Pushing Back: Inside This Issue
The counterattack is underway. Governments around the world are spending trillions of dollars to cushion their economies from the wrath of Covid-19. In the U.S., the rescue mission will cost a mammoth $2t, with $50b of that allocated for airlines rocked by a near-shutdown of the entire travel sector.
Will it be enough? That depends on how long the crisis lasts and when people start travelling again. Across the industry, some like Ryanair are optimistic — the experience in China suggests a three-month period before the virus is contained, it says. Others like Air New Zealand are more pessimistic, worrying the industry might never be the same. Some, meanwhile, are better positioned than others to endure a long road back to healthy travel demand. U.S. carriers have their government money and their intact borrowing capacity. Singapore Airlines just received massive financial support from its government. Qantas, with much less taxpayer support but a war chest of cash, is gutting its cost base while planes sit idle.
Public support for Europe’s airlines has thus far been uneven. U.K. carriers are begging London to do more. On the other hand, some of the most vigorous rescue efforts have involved desperate cases like Alitalia and Norwegian. China, which is subsidizing international flights and waiving various fees and charges, is the market everyone is watching. Covid containment efforts there appear to have worked well, leading to a gradual recovery of economic activity, including air service. This week, Chinese airlines will report their fourth-quarter financial results, perhaps shining more light on just how durable the recovery there is.
“These are uncertain times, and our challenge is to hold on to as much cash as we can so that if this goes beyond three months, that we are a winner on the back side of this.”Azul CEO John Rodgerson
- EVA Air: $32m; 5%
- China Airlines: -$24m; 0%
Net result in USD; operating margin
*Net profit excluding special items (all operating figures exclude special items)
Covid Crisis 2020
- March 5 seems like eons ago in the war against Covid-19. The pandemic is far more pervasive now, and far more impactful to airlines. So last week (March 24), IATA updated its industry damage assessment. It now says airlines worldwide will see a 44% y/y drop in revenues, equivalent to $252b. In the earlier March 5 assessment, IATA said the worst-case scenario would be a revenue loss of $113b.
What it couldn’t foresee then were the travel restrictions imposed by most countries, effectively shutting down international air travel. The new estimate assumes these restrictions persist for up to three more months, followed by a gradual economic recovery (not a V-shaped one) later in the year. Of the $252b in losses, about 35% will be incurred by airlines in the Asia-Pacific region. European airlines will account for another 30%, and North American airlines another 20%. Globally, traffic measured by RPKs will likely fall 38%.
There’s really no way of overstating how bad this crisis is for airlines. IATA uses the term “apocalypse now.” And by now it means now, a crisis so urgent that governments need to act. Airlines, it says, need some $200b in liquidity support, noting how many carriers entered the crisis holding enough cash to cover just two months of expenses. Based on current losses and forward booking trends, they’ll run out of cash well before an eventual recovery arrives. IATA’s top priority is pressuring governments to provide more industry aid. One way it’s doing so is via op-eds and letters appearing in major newspapers across the world, from France’s La Tribune to the Jakarta Post.
- There is some glimmer of hope in China, where air travel bookings are now rising from severely depressed levels in February. IATA itself shows traffic trends now on the mend. Yields, it said, were down by about 30% y/y during the first two weeks of March, but this compares to a 50% drop in mid-February. Those figures include international journeys too — domestic yields look much better. CAE, a Canadian company that builds flight simulators, said it received two orders from Chinese carriers in the past week, a small sign of hope. AAR, one of the world’s largest maintenance providers to airlines, said it’s indeed seeing a pickup in business from China. Just two weeks ago, it won a multimillion dollar landing gear order from a Chinese airline.
- In one of the earliest examples of government support for the airline sector, Norway provided $275m in loan guarantees. About half of that will go to Norwegian, which already has access to some of that money. The embattled carrier is mostly now just flying domestically and between Nordic capitals. It dismissed 90% of its workforce. Of course, it might not have lived, period, had there been no crisis.
- There’s another European airline for which the crisis is proving a means of salvation. Alitalia, also the beneficiary of quick government action, will be re-nationalized. But not, apparently, without major changes. No official word yet, but Italian news reports say a new Alitalia will be created in May, operating a slimmed-down fleet of somewhere between 20 and 70 planes. It has about 110 today. The trickiest question is how to rightsize the workforce to appropriate levels. Government officials are discussing the matter (via teleconference) with unions. The airline wants to shed about 7,000 workers.
- The big story for U.S. airlines last week was of course the giant federal aid package that passed last week (see feature story). In the meantime, American, United, and Alaska all borrowed more money last week, the equivalent of stuffing as much cash as possible under the mattress in case this crisis persists for many months. The fact that banks will lend them more money (on top of credit lines they agreed to pre-crisis) is a good sign. It means they still expect U.S. airlines to eventually be well enough to repay their loans in full, with interest. Lenders clearly still see value in collateral like planes and airport slots too. After 9/11 and during the global financial crisis, U.S. airlines had a much harder time securing new capital. Southwest CEO Gary Kelly filed a video message to employees last week, admitting that the airline is “losing big money” on every single flight right now. But like other U.S. carriers it’s refused to furlough any of its workers. Alaska, meanwhile, just cut its planned April flight schedule by 70% — demand is currently running 80% down from last year’s levels.
- A4A, the chief U.S. airline lobby group, said that on March 28, traveler throughout at TSA airport checkpoints was down 91% y/y. Just 184k passengers passed through airport security nationwide. A4A separately said that on March 26, U.S. airlines had 1,297 planes out of service, representing 21% of their total fleet. As recently as Feb. 29, this figure was just 7%. Every U.S. airline, meanwhile, has seen their credit rating dropped — only Southwest still has an investment grade rating from S&P.
- Airline market conditions in Brazil, like everywhere else, are vastly different than they were on March 12, when Azul reported its Q4 earnings. At that time, the airline said the Brazilian domestic market was still more or less functioning well. Now, big cities like São Paulo and Rio de Janeiro have joined the global rush to close most businesses and urge people to stay at home. Azul thus felt it necessary, on March 24, to update investors on how things have changed. Through April 30 at least, the carrier will run just 70 flights a day to 25 cities, implying a 90% reduction from its planned schedule.
Executives say they’re acting swiftly to bolster the firm’s cash position, cutting management pay, conducting advanced sales of TodoAzul loyalty points, and negotiating payment deferrals with aircraft lessors and other vendors. It’s also talking to banks about securing more capital. And critically, it’s variablized its cost base through drastic cuts to what under normal times are fixed labor costs. To achieve this, it got more than 7,500 employees to accept unpaid leave of between one and six months — it’s pushing for that number to reach 9,000.
By April 1, Azul believes, 50% of its workforce will be “off the books.” And the figure will go to 65% not long after. CEO John Rodgerson also wanted people to know that executives have surrendered all bonus pay despite Azul’s tremendously successful 2019. Normally, on average, Azul’s expenses would be roughly $176m a month at current dollar-real exchange rates (the real has depreciated sharply over the past year and still more in recent weeks).
The weak currency, incidentally, along with high taxes, makes fuel inordinately more expensive in Brazil than elsewhere, which also means it saves more when its planes are grounded. Put another way, fuel typically accounts for a larger portion of a Brazilian carrier’s cost base, which means they typically have a more variable cost base. And in times like these when planes are not flying, the greater the portion of variable costs the better.
Azul thinks the Covid crisis will last just two to three months, even envisioning a near-full restoration of schedules by July. If it’s a “six-month issue” however, governments will surely step in with aid, it believes. Azul is particularly crucial to the Brazilian economy, it also believes, because of all the Embraer planes it ordered, and all the small otherwise disconnected small cities it serves. Other stakeholders like lessors meanwhile, would likely assist Azul in the short-run, knowing the airline has a lot of growth planned in the long-run.
The carrier’s E195 deal with the U.S. startup Breeze, by the way, is still in place. And so is its E195 deal with LOT Polish, though deliveries might be pushed back. Azul, remember, also holds convertible shares in TAP Air Portugal, which Rodgerson said would likely receive Portuguese government support — the country’s economy would be “destroyed” without TAP.
- Singapore Airlines, no less wounded by the Covid crisis than its weaker peers, raised a massive $13b in new funds through both debt and equity, in other words both borrowing and issuing new shares. Who would buy shares in an airline right now, let alone an airline with only international routes? The answer in this case is Temasek, a government wealth fund that’s already the carrier’s largest shareholder. The new capital boost is thus government aid in a different form.
Few governments care more about their aviation sector than Singapore — it contributes an estimated 12% of the island’s GDP. In fact, the government also provided U.S.-like wage support for Singapore Airlines, plus a reduction in landing fees at Changi airport. It might just be the most generous state support that any airline has gotten so far, which could also position it well when recovery comes. On the other hand, bad fuel hedges are complicating the carrier’s efforts to remove costs.
- One airline actually is reporting relatively healthy load factors: Qatar Airways. The airline is maintaining an international network to more than 70 destinations, as of now, although that number could change as government travel restrictions around the world shift. Qatar Airways said it is adding capacity to this network, and has upgauged Frankfurt, London, and Paris flights to A380s. Load factors on some flights top 80%. The airline said most of this traffic is from people scrambling to get to their home countries, flying through its hub in Doha. Late last week, Qatar said it is adding 48,000 seats in April to its Australia network and is adding its first flights to Brisbane. To be clear though, bookings for future travel are a fraction of what they’d normally be.
- Australia’s Qantas further solidified its defenses against a lengthy virus war by securing $600m (U.S. dollars) in additional cash. How so? By borrowing it from a syndicate of banks. It will pay an interest rate of less than 3% over the ten-year life of the loan, with the low rate reflecting both cheap money conditions in international credit markets and the fact that Qantas is putting up seven B787-9s as collateral. The loan also contains no financial covenants (safeguards to protect lenders if the borrower’s financial conditions deteriorate).
Qantas now has about $1.8b in cash on its balance sheet, with another $600m available through a preapproved credit line. In addition, it still has a lot of unmortgaged aircraft and other assets left to use as collateral if needed. And it doesn’t have major debt payments due until mid-2021. Though it is getting some government relief in the form of airport fee, fuel tax, and security tax rebates, Qantas seems fit enough to endure a long crisis without additional government aid.
- The situation couldn’t be any more different at badly struggling Virgin Australia. It can forget about receiving financial support from its airline shareholders, i.e. Singapore Airlines and Etihad, which have their own problems to manage. And ratings agencies last week downgraded its credit. After the latest round of cuts, Virgin is now operating just 10% of its mainline domestic capacity. Tigerair is completely grounded. So are all international flights (though at least mid-June). One hundred twenty-five planes are on the ground. 80% of the workforce is on “stand down” (see labor section). All airport lounges are closed.
Whereas Qantas appears optimistic that at some point, it can resume business as usual, Virgin’s CEO Paul Scurrah said more pessimistically: “I am mindful that how we operate today may look different when we get to the other side of this crisis.” One manifestation of this is a move to close its Tigerair pilot base in Melbourne and its pilot and flight attendant bases in New Zealand. Virgin, unlike Qantas and other muscular airlines, is thus using the crisis to permanently restructure its cost base. But might Virgin run out of cash? If it did, Canberra would likely step in with additional relief; it wouldn’t after all want Qantas to be the country’s only major airline.
- Air New Zealand is closer to Qantas than its former partner Virgin Australia in terms of financial resiliency. But it still felt compelled to ask its government for a pool of $540m it could borrow as needed. The money will be available for 24 months, accessible if the airline’s cash balance drops below certain levels. The money won’t come cheap — ANZ will pay the government an annual interest rate of at least 7%. Officials also forced it to cancel a dividend it was planning to pay shareholders last week.
And the government also has rights to convert its debt to equity, which would lead to a greater ownership stake—it already owns 52% of the airline, having once controlled 100%. That said, the airline’s current management team retains full decision-making power — the government won’t get involved in commercial or operational decisions. It will in fact pay the carrier for public service flying, like maintaining critical air cargo links and repatriating kiwis stuck abroad.