Seems like yesterday, but we remember when certain ground handlers soured on the fixed costs and obligations imposed on cargo handlers such as long-term warehouse leases, scissor lifts, casters, automatic storage and retrieval systems, hi-lo forklifts, and of late, cargo screening equipment. Not to mention the risks of high governmental fines and penalties for breaches of cargo security and Customs regulations. Instead, some chose to concentrate on passenger aircraft handling and related services. Others, recognized the continuing need for air cargo, improved their efficiency and doubled down on long term cargo warehouse space. How things change frequently in this industry.
Covid-19 created opportunities for cargo handlers, especially those able to service scheduled and chartered freighters. While air cargo performed well overall during the pandemic, the benefits and impact have not been uniform. Markets reliant on the belly capacity provided by international widebody passenger aircraft have seen material reductions in volume.
Gateway airports with existing freighter operations benefited from the diversion of belly cargo onto chartered freighters, while other gateway airports and their handlers suffered from the loss of belly cargo. As an example, from June 2021 to June 2022 SFO international cargo volumes (which are highly dependent on belly capacity and limited freighter service) were down 14.2%, which was an improvement from 2020, as 2020 volumes were down 30% from 2019. Conversely, LAX reported that 2020 was its busiest year for cargo volume, despite a 67% reduction in commercial passenger volumes. However, from July 2021 to July 2022, air cargo volumes were down by 9.40%.
At some gateway airports, there is a lack of warehouse capacity and staff shortages driven not only by Covid-19 restrictions but as of late tight labor markets, which has significantly impacted breakdown times for imports, and build-up times for exports. Increases in online shopping has increased operations of FedEx, UPS, and Amazon. Despite significant losses in international cargo traffic, SFO domestic cargo volumes actually increased by 21% in 2020 over 2019 and 39% from June 2021 to June 2022.
We expect to see ground handling acqusitions gather pace through 2023
Governmental assistance programs provided temporary relief to both above and below wing passenger aircraft ground handling, but global relief was uneven, and in any event is over. While there is some uncertainty about the timing of return to prior revenue levels, local air travel is mostly on track to recover by the end of 2023, while international travel is expected to take to the end of 2024. Thanks to the expedited distribution of vaccines to those who want them or were required to be vaccinated, Covid-19 relief funding and economic stimulus legislation, pent-up demand, the need to provide services to the air cargo industry should remain strong for the foreseeable future, but perhaps not as strong as hoped early in 2022. While we are seeing an uptick in business travel, it is unknown to what extent the advent of Zoom and other teamworking applications will affect business travel over the longer term.
The outbreak of war between Russia and Ukraine creates new risks, and in adversity there always appear opportunities. At some point, there will be Billions invested in infrastructure in Ukraine and a significant growth of military budgets in Europe. Thus, there may be opportunities to offer military branches assistance with fueling and both military and large freighter aircraft handling. Again, this shows why this industry must be ready to adapt to events as they occur.
Due to a combination of the government support programs like in the US, the Payroll Protection Program (PPP) and the Payroll Support for Air Carriers and Contractors (PPT), layoffs were allowed and accommodations with property owners and suppliers, most airport and airline services companies have survived, some better than others. Even in countries where there was no government support, most ground handlers have survived. Now that passenger flights are returning (especially to tourist destination, note Cancun’s growth) and cargo flights continue, these companies are once again becoming profitable. As discussed below, because of labor issues, expected airport fee and rental cost increases, there is a greater need for consolidation of smaller operators, and greater efficiencies, some of which will be due to consolidation, productivity based on IT, and changes in operations.
Some large ground handlers have recognised the value in diversifying and are seeking to purchase companies which provide complimentary services such as fueling, security provision, building and aircraft cleaning, GSE maintenance and repair, duty free and airport retail.
Pressures on airports
Summer passenger traffic in the US and in Europe proves that passenger traffic is not only back, but because of labor shortages exceeds the ability of airports to handle. This pent-up demand has created huge problems at gateway airports caused as mentioned in part by difficulty in hiring ground staff. According to Airports Council International’s 2nd Q 2022 Report, while some markets have experienced a robust recovery, on average and under the current projection, accounting for the slower than expected first quarter of 2022 due to the Omicron wave, global passenger traffic is expected to reach back to 2019 levels in late 2023 with the full-year recovery to 2019 levels in 2024.
Despite the expected recovery, as just mentioned, labor issues remain such as the loss of trained handling employees, high costs to rehire, badge and train new employees, and increases in wages due to a tight labor market. All of the above are likely to result in higher labor costs for some period of time.
Pressure on airport operators to increase revenue may affect rental costs as well as airport fees. There is pressure on privatized airline terminals, private cargo warehouse operators and other private property owners to increase revenue to recover lost revenues and profits.
Lack of space at gateway airports may cause rent increases and pressure cargo handlers to enter into long-term leases. New warehouse development may help - but the timing is uncertain.
Lastly, airlines under pressure to keep costs low until premium and international passenger traffic returns will seek cost reductions from their suppliers but this is coinciding with a period of rate escalation as suppliers seek to pass through the higher labor costs necessary to attract and retain employees and reflect the impact on other costs which the current high levels of inflation has created. This is leading to significant contract churn in a highly competitive environment.
The two greatest risks are whether companies will be able to hire and retain ramp and warehouse staff, and the likely worldwide economic downturn. It is also possible that long wait times for new GSE may become an issue. Workforce scarcity at handlers and at airlines at European and other airports have caused huge delays and flight cancellations and these problems are expected to continue for some time.
Consolidation
Based on a recognition that even though ground handling is considered low margin, profits are available, consolidation and changes in ownership continue. In the United States, Alliance Ground Support has new owners, and these owners just acquired Total Airport Services and Airport Terminal Services (and previously acquired Maestro). Worldwide Flight Services recently acquired Mercury Air’s cargo handling operations. Menzies was acquired by Agility and is now together with National Air Services (NAS). We expect to see other significant ground handling acquisitions through at least 2023.
Despite all of the issues resulting from the pandemic, the balance of 2022 and 2023 will see a continued upswing in aviation related service industry acquisitions and consolidations. So far, the trend is for higher sale prices for certain types of operations. Smart buyers are valuing companies not only on multiples of EBITDA and revenues but on future growth in revenues and EBITDA based on defensible future projections.
The current labor market, lag times for delivery of new GSE are problematical and an issue in any acquisition, additional efficiencies created by the consolidation of ground handlers can in fact be a driver and a cause for further consolidation.
As many of the larger ground handlers have been sold in recent years, we expect that smaller, closely held country-specific ground handlers will be of interest to the consolidators. These will present new issues as these country-specific companies often organize their business to provide services rarely performed by international handlers, create mechanisms and incur expenses to take advantage of local tax rules that benefit their ownership, and tailor their businesses to country-specific business practices and local conditions. Moreover, as private equity is now involved, it may have reached a point where worldwide ground handlers go back onto the market. Proof of this is the discussions between SATS and Worldwide Flight Services about an acquisition by SATS of Worldwide Fight Services.
As aviation services advisors, brokering acquisitions and consulting on operations, we have seen that there is a continuing need to continually restructure operations taking into consideration local conditions, to at least lessen any impact to the business of these country-specific practices and worldwide reactions to Covid-19, war between Russia and Ukraine, inflation and fuel prices.
Moreover, no longer are parties relying on a multiple of a prior three-year average of EBITDA, but instead recasting recent EBITDA to rid the calculation of non-recurring costs and relying on projections of revenues and income over the next three to five years. As passenger and cargo flight activity is expected to rise significantly especially in high populated countries which will play larger economic roles in the future, rosy forecasts are a reasonable way to envision the future of the ground handling industry.
