Intuitively, the airline sector would come across hard times after the Covid-19 outbreak. Massive cancellations already happened and others are in their way. In this article I will try to assess some of the impacts on the industry and what could the future bring.
Boeing (BA) is down roughly 70% since the beginning of the year, United Airlines (UAL) has fallen nearly 76%, Royal Caribbean (RCL) is down more than 83%. Southwest is planning on cutting 1,500 daily flights, Ryanair, EasyJet, Virgin Atlantic and British Airways parent company IAG have warned about “significant cancellations”.
These are hard times, the financial markets are in turmoil, the supply chain has been disrupted, and the demand for goods and services that are not related to basic needs or home entertainment have sharply collapsed. The business model of the airline industry heavily relies on the expectation of a predictable flow of passengers (with a certain standard deviation). It is a capital intensive one, planes can take one to two years, or more, since its order until its delivery. It means that at least a part of it must be paid before the airline actually possess a ready to fly aircraft. So, there is money outflow without having the possibility of having an inflow from that same source. Therefore, many airlines are already facing the problem of not having an inflow from current operations to pay their duties, “airlines are both capital and labor intensive so there has to be support of the costs that cannot be avoided even if an airline is grounded” said aviation analyst John Strickland in an interview for BBC. According to the most recent impact assessment from the International Air Transport Association (IATA), the typical airline has cash and equivalents that cover only 2 months of revenues.
Another thing to bear in mind is that an iPhone, for example, even if it is not sold today, can be sold in the future. A flight ticket cannot, mainly those that represent empty seats in an actual flying trip. Given that, we can all understand that the disruption with all the travel bans is massive. To aggravate the problem, cancellations of flights brings with it customers demanding refunds.
As stated in The Guardian, airlines around the globe waited five years to become profitable again after the 2001 terrorist attacks, accounting for a loss of more than US$40bn. It happened again in 2008, losing on aggregate US$8bn.
According to an HSBC analyst “It’s a question of how much cash reserves they have, how agile they can be… On the upside, fuel prices are falling, interest rates are low and governments are looking at what they can do. But we shall see if smaller airlines can survive.”
We can be talking about enormous bailouts from governments or excessive indebtedness, with a false sense of security while rates are low. In the short term, Virgin Atlantic in the UK asked for an emergency credit line of US$7.5bn, while in the US, airlines are seeking up to US$50bn in aid. The US Senate already passed the bailout. Meanwhile, the UK Government stated in March 24 that is not willing to bailout the industry, at least for the time being, providing help only with staff wages and with the deferral of some rates and tax payments. This news emerged after IATA evaluation of potential losses rounding US$252bn in revenues for 2020 (more than double its “worst-case scenario” forecast was two weeks ago). Government’s position comes from the perception that the airlines decision to proceed with planned dividend payments hardens the problems.
It is a fact that fuel prices are dropping, but if 80-85% of fleets are expected to be grounded in April, as Virgin Atlantic published, there is not much room to profit from that. Ryanair even stated that by April and May “a full grounding of the fleet cannot be ruled out.
“With all of this, comes several issues in paying to staff members. They cannot work from home neither do so on the spot. Norwegian Air, announced it would temporarily lay off more than 7,500 staff, 90% of its workforce, Scandinavian Airlines SAS will do exactly the same. Virgin Atlantic has asked staff to take an eight-week unpaid leave. So are doing the three major airlines in the US, American, Delta and United.
Consequently, it seems that without government support, the airline industry has little to no salvation, largely contributing to the massive unemployment we will observe in time ahead. The British largest domestic airline, Flybe, is already filing for insolvency. Therefore, the political and moral dilemma of letting failing private companies go down or rescue them up, will arise in the near future in the midst of political decision.
Time for big decisions all around the political and economic world.
Article published in our March Newsletter
Guilherme Corga, MSc in Finance