REBOUND TAKES FLIGHT

. . . though carriers grappling with today's economic challenges

BY KATHRINE K. BECK

They're back!

Air passenger traffic around the world increased by more than 20 percent in the first half of 2004 over 2003, and cargo traffic was up 13 percent. After some very rough years-and despite challenges that airlines face today-the long-term forecast for air travel is healthy again.

The end of the SARS (Severe Acute Respiratory Syndrome) global epidemic scare, low fares and the return of skittish passengers after the 2001 terrorist attacks are all contributing factors. But the underlying driver of air travel demand has always been economic growth, reflected by gross domestic product.

According to Boeing market forecasters, during the next 20 years gross GDP growth around the world is expected to be 3 percent annually, and air travel should increase at an average yearly rate of 5.2 percent. The additional growth above GDP is due to increased foreign trade and a more liberalized airline market. Liberalization leads to increased competition. That, in turn, leads to airlines providing more convenient service and lower fares.

History shows that competition leads to lower fares and improved networks. The continued success of the 737 and lively market interest in the long-range 7E7 shows that Boeing Commercial Airplanes is well-positioned for the near future, said Drew Magill, Boeing director of market analysis. The 7E7 will allow airlines to provide more nonstop flights and more frequency with lower operating costs.

An expected gain in commercial airplane sales was one factor Boeing cited when in July it raised its 2004 earnings forecast. The company predicted commercial airplane deliveries of 315 to 320 in 2005 (the guidance for 2004 is approximately 285 airplanes), with increases in 2006. Boeing President and CEO Harry Stonecipher recently told industry analysts, "Right now we think we've got a real winning horse called the 7E7, and the airlines are telling us that."

While the long-term outlook is good, Commercial Airplanes' customers still face daunting short-term challenges.

In its June 2004 "Statement on the State of the Airline Industry," the Air Transport Association, the trade organization of U.S. airlines, said: "Record high oil prices and the nation's ongoing war on terrorism, including sustained uncertainty in Iraq, have presented new barriers to improving the industry's financial health."

All this is occurring in a highly competitive environment where passengers are demanding-and getting-record low ticket prices. Airfares have not kept pace with inflation, and some airlines are operating at a loss to retain market share.

Joe Leonard, Chairman and CEO of Orlando, Fla.-based discount airline AirTran Airways, told industry analysts that some fares now result in revenues to airlines of about four cents per seat per mile. That's less than the eight to 10 cents it typically costs to operate the flight.

A recent Aviation Week article pointed out that discounters, long considered the bright spot in a hard-hit industry, are also coping with labor issues and the financial problems that often accompany rapid growth.

While AirTran and other discounters such as JetBlue and Southwest are still profitable, ATA said that from 2001 through 2003, U.S. airlines lost $23.2 billion. The group predicted the industry would lose upwards of $3 billion in 2004.

If airlines are hurting but need to carry more passengers, why don't they buy decommissioned airplanes parked in the Arizona desert in large quantities?

Aviation expert Richard Aboulafia, vice president and analyst with the Teal Group in Alexandria, Va., noted that there are plenty of financial incentives for airlines to buy new equipment. But, he said, "There are very few new 737s [in the used market]. . If all of a sudden there's lots of modern stuff thanks to bankruptcy . it could change the picture considerably."

When asked what he thought Boeing has to do to keep airlines buying new airplanes, Aboulafia replied, "Make 7E7 happen as planned. 7E7 is shaping up and looks like it could be a winner-great costs, new technology, and terrific capabilities." He also called the low announced price of the 7E7, around $120 million, "a very admirable target."

"Today airlines are more focused on cost than they ever have been, and they look to us," Magill said. "Every airline is really looking at reducing costs right now, including low-cost carriers."

"We must . encourage efficiency and cost consciousness across the industry's value chain," said Giovanni Bisignani, director general and CEO of the Geneva-based International Air Transport Association, which represents more than 95 percent of the world's airlines.

For Boeing, this clearly means offering customers a low-cost product. Magill noted that, the airline industry's problems notwithstanding, there is another very big reason Boeing must keep costs down to keep sales coming. "Even as recovery starts to occur and airlines start to become more profitable," he said, "we're still facing very intense competition from Airbus."

kathrine.k.beck@boeing.com