The way ahead for transport survey 2009

September 2009

Contacts

The impact of the global financial crisis on the aviation, rail and shipping sectors

In response to the wave of bad news and poor results from companies in the aviation, rail and shipping sectors following the global financial crisis of late 2008, we decided to initiate The Way Ahead Survey, timed to coincide with the first signs of improving confidence.

Our aim has been to try to find out how participants in these sectors view the short to medium term future, but more specifically their strategy for managing the impact of the crisis. We identified the principal elements of strategy as involving the sourcing of finance through debt, investment or cash; co-operation in joint ventures or other business combinations and consolidation by merger or acquisition.

The survey results allow us to analyse the effects on each sector within the industry, to understand which are the most resistant to the economic downturn and which are most likely to recover fastest. Unsurprisingly, responses were tinged with realism, if not pragmatism; the global financial crisis has clearly had a profound effect on the transportation sector as a whole.

Aviation sector respondents appear to be the least positive about the current business environment. The sector has been forced to contend with a series of challenging issues, including the lack of available financing, fluctuations in fuel costs and the reduction in premium and leisure travellers.

Rail sector respondents are substantially more positive, thanks to the high level of government support and reasonably consistent passenger numbers.

Shipping respondents appear to be the biggest victims of the drop in global trade, while also suffering from the lack of available financing. Container shipping and dry bulk carriers are regarded as the most affected sectors within the shipping industry.

The survey naturally confirms some widely held views, but also produces a number of unexpected findings. We hope that you find it both interesting and informative.

Executive summary

A substantial 961 individuals across the aviation, rail and shipping industries responded to this survey providing an authoritative and wide ranging examination of those transport sectors’ state of health. The main findings are as follows:

Transport industry overview

  • The aviation sector is the most pessimistic about the economic climate, with nearly half of aviation respondents expecting the downturn to take another two to three years to dissipate.
  • 68% of rail industry respondents expect an upturn in business within 12 months, making it the most optimistic sector.
  • South East Asia (including China) is the region likely to recover quickest from the recession, according to respondents in all three transport sectors.
  • Around 80% of respondents in each sector view the rail industry as the best insulated from the current economic turmoil.
  • More than three-quarters of respondents agree or strongly agree that banks will concentrate their lending activity on domestic companies in the foreseeable future.
  • 47% of aviation respondents expect to retrench as a result of the recession and 43% anticipate disposing of non-core assets.
  • Infrastructure investment would be the most helpful form of state intervention, according to respondents in all three sectors.

Aviation Sector

  • 73% of respondents expect fleet sizes to decrease in 2009.
  • 90% think it is likely that there will be a significant number of cancellations or deferrals of large aircraft orders up to the end of 2010.
  • The Middle East and Asia are expected to receive the largest number of aircraft deliveries up to the end of 2010.
  • 58% expect up to 20 air operators to cease trading during 2009.
  • 58% would consider entering into a cooperation agreement or forming an alliance with a strategic partner in the next 18 months.
  • Consolidation is most likely to occur amongst European majors.
  • Only 6% are fully prepared for the European Emissions Trading Scheme.
  • 70% indicate that EU competition law has had no impact on their business.
  • 61% expect to see growth in operating leases or airline corporate debt as a result of the current economic climate.

Rail sector

  • 83% of respondents envisage passenger numbers dropping by no more than 10% by the end of 2009, compared with 2008 numbers.
  • Only 43% expect a moderate or significant increase in rail infrastructure spending as a result of the recession.
  • 51% expect it to be two to three years before pre-recession levels of revenue are restored.
  • 51% expect rail freight to be the activity most affected by the recession.
  • The infrastructure and commuter services sectors are expected to perform best during the recession.
  • 76% expect that there will be new opportunities to invest in rail assets as a result of the recession and new equity will be attracted to the industry.
  • 83% suggest that increased rail competition will not be damaging to their businesses.
  • 91% agree that high-speed rail is essential for future economic growth.

Shipping sector

  • 77% of respondents expect consolidation to occur in the shipping sector.
  • 58% anticipate a significant role for private equity and hedge funds.
  • 68% expect joint ventures between private equity/hedge funds and banks to take advantage of opportunities presented by low vessel/stock values.
  • 68% predict that there will be a reduced use of the KG investment model in the future.
  • 63% anticipate widespread bank enforcement of troubled shipping loans.
  • 66% expect these enforcements to peak in three to nine months time.
  • 81% predict that it will take at least 12 months before the number of banks actively lending to the shipping market increases.
  • 79% see no return to pre-crisis levels of available bank debt within three years.
  • Container shipping is regarded as the biggest victim of the global financial crisis.
  • 78% see the role of Export Credit Agencies as more than a short-term solution in bridging the liquidity gap.
  • 25% already see new players (i.e. those without a track record in shipping sector investment) entering the market.
  • 77% say that EC competition law has had no impact on their business.
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Methodology

The survey was sent to people involved in all aspects of the business of the aviation, rail and shipping sectors, not only transport operators, but also to financial institutions, regulators, representative bodies, governments, insurers, ship managers and maintenance providers.

The survey, which received 961 responses from individuals connected to the shipping, rail and aviation transport sectors, is divided into four sections. The first general section was sent to respondents in each of the aviation, rail and shipping industries and provides an informative comparison of how each sector is managing the economic downturn. For each transport sector there was also a unique section of the survey, designed to explore in more detail the current challenges and trends within that sector.

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Transport industry overview

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Aviation sector findings

The aviation industry has entered a period of great difficulty and uncertainty. Forty air operators ceased trading during 2008 and many commentators have predicted a similar number of casualties during 2009.

Those who continue to trade are adjusting their business to cope with the consequences of the global financial crisis. With reduced revenues in an industry with traditionally high fixed costs, airlines face difficult decisions about fleet sizes, route networks, cost control and passenger service levels.

However, our survey results indicate signs of positive sentiments in the industry. Only a small minority of those surveyed suggested that the market would worsen in 2009, with over half seeing improvement in their business over a 6 to 12 month period.

Retrenchment is occurring in the aviation industry, but perhaps not as severely as many commentators and industry experts have forecast. Respondents to our survey remained reasonably upbeat about growth prospects in regions such as South East Asia (including China) and the Middle East.

Expectations of further consolidation within the aviation industry have not yet been borne out in the form of full corporate mergers. Over half of respondents believe that there will be more alliances and cooperation agreements with consolidation being most likely amongst major airlines in Western Europe and North America. The focus of the aviation industry appears to be on managing the short term effects of the global financial crisis. Corporate survival is the priority rather than issues such as regulation and environmental legislation. Respondents are less concerned about EU competition law and, as a general rule, seem unprepared for some important forthcoming legislative changes.

Our survey also reviews current and future funding sources and investigates respondents’ views about what alternatives might be available in the light of prevailing liquidity constraints. Operating leases and the issuance of airline corporate debt are both expected to grow in importance.

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Rail sector findings

Of the three transport sectors that were surveyed, rail appears to be the least affected by the economic downturn. Passenger numbers might be moderately down or expected to diminish slightly, but the fundamentals of the industry look solid.

The primary concerns of the sector appear to be whether government funding will decrease and whether infrastructure investments will be put on hold. Respondents recognise that the financial sector rescue packages provided by governments may in turn impinge on rail industry funding. This moderate negativity is to some extent countered by the realisation that governments are compelled to support the rail sector, because their economies depend on it. Rail is of course essential to business in most countries with large commuter populations. The rail sector is also a major employer (Indian Railways is one of the world’s largest employers with around 1.4 million employees) and governments can ill afford to allow further unemployment to infect their economies.

Although a relatively small sector in comparison to passenger travel, rail freight is expected to be hardest hit by the economic climate. The fall in global trade and the drop in demand for raw materials has undoubtedly had a significant effect.

Respondents predict a moderate influx of private equity and other investment capital in the coming years, with investors taking advantage of limited risk and lower valuations of rail assets.

Respondents also show a modest interest in mergers between train operators, but with many state-owned rail systems still in existence the scope for mergers may be limited. In summary, the concerns of the rail industry are on a different scale to the anxieties within the aviation and shipping sectors. Although train operators such as National Express in the UK  have run into financial difficulty, instances of crisis within the industry are expected to be rare.

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Shipping sector findings

The collapse in world trade and the limited availability of financing has caused unparalleled levels of anxiety within the shipping industry. The prospect of a massive oversupply of ships if the economic climate does not improve (and possibly even if it does) is one of the big problems facing the industry.

The recent shipping boom caused in part by the emergence of China as a manufacturing superpower led to unprecedented levels of ship orders and as more and more vessels continue to be delivered during the economic downturn, the supply and demand situation is becoming increasingly unbalanced.

Container ships and dry bulk carriers appear to be under the most serious threat according to the survey, with global trade severely depressed and demand for raw materials dramatically reduced. Ship arrests have risen sharply in recent months and respondents expect bank enforcements of problem shipping loans to peak within 12 months. Increased caution amongst banks has led respondents to believe that shipping loans no longer features prominently on their lending agendas and respondents see an increased role for ECAs as a source of ship finance.

Like the aviation and rail sectors, shipping respondents also recognise the potential impact of private equity and other new investors, although there is an expectation that this may well occur through joint ventures involving banks and other companies with shipping expertise.

In contrast, the majority of respondents see a more limited future for the KG investment structure in the immediate future. Many recognise that typical KG investors have lost confidence in the model and other forms of funding will have to come to the fore.

As a result of the tough climate, economies of scale are becoming increasingly attractive to the shipping sector with 77 per cent of respondents expecting further consolidation to occur within the industry. Currently, EU  competition law has only a limited effect on the sector and so any future consolidation is unlikely to hit regulatory hurdles according to those that were surveyed.

The shipping sector, whilst experienced in weathering the peaks and troughs of a typically cyclical business, is facing up to one of the toughest periods for quite some time, but respondents are sanguine about the future recovery of the South East Asia market and its impact on global trade.

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Conclusion

The findings of this survey range from the unexpected to confirmation of an anticipated response. In broad terms, they reflect a different outlook and level of concern in each of the three surveyed sectors of rail, shipping and aviation, although at times there are some interesting but possibly coincidental, similarities and parallels.

In rail, there is perhaps the greatest sense of equanimity with considerable concern about freight activity, balanced by reasonable optimism that passenger numbers will hold up and a general acceptance that the rail sector is the sector least adversely affected by the recession. On the shipping side there is a sense that there will be an improvement in the next twelve months with a rise in asset values and an expectation that bank debt and stock market investment will soon return to the shipping sector. This is tempered by considerable gloom in relation to container and bulk shipping and a high level of expectation of major mortgage enforcement action. In aviation, the picture is considerably gloomier with an overall sense of contraction in the industry reflected in an expected reduction in the number of carriers, cancellations and deferrals of new orders and a real prospect of widespread retrenchment. In terms of parallels, about 60 per cent of respondents in each sector expect their business will be recovering within the next 12 months and all sectors regard investment in infrastructure as the best way that governments can assist their recovery. Similarly, all sectors agree that, by region, South East Asia (including China) will be the quickest to recover from the recession with the Middle East and India following strongly.

In terms of the narrower focus on the primary responses to the recession which the survey was motivated to test, the responses from the three sectors were equally varied.

With regard to sources of finance the rail sector is clearly of the view that state funding is the primary source of financial support. This is unsurprising given the high level of state ownership of rail operations which, even when privatised or franchised in some way, generally need state support. In the shipping sector, bank debt was seen as the primary source of funding (even if not at past levels of funding) with third party investment another hoped for source of funds. The reliance on bank debt in the shipping sector reflects that this has been and continues to be the traditional source of finance for shipping but respondents recognise that banks’, lending capacity is limited and see export credit agency support as an important feature of future loans. The hope that third party investment might be found may reflect the bold optimism of the shipping market which has raised money in the capital markets with some success in the recent past. In the aviation sector, shareholder funds and equity are seen as the primary source of cash, perhaps reflecting the difficulty of persuading banks to lend to the industry. There is no clear view as to the role of other funding sources, with opinions fairly evenly divided as to the nature of debt aviation companies can raise.

Another recession beating strategy which this survey sought to test was co-operation with others in joint ventures, alliances or pools. This seemed most popular in aviation where alliances have long played a role in achieving some form of effective consolidation of the market and respondents seem to view this approach as still offering benefits. Respondents from the rail industry indicated that they would like to be able to set up joint ventures but there was a considerable body of opinion to the effect that the rail market is insufficiently competitive as it is and that joint ventures would be against the interest of the consumer. Rail is probably the least fragmented of the three sectors with relatively few operators overall and a high proportion of those being under state of control in some way. In such a market, joint ventures might be seen as difficult to construct but strategically valuable if they could be achieved. For shipping, cooperation arrangements did not emerge as the primary business strategy to beat the recession. Shipping has a long history of 96 The way ahead for transport Norton Rose Group September 2009 companies working through some form of collective operation, such as a pool or conference, but now that many such structures are challenged by competition laws the responses to the survey may reflect a more cautious view being adopted in relation to such combined operations.

In any recession there will be winners and losers and for the winners there are fresh opportunities which arise due to distressed asset sales and reduced asset values. In such an environment, consolidations through mergers and acquisitions become real possibilities for those with the available cash and the survey sought to test the appetite for such activity. Shipping respondents clearly expect there to be consolidation which is hardly surprising in what is probably the most fragmented of the three sectors surveyed. Shipping offers many relatively small sized operations with assets of currently relatively low market value and owners who may be in poor financial straits. Respondents expect private equity and other investment funds to emerge to buy shipping assets and companies. Rail respondents did not expect much consolidation, probably reflecting again the relatively larger state ownership of rail operations and the less fragmented nature of the industry. However, there are likely to be opportunities for investment and consolidation in the freight sector where there are probably more private companies participating either as operators or as providers of rolling stock, particularly given that freight is anticipated to be the most affected segment of the rail industry. In aviation, a reduction in the number of operators is anticipated and this may be by way of operators going out of business but it may also be by way of consolidation by merger and acquisition. The focus of such activities is thought to be Western Europe and North America which are relatively congested markets where the competition may be seen to be more intense, thus generating a greater likelihood of investment targets.

Among the other findings of the survey, perhaps those most worthy of note are the lack of preparedness across the industries in relation to matters such as emissions control, the impact of European Union law and regulation and, primarily among aviation respondents, proposed changes to accounting rules. We were struck particularly by the sense that European Union law was not thought to have a great impact on transport industries despite the fact there have been a number of relatively high profile investigations into particularly the aviation and shipping sectors. A lack of focus on emissions issues and changes to accounting rules may to some extent be excused by there being a greater focus on day to day survival but the fact remains that emissions control and accounting standards are matters which the industry must prepare for and tackle.

Overall, the survey reveals three transport industries with differing outlooks and prospects. Where the three produced similar results the fundamental reasoning in each case is likely to have been similar. That rail is generally regarded as the sector least affected by the recession, was not a great surprise nor was the finding that South East Asia (including China) is seen as the region most likely to recover quickest from the recession but this latter view may have been tinged to some extent by a degree of hope that this will be the case given the strong showing of that region in recent years. The desire for state investment in infrastructure across all three sectors highlights the importance of such investment for growth and efficiency and thus profit. But how each sector will live to survive the recession is possibly more telling in terms of the way ahead for transport. In aviation, retrenchment and disposal of non-core assets seem to be high on the agenda while in shipping, consolidation is the primary strategy with hoped for new investors expected to arrive very soon. From the relative comfort of the rail industry, where state support is seen as a cushion against the ravages of recession, it is the freight sector which needs to be the most resourceful, but there is generally anticipated to be a real opportunity to attract new money to the rail industry where relatively stable long term returns should be available.

It remains to be seen how the way ahead emerges for each transport sector with the prospect of a prolonged recession causing significant structural change to the shipping and aviation industries in particular.

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