35090685931_0b37dd43a1_k (1).jpg Nigel Howarth/AWST

Airline Cyclicality Now Driven By Capital Costs, Executives Say

Sustained low fuel prices, more balanced demand reduces risk of downturn.

MIAMI BEACH — If the current global air transport demand boom cycles into bust, the most likely factor to trigger the downturn isn't high fuel prices or foolhardy airline strategies such as chasing market share. It's rising interest rates.

That's the consensus of a collection of senior executives who shared their views with delegates at the recent Aviation Week Airline Engineering & Maintenance: North America conference here.

"Interest rates are the new fuel price," says Jonathan Berger, managing director of Alton Aviation Consultancy.

Fuel prices have been down substantially since mid-2014, and there is little indication that they will climb rapidly anytime soon. Airlines that revamped their long-term fleet strategies before this dip—notably the U.S majors that restructured after 9/11—built their business plans around much higher fuel costs, and are reaping the benefits.

"The fuel-cost assumption was set at $100 per barrel," Berger says. "It's down at $60. That's huge."

Another major historical cyclicality risk—an industry too heavily shaped by the fortunes in the once-dominant and now-mature North American and European markets—has also changed. The rise of the Middle East, recent financial headwinds notwithstanding, and continued emergence of the Asia-Pacific markets "means there is more balance," says Abdol Moabery, CEO of GA Telesis.

With demand spread out, a slump in one region is less likely to be a drag on others. This gives OEMs more options for re-allocating deferred orders and helps limit declines for MRO suppliers, such as parts producers, that are not dependent on a specific region.

Another factor mitigating the risk of a global slump is the airlines' increased focus on generating returns on their investments. Examples abound: Unprofitable routes are cut, bloated spares pools leaned out, used parts are welcomed, and—perhaps most significantly—capacity is kept in check. Through August, global airline revenue passenger kilometers were up 7.9% year over year, while capacity increased 6.5%, International Air Transport Association figures show. 

"By looking at return on invested capital instead of just revenue growth, the game changes," Moabery says. "As long as airlines are profitable and they manage capacity the way they are managing it today, [and] the cost of capital stays low, there won't be more cycles."

Executives acknowledge that interest rates won't stay low forever. How high they rise, and how quickly, could dictate whether the current environment is the new normal or just another cycle.

"I do think we're all living off this low interest-rate environment," says Michael Rezman, StandardAero's VP Business Development. "If it goes up slowly over time, we may get into a period of slower growth or stability."

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