Airlines around the world are beginning to tentatively return to the skies after the most dramatic disruption in the sector’s history. With mass international travel unlikely to return to 2019 levels for three years, we believe aviation recovery will significantly lag economic recovery at all major regional levels. Overall, we expect a few survivors to emerge more dominant in a notably smaller sector in two to three years with the pandemic having forced a restructure of airline economics.
As governments and economies make tentative steps towards reopening borders, the complications for the aviation sector continue to multiply and diverge between regions and carriers. All of which will differentiate the recovery and survival chances of global and domestic airlines, as well as aircraft manufacturers, the broader supply chain, and connected industries such as tourism. Italy, Hong Kong and Singapore will partly resume their international services this week, while the UK has newly imposed a 14-day quarantine on all arrivals, and Spain intending to lift its quarantine from 1 July. The pace that airline carriers can return to operations will depend on the region of their operations, travel routes and government international passenger requirements between connecting countries, as well as in observing on-board social distancing measures such as the requirement to leave middle seats empty, which will impact flight financial viability.
The SARS epidemic is the best benchmark. In 2003, cancelled flights across Asia and North America together cost carriers $6bn in lost revenue, according to the International Air Transport Authority (IATA). European carriers largely escaped unscathed. By comparison, Covid-19 is forecast to cost the global aviation sector up to $314bn in lost revenue this year. The difference in scale is due to the potential rise in international travel in the subsequent near two decades, including the massive Chinese market share. Governments around the world have responded with highly uneven financial aid – from substantial to minimal.
Finance and bailouts
Governments have provided $123bn to airlines in loans, wage subsidies, deferred taxes, loan guarantees, equity finances, as well as in other support. Regionally, financial support has varied substantially. In the US, government financial aid to its national carriers is so far equivalent to around 33% of 2019 annual ticket revenues. In Europe, the equivalent figure is 15%. Last week the German government finalised a €9bn bailout for Lufthansa, taking a 20% stake as the airline reported a €1.2bn first-quarter loss. Lufthansa also announced the shutdown of its discount carrier, Germanwings, and plans to cull 10,000 jobs. Government financial aid in Asia-Pacific is so far around 10% of 2019 annual ticket revenues, including just 2% in China, now the world’s second-largest aviation passenger market with annual ticket revenues of $123bn. In Africa, the Middle East and Latin America, average aid is just 1% of 2019 ticket revenues. [All data points according to IATA, the global airline trade association.]
Contraction of sector is only just beginning. Global airlines are entering this ‘restart’ on a precarious footing, and the bigger financial challenge is still ahead. Of the $123bn in government financial aid, around $67bn is new debt with only $11bn in equity, according to IATA data. Governments will need to pivot from unprecedented liquidity support to solvency support, for which in part the risk has become more acute due to the extra debt governments have loaded onto airlines to give them a fighting chance of survival. As a result, the aggregate debt levels for the global aviation sector is forecast to reach historic highs of around £120bn by year-end. Global airlines must balance the increased solvency risk stemming from the weight of their heavier debt load with navigating a path forwards towards a viable new airline economic model. At the same time, in the near term, the sector will need to grapple with regional differences in health and security requirements, potential resurgences of the pandemic, and emerging new passenger behavioural changes: all of which could depress the recovery of air traffic demand. The probability of airlines being forced to ground flights again in the autumn or winter is both difficult to accurately estimate and imprudent to ignore, which makes the ‘restart’ more akin to a ‘trial and error’ exercise.
We expect these headwinds will lead to higher fares and decreased demand for business travel (and associated lucrative business and first-class seating capacity), and long-haul flights globally. Subdued demand will lead to cancellations and deferrals of new aircraft deliveries over the next three years, which extends to aircraft manufacturers, and beyond. For example, Emirates is reportedly in discussions with Airbus to cancel five of its final eight A380s and plans to retire part of its current fleet early. Early cancellations could cost Emirates around $350m. The Gulf carrier is also reportedly looking to cut its workforce by 30,000. Unwanted jumbo airlines could be converted into freighter planes or mothballed until demand returns.
Short-to-medium-haul airlines will likely see demand recover faster; however, their ability to maintain flexible pricing policies will be tested, likely a function of carriers fixed operating costs and liquidity. Low fuel prices will benefit those carriers that have invested most in fuel-efficient fleets. However, downside risks remain in abundance. Governments’ travel policies, including international flight restrictions and the implementation of social distancing measures, will impact short-haul carriers’ recovery. Lengthy check-in processes, quarantines for holidaymakers returning to their home countries (as imposed by the UK), the possibility of sporadic shutdowns of travel routes due to the resurgence of coronavirus in the autumn and winter, recession-induced lower disposable income levels, as well as holidaymakers’ perceived confidence, are all risks to passenger demand.
Across the sector, and connected supply chain and associated industries, further bankruptcies, conditional bailouts and nationalisations are likely, while distressed M&A consolidation is also likely. Mitigating the risks of restarting air travel and identifying a modified viable economic model for airlines and connected industries are complex and intertwined undertakings. If your business, or portfolio company, is directly impacted by the challenges in the aviation sector and would like to discuss your strategic options, do get in touch with us and let us see how we can lighten the load.