Commercial smog in Asia December 1997

What’s happening in Asia at the moment is an eerie reminder of the Western market before the great slump of the early 1990s — a combination of over–expansion, weakening demand and financial innovation.

The immediate problem is that Asian airlines are committed to taking delivery of and paying for about $18bn of aircraft now or in the near future (this figure has been estimated by taking the aircraft scheduled for delivery in the second half of 1997 and the whole of 1998 then plugging in our estimates of the relevant new price for each type). We have then calculated the effect of the devaluation of local currencies against the US dollar on the various airlines' budgeted expenditure.

These airlines are going to have to find an additional $3.4bn in financing. To put this figure in context: it is over three times the $1.1bn in net profits that the Asian airlines reported in 1996.

While this figure is alarming, it may not necessarily have a direct impact on the airlines' bottom lines. It depends on how the exchange rate losses are accounted for. Some companies will reflect the currency effect on their balance sheet debt through a one–off exchange rate loss which will show up fully on the P&L bottom line; others will also revalue the corresponding assets (existing aircraft and those on order) upwards to balance the increase in debt, and the effect on the P&L will only be apparent through an increase in depreciation charges.

Boeing, which accounts for nearly 80% of the Asian deliveries scheduled for the short term, has decided not to panic: President Ron Woodward, speaking at the World Affairs Council on November 20, stated: "So far we're feeling comfortable", and went on to explain that Asia’s airlines seem to have been insulated from the currency turmoil because the bulk of ticket sales are denominated in dollars.

This is true but it is becoming very difficult to untangle the currency effect on revenues from effects caused by stock–market chaos, dented business confidence, political changes or, indeed, smog.

Take Cathay Pacific. Hong Kong resisted the currency speculators, and the Hong Kong dollar has for the time being retained its parity with the US dollar. But 20% of Cathay’s revenues are in Yen, which has devalued against the dollar, further diminishing the former colony’s attractiveness as a Japanese tourist destination. In August, the latest available month, arrivals from Japan were down 56%, while SE Asian arrivals dropped 34% and European 18%. The result for Cathay was an unprecedented 11% decline in RPKs.

MAS is one carrier with a heavy reliance on dollar–denominated tickets which could conceivably benefit from the collapse of the Ringgit, but the parallel crash in the Kuala Lumpur stock–market scuppered its plans for a rights issue which was to have financed its fleet expansion. Its debt/equity ratio has deteriorated to 2/1. The benefits of MAS’s, and Thai’s, restructuring strategies are not totally lost, but they are not visible at present.

Korean Air had been one of the few carriers maintaining traditional Asian growth rates — traffic was up 13% in July but this was on the back of a 17% increase in capacity. Since then traffic numbers have dried up, as has the outward travel market following a 25% devaluation of the Won. With one of the most ambitious fleet expansion commitments in the world, Korean would seem to have enough problems of its own (analysts are predicting a Won250bn loss for 1997, compared to a Won210bn loss last year) but it is also under pressure because its parent Hanjin is the second most loss–making of the $1 (the most loss–making, Sammi, recently declared bankruptcy).

JAL’s traffic growth this year had been almost non–existent, partly because ANA has been pumping capacity into the international market, but now both airlines face the fall–out from the Yamaichi episode. In the last recession Japanese corporations reacted not so much by restricting total business travel but by downgrading the class of business travel, so JAL and ANA can expect a significant reduction in their average yield.

Surprisingly, the airlines best suited to coping with the crises could be the weakest in the region — PAL and Garuda. The Philippines and Indonesia are used to dealing with currency devaluations and their middle, flying classes tend to keep their investments in hard currencies, so their wealth may have been boosted by the currency crisis, while at the same time tourism may be boosted by lower local currency charges.

This is one small patch of clear sky in the commercial smog. But in general, Asian airlines face very serious problems to which there are no easy answers.

The most logical response would be to negotiate delays or even cancellations of deliveries, but the manufacturers seem set against this. The alternative is to turn to sale/leasebacks of the new equipment as a means of obtaining injections of harder currencies. Activity in this field is expected to take off, especially as Western banks have seen their margins eroded to such a degree on credit–based lending that they are again willing to take a risk on asset–based deals.

Superficially attractive to the airlines, a burst of Asian sale/leaseback activity could generate future problems for the regional industry. Unless traffic growth suddenly resumes at record levels airlines could find themselves stuck with surplus capacity at the same time as paying rentals that reflect peak market pricing. That will lead to real sales of equipment, which may depress asset values, which in turn will make the leveraged airlines even less competitive … a vicious circle.