Singapore Positions Itself for Post-Pandemic World

Madhu Unnikrishnan

May 17th, 2020

  • Already by Feb. 14, while reporting financial results for the final quarter of calendar year 2019, Singapore Airlines knew it had a virus problem. Covid-19 was already spreading through China. Singapore soon became the second country with recorded cases. But the airline didn’t yet know how catastrophic the problem would become. It was still celebrating a pretty strong finish to 2019, underpinned first and foremost by ongoing demand strength for its core offering: Premium intercontinental air travel.

    Before the virus became a grave concern, the biggest headaches for Singapore Airlines included wrong-way fuel hedges, a weak U.S. dollar, a slumping cargo market, low-cost competition within East Asia, and aircraft disruptions (i.e. Rolls-Royce engine issues and the B737 MAX grounding). Some of these worries seem quaint now, with the airline’s entire revenue base wiped out by a halt to virtually all international air travel. Hedge losses, for sure, remain a problem, and last quarter contributed to massive accounting losses. Even excluding the hedge adjustments, Singapore Airlines lost money from January through March, though its negative 2% operating margin excluding special items wasn’t terrible (it earned a positive 6% figure in the same period a year ago). It was by the way, the airline’s first fiscal year net loss (its fiscal year ends in March) ever, in nearly a half-century of flying.

    The current April-to-June quarter will be far worse, with much of its fleet grounded and meaningful revenues coming only from cargo transport. Cargo revenues last quarter only dropped 4% y/y, compared to a 27% freefall in passenger revenues. Total revenues were down 22%, while operating costs ex items fell just 15%. The company was effective in removing costs as its grounded planes in the second half of the quarter — labor costs notably declined 62%, reflecting pay cuts, reduced work hours, and other measures. Though much of the Singapore Airlines workforce is represented by unions, these unions tend to have much more limited negotiating power than airline unions elsewhere. The carrier’s calendar Q1 ASK capacity declined 14%.

    Currently, 96% of the group’s passenger capacity is grounded, and will remain so through the end of the quarter. This includes mainline, Silk Air and Scoot, the latter a low-cost operator. Like the rest of the industry, the group is now modifying passenger services with concepts like social distancing in mind. It’s talking to Airbus and Boeing about delaying aircraft deliveries. It’s addressing customer concerns by relaxing typical ticketing rules and extending the validity of loyalty status for its KrisFlyer members. It’s trying to use the downtime to provide skills training to staff. And it’s benefiting from extremely generous government support, including wage subsidies and rebates on Changi airport fees.

    Most importantly, as an airline controlled by a government investment arm, Singapore Airlines got state buy-in for a giant sale of new shares that should generate a massive $6b in funds when completed next month. The airline can also issue more than $4b in convertible bonds if needed. And it’s pursuing other sources of funding including potential aircraft sale-leaseback deals.

    Looking ahead to later this year, when travel restrictions should start to loosen, management has established a “restart task force” divided into teams handling 1) government and health matters, 2) passenger service, 3) crew and aircraft readiness, and 4) supply chain management. Executives acknowledge that uncertainty levels are great, about the virus, about the economy, and about government travel policies. As a carrier dependent on premium business travel, it worries about longterm adoption of videoconferencing and changes to corporate travel policies. Without any domestic routes, it could get a slow start on recovery.

    On the other hand, it will benefit as weaker, less-capitalized rivals shrink and disappear. Before the crisis, Gulf carriers were scaling back capacity and regional rivals Thai Airways and Malaysia Airlines were in deep financial trouble. Singapore Airlines itself sees all the new capital it’s raising as a means to buy time so that it can resume pursuit of longer-term strategic initiatives when the crisis abates. These include new partnerships, including a joint venture signed with Japan’s ANA on the eve of the crisis. It forged partnerships with Malaysia Airlines and Garuda too, complementing joint ventures with Lufthansa, SAS, and Air New Zealand. Another close partner, Virgin Australia, is now bankrupt, which will cost Singapore Airlines its substantial ownership stake in the carrier. Virgin isn’t going away, however, and might wind up retaining its alliance with Singapore under new ownership. Singapore also has joint ventures in India (Vistara) and Thailand (NokScoot).

    It still believes in longterm fleet replacement, retaining (if delaying) orders for B777-9s, B787-10s, A350-900s, B737 MAX 8s (for SilkAir), and A320 NEOs (for Scoot). Before the crisis, it was busy densifying A380s and preparing to phase out the Silk Air brand, outfitting its narrowbodies with lie-flat seats. Last year, it expanded its U.S. presence with ultra-longhaul A350s (North America still accounts for less than 10% of revenues, making it less important than even the carrier’s Indian subcontinent/Africa entity). It expanded to Europe and Australasia as well, these being its two most important markets outside of East Asia. But all that has to wait. For now, the best it can do is pursue some cargo and passenger charter opportunities. Encouragingly, several Pacific rim economies like Taiwan, Australia, and New Zealand—all important markets for Singapore Airlines — seem to have the virus under control.

    But Singapore itself offers a cautionary tale: On Friday alone, the city-state recorded almost 800 new Covid cases, part of a second-wave outbreak tied to foreign worker dormitories. That raises another worrisome point: Singapore’s economy is highly dependent on international trade and imported labor, both threatened by post-pandemic realities.

Long Road to Recovery for Korea’s Airlines

  • Last year’s cargo weakness was poison for Korean Air, which as recently as 2018 got 24% of its total revenues from hauling freight. South Korea is, after all, an export powerhouse. Like for Singapore Airlines though, bullish premium longhaul passenger demand was enough to keep Korean Air profitable at the operating level last year, if barely. Its 2019 operating margin was just 2%, and losses were heavy at the net level — for that blame the cost of servicing heavy debts. This was the unflattering if at least manageable situation going into the Covid crisis.

    Since the crisis began, managing to stay alive has been a challenge. Pulling out all the stops, Korean Air has lobbied for state aid, sold non-core assets, and last week announced a share sale that should raise about $800m. Who wants to buy stock in a hobbled carrier like Korean Air right now? For one, it’s top shareholder Hanjin Group, which agreed to buy about $250m worth. Add to that another $1b or so in government assistance. The airline also has 70% of its workforce on six-month leave, big executive pay cuts in place, and most of its fleet grounded.

    During Q1, as the Covid pandemic spread quickly from China to Korea, Korean Air’s passenger revenues tumbled by one-third y/y. An industry shortage of freighter capacity amid all the global aircraft groundings triggered a yield spike that lifted the carrier’s cargo revenues 1%. But the net effect was still a 23% fall in total revenues, which was far greater than the 15% drop in the carrier’s operating costs. Passenger ASK capacity, like total revenues, fell 23%. The end result: More heavy net losses and this time operating losses too, though operating margin was a not-so-awful negative 2%.

    Before the world fell apart, Korean Air was banking on a close partnership with Delta to lift its margins and move on from corporate scandals (remember the Nut Rage lady?) Delta in fact bought a 10% ownership stake. Korean Air also ordered more Dreamliners last year, expanded shorthaul business class cabins, axed first class cabins on a portion of its longhaul fleet, added new China flights, and beat back a hostile takeover attempt led by (her again) the Nut Rage lady.

    On January 23 of this year, however, it gave the first sign that things would go terribly wrong. That day, the carrier announced it would stop flying to Wuhan, site of a mysterious new viral epidemic. South Korea has since won praise for managing the pandemic, with rigorous testing and contact tracing. But Covid-19 is a tough enemy, surging back with a wave of new Korean victims last week. That could stall what Korean Air hopes will be a gradual lifting of international travel restrictions next month. Keep in mind that about 30% of Korean Air’s pre-crisis passenger revenues came from North American routes, and another 20% from European routes.

    If this sort of intercontinental travel indeed takes years to recover, as some predict, it could be a long road to revival for Korean Air, even putting aside shortcomings like the presence in its fleet of 22 A380s and B747s.  
  • Already by March, Asiana’s passenger volumes were down by nearly 100% y/y (95% to be exact). Earlier in the first quarter, the carrier faced demand headwinds on its Japanese routes, the consequence of a political dispute. A weaker Korean won was likewise troubling.

    But the real pain started with the viral outbreak, which was most responsible for a brutal negative 18% Q1 operating margin. Asiana’s total revenues plummeted 22% y/y, never mind that cargo revenues increased 15%. Cargo in fact accounted for 35% of all revenues in the quarter. But a 34% freefall in passenger revenues was simply overwhelming. Operating costs only declined 8%, with fuel outlays down 15% and labor costs down 5%. Other numbers further highlight the Q1 distress: A 32% drop in RPK traffic despite just 19% less ASK capacity. Load factors dropped from 84% to 71%. Passenger revenues on Japanese routes declined 58%. On ASEAN routes — that’s Asiana’s largest market — revenues fell 35%.

    The company’s already heavy debts, meanwhile, spiked even higher, erasing recent efforts to get its balance sheet under control. Asiana also operates two separate low-cost carriers. One is Air Busan, which posted a gruesome negative 41% Q1 operating margin. Air Seoul wasn’t all that much better at negative 27%. Asiana has long posted inferior margins to those of its bigger rival Korean Air. That was even true in 2015, when Korea was tested by a viral outbreak called MERS, badly hurting airline peak season revenues that year.

    Asiana was on a path to reform, however, cutting routes, cutting costs, adding A350s and A321 NEOs, and most importantly attracting the Hyundai conglomerate as a new investor. Its investment, though, was stalled by the crisis, and now remains uncertain. Keeping Asiana alive for now: Government aid.
  • Results were even worse for the normally-profitable shorthaul LCC Jeju Air. With heavy exposure to disrupted shorthaul markets, most importantly China and Japan, Jeju suffered a negative 28% operating margin. Revenues dropped 42% y/y, compared to a mere 16% drop in operating costs. ASK capacity decreased 26% even as five new planes were added, implying low rates of utilization. In last year’s Q1, the carrier produced a positive 11% operating margin. But that was before Korea-Japan tensions flared, before overcapacity on Korea-China routes, and before, most importantly, anyone had heard of Covid-19.

    To help matters, Jeju turned to consolidation. At first, its parent company was interested in investing in Asiana. When that thankfully didn’t happen, Jeju purchased a large stake in LCC rival Eastar. That deal, though, is also in question following the onset of the Covid crisis. Jeju, meanwhile, might have wished it never placed a large B737 MAX order. On a brighter note, The Economist reports that flight capacity on the busy Seoul-Jeju route was almost fully back to pre-crisis levels this month, responding to a “swift” bounceback in domestic tourism. Last week’s second wave of infections though, puts some doubt into the resiliency of the domestic recovery.

Azul Sees Demand (Slowly) Recover

  • Having entered 2020 as one of the world’s most profitable airlines, Azul was expecting another strong year. The Brazilian economic outlook was brightening. The Brazilian airline sector was flourishing following the collapse of Avianca Brasil, leaving just three main competitors (Azul, Latam, and Gol). Azul was aggressively growing and upgauging its fleet, expanding its cargo flying, planning new longhaul routes like Campinas-New York JFK, expanding its domestic network through the purchase of a regional carrier called TwoFlex, developing joint ventures with United and TAP Air Portugal, building its loyalty program, and offloading older E-Jets to LOT Polish and Breeze, the latter a new U.S. startup launched by Azul’s founder David Neeleman, also of JetBlue fame.

    As late as March 12, Azul was still optimistic, insisting domestic demand was still holding firm. In the second half of March, however, Azul was forced to cut about half of its normal capacity. In the final days of the month, its network was down to just a few routes. Ultimately, results for Q1 were still positive at the operating level — operating margin was 6%, consistent with the positive results seen at other Latin American carriers (i.e. Gol, Volaris, Copa).

    But when things go wrong in the world economy, Brazil seems to always suffer disproportionally, tanking its currency and wreaking havoc on the net results of its corporations. Azul’s Q1 net loss — no kidding — was $1.4b due to heaps of accounting adjustments for forex movements and wrong-way hedges. Even normalized without the messy accounting through, the weak real’s hurtful impact on debt servicing meant net results were in the red, to the tune of $57m. What’s most important, however, is cash, and Azul thinks it has enough (or could raise enough) to stay in business through the end of 2021.

    Demand is in fact already starting to creep back, bottoming in mid-April. Oil and gas companies, surprisingly, are flying a bit more than expected. On the other hand, Brazilian finance companies are not. In a broader sense, business traffic is still largely dormant, and probably will be until São Paulo lifts its lockdown, currently in effect through May. Brazil, as it happens, has been hit hard by Covid outbreaks in recent weeks.

    Even so, Azul is gradually adding back flights, flying only when cash revenues exceed cash costs (now’s not the time to worry about noncash costs like depreciation or indirect costs like management overhead). People are booking late, which means it can make last minute decisions on whether to operate or cancel. It also has flexible crew contracts that allow for close-in schedule adjustments. Management sees demand recovering to about 40% of pre-crisis levels by December.

    In the meantime, it’s talking to Brazil’s public development bank about credit support. It suspended all E2 E-Jet deliveries until 2024. It’s talking to Airbus about altering delivery schedules. It hints at a desire to adopt more favorable labor contracts. Those contracts to sell older E-Jets to Breeze and LOT Polish, it says, are still valid. Cargo is a big bright spot, with lots of potential to grow in tandem with Brazilian ecommerce. An estimated 60% of Azul’s costs are variable, almost 80% of its staff have accepted unpaid leave, and 90% of its aircraft are leased rather than owned. Its wholly owned loyalty plan, with 12m members, can sell miles for cash if needed. Ownership and credit exposure risk to TAP Air Portugal is mitigated by the government support TAP will likely get, not to mention the airline’s loyalty program which serves as collateral for Azul’s loans.

    As it looks to rebuild the domestic network in conjunction with demand recovery, Azul insists it has one big advantage over rivals: Its diverse fleet consisting of everything from nine-seat Cessna Caravans to 200-plus-seat A321 NEOs. Widebody A330s for international use might take longer to recover relevance. But the point is, whatever happens with demand on a given route, Azul will have an appropriately-sized aircraft to serve it.       

El Al Enters Crisis Troubled

  • Israel’s El Al finally reported its Q4, 2019 results, which showed a negative 4% operating margin. This marked a modest y/y improvement as revenue growth of 5% outpaced a 3% increase in operating costs. Cheaper fuel helped. So did the fuel efficiency and other advantages of newly arriving Dreamliners. The airline also improved revenue generation from its loyalty plan, ended its low-fare “Up” experiment, and took advantage of robust inbound tourism and demand from a thriving domestic tech sector.

    Nevertheless, El Al remained a troubled airline, recording its second straight year of net losses. It only barely eked out a positive operating margin for the full year. So it entered 2020’s Covid crisis already on weak footing. Part of its weakness is structural: Lack of alliance partners, Israel’s largely-closed borders with immediate neighbors, limited economies of scale, and low fleet utilization (due to the grounding of flights each week during the Jewish Sabbath). It also faces intense competition following a decade of open skies agreements with the European Union and elsewhere.

    Some of El Al’s toughest rivals include Aeroflot, Turkish Airlines, and European LCCs like Wizz Air and easyJet. The new B787s allowed for more longhaul routes, like Tokyo and Chicago. Or so it hoped — the Covid crisis forced it to postpone these two launches. Another postponed route was Dusseldorf. The good news, in a modest sense, is that El Al was always a sizeable cargo airline whose freighter capacity is serving it well at the moment.

    Israel, meanwhile, is seeing Covid infection rates drop as it looks to reopen its tourist sector next month. Talks are underway with Greece and Cyprus about creating one of the so-called “travel bubbles” up for discussion elsewhere.

    But El Al itself is battered financially, begging for government aid, specifically loan guarantees. The airline no longer has any state ownership. But it remains an important tool of the state, when coming to the aid of threatened Jewish communities abroad, for example.

Allegiant Expresses Optimism

  • March is the pinnacle of peak season for Florida, which explains why it’s typically the strongest month of the year for Allegiant. Not this atypical year, of course. But even with March disrupted by the coronavirus, the world’s most profitable airline by operating margin last year (see chart below) managed to earn a profit excluding special items last quarter. It was the only U.S. airline with a Q1 profit excluding items, aside from the regional carrier SkyWest.

    Nor was it a small profit — Allegiant’s Q1 operating margin ex items was 13%. To be clear, this was a big drop from its 20% figure in the same quarter a year ago. But even this was a less severe y/y drop than any other U.S. carrier. Revenues fell 9% while operating costs fell 2%, all on 4% more ASM capacity.  Both fuel and labor costs declined, by 11% and 5%, respectively. March revenues alone, for the record, dropped 40% from last year’s levels. Allegiant is uniquely structured to ground planes in periods of low demand without blowing up its unit costs. Low demand, for sure, is not the same thing as no demand, which is close to the state of U.S. air travel at the moment.

    But Allegiant seems well placed for an eventual recovery with its near-100% reliance on price-sensitive domestic leisure travel. Most of its customers, furthermore, live in regions of the U.S. less affected by the Covid crisis thus far, where the “sentiment is very different” than in big metro areas like New York, Dallas, Atlanta, or Los Angeles. Allegiant is actively surveying its customers, who are “telling us they overwhelmingly believe things are getting better.”

    Most think it will take more than six months for things to get back to normal, but nearly two-thirds plan to travel by air before the end of this year. About half, meanwhile, say they’ll stay in a hotel or vacation rental property. Another third plan to visit friends or relatives and the remainder will travel to their second home. Surveys also show a majority who report unchanged or improved personal finances, which could reflect a preponderance of retirees unaffected by the job market collapse.

    CEO Maury Gallagher compares consumer sentiment to the mix of opinions within his own family: Some people who won’t leave their homes and others who are ready to get moving again. Like the airline industry at large, Allegiant wants to size itself to accommodate the latter portion, which will hopefully grow over time, even if not to 100% for several years. As optimism builds, Allegiant is sure enough seeing a jump in recent flight searches on its website, and more importantly a modest “uptick” in bookings. That’s particularly true for flights to Florida’s west coast and panhandle (i.e. Tampa/St. Petersburg, Punta Gorda, Sarasota, and Destin), where beaches have reopened.

    On the other hand, Allegiant’s two busiest markets — Orlando and Las Vegas — are largely still dormant with theme parks and casinos still closed. The new Las Vegas Raiders stadium for which Allegiant bought naming rights is supposed to open in late August (every game for the entire season is already sold out, according to the Athletic). The company, remember, was also building a new hotel resort in Punta Gorda, work on which is suspended for now.

    That’s one measure management took to preserve liquidity. It’s also due to get $172m in federal CARES Act money to cover payroll. A less discussed benefit of the CARES Act is tax relief that will net Allegiant $100m in refunds this quarter and at least as much next year. It can access another $276m in CARES Act lending help if needed. More than a quarter of the airline’s workers have accepted voluntary leave or pay reductions. Its fleet will shrink by about 25 planes. It has no meaningful aircraft purchase commitments beyond this year. Current cash burn is down to about $2m a day.

    Feeling a more imminent sense of recovery than perhaps some of its peers, Allegiant is keeping all of its 18 crew bases intact. And it’s keeping a sizeable portion of its flights on sale, ready to go if bookings merit, or ready to cancel shortly before departure if not. For example, it has about 75% of its flights available for sale in May, compared to only about 30% for most U.S. carriers. That said, it actually operated just 13% of its planned departures in April. Other near-term tactics include measures to promote onboard health and efforts to get road trippers to book hotels on its website.

    Management acknowledges that it would eventually have to close some smaller bases if demand remains suppressed for a long time. It hints at a desire to experiment with new labor compensation models. But there’s one thing in particular that makes Allegiant think it might ultimately benefit from the crisis. The fact is, a critical part of the carrier’s success is its opportunistic buying and selling of aircraft. And now, the crisis has radically altered the aircraft market, not to mention the market for aircraft parts and maintenance.

    It can’t help but salivate at Avianca’s 45 CFM-powered A320s, some likely available at distressed prices as the Colombian carrier restructures in bankruptcy. Many more such opportunities abound, as they did with MD-80s in the immediate post-9/11 era. In the carrier’s 2007 annual report, it noted how “ownership cost of the used MD-80s sought by us are more than 80% lower than comparably sized new Airbus A320 and Boeing 737 aircraft.”

    As Gallagher likes to say as he purchases planes on the cheap: “We [are] a noncapital-intensive business competing in a capital-intensive industry.”

The Butchery Begins

U.S. Airline Scoreboard: Q1 2020

RevenuesNet resultOperating MarginNet MarginRev Y/YExpenses Y/YRev/Exp differenceASM/KsFuel Y/YLaborAverage FuelPretax Margin
1Delta$8.592b($326m)-5%-4%-17%-5%(13 pts)-6%-18%5%$1.82 -4.9%
2American$8.515b($1.129b)-16%-13%-20%-2%(17 pts)-7%-17%2%$1.83 -17.0%
3United$7.979b($639m)-11%-8%-17%-2%(15 pts)-7%-15%3%$1.90 -13.0%
4Southwest$4.234b($77m)-3%-2%-18%-6%(11 pts)-7%-14%-6%$1.90 -3.4%
5Alaska $1.636b($102m)-9%-6%-13%-2%(10 pts)-1%-12%5%$1.93 -8.9%
6JetBlue$1.588b($116m)-8%-7%-15%-4%(12 pts)-4%-16%5%$1.86 -9.6%
7Spirit$771m($59m)-8%-8%-10%8%(18 pts)-2%-7%18%$1.81 -9.7%
8Hawaiian$559m($34m)-8%-6%-15%-1%(14 pts)3%-10%8%$1.83 -8.0%
9Allegiant$409m$33m13%8%-9%-2%(8 pts)4%-11%-5%$1.87 10.3%
TOTAL$34.283b($2.448b)-9%-7%-17%-3%(14 pts)-6%-16%2%$1.86 -10.0%

*All figures exclude special items

And in Other Earnings News

  • U.S. regional airline Mesa reported $2m in net income for calendar Q1 but warned that this coming quarter could be ugly. The regional carrier reported that it is down to operating 194 flights per day now, down from 650 per day before the pandemic. It is delaying the delivery of 20 E175s and will continue to operate CRJ-700s for United until it takes the Embraers. Mesa took $93m in payroll protection funds provided through the CARES Act. Because it did not take more than $100m, Mesa is not required to offer the government stock warrants.

    Mesa shares labor costs with the mainline carriers for which it operates, so it said it could offer a cost reduction to its mainline partners. Mesa still is in talks with the U.S. Treasury about taking a loan through the CARES Act.

    CEO Jonathan Ornstein expects incremental improvement in traffic through the year, and said the company expects to be operating at 50% capacity by year end. Although jobs are protected until Sept. 30, Ornstein said the company is accepting voluntary leaves of absence and is in talks with its unionized workgroups for wage concessions to avoid furloughs and layoffs.
  • Chorus, the Canadian regional airline flying as Jazz for Air Canada, earned a comfortable 13% operating margin in Q1. This quarter will be rougher, with more than 70 of its planes parked and roughly 65% of its workforce inactive. Air Canada Express capacity is down 90% y/y for April and May.

    But Chorus sees some green shoots as it works with Air Canada on mutually beneficial remedies. The company is also a major lessor of regional aircraft to airlines around the world, parts of which are starting to show signs of a travel revival. It’s seeing capacity ramp up in Asia and Europe, for example. And it’s encouraged by the prospect of airlines downsizing to smaller planes in the context of lower demand. In addition, domestic markets are restarting first, and carriers tend to use lots of regional planes domestically.

    Even KLM, without a domestic network, is restarting intra-European flights with Embraer jets. Another Chorus customer, Lion Air, is restarting regional flights within Indonesia. Virgin Australia, alas, is a customer too — Chorus is hopeful it will retain its ATR turboprops even under new ownership.

Madhu Unnikrishnan

May 17th, 2020