Ready for Leaner Times

posted on 8th February 2019
Ready for Leaner Times

Cargolux president and CEO Richard Forson is expecting tougher times ahead for his company and the air cargo industry in general after two stand-out years in 2017 and 2018. Nevertheless, the Luxembourg-based cargo airline is poised, for the second year running, to announce record annual profits, despite a progressive weakening in demand last year that is likely to become more keenly felt in 2019 and possibly beyond.

“I’m mindful of the fact that we’ve been benefiting from a buoyant market that all commenced in the fourth quarter of 2016 − the one that really took everybody by surprise,” he notes. “We then had 2017 − which I think people were still surprised by and which came forward into 2018.”

Forson, who has been at the helm since August 2016 having previously held the post of CFO, noted that while Cargolux would be “in excess of one million chargeable tonnes again for 2018”, the final quarter of last year had confirmed the slowdown in demand growth. “The additional capacity coming on to the market put pressure on yields as well, causing them to decline from their peaks,” he observes.

As to how Cargolux had been able to maintain and even improve on the outstanding bottom line performance of 2017 in 2018 as market conditions became increasingly more challenging, Forson highlighted “revenue management initiatives taken during the course of the year, which significantly impacted how Cargolux sold its capacity”.

He continued: “The past couple of years have obviously been very good in the industry, and I don’t think there’s a cargo airline out there that didn’t make money in 2017 and in 2018. So we’ve had good years, but let’s look at the future now. It’s not always going to be like this. Difficult times are coming and as a CEO I have to ensure that the business is able to weather the storms that lie ahead until the next upturn comes in.
“The crucial element is not to get carried away with what was achieved in 2017 and 2018, but to take cognizance of what will potentially face us in the years to come − whether it be from a possible escalation in US-China trade tensions and President Trump’s policy of bringing production back to America and ‘buying American’, along with his threat to impose higher tariffs on motor vehicles out of Europe into the US. These are the kind of risks the air cargo industry is facing today.”

Economic conditions
On whether the strained trade relations between the US and China was already weighing on cargo demand, Forson says: “We’ve not noticed any significant impact to date on volumes. Rather, what we may be seeing are deteriorating economic conditions (in China) that are affecting demand for its imports. GDP growth is starting to decline, and when that starts to happen, obviously countries that supply raw materials to China will begin to feel the effects as well. It’s all very unpredictable, but if there is a full-blown trade war between the US and China it will definitely affect trade volumes between the two countries.”

He continues: “Is it going to result in the US manufacturing its own requirements for consumer goods, or will production shift to other countries in southeast Asia (that are) not subject to US tariffs and start to supply the US market? The latter has already happened to a certain extent due to rising labour costs in China. There have been operations set up for manufacturing exports in countries in southeast Asia such as Vietnam, Thailand and Cambodia.”

But the uncertain global economic outlook is also a cause for concern. “Some economists are forecasting a recession in 2020 and I think the consensus is that the growth in the global economy is declining,” he notes. “The question is, is it going to be a hard or soft landing?”

He points to interest rate rises in the US and how this might impact consumption, and also to the clouds gathering over the Chinese economy. “Personal debt in the US is at an all-time high and savings at an all-time low. With the low interest rates, consumer have been spending and buying,” he notes. “So what’s going to happen once interest rates start to increase?

“And in China, if the GDP does not grow at a rate that is deemed necessary to allow the expansion of the economy, what impact is that going to have on consumption and what will be the repercussions for exports out of Europe and elsewhere − and the globalised economy in general?”

The worst-case scenario would be a “double whammy” effect from weakening economic conditions in the US and China triggering a drag on demand, Forson notes. He points to the long-established observation that if the US sneezes, the world catches a cold, noting: “And it’s the same now if China sneezes.”

Flexibility
Forson says Cargolux’s philosophy has always been to be agile and flexible and to be able to react when economic downturns kick in. “My focus is on the sustainability of the organisation,” he adds. “Sustainability during the good times is never in question, but for me the important thing is sustainability when times are not good, and we’ve seen some pretty rough times since 2008. Being able to adjust and reduce costs when this is the case is a key factor. We have expenditure that is completely variable, for example, fuel. If you don’t fly, you’re not going to pay for fuel. The challenge is to what extent I can make my fixed costs variable.”

He highlighted the fixed costs tied up in Cargolux’s aircraft, but also the “added flexibility of having a single-type fleet”, enabling the airline to ground capacity if demand reduces significantly.

China venture on ice
Meanwhile, the ongoing US-China trade tensions have led Cargolux and its partner, Henan Civil Aviation and Investment Company (HNCA), to review the launch of their cargo airline joint-venture (JV) Henan Cargo Airlines (HCA), Forson confirms. Plans were outlined in June 2017 for the JV airline to begin operating three B747 freighters from late-2018 on intercontinental routes to and from the world’s fastest-growing cargo airport, Zhengzhou in central China.
Provision is made for Cargolux to hold a 25% stake in the new cargo carrier, the remaining 75% being in the hands of HNCA − which also owns 35% of Cargolux − and the Xinggang Investment Group, responsible for the 400 sq km Zhengzhou Airport Economic Zone located 30 kilometres southeast of downtown Zhengzhou.

“The JV will stay on the back burner for a little longer. We left the actual launch date open and to put a date into stone now would be a bit presumptuous from my side,” says Forson.

“The US-China trade dispute has caused us to take a step back and re-assess all of the assumptions that were made earlier and take into account what the risk factors are while also looking at what percentage of the goods would be subject to tariffs beginning at where we currently stand to a scenario where all the goods imported from China into the US would be subject to tariffs and the other way around. What potential drop might we see in air volumes and what alternative trade lanes could emerge?”

Asked whether in the event of trade relations becoming even more strained between the two countries, the JV’s service offering could be re-directed away from US-China routes, Forson responds: “At this stage, it’s worth considering potential new lanes and what the position is on traffic rights. If there was a fall-off in air exports to the US from China it could benefit other sources of supply such as countries in southeast Asia. But what we shouldn’t forget is that China is the second-biggest economy in the world today and even if it continues growing at (only) 5-6%, they are likely to overtake the US in maybe the next 5-10 years. So there is always going to be a need for us to have an extensive footprint in China.”

Fleet renewal
As to Cargolux’s fleet, which currently stands at 16 B747-400Fs and 14 B747-8Fs, renewal is on the horizon. “The -8 will go to 2040, but the -400 is reaching the end of its life and we’ll have to start a retirement programme − probably from 2025 onwards,” Forson acknowledges. “As for its replacement, there’s currently only one aircraft we can really look at, the B777-200, but which I’ve always seen as complementary to the B747 rather than offering similar capabilities. I’m also interested in whether Boeing is going to launch a 777X freighter and if they are going to do it, when and what will the performance characteristics of this new aircraft be?

“I would also very much like to see what Airbus has to offer by way of a wide-bodied freighter. The A330 programme has not been a success. With the A350 programme, we’d be very interested if they were to come to market with a freighter aircraft. But one has to plan it carefully because having different types of aircraft in your fleet obviously introduces a complexity that you have to manage.”

He remains confident that there will always be a place for freighters in the transport of air cargo, even though today an increasing percentage of shipments is transported in passenger aircraft bellies. “One positive development for cargo carriers could result from airlines increasingly concentrating on ‘point to point’ passenger services on certain routes instead of going into hubs,” he notes. “This could lead to less belly space being available for cargo on passenger aircraft, which would need to take on more fuel to fly non-stop. This, in turn, could generate more demand for main deck capacity.”

Modernising processes
Meanwhile, the modernisation of Cargolux’s operating processes through the greater use of technology also figures prominently among Forson’s strategic objectives. “We recognise the importance of making the transition from how we do things today and how we should be doing them in the future,” he says.

“Our major customers are investing significant amounts of money in technology and the digitalisation of data. From our side, we’ve also embarked on a transformation programme in order to automate processes and make information more readily available to decision-makers, as well as improving efficiencies across the organisation.”

He continues: “Cargolux is going through some very significant revamps, but we’re not going to spend €40-50 million on anything without being sure what we’re going to get out of it and whether it fits with the requirements of customers. There are plenty of cases out there of companies spending significant amounts of money in this way and not getting the benefits.”

Among the IT changes, Cargolux is moving its non-core IT systems in-house, leaving the e-Champ system, and moving its core cargo systems across to Champ’s widely used Cargospot system − moves that are in line with its IT partner Champ’s own wish to focus purely on cargo systems. The carrier is also investing significantly in its revenue management systems and e-platform, Forson adds.

“What I have recommended to the board of directors is that even if 2019 does not turn out to be a good year, we should continue investing in the IT arena because I think that’s essential to the success of the airline,” he explains.

Increasing digital interfaces with forwarders is a prime example “of the way things are moving now”, Forson emphasises. “I need to know what my forwarders require from me and interact with them automatically. If they want information on rates, the allocation of space on aircraft, and making bookings for spot cargo, they should be able to do it themselves without calling up Cargolux.

Automated communications
“Ultimately, everything will be done on an automated basis. We don’t need to have people inputting data − one of the key aspects of digitalisation being that once data enters the system, no one should be touching it.”

But Forson also highlights the value of good ‘old-fashioned’ collaboration with forwarders as a way of enhancing service quality – something that Cargolux has been trying to do for many years within the air freight quality organisation Cargo iQ.

Within the framework of a recent ‘performance-improvement challenge’ initiated by Cargo iQ, Cargolux teamed up with Panalpina to improve the quality rating for FWB (Electronic Freight Way Bill) performance between the two companies at Luxembourg Airport – improving it from 69% to 94% in just six months and beating the target that they set for themselves by nine percentage points.

The modernisation of Cargolux’s operating processes also extends to physical cargo handling at its Luxembourg hub. “We are working with Luxair Cargo to increase the capacity of our warehouse, basically to deal with peak season demand,” he notes. “Luxembourg has always been and will always be our major hub. The airport is also undertaking infrastructure developments, for example, in adding parking spaces for freighters.

“Can we expand more in Luxembourg? I think so, but obviously there’s a limit to it. We also have the Cargolux Italia hub in Milan available to us, which could facilitate further expansion in our operations.”

In a cyclical global air freight market that has seen a large number of cargo airlines come and go over the years, while others have joined and then exited widebody freighter operations, Cargolux has proven itself one of the few to be able to adapt and survive. And with the airline entering its 40th year in 2019, Europe’s largest and most-enduring all-cargo carrier is preparing for the next wave of change.