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Cargo airlines throttle back on aircraft leases, ATSG says

Company to postpone converting some passenger jets to freighters as demand wanes

ATSG leases Boeing 767 freighters to operators around the world, including SkyTaxi in Poland. (Photo: Flickr/Steve Knight (CC BY 2.0)

A number of freighter operators are starting to back out of, or postpone, commitments for upcoming aircraft leases, underscoring how the prolonged contraction in demand for air cargo shipping is squeezing cash flow across a wider cross-section of the industry.

Executives at Air Transport Services Group (NASDAQ: ATSG), a leading lessor of cargo jets that also provides cargo flying and other services, said Tuesday that weak interest from international airlines is a key reason why it lowered second-half profit guidance by $45 million and is taking a more conservative approach towards freighter investments. 

The company presented a window into how pain from the freight downturn is spreading during an analysts briefing on its disappointing third-quarter earnings one day after the board of directors fired Rich Corrado and named its chairman, Joe Hete, as CEO.

Air Transport Services Group late Monday reported adjusted earnings before interest, taxes, depreciation and amortization of $137 million, 16% below the third quarter of 2022. Other drags on performance included inflation, the conflict in Israel and unexpected maintenance.  The company’s stock price dropped 23% on Tuesday and another eight points Wednesday to close at $14.32. The stock is down more than 40% year to date. 

Susquehanna Financial Group downgraded ATSG’s stock to “neutral” because of the magnitude of the earnings miss against Wall Street expectations and the revised guidance, which likely will carry over into 2024.

“Our new reality is that growth will be more difficult to achieve than before,” said Hete, who once ran the company for 17 years and is tasked with shoring up results and investor confidence. 

The markdown in second-half operating profit includes $24 million for the company’s leasing business, Cargo Aircraft Management, because all-cargo airlines are scaling back on planned freighter leases. The company now expects to deliver 16 newly converted freighters in 2023, three fewer than previously communicated. It has commitments for 14 passenger-to-freighter conversions next year, two less than listed during the summer. 

“In mid-October, we were contacted by certain airline customers of CAM expressing that they were experiencing lower customer demand, which is negatively impacting their financial results and outlook,” President Mike Berger told analysts. “The air cargo industry is undergoing rapid changes this fall. Unfortunately, we are not immune to that.”

Many carriers aren’t in a hurry to take aircraft as they would be in a more robust economic environment, CFO Quint Turner added. 

According to Mexican aviation news outlets, mas Cargo Airline has parked both of its Boeing 767-300s to optimize operations around a uniform fleet of Airbus A330 freighters. Mas leases the 767s from ATSG and was recently scheduled to receive another one. Berger said mas hasn’t returned any aircraft so far and ATSG expects the airline to honor its lease commitments. The decision, however, indicates there won’t be any future growth with that customer. 

ATSG’s biggest commercial customers are Amazon and DHL Express, which lease aircraft and pay ATSG’s two cargo airlines to fly packages on their behalf. Passenger charter subsidiary Omni Air International flies troops and other personnel for the U.S. government, accounting for about 30% of company revenues. The leasing business is increasingly placing aircraft outside the U.S. with smaller operators, most of which function as contractors for global express operators Amazon, DHL, FedEx and UPS.

The parcel giants, with double-digit declines in volumes, are rationalizing oversized air networks and partner carriers are feeling the trickle-down effect. ATSG’s comments are further evidence that more all-cargo operators and lessors are pausing new orders and, in some cases, reversing course. Earlier this year, Cargojet canceled plans to buy and convert four Boeing 777s and Air Canada told Boeing it no longer needed two factory-built 777 freighters.

Cargo airlines ABX Air and Air Transport International are flying fewer hours on long-haul routes for international customers, with overall cargo hours down 4% during the quarter, management said. But both carriers are on track to meet full-year targets for adjusted pretax income.

ATSG, until the third quarter, had largely escaped fallout from the ongoing freight recession, which has seen air cargo volumes fall about 13% since the end of 2021, with rate declines of 40% to 50% for the majority of this year. During the second quarter, revenue increased 4% and adjusted earnings were on par with the prior year. 

And there were few signs of customer backpedaling, other than Vietnam Airlines quietly canceling plans for two Airbus A321 narrowbody freighters. Company leaders said last summer they would time future aircraft purchases closer to when production slots for conversions open up.

Showing more caution

But investors pressured the cargo-focused company to downsize capital expenditures because of deteriorating market conditions. Management responded in August, trimming $65 million from the investment budget for 2023. On Monday, the company went further, cutting 2024 capital expenditures to $505 million, $100 million less than mentioned in September and $280 million less than this year.

Executives said their hybrid business model, which includes maintenance and airport ground services, gives them the flexibility to hold off on acquiring feedstock and moving ahead with the conversion process as market conditions change. 

Hete said the aviation firm is not sending additional 767-300s for conversion beyond the seven currently in process. Six Boeing 767 passenger aircraft already purchased on the second-hand market will be parked until demand improves. CAM can still generate income from those assets by leasing out the engines to other operators, loaning aircraft to Omni Air if there is demand for more passenger service or leasing aircraft to a needy passenger airline, he said.

Berger said ATSG still has its eye on long-term growth, reiterating the refrain that e-commerce growth and airlines’ need to replace older freighters justified capital spending.

Airbus and Boeing have forecast air cargo demand will grow at a compound annual rate of about 3.5% to 4% through 2040. Changing operating behaviors in the passenger sector, including greater use of smaller jets with better fuel efficiency on longer routes and more point-to-point flying that bypasses airport hubs, could also increase shipper interest for dedicated freighters.

Berger said Asia will be a magnet for converted freighters. “A big part of our future is international. And we are a global organization. We’re looking forward to that growth going forward,” he said. Uzbekistan-based My Freighter on Wednesday took delivery of its first 767 cargo aircraft, Turner confirmed to FreightWaves. The lease was initially reported by Cargo Facts.

ATSG’s revenues were impacted by the return of 11 Boeing 767-200s in the past year after their leases expired. The planes are near end of life and more expensive to operate than 767-300s currently being marketed. CAM intends to sell two of the fully depreciated planes this quarter and more next year.

Interior of an Airbus A330 aircraft being converted to carry containers instead of passengers. ATSG has plans to modify and lease 29 A330s. (Photo:  Elbe Flugzeugwerke GmbH)

ATSG is also adding the Airbus A330 converted freighter to diversify its midsize aircraft offering as the availability of used 767 passenger aircraft begins to dry up. An Airbus facility in October inducted ATSG’s first A330 for conversion.

Israel Aerospace Industries, the Tel Aviv-based company that turns ATSG’s Boeing 767s into a cargo configuration, lost a substantial number of employees who are reservists to military duty when the war against Hamas started a month ago. Berger said ATSG has been in constant contact with IAI and is confident the supplier can meet upcoming delivery schedules.

Management questions

Forty percent of the reduction in projected profits is associated with Omni Air. Management said the outbreak of war in the Middle East caused the Pentagon to pause troop rotations at a normally busy time of year while it monitors the need to adjust its force posture in the region.

Analysts criticized leadership for being caught off guard by the change in fortunes, especially after delivering a positive message at Investor Day on Sept. 27. The disappointing third-quarter results compounded shareholders’ perception that the company has underperformed for years, and Corrado took the fall.

Executives responded that the 767 sales weren’t finalized as expected during the quarter and that a late maintenance issue stranded an Omni plane in Guam for three days, resulting in unexpected hotel costs for about 250 passengers and crew, as well as overtime pay for pilots. 

“A lot of the deterioration occurred late in the quarter. And we did not have that visibility at the time,” CFO Turner said. The Israel conflict, which also weighed on guidance, came after the quarter ended, he added.

Hete acknowledged the need to improve financial results and reporting lines to top management.

“We don’t find it acceptable. Rest assured that that is top of the list of getting back in terms of where the numbers we put out are credible to the market,” he said. 

“We believe new (and former) CEO Joe Hete is the best person to manage ATSG through this difficult period, with his focus on ‘maximizing returns’ and taking a ‘more measured’ approach to growth strategically right-minded. At the same time, with ATSG finally delivering an investor day approximately just six weeks ago and then sharply pivoting on its outlook, we believe it’s going to take some time before investors are again comfortable with the story,” said Susquehanna equity analyst Christopher Stathoulopoulos, in a client note. 

Executives, including Corrado, have long lamented that investors and analysts misunderstand ATSG’s value proposition, noting that the ability to secure long-term leases, and carry out dedicated contract flying for e-commerce customers, differentiates the company from traditional cargo airlines wholly subject to volatile market forces.

Stifel transportation analyst Frank Galanti said the market is overreacting to the downward revisions in guidance given future requirements for midsize freighters and expects the company to soon outperform low expectations, which will improve the stock price.

Satish Jindel, CEO of parcel consultancy ShipMatrix, blasted ATSG’s board for making Corrado the scapegoat for a profit shortfall during a prolonged freight recession that was out of his control. 

Corrado was Hete’s hand-picked successor and Hete was able to provide mentorship as chairman.

“No one should get the blame. Shareholders should not set the direction of a company because they can be in today and out tomorrow. They have no allegiance,” Jindel said. “If the shippers, the customers, were complaining and employees were complaining about Rich Corrado, then yes. And the board should not be wrapped up in trying to please the shareholders.”

Pilot contract

Meanwhile, the federal government is mediating stalled contract talks between subsidiary Air Transport International and its pilots’ union. Talks have broken down over work rules, retirement and compensation. On Oct. 30, the Air Line Pilots Association opened voting to give union leadership authorization to call a strike when legally allowed. The sides can’t initiate self-help tactics until the National Mediation Board releases them from the mediation process.

ALPA says 207 pilots have left ATI so far this year, a third of the current pilot roster.

Hete acknowledged that ATI is experiencing attrition, with pilots taking significant hiring bonuses to join mainline passenger carriers. Other cargo and regional passenger airlines face similar staffing challenges.

“At the end of the day, you’ve got to have a contract that works for both sides. So if you’ve got the union side asking for FedEx or UPS wages or industry-leading, and that’s not in the cards from what we get from our customers, then that’s just not something we can agree to. So the key is finding a happy middle ground between their demands and our needs to keep things on the rails,” said Hete.

Click here for more FreightWaves stories by Eric Kulisch.

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Eric Kulisch

Eric is the Supply Chain and Air Cargo Editor at FreightWaves. An award-winning business journalist with extensive experience covering the logistics sector, Eric spent nearly two years as the Washington, D.C., correspondent for Automotive News, where he focused on regulatory and policy issues surrounding autonomous vehicles, mobility, fuel economy and safety. He has won two regional Gold Medals and a Silver Medal from the American Society of Business Publication Editors for government and trade coverage, and news analysis. He was voted best for feature writing and commentary in the Trade/Newsletter category by the D.C. Chapter of the Society of Professional Journalists. In December 2022, he was voted runner up for Air Cargo Journalist by the Seahorse Freight Association. As associate editor at American Shipper Magazine for more than a decade, he wrote about trade, freight transportation and supply chains. Eric is based in Portland, Oregon. He can be reached for comments and tips at [email protected]