Forecast Revenue Losses Spiral Higher

In late March 2020, the International Air Transport Association (IATA) said that without government support, up to half of all airlines face possible bankruptcy. “We have a liquidity crisis coming at full speed – no revenues and costs still on our (books), so we desperately need some cash,” Alexandre de Juniac, director general of IATA said. 

IATA’s latest forecast in April 2020 (it’s fourth in two months) is for the global airline industry to record passenger revenue losses of $314bn, up from an estimated loss of $29bn on the 20th of February 2020.

DateForecast Passenger Revenue Losses
20-Feb-20$29bn
05-Mar-20$63bn to $113bn
24-Mar-20$252bn
14-Apr-20$314bn
IATA – Revenue Passenger Losses Forecasts

The latest figures reflect a significant deepening of the crisis, including more severe domestic restriction, longer expected restrictions on international travel and the virus spreading to Africa and Latin America. IATA stated that the end of March forecast was based on a global economic recession less severe than the Global Financial Crisis (GFC). However, expectations have become much more pessimistic since then. The latest Oxford Economics forecast shows that the loss in global output could be double that of the GFC. This has implications for our view on the speed of the recovery in air travel in the second half of 2020.

IATA – COVID-19 – Updated Impact Assessment – 14 April 2020

According to IATA, “The industry’s outlook grows darker by the day. The scale of the crisis makes a sharp V-shaped recovery unlikely. Realistically, it will be a U-shaped recovery with domestic travel coming back faster than the international market. We could see more than half of passenger revenues disappear. That would be a $314 billion hit. Airlines could burn through $61 billion of cash reserves in the second quarter alone. That puts at risk 25 million jobs dependent on aviation.”

Liquidity Crunch

At the end of March, IATA estimated that airlines may burn $61bn of cash in Q2 2020, based on a 68% year-on-year decline in revenues in the quarter.

A big issue for airlines is that they have significant levels of fixed and semi-fixed costs which are difficult to manage over a short period of time. These costs are estimated to account for around 49% of operating costs.

Since this estimate was produced the forecast decline in Revenue Passenger Kilometers (RPKs) for 2020 compared to 2019 has declined from -38% to -48%. This has the added effect of increasing the pace of cash burn for airlines. US and Europe airlines are forecast to face an additional 9% of RPK declines!

At the beginning of the year it was estimated, that on average, airlines had enough cash to up to three months of non-avoidable costs. However, a break down of these numbers reveal that 75% of airlines had less than three months cover.

Cowen Equity Research looked at the relative position of global airlines with respect to liquidity. They noted that there “will soon be clear winners and losers in Europe, where the airline industry contains a few less-than prepared airlines and hasn’t seen consolidation the way the US has seen it over the past decade. US airlines emerged from the Financial Crisis stronger, better capitalized and less leveraged than pre-crisis. Still, the current demand environment is stress testing all airlines no matter docile.” From the Ishka chart, it can be seen that in general US airlines have better balance sheets and that airlines with relatively strong credit positions are mostly clustered in Europe and North America.

The US and Europe Adopt Different Responses

In the US, the federal government has just agreed on a bailout of the airline industry using a combination of grants and loans. In Europe, the approach has focussed on loan guarantees and a desire not to distort the competitive landscape.

One big difference between the two regions is that the US has six big carriers who dominate the market. The European market is more fragmented and some airlines are likely to be supported out of national pride rather than pure financial logic.

The US Response

The US has agreed on a €58bn federal stimulus aimed with $29bn intended as direct, immediate aid, with much of it required to be used to pay employees, many of whom have been furloughed due to the drop in passenger traffic.

Under the terms of the $29bn loan agreements, the federal government will take an equity interest in the companies until the loans are repaid. It prohibits stock buybacks and share dividends for at least a year after the loans have been repaid and also restricts executive compensation to 2019 levels.

Airlines must keep flying if they accept coronavirus relief and are prohibited from laying off or furloughing employees until September.

The European Response

The European response is taking place at the national level with the European Commission applying the state aid rules. Due to the severity of the crisis, the Commission has relaxed the rules on new state aid in order to help governments mitigate the economic impact of the virus outbreak.

The goal of the Commission is to make sure that taxpayers are sufficiently remunerated for their investment, and companies that receive capital support are subject to controls and governance provisions that limit possible distortions to competition.

Last weekend it approved Sweden’s €455m package of loan guarantees which is widely expected to benefit Scandinavian Airlines SAS), partly owned by the Danish and Swedish governments, is expected to be the main beneficiary. The scheme will be open until the end of the year and will for six years.

In Belgium, Brussels Airlines – the Lufthansa subsidiary – has indicated that it needed state aid to survive the current crisis amid as rumours of nationalisation. Indeed the Italian government has nationalised Alitalia. Air France-KLM is expected likely to get aid from both the French and Dutch governments, both of which own a 14% stake.

Belgium has secured approval from the Commission for a scheme aimed at supporting the airports at Charleroi and Liege and their operators will have more time in which to pay costly concession fees. It has also been reported that Shannon airport has applied to the Irish government for COVID-19 wage subsidies to forestall potential layoffs.

France secured EC to defer certain aeronautical taxes until next year and airlines 24-month-long grace window in which to pay them back.

As can be clearly seen the European response is piecemeal with issues being dealt with at the national level and not in the context of the European Common Aviation Area (ECAA)!

Airline Consoliodation

While there is currently a lot of uncertainty as to when the airline industry is likely to recovery, it is fairly clear that there will be fewer airlines and that the surviving airlines will have smaller fleets and a reduced capacity! There will also be airline bankruptcies, this trend began a couple of years ago, but the current crisis is likely to ensure that bigger airlines with larger fleets will also fail.

Airlines are currently decommissioning and retiring older aircraft and reducing capacity. They are also deferring and cancelling orders for new aircraft. At the beginning of the month, Lufthansa decommissioned 40 jets, closed its Germanwings subsidiary, reduced Eurowings capacity by cutting long haul flights and announced an accelerated restructuring of its Austrian Airlines and Brussels Airlines subsidiaries.

As well as scrapping its dividend the airline also said that it was in daily talks with the German government about its rapidly diminishing liquidity. The carrier, which has cut 95% of its flights, also has an unencumbered fleet worth €10bn against which it can raise funds.

Several analyst notes have indicated that Lufthansa will be 20% smaller in the future. The Financial Times reported on a memo circulated to staff at one of Lufthansa’s technical sites in Ireland where it outlined a worst-case scenario. It stated that it would only be able to ramp up to 25% of its pre-crisis capacity in October, and would still be only three-quarters of its former size by the end of 2020.

The future?

What is very clear is that the spread of the COVID-19 virus is more virulent than was previously thought likely and each time IATA produces a stressed scenario, it is being swamped by what is actually happening. The estimated losses have risen by over 10 times in just 2 months!

The airline industry has proved itself to be very resilient to unexpected shocks in the past and has an ability to refine and improve its operating and business model. This was most recently illustrated by the recovery of the industry after the GFC. The main concern now is how long it will take for the industry to get back to growth.

In a recent note, on the downgrade of Ryanair and EasyJet, Fitch noted recovery of the aviation industry to lag behind that of the broader economy. With lockdown and social-distancing relaxation scenarios uncertain, we assume air travel restrictions, especially on international flights, to remain in place well beyond the second half of 2020. This will in turn, coupled with economic weakness, affect the propensity to travel beyond 2021.