Airlines Report Grim Earnings With a Few Surprises

Madhu Unnikrishnan

November 1st, 2020

  • It was a major margin laggard in the pre-crisis era. What now, are Air France’s chances to exit the Covid era on stronger footing relative to its peers? Can KLM emerge from the darkness just as strong as it was pre-crisis? Sometimes, it takes a radical revolution to change the order of the universe. And maybe, just maybe, Covid’s upending of the status quo is Air France/KLM’s opportunity to address chronic deficiencies, most importantly uncompetitive French labor costs and loss-making French domestic flying.

    Needless to say, the current crisis is painful. The airline likely wouldn’t even be here now without a big bailout from both the French and Dutch governments. The money it received was all borrowed though — none of it provided as equity. That’s different from the bailouts carriers like Lufthansa and Singapore Airlines received, or U.S. carriers for that matter. So the Franco-Dutch giant suddenly has enormous debts, prompting management to actively look for ways to raise more equity (it was lucky its plans to buy a stake in Virgin Atlantic never happened). But at least it can rest easier knowing the bailout money will cover its needs until the recovery, right?

    Not really. While it doesn’t face an immediate liquidity crisis, CEO Ben Smith, according to Bloomberg, says the money will cover less than a year of its needs. And that’s a problem because the recovery isn’t happening. It looked like it would, based on encouraging shorthaul demand revival in June, July, and into August. But business traffic never did return in the fall, as it usual does. And worse, Europe began suffering a dangerous second wave of Covid-19 infections, leading to the closure of many borders within Europe. There’s now amplified chatter about the possible need for more state aid, reportedly straining longstanding tensions between Air France, KLM, and their respective governments. If all this sounds bleak, it is.

    But let’s now emphasize the positive. In Q3, Air France/KLM’s operating margin was negative 41%, which was much less severe than what IAG suffered (see item below). In fact, it was similar to what the U.S. LCC Allegiant reported last quarter (see its writeup below). This by no means suggests a new future reality. But for the time being, Air France/KLM is managing through the crisis better than most thanks to a few factors. One, it’s a big cargo player, and its B777-300ER-heavy fleet is exactly what you’d want for a cargo boom — A350-900s are good cargo planes too. The airline saw its cargo revenues grow 34% y/y to $786m, which was 27% of total group revenues.

    Secondly, Air France and KLM are both flying a lot more than either Lufthansa or IAG, while claiming all of its flights are cash positive (i.e. they’re able to at least cover direct operating costs). The cargo factor is one reason why it can get away with more flying than some. In addition, Air France has a pretty big domestic market that’s still generating some leisure demand. It more importantly has lots of busy family-visit routes to overseas French territories and former French colonies — think Guadeloupe, Reunion, Beirut, and much of its African network. What’s more, Amsterdam happens to be the busiest airport in all of Europe right now, thanks to its utility as a connecting hub. With so many nonstops gone, connections are becoming more necessary, and will be for years to come, KLM argues.

    Remarkably, KLM’s Q3 operating margin was just negative 20%, on par with what its partner China Eastern produced in the fast-recovering Chinese market. Air France’s margin was negative 54%, still relatively mild. Transavia, meanwhile, benefitting from the temporary jump in leisure demand this summer, held its loss margin to negative 5%.

    Groupwide, Air France/KLM cut capacity 58%, compared to IAG’s 79%. It is important to note that the carrier is still receiving wage subsidies that keep its labor costs artificially low. It would be flying less without these subsidies, though some other airlines are getting similar help. The crisis, in any case, gives Air France in particular a rare chance to enact needed labor reforms, on top of several important ones it was able to extract just before the crisis. That’s not a given though. On the Dutch side, KLM pilots just rejected a five-year wage cut. And that puts bailout money at risk — the aid is conditioned on securing cost cuts. Just as threatening is the state of Covid in Europe, with France for one locking down businesses again last week. It should make for a very distressing winter.

    Beyond that, KLM hopes to gradually restore its past margin strength while Air France accelerates major reforms enacted before the crisis. They include major fleet restructuring, the expansion of Transavia France, and addressing chronic French domestic losses. The terms of its bailout should actually help in this regard, forcing Air France to cut shorter routes that overlap with the country’s high-speed TGV rail network — the idea is to cut aviation’s contribution to climate change.
  • IAG didn’t disclose operating margins for each of its airline brands, as it usually does. But you can safely assume they’re all losing big money, especially because the U.K., Ireland, and Spain have some of Europe’s most severe travel restrictions. IAG as a whole lost $1.4b net excluding special items in what’s supposed to be the best quarter of the year for European airlines. Operating margin was negative 105% as roughly 80% of its normal flying was suspended. On two separate occasions now, IAG had to reverse plans to restore more capacity in hopes of seeing this summer’s demand momentum continue. Instead, demand peaked in July before leveling off and remaining subdued into November.

    It’s the travel restrictions, more so than consumer confidence, that’s holding back the recovery, IAG believes. As evidence, it cites data showing a sudden burst of bookings after the Canary Islands were taken off the U.K.’s quarantine list on Oct. 22. No wonder why it wants to see more restrictions removed, banking on Covid testing for passengers as a means to do so safely.

    In the meantime, British Airways, now under a new CEO, alone cut 9k jobs last quarter, with more gone this quarter. At Aer Lingus, job cuts are at about 800 and counting. Jobs at Iberia, Vueling, and Level are for now protected by Spanish government wage subsidies. Level however did close its Vienna, Paris, and Amsterdam bases, leaving only Barcelona. Vueling did cut a fifth of its management team. With Willie Walsh in retirement, IAG’s new chief Luis Gallego, a veteran cost slasher, doesn’t have any big government bailout money to work with. But he does have a fresh supply of cash from owners, led by top shareholder Qatar Airways. Yes, cargo was helpful, but IAG isn’t as big of a cargo player as Air France/KLM and certainty not Lufthansa.

    Losses accumulated, meanwhile at businesses like BA Holidays and Iberia maintenance. BA did strike a lucrative marketing partnership with Delta’s close friend American Express. Its own close friend in the U.S., of course, is American. Uncertainty runs high for BA, which is crucially dependent on transatlantic markets and now faces a leaner bankruptcy-cleansed Virgin Atlantic. BA isn’t yet sure what it will do as far as future flying from London Gatwick. For now, it’s moved most of its shorthaul flying to Heathrow. It extracted important labor concessions in terms of pay and work flexibility, building on its history of acting quickly and forcefully on cost cutting during times of deep distress.

    Iberia’s fortunes, meanwhile, depend on Latin American markets, where the competitive landscape could change dramatically in its favor if IAG completes its takeover of Air Europa. It makes no secret that it still wants the airline, but only at a dramatically reduced price. Air Europa is now in the process of getting rescued by Madrid, which could lead to IAG getting it for nothing but some assumption of debt. We’ll see.

    As the group as a whole contemplates recovery scenarios, one area of focus is the longhaul premium economy segment. This was already growing as a contributor to overall revenues and was particularly helpful in the financial crisis recovery a decade ago. It’s thus looking at options to add more premium economy seats to its widebodies, targeting both business travelers trading down from their lie-flat luxuries and wealthier leisure travelers trading up from the squalors and depredations of economy class (that was a bit harsh). It says, in fact, that just 13% of the group’s revenues come from corporate contracts. Premium-heavy B747s are gone at BA, part of a move that positions IAG to be smaller for at least another two years. This quarter, it won’t fly more than 30% of its normal capacity. And it won’t break even on operating cash flows by the end of this year after all.
  • All Nippon, Japan’s largest airline, got its operating margin down to negative 72% in calendar Q3 after domestic travel restrictions lifted and demand started to recover. Net loss margin excluding special items was negative 54%, lifted by income tax credits. Back on the operating line, revenues fell 69% y/y as costs fell 41%, all on 66% less ASK capacity. For ANA in normal times, the domestic market is similar in size to the international market in terms of passenger revenues. And while the Japanese domestic market isn’t recovering as fast as the Chinese domestic market, it is recovering rather steadily. ANA is now operating about half of its mainline-branded domestic capacity (compared to just 30% of international). But just as importantly, its low-cost Peach unit is operating more domestic capacity now than it was at this time last year. Last year, remember, ANA merged its two LCCs Peach and Vanilla Air.

    Now, surprisingly, it plans to create a third airline brand (or fourth if you count Skymark, which it partly owns). The new unit, launching in 2022, will target low and mid-yield travelers not addressed by ANA mainline or Peach.  It will use the group’s Air Japan platform and use two-class 300-plus seat B787s rather than Peach’s narrowbodies. Targeted markets include the ASEAN region and Australasia.

    ANA is separately taking a page from AirAsia’s playbook and attempting to leverage its customer database to build new revenue streams. A foundation of this new “ANA X” platform initiative will be its tour operator unit, with eyes on generating more e-commerce even in the non-travel space (selling real estate insurance for example). Back in the air, ANA is earning strong yields in the international cargo space. Domestic tourism is getting a boost from its own promotions and government stimulus policies. The government is also providing wage subsidies. Still missing though are the many foreign visitors that were coming to Japan before the crisis, often flying within the country during their stay. The Tokyo Summer Olympics, postponed due to Covid, were supposed to further advance this trend of foreign tourism, an important economic force countering the stagnating influence of a rapidly aging and shrinking population. Currently, most of ANA’s international flying is undertaken with cargo demand in mind. Peach, however, is just now restarting flights to Taiwan.

    When intercontinental demand returns, ANA will prioritize its most profitable routes from Tokyo Haneda airport. Tokyo Narita, which will remain important for sixth-freedom connecting traffic (i.e. North America to the ASEAN region) will be a secondary focus. Just prior to the crisis, remember, ANA was able to announce 12 new routes from Haneda thanks to slot expansion. Some were new to the network, like Moscow, Istanbul, Stockholm, Milan, and Shenzhen. Others were cities it was already serving from Narita, including five in the U.S. Also just before the crisis, ANA signed a joint venture agreement with Singapore Airlines (it has JVs with United and Lufthansa as well) and a more modest partnership with Virgin Australia (it separately owns sizable stakes in Philippine Airlines and Vietnam Airlines).

    Another big pre-crisis strategy was attacking the Hawaiian market using A380s. Finally, in a last pre-crisis hurrah for Boeing pre-crisis, ANA — in late February — ordered another 20 Dreamliners, some of them B787-10s (it has B777-9s on order too). A key focus now of course, is cutting costs. It’s furloughing foreign pilots, cutting management salaries, postponing aircraft deliveries, insourcing airport handling and maintenance work, leasing a larger portion of its fleet, transferring surplus employees to the Toyota motor company, downgauging domestically, and giving more responsibility to Peach and, ultimately, the new LCC it’s creating.

    Peach will look to do longer-haul routes with narrowbodies, including A321 LRs. It’s also expanding from Nagoya as a third base for leisure traffic alongside Tokyo Narita and Osaka Kansai — note that Nagoya-based AirAsia Japan just closed its doors. High-yield business demand, by contrast, won’t return to pre-crisis levels for years, ANA believes — perhaps not ever. So it needs to reorient itself toward capturing more leisure demand. That means not just expanding Peach, starting a new LCC, and slashing costs. It also means improving distribution, hence a new partnership with Google Flights. ANA and Peach will also start codesharing and cooperating in other areas.

    ANA, by the way, also owns 18% of a small Fukuoka-based carrier called Star Flyer. For the airline’s current fiscal year that ends in March, losses will unsurprisingly be heavy. Operating margin for the fiscal year, management estimates, will be negative 68%.
  • Japan Airlines, which routinely out-earned its bigger rival All Nippon throughout the 2010s, is losing that distinction in the pandemic era. In calendar Q3, for the second straight quarter, its operating margin was worse, registering at negative 80%. Though the distinction isn’t too meaningful, what is relevant is a temporary loss of one of JAL’s most important strategic advantages. Pre-crisis, it profited much more than ANA in Hawaii, which represented a double-digit percentage of JAL’s overall passenger revenue (13% in last year’s calendar Q3). Jealous, ANA tried to crash the party with an A380-led Hawaiian offensive, as discussed above.

    But JAL is fighting back, even after U.S. regulators quashed its attempt to joint venture with Hawaiian Airlines. JAL will soon send its new low-cost carrier Zip Air to the Aloha State, offering Dreamliner service tailored for leisure passengers, including premium leisure. Hawaii, indeed, will be an ongoing theater of war between JAL and ANA post-crisis. Their networks and business models overlap in many other ways too, including a U.S. mainland franchise buttressed by joint venture partners (American in JAL’s case, United in ANA’s case) and efforts to drive more sixth-freedom traffic between to the ASEAN region via Tokyo Narita. JAL was likewise adding more international flying from both Tokyo Haneda and Narita and cultivating partnerships in key markets outside the U.S. (i.e. with Lufthansa, Aeroflot, Vistara, China Eastern, and Malaysia Airlines).

    The near-term focus now, of course, is the domestic market, where JAL is shifting some widebodies and adding new A350-900s. Just as ANA has Peach at home and soon a new LCC for abroad, JAL has Jetstar at home, complementing its new international LCC Zip Air. Zip, by the way, will grow to six B787s and possibly more, flying from Narita. JAL, meanwhile, will retire older B777s, will seek to drive more revenues from sources other than air service, including its loyalty plan and related credit cards. It’s marketing to “workation” people combining work with vacation. It also notes that domestic demand among group tours, a big market in normal times, is starting to revive. 
  • With a near Covid-free population of more than 1b people, China is furthest along in getting its airline sector back to normal. It’s not quite there yet, not with international markets largely still closed, and with domestic carriers scrambling to win back passengers with low fares. The July-to-September period was, to be sure, another loss-making quarter for China’s airline industry. In the same summer quarter last year, the country’s six publicly traded carriers tracked by Airline Weekly earned an outstanding operating margin of 15%. This year was almost a mirror image: Negative 12%. But that’s far better than what most carriers elsewhere in the world are managing.

    And within that average are some carriers doing much better than others. Two in fact, earned operating profits last quarter. Juneyao Airlines, based in Shanghai and aligned with China Eastern, produced a 3% Q3 operating margin. Spring Airlines, also based in Shanghai but sporting a low-cost business model, generated a positive 2% operating margin. More on these carriers in a bit.

    First, look at Guangzhou-based China Southern, the clear standout among the country’s Big Three airlines. It was alone in reporting a net profit, amounting to $135m. But don’t pay too much attention to that. When stripping out one-off gains, it was really loss-making. Truly impressive though, was an operating margin of merely negative 2%, despite significant pre-pandemic international exposure (about 30% of its RPK traffic in 2019). China Southern had much milder loss margins than its peers during Q2 as well, aided by minimal exposure to the beleaguered Hong Kong market (an important revenue source for Air China and China Eastern). China Southern’s Q3 revenues fell 40% y/y on 33% less capacity, while operating costs fell 29%. Domestically, its ASKs were down only 6%.

    All Chinese airlines right now are getting helpful cost relief from cheap fuel and a strong Chinese yuan. Cargo is another bright spot. China Southern, for its part, is probably benefitting most from the troubles at Hainan Airlines, which has a large presence in China’s southeast, including Guangzhou. China Southern, sure enough, is and long has been the largest carrier serving Hainan island. In Beijing meanwhile, another big Hainan Airlines market, China Southern is building a hub at the new Daxing airport south of the capital. Its international ambitions there are on hold, temporarily reducing the importance of a new alliance with American. Other partners include British Airways, Emirates, and Qatar Airways, not to mention its control of domestic ally Xiamen Airlines.

    On the other hand, it recently left the SkyTeam alliance. American and Spring Airlines, by the way, own small stakes in China Southern. Note that Chinese carriers don’t provide much commentary on their Q3 results, but there’s one more factor that might be contributing to China Southern’s relative strength: It has the most grounded B737 MAXs of any Chinese carrier, which helpfully keeps capacity less than it otherwise would be.
  • Air China, long the best performer of China’s Big Three, faces challenges in its home market Beijing. The city’s air traffic was momentarily disrupted this summer due to a Covid outbreak. And commercially, Air China faces new competition in the capital from airlines building hubs at Daxing airport. In Q3, the carrier saw a 50% y/y drop in revenues but just a 33% decline in operating costs. As a result, operating margin was negative 10%. Compared with results last summer, that’s terrible. Compared with results carriers elsewhere in the world are showing, that’s encouraging.

    Air China, with heavy dependence on longhaul international routes, flew 43% less capacity last quarter, the steepest drop among the Big Three. But its domestic capacity was more or less in line with its Big Three rivals, down by just 5%. Air China owns large stakes in Shenzhen Airlines, Shandong Airlines, and Air Macao, as well as in Cathay Pacific, thus absorbing part of the latter’s heavy losses. It also agreed to help recapitalize Cathay.
  • China Eastern, as usual, was the worst-performing of the Big Three last quarter, with its negative 17% operating margin. Its revenues and operating costs shrank by similar percentages as Air China. Its ASK capacity was down a bit less, shrinking 36% y/y. Domestic ASKs were down only 3%. Based in the giant but competitive Shanghai market, China Eastern is aggressively discounting tickets to drum up more domestic tourism. Promotions include air-rail passes and unlimited flying for a set price through the end of the year.

    Pre-crisis, the airline was ambitiously advancing its international credentials, joining China Southern in building a Beijing Daxing hub. Its Shanghai Airlines affiliate began flying widebodies. It was developing partnerships with Delta, Air France, Qantas, and Japan Airlines. Back at home, meanwhile, it had big plans for its Beijing-based LCC China United, now flying from Daxing instead of the small airport Nanyuan. In Shanghai, its cross-ownership with Juneyao turned a rivalry into something more cooperative.

    Looking ahead, China’s return to solid economic growth adds momentum to the country’s airline recovery. The next key milestone is for international markets to reopen. There’s the upcoming Chinese New Year as well, in February, which will mark roughly a year since China was hit with the world’s first wave of Covid infections. But all that aside, China Eastern needs to address its pre-crisis habit of repeatedly underperforming its peers.
  • Well, at least it doesn’t underperform Hainan Airlines anymore. Once a superstar of Chinese aviation, Hainan impressed investors and travelers alike with a more efficient, productive, and consumer-friendly business model than its Big Three peers. It capitalized on a boom in tourism to its namesake island Hainan, sometimes called China’s Hawaii. At the same time, it ambitiously built a fleet of Dreamliners, sending them to points around the globe. It became an especially large player in the U.S. market, serving seven airports there.

    But the walls came tumbling down with the onset of the Covid pandemic. International markets closed. Expensive widebodies were left with little to do. And all the while, Hainan’s parent company HNA was buried in debt, the consequence of a reckless overseas buying spree. To be clear, Hainan Airlines was already in a state of decline before the pandemic, reaping the wreckage of over-expansion. In fact, 2016 was the last year in which it shined above its peers with double-digit margins. In 2019, its operating margin was just 2%.

    And this year? Well, last quarter, its operating margin was negative 47%, resembling figures from carriers in countries with far less mature recoveries. Its 56% y/y slashing of ASK capacity — with an even drastic 39% cut to domestic capacity — helps explain not only its 62% drop in y/y revenues but also part of why rivals like China Southern are improving their margins so significantly. Hainan’s operating costs, for the record, fell negative 39%.  
  • Back to Juneyao Airlines, its welcome 3% Q3 operating margin came as it cut ASK capacity 12% y/y, driven entirely by less international flying. Domestically, it actually increased ASKs 10%. Revenues, to be clear, are still severely depressed, declining 39%. And operating costs aren’t falling as much, down just 28%. But this was an airline with an 18% operating margin last summer, which meant it could still make money despite a drastic fall in fortunes. It’s the point that Spirit and Allegiant make in the U.S., by the way — that because they were so profitable pre-crisis, it won’t take much to simply cross the breakeven line.

    Juneyao itself is a full-service carrier catering to business fliers, who even in China, aren’t yet returning to the skies in full force. But the airline also owns an LCC called 9 Air based in Guangzhou, where its domestic seat counts for November are scheduled to increase 21% y/y, according to Cirium. That’s roughly in line with the overall domestic growth for the Juneyao-branded operation. Just before the crisis, Juneyao was beginning to dabble in intercontinental markets using newly arrived B787-9s.  
  • The LCC Spring Airlines, which earned a 22% operating margin in last year’s Q3, managed a positive 2% result last quarter. Spring ambitiously grew domestic ASKs 46% y/y, allowing it to win a greater share of the Chinese market. But that was only because it redirected planes back home after pursuing aggressive shorthaul international expansion. In fact, its overall ASKs actually shrank 4% last quarter. The airline recently received its first A321 NEO, part of a fleet that now tops 100 planes. It runs a joint venture airline in Japan, which cooperates with Japan Airlines. And its chairman Wang Yu told Reuters last month that some of its stronger domestic routes are seeing fares almost back to last year’s levels. He separately said Spring has no plans to add widebodies, a testament to business discipline sometimes lacking among China’s private-sector airlines. 
  • In some ways JetBlue has the right characteristics for the crisis recovery phase. It carries mostly leisure passengers, with a heavy component of family-visit traffic. It’s overrepresented in Florida and the Caribbean, two markets showing at least some signs of life. On the other hand, a large of portion of JetBlue’s passengers originate in the U.S. Northeast, specifically the New York and Boston areas, which have been among the strictest in terms of traveler quarantine requirements.

    These pros and cons netted out to a $477m net loss ex special items last quarter. Operating margin was worse than what most of its rivals produced, registering at negative 128%. Like everyone else, JetBlue cut capacity dramatically y/y — 58% — but saw revenues fall much more: 76%. Operating costs declined just 39%, aided by a 78% drop in fuel outlays but a more modest 17% dip in labor costs. During Q3, remember, the U.S. federal government covered most of the industry’s labor costs, which won’t be the case in Q4. Still, JetBlue hasn’t announced any mass layoffs.

    But it’s for sure working diligently to slim its cost structure, recognizing the diseconomies of scale it faces while shrinking. In its own words: “We are taking an aggressive approach to improving our cost structure, better aligning our fixed and variable cost base to temporary lower revenue and capacity.” This quarter, capacity should be down by 45% and revenues down by 65%. Management also mentioned the likelihood of airport and health care costs rising. On the other hand, newly arriving A321 NEOs and A220s, despite some delivery deferrals, will help reduce unit costs in the long run. Much of its other cost cutting, frankly, involves labor. As for revenue, the airline will get a boost from its decision to start selling middle seats again earlier this month. A policy of capping load factors at 70% will end December 1.

    More strategic is a new alliance with American, a move management says will help preserve jobs (unions typically don’t like such alliances because they worry they’ll reduce the incentive to grow organically). By partnering with American (assuming regulatory approval), JetBlue enhances the appeal of its loyalty plan. It boosts its utility in New York and Boston. It can offer connections to American’s intercontinental flights. And it can help fill the many seats expected to go empty while demand remains weak. JetBlue will not however, like Alaska, join the oneworld alliance. Nor will it join American’s joint venture with IAG. Not with its own plan — still intact but not yet detailed — of flying to London with A321 LRs next year.

    JetBlue, meanwhile, announced roughly 60 new routes since the crisis began, some linked to big expansions in Los Angeles and Newark. This will help its transcontinental franchise which is currently one of the better performing parts of its network. Same for Mint, its transcon premium product. Also doing relatively well are its many leisure and family-visit routes to Florida, the Caribbean, and Latin America. At present, 20 of JetBlue’s 35 international destinations are open to American travelers. In addition, states like Connecticut and Massachusetts are starting to relax their quarantine rules, permitting travelers to present negative Covid test results as an alternative. When New York state removed California from its quarantine list, by the way, demand correspondingly increased.

    JetBlue speaks about Covid testing with great hopes and expectations, fearing even a vaccine might not be a total solution. Demand will also improve when tourist attractions like Broadway in New York City reopen. It sees clear evidence of pent-up travel demand, with forward bookings showing steady improvement despite the latest surge in Covid cases throughout the country. As it monitors demand, the airline pins additional hopes for recovery on its travel products division, a recent upgrade to more advanced Sabre revenue management software, and the ongoing if delayed densification of its A320s.  
  • What’s the U.S. state that’s had the strictest quarantine rules throughout the crisis? The answer is Hawaii, which explains why Hawaiian flew just 13% of the ASM capacity it operated in last year’s third quarter (it might frankly also explain the state’s low infection rate). Revenues were down 90% y/y, operating costs were down only 41%, and operating margin came in at negative 287%. This was down from Q2’s even uglier negative 366% figure but still not representative of the same quarter-to-quarter progress seen at most other airlines. It’s simply a waiting game for Hawaii to open up, which is fortunately starting to happen.

    On Oct. 15th, the state implemented a pre-travel testing option enabling U.S. mainland travelers to avoid having to self-quarantine upon arriving to the islands. When the plan was announced in mid-September, bookings for Q4 improved to roughly 30% of normal levels, up from just 10% before the announcement. Now with the testing policy in place, the percentage is up to between 35% and 55%, with more strength late in the quarter. Hawaiian says it sees some booking momentum for Q1, 2021 as well. By next summer, it hopes to operate 15% to 25% of its steady-state U.S. mainland network, with readiness to flex up or down as appropriate. It didn’t operate any international routes last quarter, and only recently restored once-a-week Tokyo service for essential travel. The state of Hawaii said Japan will be included in the pre-flight testing regime soon, with other countries like Korea perhaps following. Hawaiian, though, doesn’t expect to restart Australia and New Zealand routes until 2021. Quarantines remain a depressant to inter-island travel.

    Despite such little flying and revenue generation — and even while much of its costs remain fixed — Hawaiian’s liquidity isn’t an issue. That’s thanks to aircraft sales and borrowing, including participation in Washington’s CARES Act loan program. The heavy borrowing does mean, however, that restoring its balance sheet to health will be a long and arduous journey. And until it does return to health, the airline’s ability to grow and invest will be constrained. Hawaiian will still replace A330s with B787-9s, but they won’t start coming now until late 2022 following a deferral arrangement with Boeing.

    Hawaiian separately cut its workforce by about a third, mostly through voluntary means. It’s still capping load factors at 70% to reassure travelers. It joined rivals in axing ticket change fees. A rare bright spot is cargo, with charter flying also providing some revenue. As a predominantly leisure carrier with many of its customers in flourishing tech centers like San Francisco and Seattle, its recovery should be relatively swift once travel restrictions are removed. Note, however, that booking curves tend to be pretty long for Hawaii trips, and many people right now are booking trips close to departure.

    When demand does return, it won’t automatically translate to smooth sailing for Hawaiian. At that point, 2019-style challenges reappear, namely competing with Southwest as it builds a Hawaiian franchise, along with other rivals hungry for all the leisure traffic they can muster, i.e. Alaska and the Big Three. Looking east, Hawaiian’s pre-crisis alliance plans with Japan Airlines were checked by DOT reproach. At the same time, All Nippon was hurtling A380s toward the island in hopes of capturing more market share. As mentioned earlier, JAL will soon send its new Zip Air affiliate to Honolulu.
  • Back on the U.S. East Coast, Florida-based Spirit believes it will lead the industry in returning to profits, highlighting its ultra-low cost base, its heavy reliance on leisure and family-visit travel, and the strong margins it was able to produce before the crisis. Just getting back to break even, it explains, won’t require anything near 2019 levels of demand and unit revenue. In fact, it can probably get there at current unit revenues but only when capacity is back to pre-crisis levels. It doesn’t have the demand yet to justify that, but it hopes the day is not too far off.

    Last quarter, its ASM capacity was still down by a third y/y, this after weaker-than-expected bookings this summer forced it to temper its restoration. Yields and unit revenues were still so low that revenues fell far more than capacity — they were down not one-third but almost two-thirds (60% to be precise). This month, capacity should be down almost 40%. But it’s currently planning for a drop of more like 20% for November and December. Like other U.S. airlines are reporting, demand is more resilient to the Covid spike this fall than it was to the spike in early summer. Attribute this to greater traveler confidence about safety, and the fact that more tourist attractions (Florida beaches for example) are now open. Note that nearly half of Spirit’s entire capacity touches the state of Florida.

    In addition, many of the Caribbean islands Spirit flies, along with points elsewhere in Latin America, are opening their borders to American tourists. These tend to be big family-visit markets as well. Looking ahead, Spirit is encouraged by bookings for Thanksgiving and is hopeful for the Florida peak season next quarter. Management doesn’t see the crisis creating any big paradigm shifts, instead expecting a return to the realities that made Spirit so successful in the past, i.e. low costs and high ancillary revenues are a path to high profits. It still plans to take 16 Airbus NEOs next year, following a big plane order it placed just before the crisis. It’s opportunistically entering markets like Orange County where local slots became available. It was able to avoid furloughs thanks to new cost-saving labor agreements. In January, it will introduce a new loyalty plan. Operational reliability, a problem last year, is much better now. Managing capacity on offpeak times and days will be key this winter. It decided against taking government loans after pledging its loyalty and brand assets to secure good terms from the private sector.

    It does see cost pressures from its temporary capacity cuts, as well as in areas like labor, airports, and aircraft leases. But most of its higher-cost rivals, it thinks, won’t be able to break even with the low fares likely to prevail while business traffic remains subdued. That will force them to cut more capacity, and by extension put further upward pressure on their unit costs. “Our model,” asserts CEO Ted Christie, “shines in tougher times.”   
  • Then and now, Allegiant has always taken a unique approach to airline economics. It counterintuitively found great success by flying its aircraft less, not more. Its approach to managing the Covid crisis, meanwhile, is counterintuitive again: fly more, not less. Its Q3 ASM capacity was down just 9% y/y, with flights down just 12%. That’s not because its demand was so much better than what other U.S. airlines saw. In fact, Allegiant’s Q3 passenger volumes plummeted 47%. It thus filled just half all of those seats it flew. But the flying was cash-positive enough to temper losses, leaving it with a negative 39% operating margin — not bad, all things considered. Revenues dropped 54% y/y and operating costs declined 23%.

    All of these figures, to be clear, exclude the wage subsidies it received from Washington. If you do include them, Allegiant actually broke even at the operating level last quarter, propelled by a positive 17% operating margin during September alone. Even without those subsidies though, September was cash break even for the airline. It’s odd to see September emerging as the best month of the crisis so far for Allegiant, because it’s historically its worst month of the year. But history is now irrelevant. The fact is, would-be travelers are feeling more confident and less deterred by Covid case spikes than they were this summer. Average daily gross bookings have increased from just over $2m during Q3 to more than $3m thus far in Q4. October is looking better than September, and the upcoming holidays look promising as well.

    Executives made clear that there’s still a long way to go before full recovery. But they use the term “best of the worst” to describe the carrier’s position. While it did need to borrow $300m to ensure sufficient liquidity, it did not have to issue any new equity like many other U.S. carriers. Nor did it take any government loans. In terms of operating costs, variables are down some 30%, which is more than three times its capacity drop. It did feel the need to undertake some involuntary job cuts, some affecting pilots. Its most exciting cost cutting prospect though, involves the severely depressed aircraft market. A320s, it says, can now be leased for what it previously paid for smaller A319s. Most of its rivals, meanwhile, have big aircraft order books locked in at pre-Covid prices. They also have much more debt to repay, which Allegiant believes will limit their ability to discount fares.

    On hold for now is the LCC’s Sunseeker real estate project in Florida — it’s hoping to attract partners willing to assume some of the investment. Most of the business model remains intact, however, including a heavy bet on sports marketing to improve its nationwide brand awareness. Allegiant Stadium in Las Vegas is now hosting NFL games. And the brand exposure could help explain an increase in the number of direct visits to its website, at the same time indirect visits (via search engines like Google, for example) are down. Allegiant says travelers want nonstop flights more than ever, which is what it offers. And it sees major growth opportunities as demand recovers.

    Looking at Allegiant’s October schedules via Cirium, seat capacity from some key markets like Orlando Sanford and Las Vegas are down by some 20% y/y. In other big markets, the decline is less severe (down 12% from St. Petersburg/Tampa, for example). And in some like the Florida Gulf Coast cities Punta Gorda, Sarasota, and Destin, the airline is flying more this year than last. Ditto for Nashville and to a less extreme extent, Cincinnati.
  • SkyWest, the U.S. regional giant, posted a negative 25% Q3 operating margin, excluding federal payroll support. Its net result excluding that support was negative too. As you can see, loss margins were milder than those of its partners, and of U.S. airlines more generally. But the crisis is challenging nonetheless, with SkyWest flying only about 60% of its normal capacity last quarter.

    It does however believe its two-class regional planes are well-placed to play an important role for its partners United, Delta, American, and Alaska as they rebuild their schedules. In fact, it just signed a new agreement with American to add 20 used CRJ-700s. It’s also acquiring another 21 CRJ-700s from an operator currently flying them in a 50-seat premium configuration for United (these are what some call the CRJ-550s). SkyWest’s most popular plane is the E175. Less popular are CRJ-200s, of which it admittedly has too many.

    Separately, it’s optimistic about its pro-rate business, in which it handles scheduling and pricing itself. It also sees opportunities in the pandemic-era trend of people moving away from big cities to smaller communities where regional air service is paramount. SkyWest, did by the way, avail itself of federal CARES Act loan money. A major focus now is ensuring it’s ready to fly the capacity its partners will need next spring and summer season, which effectively starts in March. It’s all a big question mark currently. But a general assumption is that SkyWest’s block hour capacity will be down by about 20% for the “foreseeable future.” It does have in its mind, however, a summer 2021 potentially characterized by “impressive demand, particularly with the smaller sized aircraft we have, and where we fly.”
  • In India, IndiGo is making the best of a bad situation. By ramping up domestic capacity, adding international charter flights, cutting costs, gaining market share, and chasing cargo revenues, the LCC managed to improve its calendar Q3 operating loss margin to negative 52%, versus negative 344% in the previous quarter. Revenues, aided by a 20% y/y surge in cargo sales, fell by 66% y/y, not much more than its 63% reduction in scheduled ASK capacity. Operating costs, aided by pay cuts, cheap fuel, and of course less flying, declined 52%.

    Like other airlines, IndiGo’s focus right now is generating cash, not accounting margins (which take non-cash and indirect costs into account). Still, the margin improvement highlights real market improvement, particularly as the government progressively lifts its cap on how much capacity carriers are allowed to operate. The current cap domestically is 60%, with the likelihood of soon moving to 80%. IndiGo, despite weak load factors down some 20 points y/y, will quickly restore capacity to the maximum amount allowed; the fact is, the more it flies, the more its cash burn declines. “Once we are back at 100% capacity,” it adds, “we will have lower unit costs, a stronger product, a more efficient fleet, and a robust network.”

    Note that some local government flying restrictions remain in places like Mumbai, Chennai, and Kolkata, which limited IndiGo to just under 50% of normal domestic capacity in September. Internationally, it’s flying about 20% of normal, mostly with charters to countries with which India has “bubble agreements.” It now has one with Bangladesh, with Nepal potentially next.

    Looking ahead, IndiGo remains highly interested in expanding internationally, specifically with all the new A320 and A321 NEOs it’s set to receive. It’s still taking its deliveries more or less on schedule, as it simultaneously removes prior-generation CEOs as soon as their leases expire. The fleet count won’t grow next year as a result of these aggressive CEO removals. But the airline remains committed to longterm growth as it retains confidence in India’s longterm aviation potential. It’s already approaching 300 planes by the way (almost all leased), including a fleet of ATR turboprops and about 25 A321 NEOs already on property.

    But will it ever fly widebodies? Three years ago, it entertained the possibility of buying Air India, eyeing the creaky state carrier’s B777s and B787s, not to mention its international route rights and airport slots. That’s no longer a consideration. But it’s constantly evaluating the economics of organically adding widebodies, stating pre-crisis that they simply wouldn’t be profitable. Now, with airplane prices way down and fuel very cheap, the economics look better but still not compelling enough. Note that rival Vistara is now flying B787s intercontinentally, with SpiceJet dipping its toe into longhaul markets with wet-leased A330-NEOs. IndiGo is also watching Jet Airways, the defunct Mumbai-based carrier that’s trying to revive under new ownership.

    As for IndiGo’s narrowbodies, it’s lucky: The NEOs it has are holding their values better than other planes. It’s also able to still do some sale-leaseback deals with its ATRs. To further enhance liquidity and ensure sufficient cash, it’s currently evaluating different borrowing options. Encouragingly, its September cash position was better than management expected as the carrier added back more capacity. To be clear, business and corporate traffic account for about half of IndiGo’s revenues during normal times. And that’s far from returning to pre-crisis levels. It does see some early signs of recovery, however, in small business demand.

    It’s separately seeing a revival in some directional traffic flows, including non-metro to metro (in other words, secondary cities to big cities like Mumbai and Delhi). Its industry leading domestic market share now stands at 58%, up from 48% at the start of 2020. It’s marketing itself as the “lean clean flying machine” to restore traveler confidence. And it’s trying to digitize as much as it can, including all customer touch points—“no more paperwork, no queues or phone calls… let’s digitize everything.”
  • Finnair’s Q3 results included a $232m net loss and a negative 172% operating margin, which would have been worse if not for strong cargo revenues. They dropped just 40% y/y compared to a 92% decrease in passenger revenues. Flights to China were strongly cash positive thanks to cargo most importantly but also a 70% passenger load factor. The problem is, Finnair is currently authorized to operate just two weekly flights to China, one to Shanghai and the other to Nanjing. It’s hoping China’s government opens more access soon.

    Closer to home, there’s another area of light in the sea of darkness: Domestic tour packages to Finland’s Lapland region. Even in the winter, the airline notes, Lapland has sunshine (if not warmth). On Finnair’s European routes, meanwhile, demand is minimal due to Finland’s stringent travel rules — it has perhaps the toughest restrictions anywhere in Europe. When restrictions did relax briefly this summer, demand was quick to respond. Now, however, Finnair expects a bleak winter season, when demand is typically slow even in good times. It plans to operate just 15% of ASKs this winter.

    Early next year, it will review summer schedules with hopes there’s justification for a more robust schedule. Helpfully, Finnair’s most critical market is northeast Asia, where anti-Covid measures have proved effective, not the U.S., where the virus remains out of control. A key priority while it waits out the winter freeze is cost cutting, with eyes on slicing about $160m from its cost structure by 2022, relative to its 2019 level. It’s already cut more than 1k job permanently. And flexible furlough laws in Finland make it easy to quickly remove costs and quickly bring people back when needed. Maintenance and IT are two other areas ripe for savings.

    Finnair is separately postponing plans to order new narrowbodies, though the time for that will eventually come. To stay relevant with consumers while most of its plan sit idle, the carrier is selling Finnair-branded inflight food in supermarkets. It expects cargo to benefit from the upcoming Christmas rush. And while fearing near-term industry overcapacity as demand recovers, it expects tight capacity in the long run as airlines freeze investment in new planes.
  • Icelandair’s Q3 income statement, believe it or not, shows an operating profit of nearly $4m. But that’s only because it counted MAX-related compensation it received from Boeing as revenue. Just looking at core revenue, operating margin looks to be more like negative 5%, which removes $36m classified as “other” revenue. Negative 5% is still extremely good considering the circumstances, reflecting a 16% y/y surge in cargo revenues despite a 19% decline in freight capacity. During the summer quarter, Icelandair operated a mere 9% of its normal capacity, scaling up a bit when Europe relaxed travel restrictions just before the quarter but retrenching again after Iceland itself imposed new restrictions.

    After that, the airline was operating just 10 flights a week, compared with the nearly 300 a week it flew last summer. Keep in mind that most airlines right now are willingly running flights that lose money on an operating basis, so long as their revenues cover direct cash costs. This can have the effect of worsening loss margins for carriers that fly a lot, and flattering the margins of those that don’t, i.e. Icelandair this summer.

    In any case, what’s important now is how well-positioned airlines are to benefit from the recovery when it happens. Icelandair likes its chances following a cathartic restructuring that resulted in new longterm labor contracts with far better (from the company’s perspective) pay and productivity terms. The carrier also renegotiated all of its suppler contracts, including aircraft lease agreements, and managed to raise new equity and secure government-backed loans. As a highly seasonal airline, the timing of the demand recovery will matter a lot. Will testing, vaccines, and/or other factors allow for healthy levels of travel between North America and Europe by the spring?

    Icelandair has already published its summer 2021 schedule, with capacity down 25% to 30% from summer 2019. B737 MAXs, management thinks, will be back in service sometime next quarter.  

Madhu Unnikrishnan

November 1st, 2020