In this article, the airlines stay in the focus and how they may/manage change. Much of the world’s commercial fleet was grounded, passenger traffic dropped off a cliff and sometimes reached levels of less than 1% of previous year traffic. A proud message (actually a sad one) a day or so ago from an airline of again flying 20,000 people – from 2m people a year ago. General expectation is for a much smaller travel and tourism market – and a much smaller growth as well.
Obviously, airlines saw their revenue drop significantly yet their cost not as much. The low fuel price that normally is a great help, did have little impact, as no one was flying (for a certain period) – but thankfully, more aircraft are again where the belong: in the sky!
Bailing out airlines that are in financial trouble
Those who were in the aviation business after 9/11 remembered among other things one key message: “cash is king”. There’s a déja-vu! But today, given the global impact, one may possibly add “the one who will provide cash is the emperor”.
When looking at the airline, one can ask a few simple questions: • Does the carrier have a strong liquidity position (and perhaps also an owned fleet); • Does the carrier play a significant role in a country’s economy; and • Was the carrier already struggling before the pandemic outburst.
Having a strong liquidity position certainly helps to “buy time” and prepare for a re-structuring and cost reduction that would be required as a result of the Covid-19 impact on travel. However, especially larger legacy carriers may be limited in their [fixed] cost management: labor contracts, lease payments, hedging fees all have their limitations and cannot be “switched off” overnight. The hedging crystal ball turned sour as the current situation is unprecedented. On the labor cost front, there are two angles: salaries and amount of staff. Whereas it is much welcomed if pilots and top management are prepared to take a salary cut for a certain period, the airline would really benefit if the reduction would be there to stay. The “Kurzarbeit” scheme that Germany has, and several countries adopted too, helped many companies to stay alive as the government helped with relief on the salary front. Many airlines have communicated however the need to lay off staff – and that in substantial amounts: United Airlines stated that notices would be sent to 45% of its staff. Low Cost Carriers that reported lay-offs are in the 15-19% range.
Lease payments may be able to be delayed or reduced, depending on the airline’s credit rating and relationship with the lessor, but will need to be recouped one way or the other. This can e.g. be done by lease extensions, or stepped rents. In some cases, lessors converted outstanding lease payments into airline equity shares: an indication to believe in the airline’s ability to whether the storm – and then benefit from the upside. Other airlines used the what I call salami sausage approach: ask for a little relief, and another little relief, and so on.
Smart fleet management amongst others, helps as well to reduce airplane related cost: aside from parking/storing the fleet, which aircraft comes back into service and on which routes? If part of the fleet is owned, especially if aircraft are already fully amortized, this may be a good asset to return to the fleet later as it doesn’t need to earn money as much as other, not yet amortized, or even leased aircraft need to do. In the past years, that strong amortization profile might have hurt financially, but now is “pay-off” time! If a part of the fleet is leased, how does the airline’s redelivery skyline looks like – especially in the next years, the expectation is that these will not be replaced with newly leased aircraft (or even owned ones) as the demand is not there. What about the other skyline: the backlog of ordered aircraft? Ideally, future deliveries can be postponed and/or converted to different types, but may need to be cancelled. The review of the backlog skyline also is a good way to reduce financial liabilities (e.g. by reducing PDP and ofcourse delivery payments). Those airlines who did well before the start of the pandemic would have a much better stance than others.
Last but not least, tickets that have already been paid for ,yet its flight being cancelled, provide a significant stack of liquidity, in some cases up to 80% of the airlines’ total liabilities. Mostly, the passenger can convert this into a voucher for a future flight and help the airline with providing liquidity – if the passenger doesn’t need that liquidity him/herself. Waiting for a refund, even if confirmed by the airline, can take a long time. There are plenty of social media messages on airlines dragging their feet on repayments: EU law is 7 days, reality is more than 7 weeks, if not more than 4 months as repayments from March cancellations are still due.
But also large balance sheets are not immune to revenue drying up. United stated to have lost USD40m a day on its fleet not flying as it should be. Delta lost USD 100m a day by the end of March and set as target to reduce this to a loss of USD50m a day. That makes the Euro 1m a day loss by Lufthansa Group sound tiny. But imagine how much revenue (and time) is required to equalize this at the [low] airlines’ margins.
A parameter that often is looked at, and part of every risk model, is the debt serving ratio. In many cases, that ratio reduced significantly, and sometimes very close to a minimum level before a hurdle kicks in. But what can banks do, other than banking on the airline to swing back to operation and profitability fast?
The views of when it gets better range between regions, and link to recovery of GDP growth. China has recently announced a GDP growth in the 2nd quarter of 3.2% - and with that also a growth of passenger traffic and airlines’ revenue. In other areas such a Europe, where the GPD forecast for 2020 is -8.7%, the return of airlines’ traffic and revenue is much slower. The classical V-shape is not there and I more look at it as a bath tub shape: it dropped off sharply, stays pretty flat for a fairly long time before it only slowly regains back to previous levels. Tourism is in some regions a significant contributor to a country’s GPD, and with tourism only very slowly being able to return, it means not only little GPD growth, but also slow demand for passenger air traffic.
In many countries it was viewed that its legacy carriers are playing a significant role in the country’s economy and its air connectivity, and therefore would need to be supported: government bail-out packages quickly became a lifeline for airlines to survive – and for governments to become a shareholder with board seats and requirements on what the airline needed to do as a pre-requisite to enjoy the life-line. Examples range from protecting jobs, improving the fleet’s environmental friendliness (by only having modern technology aircraft), discontinuing routes that can be replaced by high-speed rail, and last but not least, establishing a business rescue/recovery plan.
Ishka estimates that as of 16th July, governments were preparing or executing $121.25 billion in confirmed bailouts or assistance measures for 139 airlines globally. Whilst debt is the vast majority of financial support, other forms according to their report are subsidies in the form of budget allocations (26%), state loan guarantees (26%), operational fee waivers or discounts (23%), state equity injections (23%), state loans (23%), state bank loans (13%), flights subsidies (10%), large business state loan programs (10%), tax waivers or deferrals (10%) and contributions by sovereign wealth funds (5%). In some cases, one could question the rationale for state aid, e.g. where an airline in its entire history never made profit. Also some LCC’s commented on the “fairness” of state aid to legacy carriers. The need for consolidation became again a frequently used phrase.
Corporate rescue/restructuring plans typically include shareholder deferrals and waivers, reduced employee count (management, admin and crew), employee salary cuts, postponement/cancellation of aircraft deliveries and selling business that are non-core to the airline, to name a few.
The aviation industry has always been a cyclical industry, and the Covid-19 pandemic made a rapid end to one of the longest upward-cycles thusfar – some of the adjustments we see today were potentially overdue and became only feasible under the current environment. Yet we know in our industry how to manage cycles and, the benefit of being in a trough is that the only way out is going up!
This reminds me of the Jennifer Warnes & Joe Cocker song: “up where we belong”!
Peter Huijbers is a Director of PH Aviation Asia Ltd., an advisory firm based in Hong Kong focused on aircraft leasing, financing, investment, and procurement which he established in 2016. Peter brings over 30 years of aviation industry background to the role, covering commercial, technical, debt/equity capital markets, leasing as well as airline fleet management and aircraft maintenance. He started his career at BMW Rolls-Royce selling engines to aircraft manufacturers before moving to Lufthansa Technik in 1999 where he initially was responsible for product management and –development, soon thereafter became Director Key Account Lessors and Banks. Following that, he was Managing Director of Nordcapital Aviation before moving to Hong Kong in 2012 to join Hong Kong Aviation Capital where he was Head of Airline Marketing being based in Hong Kong. After that, Peter established CALS Aviation group – a Chinese owned aircraft operating lessor and was CEO until August 2018. Since March 2020, Peter is Chairman of the ISTAT Foundation, other previous roles in the ISTAT Foundation were chairman of its Scholarship Committee as well as chairman of the Communications Committee. Until December 2019, Peter was also a board member and trustee of the charitable organization Airlink. Furthermore, Peter is a member of the Advisory Committee for the Hong Kong Polytechnic University | Logistics & Maritime Studies, a Steering Committee member for its new aircraft leasing and finance program, and also part time lecturer at HKPolyU on Aircraft Finance as well as Fleet management. He graduated with distinction from the Technical University in Eindhoven in the Netherlands and has a Master of Science degree in Industrial Engineering and Management Science.