The Corona Crunch

Jason Clampet and Madhu Unnikrishnan March 2020 11 min read

Pushing Back: Inside This Issue

It’s not just a problem for Chinese airlines anymore. Or just airlines in Asia. The Covid-19 virus outbreak is now obliterating demand for travel across the entire world. Suddenly, airlines even hearty and healthy just a week earlier find themselves burning through cash as planes to cities like Milan and Seoul run empty, and as ticket sales evaporate. For the already distressed, the virus could prove lethal, as it already has for one small U.K. carrier: Flybe.

There’s still a chance for the industry to surmount the crisis with just some first and maybe second quarter bruises, if the outbreak slows and life returns to normal by early summer. Perhaps it’s just airline demand delayed, not destroyed. China, it seems, shows some faint signs of a rebound. But right now, the world is a scene of cancelled business meetings, cancelled trips, panicked travelers, government travel warnings, disrupted economies, and tanking stock markets.

And events are moving fast — just as Skift Airline Weekly is preparing to publish, Air New Zealand is scrapping its financial guidance, Korean Air is expressing concerns about its survival, JetBlue is announcing emergency measures to preserve cash, and oil prices are taking another huge tumble. Financial markets open the week in disarray.   

Airlines like Turkish, Thai, and Aeroflot, all with significant exposure to China, gave their latest assessments of the damage the virus is inflicting. This week, Cathay Pacific reports financial results. And U.S. carriers will provide more commentary at a JPMorgan investor event in Atlanta. Assuming that is, it isn’t cancelled.

Verbulence

“The world is facing a huge challenge to prevent the spread of COVID-19 while enabling the global economy to continue functioning. Airlines are on the front line of that challenge and it’s essential that the regulatory community work with us to ensure airlines are able to operate in the most sustainable manner, both economically and environmentally, to alleviate the worst impacts of the crisis.”

IATA Director General Alexandre de Juniac

Earnings

  • October-December 2019 (3 months)
  • Turkish Airlines: $336m/$28m*; 4%
  • LATAM: $227m; 12%
  • Thai Airways: -$30m; -1%
  • Aeroflot: -$107m; -8%
  • Air Mauritius: $9m; 1%

Net result in USD; operating margin
*Net profit excluding special items (all operating figures exclude special items)

Covid Crisis 2020

  • As late as Jan. 17, IATA expected worldwide airline profits to top $29b this year, with an operating margin close to 6%. The optimism extended even to Asian carriers, which IATA thought would benefit from easing trade tensions between the U.S. and China.

    It was becoming increasingly clear even then, however, that a major virus outbreak was rendering these forecasts obsolete. On Feb. 20, with the Covid-19 scare crippling the Chinese economy, IATA said the country’s airlines would see about $13b erased from their domestic revenues alone. With the virus at that point spreading to neighboring countries like Korea, and with Chinese tourists an important passenger base for many Asian airlines, IATA said the region’s airlines as a whole would see a $28b revenue loss. Global RPK traffic for 2020 would contract 8% y/y, not grow 5% as previously anticipated.

    But the virus kept spreading, well beyond Asia to places like Iran in the Middle East and Italy in Europe. Cases began appearing in the U.S. too. So last week, on March 5 to be exact, IATA revised its damage assessment once again. Now it says airlines worldwide will lose between $63b and $113b in revenues, depending on the ultimate severity of the outbreak. Airline share prices, at the time of IATA’s pronouncement, had plummeted 25% since the start of the Covid crisis — that’s a much steeper drop than witnessed during the SARS crisis of 2003.

    That worst-case scenario revenue loss of $113b, incidentally, equals almost one-fifth of the entire sector’s annual revenues. It’s also a level of loss comparable to what airlines suffered during the global financial crisis of 2008-2009. Cheaper fuel should save the industry money, but only something like $28b, IATA estimates. Add a few billion more for savings associated with measures like job and pay cuts.

    IATA is asking for further relief from governments, in the form of tax relief, lower airport charges, and relaxation of airport slot-usage rules.   
  • The good news is that airline operations and demand in China, where the virus originated, began showing signs of recovery last week. That doesn’t mean for sure that the worst is over for the country — infections could spike again. But it’s a welcome development for now. Just as importantly for airline demand, however, will be how fast China’s economy can return to normal, with implications for the global economy at large. Cathay Pacific reports financial results this week, perhaps providing more commentary on demand conditions in Hong Kong.

The View From the U.S.

  • The virus is now spreading in the U.S., driving businesses there to impose restrictions on employee travel. Some communities, notably around Seattle, are closing schools and cancelling public events. Beginning with JetBlue, U.S. airlines around the turn of the month began waiving change fees to reassure travelers.

    Last week, for the first time, evidence of severe demand destruction emerged, with Southwest reporting a “significant decline in customer demand” and an “increase in trip cancellations.” It sees this erasing between $200m and $300m in Q1 revenues. That’s a lot of money. Q1 unit revenues could fall as much as 2% y/y. It was expecting a RASM increase of roughly 4% to 6%.

    On the other hand, just since the start of the year, Southwest has saved something like $1b thanks to lower fuel prices. Mild winter weather and associated strength in operational reliability were other reasons the airline has a brighter unit cost outlook, though Q1 CASM should still be up 5% to 7%. Most of that rise is due to inefficiencies linked to its lost MAX capacity. 
  • In other U.S. news regarding the Covid crisis, United moved to cut its international schedule by 20% in April, with domestic and Canada schedules getting a 10% trim. JetBlue made some cuts as well. Spirit, speaking at a Raymond James investor conference, mentioned a clear decline in industry fares last week, though traffic volumes remain strong. It’s specifically seeing looser revenue management, in the sense that carriers are leaving cheaper fares open for bookings closer to departure. The Big Three, it noted, are bringing big planes from Asia to the U.S. domestic market.

    But Spirit downplayed concerns, calling attention to its low costs, its flexible fleet, its strong balance sheet, its many more route opportunities, its improving operational reliability, the 50% share of its revenues derived from ancillaries, the improvements it’s making to its vacation package offerings, and the revamped loyalty plan it’s launching soon.
  • Several U.S. airline CEOs joined with Airlines for America (A4A) officials to meet with President Donald Trump and Vice President Mike Pence at the White House. They discussed ways to help stop the spread of Covid-19, followed by administration pronouncements of possible short-term measures (i.e. tax relief) to help airlines through the crisis. A4A, which represents U.S. airlines in government affairs, separately established a webpage providing resources about the virus outbreak for air travelers, government agencies, Congress and the general public.
  • The U.S. Chamber of Commerce held its annual Aviation Summit in Washington last week, just as the Covid crisis swept through the industry. Alaska CEO Brad Tilden said January and February bookings were very strong, as were bookings even in the first few days of March. But with Alaska’s hometown Seattle market subject to the most U.S. cases of the coronavirus, bookings indeed began softening last week. Alaska issued an investor warning on Friday, saying Q1 RASM could fall by 5% y/y if bookings were to stop completely through the end of this month.

    American’s Doug Parker talked about having to cancel many international flights for lack of demand. As it happens, American, though it has the least exposure to Asia among the Big Three, also has the highest levels of debt. That’s a concern at times like these, when all airlines are burning through cash. That said, American did enter the crisis with lots of cash and lots of assets — all major U.S. airlines began the month with strong balance sheets.

    Indigo’s Bill Franke, owner of Frontier, said adequate cash levels were indeed the single most important weapon of survival during the crisis. 
  • Southwest’s Gary Kelly spoke at the Chamber event as well, commenting on the carrier’s latest investor update mentioned above. He said it’s still too early to have an accurate read on the ultimate financial impact of the Covid crisis, and that fare discounting doesn’t really work if people are scared to get on airplanes.

    Southwest, meanwhile, is seeing businesses cancel events, another reason why it might defer some hiring and trim its flight schedule. About one-third of its customers, Kelly said, are business travelers flying on tickets paid for by their company. Southwest itself is absolutely not cutting back on employee travel. And Kelly said history suggests that health scares are usually “short-lived.”

    Even if not, the airline is well prepared with an iron-clad balance sheet, a low cost base, and a long history of never having lost money or laid off any workers. It also entered the crisis with a fleet shortage due to the MAX grounding, which means its fleet today is smaller than it was three years ago. Kelly is hopeful of getting its MAXs in the air again by mid-year, as he waits for the plane to undergo its first recertification flights, which will be a major milestone on its path back to service.

    How much will Southwest grow after it gets its MAXs back? That depends on demand, but prior to the current crisis, Southwest had huge opportunities to grow in lots of places, Kelly said. With capacity constrained however, it’s focusing growth for now from three key airports: Denver, Baltimore BWI, and Houston Hobby.

And in Europe

  • More airlines in Europe announced measures to deal with the crisis. Finnair, with its heavy Asia exposure, cancelled more flights to China, Japan, and Korea over the coming months. It also postponed the launch of new Busan, Korea service. Norwegian, which entered the crisis with an already-vulnerable balance sheet, withdrew 2020 financial guidance.

    Ryanair’s Michael O’Leary, speaking on Bloomberg Television, says the LCC can’t cancel too many flights in the short-term because of costs and liabilities associated with EU-261 consumer protection rules. But as Italy’s largest airline, Ryanair is indeed paring back schedules into the spring. It says bookings have dropped 25% to 30% on average in the seven days to March 3, with drops even steeper for Italian routes but much less in Ireland.

    O’Leary nevertheless still wants more MAX planes, including -10s if the price is right. He’d be happy to buy Airbus narrowbodies too. Ryanair needs replacement planes for the 2024-to-2028 period.
  • O’Leary also appeared on an all-star panel of European CEOs at an Airlines for Europe (A4E) conference in Brussels. He said Italy overreacted by cancelling schools and events and feels confident the crisis will pass by the summer, aided by fare discounting. He sees a roughly 10% y/y decline in traffic for the next two or three months. Naturally, Ryanair and other European airlines are watching the busy Easter period closely. The holiday falls on April 12 this year. 
  • Lufthansa’s Carsten Spohr said longhaul routes were a “major concern” as he watches events unfold, day by day. He’s hopeful it’s just a short-term demand crisis but worries also about what might happen if health officials have to quarantine an important airport facility like a maintenance hangar, for example. Lufthansa doesn’t want government handouts but could use some help in areas like tax relief.

    Spohr, in agreement with other CEOs, thinks the crisis will facilitate consolidation in Europe’s still-over-fragmented airline market. Late last week, Lufthansa said it might cut capacity as much as 50% if bookings don’t recover. It’s even considering a complete grounding of its 14 A380s, planes that have trouble making money even in good times. According to the Wall Street Journal, Spohr told employees that at one point last week, it was getting as many cancellations as it was new bookings.

    Disruption to China or even all of Asia was bad. But Lufthansa is getting hit extremely hard now that transatlantic demand is affected. The airline reports Q4 earnings on March 19.  
  • At the same A4E event, outgoing IAG CEO Willie Walsh echoed Spohr’s sentiments about consolidation, though IAG itself is focused just on its Air Europa acquisition for now — it previously looked at TAP Air Portugal and has moved on from its stated interest in Norwegian. He did say some distressed carriers might get some breathing room as fuel prices drop. Walsh mentioned that after 9/11, airlines continued to fly empty planes, whereas carriers now are more aggressively taking capacity out.

    Air France/KLM CEO Ben Smith noted his airline’s well-diversified route network will help it deal with the crisis, adding that he too expects a return to normal booking levels by the summer.

    Europe, by the way, saw its first airline casualty from the crisis last week as Flybe ran out of money (see Sky Money section).
  • Carriers elsewhere in the world were no less affected by the demand shock. Emirates announced one month of unpaid leave for workers. Key questions on everyone’s mind: How long will the virus spread? Will there be a V-shaped recovery? How badly will the global economy be affected? How many airlines will perish? Will businesses become more comfortable with videoconferencing as a substitute for air travel?