Fleeting opportunity

posted on 9th June 2021
Fleeting opportunity

Amid the chaos of last year, Cargolux achieved an extraordinarily strong set of results in its 50th anniversary year, and that success is continuing. But CEO Richard Forson is aware it’s not always going to be this way and that cargo airlines face some significant mid-term challenges, reports Will Waters

Amid the carnage of the Covid-19 pandemic, Europe’s largest cargo airline Cargolux last year pulled out all the stops to try to meet the unprecedented needs of its customers. And although the airline’s 50th anniversary year was one where there was little otherwise to celebrate, in addition to serving the sector admirably Cargolux achieved an extraordinary set of results in 2020 that few cargo airlines could have dared to dream of – earning a runaway record net profit after tax of US$768 million, up from just $20 million in 2019.

That kind of outcome would have seemed utterly preposterous at the start of the year, when the outlook for the air cargo sector and cargo airlines was originally quite bleak, with production halted in China due to the outbreak of the pandemic. But the collapse in air freight capacity due to the grounding of most long-haul passenger operations and the unprecedented demand for the transport of PPE supplies and other products kicked off an extraordinarily busy year for the Luxembourg-based all-cargo carrier.

Its fleet of 30 freighters – 16 Boeing 747-400Fs and 14 Boeing 747-8Fs – carried more than 1.1 million tonnes of urgently needed cargo last year, a rise of 9.7%, and by the end of the year Cargolux had earned total revenues of $3.171 billion and ranked fourth among IATA’s top scheduled cargo carriers.

Cargolux proudly says it honoured all the blocked space agreements with its customers that were concluded in 2019 when market conditions were significantly less favourable. Nevertheless, the huge increases in air freight prices last year due to the loss of passenger belly capacity and the demand surges meant that it was still able to deliver the extraordinary record results.

The airline’s CEO Richard Forson modestly jokes: “I think if there are any cargo airlines that did not make a good level of profit in 2020, there would have been something seriously wrong with them.”

Nevertheless, Cargolux’s financial performance last year was exceptionally strong. And despite the challenges of the pandemic, things are looking pretty good for Cargolux again this year.

Good first half
“The first half is definitely going to be very good,” Forson notes. “For the second half, I think a lot will depend on how the various vaccination programmes get completed in order for travel to open up again, and also whether vaccination passports are going to be accepted universally around the globe.”

Although the airline and its profits are flying high, Forson is keeping his feet firmly on the ground – particularly when it comes to planning the airline’s capacity needs within this volatile and uncertain environment.

“I’m quite happy with the amount of capacity that we have; it’s always good to be shorter on capacity than long on capacity,” he notes. In a sector that’s been hurt by overcapacity in the past, he notes: “I’m looking at when demand is going to drop, and the implications for Cargolux then.

“At this point in time, I don’t have any trouble filling up my aircraft. What keeps me awake at night is when the situation reverses and belly space comes back into the market in significant quantity – or if there is an economic slowdown of significant proportions. Then I think the level of overcapacity in the market is going to be much greater than it was before – because people have been converting passenger aircraft to freighters, ordering freighters, building up fleets, and new start-ups coming online.

“So ultimately, if a decline comes, it could be extremely tough times for the industry. It’s nice to be in this current position, but I would be naive to think that it’s always going to be this way. There is going to come a time where it will reverse, because that’s the natural course of things.”

While 50-year-old Cargolux has learnt plenty of lessons about air freight’s cyclical past, he is aware that others may not have.

“I see still a lot of entrants coming into the market or people wanting to buy capacity, converting passenger aircraft to freighters, expecting this to continue until 2024,” he observes. “That’s all very well, but when you make an investment into aircraft, you’re not investing for two or three years – unless you’re fortunate enough to get it at a reasonable price on a very short-term lease.

“If you’re buying new, you make an investment for 20 to 25 years. And even if you lease, you are normally leasing beyond two to three years. That said, if the rates are high enough, people can maybe wet lease; but it’s not going to be cheap.”

Forwarder behaviour changing
He notes that the behaviour of forwarders is changing as well, highlighting: “In order to hedge themselves against any increase in prices during these times, a lot of them have entered into their own wet-lease agreements of a shorter duration, and there are parties out there that are prepared to give them that. We do year-round charters for certain of our clients, but there’s a limit to what we can offer on that basis.”

That limit is the airline’s total capacity, and the way it manages that. “We need to be able to allocate it out amongst our various customers, so we are not overexposed in any one area,” Forson explains.

He is very aware that the level of under-capacity in the market currently is only because of the pandemic – and that passenger airlines “have become innovative and used their passenger aircraft as freighters, because the rates are so attractive”.

Although some say those preighters will only fly profitably while prices are at a certain level, Forson notes: “If they own an aircraft already, then all they need to really cover are their variable costs – crew, maintenance, and fuel.”

He is also conscious that some passenger airlines “have now come to realise that they’re sitting on a very valuable asset in the belly” – and that might change the way they approach the cargo market and change the competitive landscape.

“And with the growth in e-commerce, you’ve got the big integrators in the process of adding significant 747 capacity,” he notes. “UPS has bought the last 28 B747-8Fs, so they’ll be the biggest user. But in addition to that, many of the belly operators are converting to more-efficient aircraft; it’s likely that the ability to carry cargo is enhanced versus the older generation of aircraft that they’re getting rid of.”
That all adds up to a complex picture when it comes to the capacity-demand environment – and planning the next stage of a cargo airline’s fleet development.

“Typically, what we find is when the markets are booming, that’s when airlines order,” Forson highlights. “And by the time they deliver, the market is in decline. So that’s what we need to be careful of.”

Environmental considerations
And there are also increasing environmental issues. “With the ending of the manufacturing of the 747-8F, the only aircraft left is the B777 classic freighter – but that is not new technology,” Forson highlights. “If I consider the environmental considerations and the ambition of the industry to try and cut its emissions by up to 50% by 2035, are we going to be able to do that? That’s also an important consideration when I look at re-fleeting, and it’s not going to be easy to re-fleet.”

He believes a lot of airlines that received state aid during this period “have continued to a certain extent with their re-fleeting programme – an opportunity to get new technology aircraft in and to ground inefficient aircraft, including four-engined aircraft.”
Limited options
With no more 747 newbuilds available, re-fleeting options are currently limited for large widebody freighter airlines.

“Obviously, this is the end of the four-engine aircraft era, so it will be a change for Cargolux,” Forson notes. “Any other new freighter will not have the nose-loading capability. But the biggest issue today is that besides the Boeing 777 classic, which is old technology, you don’t have a freighter from Airbus or Boeing that can be offered to customers.”

He adds: “It will also mean we would have to go to twin-engine ourselves. That brings its own set of operational complexity.”

Cargolux has not yet come to a decision on the next stage of its re-fleeting. “We would wait to see what is on offer from either manufacturer – Boeing with their 777FX and Airbus on the A350 side – what it means for the airline, what it’s going to cost, and also what kind of business case one could put together in this environment,” he notes. “What are the emissions reductions? Trying to cut emissions is going to add costs that airlines will have to carry.”

Level playing field
Environmental considerations are especially key for an airline in the EU, with Forson noting: “Obviously, we don’t want to see the playing fields being further distorted by European airlines becoming subject to a set of rules which other airlines don’t have to adhere to in their home markets.”

CO2 reduction is quite a complex topic already within the EU. “It is something on our radar, with various projects underway to see how we can reduce our carbon footprint, but at the same time not have a significant negative economic impact on our sustainability,” Forson says.

“Everyone talks about sustainable aviation fuel, but it’s four to five times the cost of normal jet kerosene. So, who’s going to pick up that cost? It cannot be the airline on its own because we will be out of business very, very quickly.”

For a Europe-based 747 operator, all these factors coming together might seem like an existential threat. But Forson is unfazed.

“That’s the challenge as we go forward: how do we continue to be a relevant player in the marketplace? We operate a 747 fleet; we still have the -8s, which are the youngest aircraft in the fleet, so they will be with us for many, many years to come.”

He continues: “The biggest question is what aircraft is going to replace the 747-400s and the ERFs? Is it going to be a product that Boeing or Airbus puts onto the table or do I start looking at converting 777-300ERs – which might not be the best, but it’s a compromise.”

But on the whole, Forson is confident in the future. “I think air cargo, or moving things by air, is always going to be part of the logistics chain,” he says. “So, I don’t think there’s a threat to our existence. It’s going to be more about optimising what we have and how we organise ourselves for the future.

“More importantly, are we going to get to a position where the aircraft manufacturers say: ‘I don’t think it’s going to be worthwhile to make an investment into a freighter’?”

That would then push the sector back to where it began: using converted passenger freighters.

“I can’t answer the question today because I don’t know,” Forson acknowledges. “Airbus and Boeing are both working on products and I wait to see what they are prepared to offer. And obviously one would then do the comparisons and pick the one that makes the most sense for Cargolux’s future.”

He says Cargolux has no plans to add aircraft in the short term, having added three ERFs in 2019, and another in 2020. “They were fairly young aircraft, so they will continue to soldier on for quite a while,” he notes.
That fourth aircraft had been planned already rather than being a response to the pandemic opportunity.

“At that stage, getting any kind of additional capacity would have been priced out of being economically viable – also in terms of the ability to operate any additional capacity efficiently with the crew numbers we have,” Forson explains.

“We are quite happy to operate with our 30 aircraft. And even going into this year, others have been adding to their fleet… We have decided to remain where we are. We continue to offer an attractive network to customers.”

Operational challenges
Besides, on an operational basis, it has been challenging operating to certain countries, Forson stresses. “In China, and in Hong Kong, we don’t do any crew layovers at this point in time,” he explains. “And there are certain other countries where we don’t operate to because of the pandemic restrictions and health exposures of our crew. So, we’ve also adapted our network to focus capacity into those areas where capacity is required most and we can service the destination reliably.”

For example, “there are certain countries in South America where we took out our rotations. And the requirements for additional crew to operate non-stop without crew layovers in China and Hong Kong also impacts our ability to continue with other routes.”

Africa hurdles
Cargolux also stopped serving Africa at one stage. Although it has reinstated Johannesburg and Nairobi, where it is able to manage crew layovers safely, “west Africa has still not been put back onto our network”, with one of the issues being the safety of crews from a sanitary perspective, Forson highlights.

But the most challenging operational restriction currently “is not having the ability to do crew layovers in China and Hong Kong, which are really the powerhouse that’s driving everything at this point”.

Nevertheless, Cargolux is still able to operate to and from China and Hong Kong at a frequency level that it wants to. “I think we’re actually offering a lot more capacity to and from all our destinations in Asia than we had before. So, that was a refocusing of the network from our side as well,” Forson explains.

He says a lot of passenger operations to and from west Africa, especially from the Middle East carriers, have continued or been reinstated. “So, there is already some form of supply going into that market. But at this stage, from a Cargolux perspective, it’s not scheduled to come back into our network. I have to focus on those areas where I see the demand to be the greatest. I can’t serve a whole network with the resources I have within the airline currently and I’m not going to go and just acquire more resources – because I’m looking into the future when times may not be as buoyant as present,” Forson explains.

“So, it’s a balancing act.”

E-commerce opportunity
While there has been much excited discussion about the explosion of e-commerce and the opportunity or threat this may bring to air freight, the self-appointed “forwarder’s airline” mostly sees e-commerce like any another commodity that it carries.

“We just do the flying,” notes Forson. “The distribution has to be done by third parties.”
The key factor for Forson “is where the goods that are going to be distributed are manufactured. At this stage, the bulk of it seems to be in Asia.

“So, we fly the goods in bulk from Asia into Europe, and into the US, for example, and from there they go to the e-commerce fulfilment centres, or the various retailers that sell through the e-commerce platforms – and from there through a different network to the final customer, mostly either the express operators or the postal service. Our business model is based on B2B rather than B2C.”

Although Cargolux does “constantly monitor what’s taking place in the e-commerce industry”, including the expansion of some of the main players into the logistics and air freight sphere, any e-commerce business Cargolux carries is managed via its freight forwarder customers rather than directly with those shippers.
“We only operate through freight forwarders; we are an airline for the freight forwarders,” Forson stresses. “You need a forwarder on both sides to handle those shipments.”

For Forson, those relationships have not fundamentally changed during the pandemic – even if some forwarders have talked about a reluctance among airlines to offer much long-term capacity and pushing customers towards the spot market.

“On our traditional markets where we have offered block space agreements, we’ve increased the amount of capacity that we are offering to clients,” he says. “Obviously, any client is not going to get what they wish for because I have to consider all of my customers at the same time and treat them fairly as well.

“So, I’m not keeping back block capacity, but I have a finite amount of capacity which I need to allocate. And I need to play fair with all the parties that have supported the airline through the bad times and the good times.

“Those parties that were fortunate enough to negotiate good rates in 2019 for 2020, they benefitted; we did not say ‘sorry, these are no longer applicable, we are changing now to a complete ad hoc system and you take it or leave it’. We honoured those commitments, at the rates that we agreed; we did not increase those rates at all.”

He continues: “Obviously, coming into 2021, the rate profile is going to be different. But we have provided an increase in capacity for most of our major clients. We’re not able to satisfy their complete demand. I try to be fair to all my major customers.”

Air freight’s prospects
On the question of whether the pandemic has changed air freight’s long-term prospects, some people talk about this crisis having increased people’s appreciation of air freight, and this being a good thing for the sector. But others say it has also highlighted the fragility of the system, meaning logistics managers are going to be cautious about relying on extended global supply chains based around air freight supply.

Forson responds: “For me, a lot is going to depend where the places of manufacturing are going to be set up in the future. At this stage, it’s focused in Asia. So, to get the products to the markets, you either use sea or air.”

Long-term outlook
He continues: “I believe that there’s always going to be a place for air freight in the marketplace. For a long time now, it’s been driven by exports out of Asia. Is that going to change? That’s a big question. And if it does change, what does it mean for the consumer? Is it going to result in higher prices because it’s being produced closer to home? Are they going to be prepared to pay the higher prices? The sole reason it went out to Asia was because of the cost of production.

“And even from China, it was outsourced to places like Vietnam and Thailand, Cambodia, Indonesia, Malaysia – all of those countries benefited from it.”

On the environmental issues, he notes: “Everybody decries the CO2 emissions of aviation. Aviation today is a very small percentage of total CO2 emissions, but because we are a high-profile industry, we are in the spotlight.”

He adds: “I think the industry does acknowledge that they have a contribution in reducing CO2 on a global basis. But as I’ve told my Corporate Social Responsibility people, I want to do something that is sustainable and that is real. I want to spend my money where I get a constant return in CO2 reduction.”

More broadly, he notes: “And even as we go forward, over the next 10 years, I think it is an extremely brave person that predicts what this industry is going to look like.”

Forson says he often gets asked what Cargolux’s capacity is going to look like in the future, and that is also difficult to precisely predict.

He concludes: “I will always want to be a relevant player in the marketplace. At this stage, I think we are number six worldwide or maybe slightly higher in the first quarter of 2021, number four at the latest measurement. But to me, that’s not the most important thing. I want to be a relevant player – in the sense that, when a forwarder needs capacity, we are on the first list that he’s going to call.

“If it means 30 aircraft or more than 30 aircraft, that’s a business decision we then have to take as Cargolux.”