Operators wary of optimism in view of slender profit margins

 - October 26, 2010, 11:15 AM

Ultimately, and unsurprisingly, the international market for private and business charter flights is a microcosm of the wider global economy in which it resides and which it serves. So, given that each new day brings fresh uncertainty and conflicting information about the fate of the world economy, why would we be surprised that the charter market too is steeped in uncertainty and insecurity?
Recent months have brought some grounds for encouragement to operators and brokers alike, but many have endured enough anxiety and discouragement since the advent of the global financial crisis some 24 months ago as to be wisely reluctant to view this as light at the end of a dark tunnel. Unpredictable swings in demand are the new norm in this market, and so too is overcapacity sustained by the continued depression in the aircraft resale sector. This has forced operators to take a cold, hard look at their cost structures as they try to survive on slender profit margins.

According to David Macdonald, product director with major brokering group Air Partner, the charter sector is now seeing steady positive growth. Air Partner’s flight bookings in the recent months of June, July and August were all ahead of the same period last year.

“The corporate and private clients are coming back,” he told AIN. “People are doing business again and they need to start flying again. People who didn’t fly privately last year are doing so this year; they simply took a sabbatical.

“We have slowly gone from being behind the drag curve to being slightly ahead of it,” said Macdonald. “The recession did not hit Air Partner as much as some other people because we’re in the flexible part of the industry and so even with people cutting back on their spending we did not see a mass exodus from products such as the Jet Card [Air Partner’s block charter program].”

“This situation showed that flexibility has a huge financial value,” Macdonald claimed. “You might think you are getting a great deal with something like NetJets [fractional ownership], but you have to build in a risk question mark, and people have been caught out by a lack of risk analysis.”

Macdonald reported that charter rates have stabilized after dipping markedly in the immediate aftermath of the financial crisis. For privately owned aircraft in the charter market under management contracts, he has observed a tendency for owners to hold out for minimum rates rather than let them be used at or below cost. “They’d rather fly less than fly for less,” he commented.

For Air Partner, arguably the most improved region has been the Middle East, which has moved from being an emerging marketplace to one that is established. Until fairly recently, the broker could barely function in that part of the world because there were so few licensed operators and so much illegal charter.

According to Per Marthinsson, CEO of online charter portal Avinode, the market is now recovering and he sees a mood of optimism among his clients. “When we talk to customers they generally feel that the summer [of 2010] has been great and some have said that it was even better than at the peak and also that [profit] margins are coming back,” he told AIN. “This is good because some of them have been flying for no more than DOCs [direct operating costs] and you can’t make a business out of this.”

Avinode is used by more than 1,400 operators in some 65 countries. Its statistics for online charter inquiries suggest that the market has been picking up since the fall of last year, but uncertainty about whether the rise in demand would be sustained has clearly lingered. Although inquiries do not necessarily correlate directly with actual volume of flight bookings, the Avinode data has shown steady month-on-month growth over the past 12 months.

According to Marthinsson, while the recession has driven some operators out of the business (either through bankruptcy or because aircraft have had to be sold), new players have also entered the market. At the same time, Avinode has observed privately owned aircraft that were not previously available for charter being added to commercial air operator’s certificates in a bid to earn some income and also aircraft that had been on an AOC but rarely made available for charter now being offered more freely to third-party clients.

“But, overall, supply [of aircraft] is still outweighing demand,” said Marthinsson. “A full recovery will be slow because demand is still low compared with supply, but the industry is going in the right direction.”

Marthinsson maintained that operators can still differentiate themselves from rivals by offering new aircraft such as the Dassault Falcon 7X, for which there is strong demand. “They also have to be more savvy in selling empty legs and improving utilization,” he added, arguing that the Avinode service comes into its own during hard times by providing the tools users need to get maximum return from their assets, through channels such as Air Partner’s EmptySectors.com site, which Avinode supports.

Avinode’s market data bears out the perception that through the downturn demand for larger jets has held up better than for smaller models. But Marthinsson suggested that the market is rebounding to the extent that light and midsize aircraft are becoming more popular again.

From the frontlines of Europe’s troubled marketplace, DC Aviation has seen a slight overall rate of recovery, but with larger aircraft flying longer sectors faring distinctly better than the smaller/short-haul end of the fleet. “Our own long- and medium-range aircraft have now regained good levels of capacity utilization,” said the German company’s new CEO, Michael Kuhn.

The Stuttgart-based operator added three Airbus Corporate Jetliners to its fleet, and Kuhn told that demand for these has proved to be “astonishingly large,” to the extent that they now account for a quarter of all its flight hours. At the same time, its Cessna Citation XLS jets are also achieving some recovery in short-haul demand.

The former Daimler Chrysler flight department set itself the conservative goal of maintaining 2009 levels of flight activity during 2010. As the final quarter of this year started, Kuhn said that the firm is ahead of its revenue projections but he cautioned that the market could need fully three years to achieve a complete recovery from its recent low point in 2009.

Russia and CIS Hit Hard But Rebounding
From DC Aviation’s perspective, the charter market in Western Europe is now seeing average growth rates of around 10 percent. Demand in Russia and the Commonwealth of Independent States saw the steepest fall in response to the financial crisis but is now bouncing back more strongly.

By contrast, Kuhn maintained, the Middle East was more resilient in the downturn and continues to offer strong potential for growth. This is why DC Aviation intends to establish a joint venture in the region, offering aircraft charter, management and maintenance, early next year. The company has also seen a marked increase in demand for flights to and from, and within, Africa.

Since last fall, DC Aviation has had clients who had not flown at all for the preceeding six months gradually getting back into chartered aircraft. Last year over­capacity in aircraft available for charter compelled the company to cut rates by up to 20 percent (at a time when other operators were discounting even more deeply). Now it sees charter rates firming up once more.

DC Aviation currently operates 29 aircraft, of which 20 are available for charter (with the remainder being managed purely for private use). This is fewer jets than it operated in 2008, after the company lost “a handful” of clients to the economic crisis. The company owns about one third of the fleet, and next month it is set to become one of the first European operators of Embraer’s new Legacy 650. A second example of the type is due to arrive next year.

For London Executive Aviation (LEA), trading conditions are also improving, with charter hours for most of its aircraft climbing by 20 to 30 percent this year. However, chief executive Patrick Margetson-Rushmore pointed out that these increases should be seen in comparison to greatly reduced activity the previous year and indicated that it is still premature to talk in terms of a recovery.

Like many operators, LEA has seen significant variations in demand within its fleet, with larger aircraft generally faring better than smaller ones. For example, the UK company’s Legacy jets were busy over the summer months, as were its Bombardier Challenger 300s. However, to stimulate demand for its Cessna Citation Mustangs it had to lower rates. “It had a beneficial effect in terms of hours, but you can play on the margins like this only for a temporary period,” Margetson-Rushmore told AIN.
LEA also operates a new Citation Excel and demand for this has also seen peaks and troughs. Part of the problem for operators today, said Margetson-Rushmore, is that it is hard to understand or predict when and why a particular aircraft will be in demand, or not.

On the plus side, LEA has lately seen renewed interest from aircraft owners wanting to use its services for pure management (that is, without offering the aircraft for charter). That said, generally flying by aircraft owners has been down by as much as 40 to 50 percent over the past 12 months.

Operators in Europe have also had to contend with quite severe currency exchange rate fluctuations over the past two years, playing havoc with profitability and competitiveness at an already difficult time. Rising fuel prices have added more pressure.

“This is a volatile market we are in, largely due to things that are outside
our control,” concluded Margetson- Rushmore. Over the past year, LEA
has confronted the factors it can con­trol–restructuring its debts and reducing staffing and wage levels to the extent that it now feels it is “out of the tunnel.”

With charter operations across three continents–in the U.S., Europe and the Middle East–Gama Aviation has a fairly comprehensive perspective on the state of the charter market. “It’s slightly better than it was 12 months ago,” said CEO Marwan Khalek. “At that time we were wondering whether the market was bottoming out. Well, that uncertainty has now gone, so we probably were. Now we see a gradual trend in the right direction, but it will be a shallow climb, and there won’t even be a steady time for some time to come. There is simply no consistency in the market.”

The continued weakness in pre-owned aircraft sales means that few aircraft have left the charter market, preventing a correction in the supply-demand ratio that would have benefited operators. According to Khalek, demand has risen slightly in recent months, which has improved flight activity volumes and charter rates to some degree. “But over the past 12 months rates have been crazy,” he told AIN. “People were buying cash flow, and that’s just not sustainable. It’s not right for the [aircraft] owners. Management companies should be more responsible. Despite the softening in demand, some operators have focused on quality, standing firm on pricing, and this is not lost on the clients who will support it because they want value rather than just price.”

Gama’s response to the challenges thrown its way in the wake of the financial crisis has been to decelerate its growth plans to the extent that expectations and targets originally set for next year have now been pushed back to 2012 or 2013. The company opted not to cut back on the size of its operation last year, preferring instead to maintain its infrastructure. It still operates more than 72 aircraft.

“We have been through a testing situation that has made us take a hard look at the business and fine-tune things,” said Khalek. He added that Gama’s European operations have probably performed the most strongly over this difficult period and probably because it has the most balanced business model in terms of the aircraft size sectors in which it competes and because it has a healthy long-term contract business with aircraft management and maintenance income.

Gama broke into the promising Middle East market at the start of this year, securing a commercial air operator’s certificate in the United Arab Emirates in February. It now has four aircraft based in the region and expects to add one or two more by year-end.

“When things started to go south [in the charter market], there was a lot of nervousness and uncertainty as operators went into a defensive survival mode,” concluded Khalek. “There are enough signals now to suggest that this [current market conditions] is business as normal and that 2006 to 2008 were a boom period and it is not realistic to expect that we will come back to that. We are better off remembering that and reshaping ourselves to a posture of sustained growth. In fact, I am impressed at how resilient our sector has been.”