Costly Oil, Slumping Dollar Spell Trouble For Airlines, Aerospace Companies

 

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"The combination of a slowing economy and the high oil prices is the danger for the airlines," says S&P's Baggaley. "Either one of them they'd be able to deal with, but the combination is likely to cause considerable pain."

Such a scenario might impact demand for aircraft from Boeing and Airbus, which have seen orders soar during the last three years, largely on the strength of sales outside the U.S. The two aircraft manufacturers are aggressively ramping up to meet demand, but production could be peaking just as the next downcycle looms. If high oil prices make that downcycle worse, they could see some orders deferred or canceled.

Boeing and Airbus have long argued that high fuel prices will spur U.S. airlines to replace their older gas guzzlers with new fuel-efficient models. But while North American carriers have parked a lot of their older aircraft, such orders have yet to materialize. If legacy carriers start losing money again, it's unclear how they would be able to finance such purchases.

Randy Tinseth, vice president of marketing at Boeing Commercial Airplanes, says while oil prices will likely remain high and volatile, the impact on aircraft makers and the economy is hard to gauge. "We continue to see strong fundamentals," he says.

The decline of the dollar to as low as $1.47 per euro is forcing EADS to look for additional savings under its Power8 cost-cutting effort (AW&ST Nov. 12, p. 52). CEO Louis Gallois declines to say if that will mean more layoffs beyond the 10,000 job reductions already announced. But he recently described the currency situation as "unbearable." The low dollar also is complicating EADS's efforts to sell off some of Airbus's industrial operations in France, Germany and the U.K. Like Airbus, any buyers would have a euro cost basis and a dollar revenue stream.

But larger companies like EADS at least have the financial wherewithal to hedge currency, which limits their exposure in the near term. EADS is hedged at $1.15 per euro in 2008 and $1.24 in 2009. That buys the company two years of breathing room to continue to drive down costs. Smaller suppliers that don't have the financial savvy to hedge are much more exposed to sharp currency swings.

The same holds true in Canada, where Bombardier and CAE have so far weathered the sharp rise in the Canadian dollar. CAE, which exports most of the aircraft simulators it sells, just reported a 25% increase in net earnings and a 26% gain in revenue. But Mortreux, the aerospace association chairman, says currency hedges provide only temporarily relief. "If the exchange rate stays the same, it will have a major impact on manufacturing in Canada in six months to two years," he predicts. "The risk is we will lose new contracts because we are too expensive, or we have to reduce R&D, or we relocate our workforce to stay competitive. In the paper industry they've already started to lay off people and stop production."

Conversely, the slumping greenback benefits Boeing and other U.S. aerospace exporters by making their products cheaper abroad. It's also a benefit to U.S. airlines, which are deriving more of their business from international routes and can repatriate fares charged in foreign currencies.