causes cost pressures for non-US carriers because both oil prices and aircraft purchases are based on that currency. Yields (ticket prices) are getting weaker but still there will be demand for added capacity. Despite some movement towards consolidation in the leasing industry there appears to be more parties planning to enter the ﬁeld. Low-cost carriers around the world are advancing their position in respect to their legacy competitors, except in the USA, where government policies seem to favour a comfortable oligopolistic status quo.
If my assumptions are correct (and this is a big “if”, subject to the usual caveats economists are famous for) what does it mean with regard to the timing of the aviation business cycle? Starting with airlines, I see intensifying competition between legacy carriers and low-cost carriers, including long-haul low-cost carrier routes, as well as between the various geographic regions of the world. Traffic will grow but proﬁtability will be weakening as yields continue their decline. For manufacturers, I see an order-to-delivery ratio of deﬁnitely below one for the next few years. This will not prevent manufacturers from increasing production levels for at least a couple of years because of the existing huge backlog. Production increases rumoured now will eventually not materialise though. With intensiﬁed competition among lessors, I see increased downward pressure on yields. Since values lag decline in demand I would venture to say we still have steam for values before a periodic adjustment will occur.
Interestingly, despite my professional training in the dismal sciences and my undeserved reputation as a pessimist, I am fairly upbeat about the short-term prospects in aviation. A downturn is on the way but I do not see it just around the corner. Surprisingly, many of my European colleagues see the realities in much darker colours but many forecasters in Asia share my views. All these views can be invalidated by unforeseen new developments but right now, this year still looks ﬁne, with a periodic downturn starting to come next year. And the long-term future of aviation is still good.