The Crisis Deepens

Madhu Unnikrishnan

March 15th, 2020

U.S. Airlines React to a World Turned Upside Down

It was supposed to be a routine JPMorgan investor conference. U.S. airline executives would assemble in New York City, describing a world of strong demand, constrained supply, falling oil prices, and a healthy U.S. economy. Then along came Covid-19.

On Tues., March 10, the JPMorgan event proceeded as planned, though held virtually amid corporate bans on employee travel. What executives actually described was a world completely upended by the virus scare: Demand falling faster than even after 9/11, oil prices falling far faster than anyone could imagine, and a U.S. economy that now appears headed for recession.

Delta was first to present. CEO Ed Bastian said net bookings (new bookings minus cancellations) had declined 25% to 30%, a drop that surely worsened a day later when President Trump announced a 30-day travel ban to Europe. As of March 10, the carrier said unit revenues for all of Q1 would likely be down in the mid-to-high single digits. In mid-January, when the virus scare was confined to just China, Delta’s Q1 forecast saw total RASM holding steady y/y at worst. Providing more specifics, Delta said it filled 77% of its domestic seats during the first seven days of March. It expects the figure to be more like 65% to 70% for the full month, which would mean a roughly 20-point y/y decline. The percentage will likely be lower still following the Europe travel ban.

Recall that after the Lehman Brothers financial crisis that began in late 2009, leisure demand held up rather well, compared to business travel anyway. In the current crisis, the demand collapse is near universal — leisure, business, domestic, international, shorthaul, and longhaul. Delta did however make a few distinctions, noting that west coast U.S. travel was more affected than the east coast. Millennials, it added, were travelling more than seniors. Latin America, importantly, was holding up much better than Europe and especially Asia.

In response, U.S. airlines, like most airlines worldwide, are responding to the crisis with actions like stepping up cleaning protocols, training workers to deal with ill passengers, relaxing ticket rules, reducing fares, easing revenue management controls, cutting capacity, grounding planes, deferring non-essential investments, suspending share repurchases, freezing new hiring, and tapping credit lines. But U.S carriers are not — at least not yet — resorting to involuntary job cuts. Nor, for now, are they engaged in concession talks with unions. The fact is, all U.S. carriers enter the current crisis with extremely strong balance sheets, which was not the case after the 9/11 and Lehman demand shocks.   

In Delta’s case, it responded by announcing a capacity cut of at least 15% versus its original plan, with international down between 20% and 25%. Asia, which in normal times accounts for 6% of Delta’s revenue, was to see a massive 65% cut. The transatlantic market before the travel ban (15% of revenues), would see a 15% cut. Domestic (72% of revenue), where cancellations are mounting and close-in business bookings weak, was to shrink 10% to 15%. Cuts to Latin America (7% of revenue) would be more modest for now. On Friday, following the Europe travel ban, Delta announced even deeper cuts. Bastian, meanwhile, said he’d forego his salary for this year.

Delta seeks to save $1.8 billion by flying less, and by taking other measures like offering employees temporary unpaid leave. That doesn’t count the roughly $2 billion in fuel savings it will reap thanks to the oil market collapse (prices have fallen further still since Delta’s announcement). The carrier is also deferring $500 million of capital expenditures, and parking both widebody and narrowbody aircraft — it was earlier shifting some widebodies from Asia to domestic flying. There’s a lot more it can do if necessary, like prematurely retire older aircraft, suspend pension funding, or sell some of the $20 billion worth of unmortgaged assets it owns, $12 billion of which are aircraft. There’s flexibility too, to further cut summer schedules.

To be clear, this is a shock of massive proportions. But while the incoming arrows are strong, strong too is Delta’s coat of armor. Unlike during prior demand shocks, it sports an investment grade balance sheet, a much larger loyalty plan, a more profitable maintenance business, and a far more variable cost base. It’s not just fuel that’s a variable cost anymore, declining as ASM production declines. Thanks to heavy use of profit sharing, Delta’s labor costs too, automatically decline in tough times. Sounding an optimistic note, Bastian thinks an eventual recovery could be just as sharp as the current downturn. The famed investor Warren Buffett seems to agree. During the week, Berkshire Hathaway increased its ownership stake in Delta to 11%.

American is moving no less swiftly and significantly in its response. It began by cutting summertime international capacity by 10% versus plan, with Asia alone down 55%. Domestic ASMs for April were to drop about 8%. By week’s end, after the Europe travel ban, the cuts were deepened. Seeking to reassure investors and the wider public, CEO Doug Parker said his airline — and the U.S. airline industry as a whole — was rebuilt in recent years to withstand a shock like this, noting that not a single one of his CEO peers asked for government relief when meeting at the White House days earlier. Domestic and Latin/Caribbean load factors in the week preceding March 10 were at healthy levels. American he said, was cutting schedules farther in the future than some of its rivals. And it was also growing more slowly than its rivals to begin with.

American indeed saw a big decrease in close-in corporate demand during the first week of March. But it also saw a “large increase” in bookings as consumers reacted to fare sales. That was a point of some disagreement among the JPMorgan participants — some airlines see fare discounting as effective, others not so much. Parker, who once boldly said American would never lose money again, emphasized that the capacity cuts were in response to demand dropping, not safety concerns. Roughly 35% of variable costs, he said, could be quickly removed as it reduces flying. It’s deferring the start of six flight attendant training classes and might do the same for incoming pilot classes. Older planes like B767s might be retired early.

Most importantly, Parker said American has more liquidity than any airline in the world, with more than $7 billion in cash on hand or easily accessible through short-term securities or banking lines of credit. It has another $10 billion of assets it could sell. Lots of uncertainty? Yes. But American insists its well-positioned to endure, and likely to emerge in an even better competitive position. While the immediate focus is managing through the crisis, executives at the JPMorgan event were keen on discussing American’s longterm strategy, which includes expanding from its most profitable hubs, upgauging and densifying planes, capitalizing on newly-improved operational reliability, and developing new alliances with Alaska, Qatar Airways, and Gol.

United, of course, is cutting too. As early as Feb. 24, it became the first U.S. airline to put numbers to the demand shock it was seeing in Asia, describing a nearly 100% collapse in near-term bookings to greater China and a 75% decline on other Asian routes. Four days later, United withdrew its financial guidance and cancelled a planned investor day event. Then, at the March 10 JPMorgan event, future CEO and current President Scott Kirby announced a 10% cut to April domestic schedules and a 20% cut internationally, on top of cuts to Asia announced last month. It will cut more in May, and “proactively evaluate and cancel flights on a rolling 90-day basis until it sees signs of a recovery in demand.”

It’s separately postponing non-critical investment projects, offering unpaid leave to thousands of workers, borrowing another $2 billion just in case cash runs low, and eliminating Kirby’s base salary through at least the end of June (same for CEO Oscar Munoz). It was fortunate also, to have clinched a new credit card deal with JPMorgan just prior to the Covid crash.

Kirby emphasized that this is likely to be a short-term crisis, but a big one. The turning point came in late February when the Italian market saw demand plummet, making clear that the shock wasn’t going to be confined to just Asia. As of March 10, gross bookings for Asia, Europe, and Latin America were down 70%, 50%, and 25%, respectively. The corporate events business was down to virtually zero. United says it’s planning for things to get worse not better. It’s preparing, in fact, for a worst-case scenario of total revenues dropping 70% in April, 70% in May, 60% in June, 40% in July, 40% in August, 30% in September, 30% in October, 20% in November, and 20% in December. The SARS crisis, Kirby said, took about 14 months to fully recover. He guesses the recovery this time will be approximately 18 months, which means around mid-2021.

Does he believe fare sales can work in the short term? Not really, beyond shifting some market share. Is he counting on government support? No, but an economic stimulus package would be helpful. What’s United’s primary objective now? Survival. What’s its secondary objective? Surviving without having to resort to involuntary layoffs.

Southwest CEO Gary Kelly delivered a message to employees, likewise stressing the gravity of the situation, but also the muscular position from which it confronts the epic decline in demand. On March 5, the country’s top low-cost-carrier (LCC), which doesn’t have any exposure to Asia or Europe, flagged a $200m to $300m Q1 revenue hit from the virus outbreak. That was after healthy bookings during January and February. Suddenly, maybe not having all those Boeing 737 MAXs it was supposed to get is a good thing.

The crisis, Kelly said, might be worse than 9/11, based on the alarming drop in bookings and sales that started in late February. “The severity of the decline,” he said, “is breathtaking.” But Southwest has lots of cash, modest debt, affordable capital commitments (especially with MAXs not arriving), and a fuel price drop that will be an “enormous help.” Kelly will take a 10% pay cut. But remarkably, the airline still sent $667 million in profit sharing checks to employees last week. “I can’t promise you no grounding of planes or furloughs,” he added, “but it will be the last thing to do.” Southwest by the way, remains 60% hedged on fuel but with contracts that allow it to take advantage of falling prices.

For Alaska Airlines, Covid-19 hits close to home. Its hometown Seattle has the most U.S. cases, prompting the carrier to run a systemwide fare sale that resulted in an “uptick” in forward bookings. It even mentioned a spike in Hawaii bookings. Earlier it mentioned that if no new net bookings transpired for the rest of March, Q1 unit revenues would be down 5% y/y. Trumpeting its “fortress balance sheet,” the carrier as of March 6 had $1.6b in cash and short-term investments, another $400m in undrawn bank credit, and 133 unencumbered aircraft that could, if necessary, generate approximately $2.5 billion. Its first-quarter fuel forecast on that day was $1.98 per gallon, down from an original forecast of $2.21.

President Ben Minicucci, speaking at the JPMorgan event, said that since Feb. 24, Alaska received 265k fewer bookings y/y for March flights, along with 270k cancellations for the month. It typically carries about 4m passengers a month. Alaska’s resilience he said, lies with its strong business model that doesn’t rely on high fares, its 20% unit cost advantage versus the Big Three, and its customer loyalty and lucrative loyalty plan. The worst quarter after 9/11, Minicucci said, saw revenues drop about 30%. After the financial crisis the drop was about 20%. Alaska, though, used those downturns to enter new markets like Hawaii and transcon.

Alaska is ready to cut where necessary, eyeing reductions to its overnight red-eye flying, for example. It entered the crisis growing slowly, and with limited capital spending commitments. The commitments it does have are under review. The airline has older B737-700s and -900s in could park. If the downturn was extremely prolonged, it could do things like sell airport slots. But eyes are still on the future, post Covid. Minicucci said Alaska remains hard at work on a new five-year business plan focusing on ways to accelerate growth, extract more revenue from merchandizing, renew its fleet, and capitalize on new partnerships with American and oneworld.

JetBlue was first among U.S. carriers to waive change fees, just as cancellations began spiking in late February. By Feb 25., revenue for the first quarter based on forward bookings was just 87% of forecast. Second-quarter advanced revenue was only 22% of expectations. On March 9, a day before the JPMorgan event, it said first-quarter RASM will be at least six points lower as the result of the Covid shock. Like others reported, JetBlue’s revenue and cost trends were both looking good prior to mid-February, with even operations better than normal thanks to benign winter weather.

The carrier has since adjusted schedules through early May, while also touting its strong balance sheet, its cash balances, and its sellable assets. But it also stressed the gravity of the situation, noting demand deterioration worse than it saw post-9/11. At the time CEO Robin Hayes was speaking at the JPMorgan event, JetBlue’s shorthaul markets were booking a bit better than average. Same for family-visit travel to the Caribbean. Transcon and other longhaul markets were seeing the deepest declines. It’s not really any better off though, even as a leisure carrier with limited exposure to corporate business.

As for JetBlue’s longterm priorities, there’s no change. Mint (its longhaul premium product) and cabin restyling (its upgrade and densification of aircraft interiors) were both producing above-average profit margins. Same for its Boston expansion. Its five “building blocks” going forward: network, fleet, cost control, product, and capital allocation. 

Despite Alaska’s comments about a post-crisis jump in Hawaii bookings, Hawaiian Airlines had sobering words to share about trends amid the Covid crisis. If there are no new net bookings for March as of March 5, it said, Q1 RASM would be down about 12% y/y. Hawaiian, remember, was unlike some of its rivals in entering the crisis already experiencing yield pressure, mostly due to Southwest’s Hawaiian expansion. It was also experiencing issues with its A321 NEO engines, forcing it to sub-optimally upgauge to larger A330s on some routes. Hawaiian doesn’t have any China exposure, having suspended Beijing service in 2018. But it’s a big player in Japan (21% of the airline’s total capacity) and also serves Korea. At this point in any case, domestic routes are affected badly too.

Giving more detail, CEO Peter Ingram told investors on March 9 that in February, bookings for the month of March were already running lower y/y by about 10%. By the middle of February, declines were about 19%, the result of weaker bookings and an increase in cancellations. Bookings for Q2 were deteriorating rapidly as well. The hit came earlier for Hawaiian mostly because it gets a lot of its business from Japan, which saw Covid-19 cases earlier. Group traffic from Japan was especially hard hit. As Ingram spoke, booked load factors for March on Japan routes were down as much as 20 points y/y. Korean routes were worse. Like United, Hawaiian postponed a planned investor day event. 

Hardly immune, the ultra-LCC Spirit reported sharply falling yields, if “reasonable” load factors, since late February. The declines, said CEO Ted Christie, are affecting both close-in and far-out bookings. Spirit like most of its peers went into the crisis with January and February unit revenues trending ahead of expectations. Same for non-fuel unit cost trends. But as of March10 anyway, the airline said it would still be on track to earn a pretax profit for the January-to-March quarter, albeit at an uncharacteristically low margin of just 2% to 4%. Lower fuel prices, expected to be just $1.45 per gallon for the year (if not lower given further price declines), is surely a big help. Spirit is also cutting capacity, in its case by about 5% versus its original schedule. Offpeak flights and routes with multiple daily frequencies are the focus of these cuts. 

Spirit blamed some of its yield declines on the Big Three, highlighting their need to fill empty domestic seats that were previously filled by passengers connecting to international flights. In normal times, Christie said, they can only get away with matching Spirit’s cheap leisure fares by subsidizing such fares with higher-yield international connecting demand. He adds that Spirit, with its low cost base, is ultimately best positioned to make money in a low-yield environment. And yes, like other U.S. carriers, its balance sheet is strong, entering the crisis with about $1 billion in cash. “I think we feel very good about our ability… to be able to deal with the temporary blip that we’re experiencing.”

By late last week, U.S. carriers were making more schedule cuts as the crisis worsened, and as more and more businesses, schools, sporting events, and other places of mass gathering announced temporary shutdowns. All hope of escaping major financial bloodletting, still a possibility a week earlier, is lost. A recession now looks likely.

The silver lining of course, is cheaper fuel, and the possibility of overseas rivals perishing. Aircraft could become cheaper too. Washington will perhaps provide some financial relief. And maybe, just maybe, the crisis will subside before summer.

Madhu Unnikrishnan

March 15th, 2020