The airline industry may be going through its toughest time, but opportunities are out there, according to a CEO panel assembled by Aviation Today. And, those prepared to take advantage of the opportunities, including cost cutting, will emerge from the current doldrums stronger and better competitors.

Perhaps the most important message from the CEOs – John McMahon, Genesis Lease; Bob Agnew, Morten Byer and Agnew; Oscar Garcia, InterFlight Consulting; Michel Merluzeau, G2 Solutions; and Jack Demeis, Continuum Applied Technology – was the fact the industry is fundamentally a growth industry.

“Sometimes people lose sight of the long term in the middle of a crisis,” said McMahon. “The industry has had its ups and downs but fundamentally it is a growth industry. It has grown at an average annual rate of over six percent for last 35 years and by any reasonable measure is likely to grow at a five percent annual rate over the next 20 years. We’ve experienced very difficult periods including the first gulf war and 9/11 and other crises in between. But in reality the industry is cyclical, subject to external economic events. But air travel is derived demand meaning that it comes from underlying economic growth. Even so, it has consistently outpaced global economic growth for a long time. The days of the jet set are long gone and, despite the doom and gloom, air transport is rapidly becoming the only true global mass transit. In North America and Europe it is a highly developed transport system. But the rest of the world is in its relative infancy when it comes to building air transport systems. India is a good example. It’s had a great growth rate over the past several years but the entire subcontinent operates substantially less aircraft than Southwest Airlines.”

Perhaps the biggest short term obstacle for the industry is the economic uncertainty compounded by the tight lending market and the volatility of fuel. “I think airlines and investors would rather have a steady, higher price, than this volatility,” said InterFlight’s Garcia. “But the rules of the game have changed with the billions of dollars invested in alternative sources. Yes, the investment in traditional oil has decreased but alternative fuels increased and there is no turning back.”

Agnew added that fuel hedging is difficult and getting more expensive. “You are either paying or buying hedges and the cost of hedging has gone up considerably so the savings to be achieved is decreasing,” he said.

McMahon also pointed to China and Russia, which despite their slowdown, still have infrastructure needs that are not going to go away including the 40 airports China has on the drawing boards.

“With every problem there is an opportunity,” McMahon concluded. “The long-term prospects remain bright for the industry. The question is when will be recovery come and can you make it? But the type of opportunities out there can only be had if you have access to capital with banks and access to equity.”

The panel said if they could chose one improvement that would really make a difference, it would be the acceleration of the ADSB implementation that would vastly improve airline efficiency and fuel consumption.

Demeis agreed reiterating that air travel in the only global mass transit and its users are key people in commercial business. “Worldwide there is substantial opportunity to move forward,” he said. “And there is a lot of emerging technology that is coming out of aviation and aerospace which will be transferred to other industries and monetized, with fuel being the best example. There is opportunity amid uncertainty.”

In addition, Garcia indicated that the airline industry is only the tip of the iceberg when seen in context of the commerce chain that exists to make those airlines work. “People ask me all the time why invest in sector that looses billions per year,” he said. “But the underlying industry is phenomenal and exponentially more profitable than the airlines,” he said. In fact, he sees the aerospace industry as a source of funding for airlines.

McMahon agreed, adding, “If you except the fact that air travel across the planet will increase over the next 20 years, it then follows that there will be a huge need for additional aircraft which will see the doubling of the current 19,000 world aircraft fleet in that time.”

He is, however, watching closely whether China GDP falls below 7-8 percent which would impact Boeing and Airbus. He also noted the a slowing of manufacturing demand throughout Asia, Europe and Latin America as worrisome.

“Oscar is right,” said Merluzeau. “The supply chain is strong. But we’ve seen a lot of small companies who have not been able to weather the storm. However, with larger OEMs, the numbers are fairly encouraging for the long term.”

Garcia indicated that the industries behind the airlines – space and defense – are less visible because they are not in as big a crisis or shrinking and the technology they develop eventually trickles down to aviation and airlines. “Aviation and air transport is highly leveraged but as you go down through industry, it is less and less dependent on a quick-return investor,” he said. “And, if you look at potential investments, the aviation sector has the thinnest margins because it has the highest dependence on oil.

“But even with thin margins, the airline industry as a whole makes money year after year,” he continued. “Yes, 2008 will be different but if you look at the total losses and you exclude the U.S. airlines in normal years, the industry makes money. Of course, that does not mean that the rest of the world’s airlines should not keep pressure on costs. The challenge is to make one of its most volatile costs – oil – fixed and with all the investigations into alternative fuels that may be happening. ”

Garcia pointed to the broader aerospace and defense industries. “You see, even after the meltdown, they are strong and robustly funded,” he said. “A lot of it is built on the demand for satellites which are aging. There are hundreds of billions in profits in the defense industry. Where is that? Why don’t we approach them to see how they can help us during this period by transferring liquidity and freeing up money for airline investment?”

Agnew agreed. “We haven’t seen the full effect of what Boeing and Airbus are going to have to do and how far they will have to dig into pocket as far as keeping aircraft moving,” he said. “He said lessors have commented on the fact that one deal United tried to do to increase its liquidity which failed would have meant it would have doubled its lease rate. But, that is a two edge sword, meaning that residual values will remain strong if that kind of financing remains difficult.”

Agnew sees a growing tension, between buyers and sellers. “We’ve been involved in a number of transactions that have not come to fruition,” he said. “Even after all honest haggling, the sellers are not quite willing to take the loss that is being asked of them. We are seeing a bid-ask gap of 15 to 17 percent on whatever the value of the asset might be.”

Garcia added that there is money for lending but not to everyone. “Only to fittest and most data-driven companies that can offer realistic proposals,” he said. “They are getting the money.” He also pointed out there is a disconnect between investors understanding the cyclical nature of the industry. “Those in it for the short term miss the point. We can promise realistic cycles and we deliver. Airlines are very good a forecasting cycles and responding early. The conclusion is that yes we are in a crisis but we are approaching a new world order after which we will be back in business and preparing for the next cycle in 2019 or 2020.”

Indeed, Agnew said that history shows that cycles don’t tend to last that long and from peak to peak is eight years at most. “The question then becomes whether people are right that things are different this time,” he said.

The huge levels of orders slated for delivery over coming year is going to be the challenge, said McMahon. “There are a number of experienced aviation banks,” he said, “so money is still available but on a more limited basis, and margins under pressure. There is almost an exclusive focus on latest generation aircraft because banks take the long view.” However, Demeis noted that airlines, in the face of falling fuel, are rethinking some of their older aircraft because of the cost of capital and their inability to get it.

Merluzeau sees Boeing 787 delays as a benefit in that it stretches out the life of the aircraft, as well as extending the life of others. “There is a strong market for 767 and 757 which is indicative of the fact that airlines already factored in delays of 2-3 years,” he said. “Boeing is finding more problems than initially thought so I don’t see it entering service until 2010. To some extent, that’s a blessing in disguise and will help carry the aircraft another 2-3 years. More than that, however, it means that we are going to see tremendous opportunity for upgrades for the757, 767 and A330s in the next decade in terms of avionics.”

He also indicated that the industry is doing what needs to be done to tap into that money. “There is no question that 2009 is going to be a year of intense survival skills for airlines,” he said. “But airlines have been hard at work to cut costs and be more efficient and I would say that whoever can weather 2009 will be okay beyond that.” Airlines, said Garcia, have saved 18 percent of their costs in the last year, according to IATA, and should be all right if oil stays low.

Continuum Applied Technology’s Jack Demeis cautioned on too much retrenching at the risk of market share which must be there when good times return. “Sometimes, when times are tough, people hunker down into a fetal position which makes it difficult to see the opportunities,” he said. “You have to keep your eyes open to possibilities which is essential for the long term.”

“The keys to successfully weathering the storm,” said McMahon, “is liquidity and having sufficient cash to meet the obligations as they fall due. Not having any near time refinancing obligations is a major plus. Not having unfunded contractual obligations like aircraft purchases is a plus. Those with the right aircraft – the latest generation, fuel efficient and relatively young are better positioned than others.”

“As for leasing companies, the key is to have no undue exposures to any one airline or region,” he continued. “It will be the quality of the operating platform, global reach and the ability to deploy and redeploy aircraft quickly.”

The CEOs noted that, although the airlines in the rest of the world still have much to do, U.S. carriers have accomplished a great deal in cutting costs.

“But,” said Garcia, “airlines have been successful in picking the low and medium hanging fruit. Cost and management efficiencies are about 90 percent complete. The good news is that, in the last two to three years, they have achieved a huge level of efficiency. What they are facing now is the high hanging fruit which is largely beyond their control – the infrastructure and framework issues that are necessary to achieve greater efficiency.”

Demeis, however, said there is still much airlines can do to achieve further cost savings. “Financial crises demand more efficiency and cost cutting, which requires an organized planned effort to establish what the true costs are, how they interrelate to all aspects of the company and what it is that truly creates our profits for us,” he said. “We have bottom-line discussions with airlines, concerning increasing sales versus cutting costs. You have to have the systems in place to accurately see what is going on in the business. It doesn’t happen as often as we’d like to see. You have to maintain strategic investments but you also have to know that everything isn’t strategic so you have to focus on what really has to be there. This process is nothing different than any type of improvement process, you have to measure, define what you measure and the key metrics, understand the vital statistics and make changes. Then you monitor the impact and repeat the process. It is being productive without waste and doing more with less.

“Focusing on growth in these times may be challenging but it is critical,” he continued. “Measure, measure, measure. That is the key to finding more efficient and cost saving operations. You have to have an efficient way of viewing and collecting information on how a company is operating and, if you do, you will find a lot of opportunity there for more savings even in North America. Yes, you have to take care of the fires that are right in front of you but you must still work on mid- and long-term growth as well.

“So it is the internal processes that have to be controlled and airlines have 100 percent control over that,” he continued. “You have to attack costs in multiple areas and multiple levels. One little piece may not yield much but the whole will have a big impact. There is also no substitute for value if you look at what the customer wants and needs. People are willing to spend money as long as they see substantial value there.”

Demeis also said airlines must take an enterprise view of cost cutting such as centralizing management of everything including inventory control that will make airlines more efficient overall.

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