The Airline Shake-out Starts Up

The Airline Shake-Out Starts Up
May 2020

This month saw two of Latin America’s three largest airlines file for bankruptcy: LATAM and Avianca. They are the most visible casualties to date of the unprecedented fall in air traffic since the onset of the COVID-19 pandemic, though they certainly won’t be the last. Today’s Infrastructure Ideas looks at some of the emerging implications for airlines of the unfolding shake-out.

Airline travel was one of the areas first and most severely disrupted by the emergence of the coronavirus. With the combination of passenger health concerns, and uncoordinated government travel bans and/or carrier stops, anywhere from 75 to 90% of passenger volumes disappeared in less than one quarter. The level of passengers in the US dropped below 100,000 per day, last seen in the 1950s. Five months in, the financial impacts are starting to show in a big way. IATA has estimated lost industry revenues at over $300 billion, and not too many carriers have the Balance Sheet to withstand this.

Already in February, Air Italy – the old Meridiana Air partly owned both by the Aga Khan Fund and by Qatar Airways – went into liquidation, and Turkish Atlas Global filed for bankruptcy. In April Air Mauritius entered administration and Virgin Australia filed for bankruptcy, while in May LATAM and Avianca were kept company by TAME Ecuador, which entered liquidation. Other airlines whose positions were already difficult before COVID-19 are trying to stay afloat: South African Airways, the largest airline in sub-Saharan Africa, remains in bankruptcy, hoping for some kind of rescue, while SAA Express, its regional affiliate, has entered liquidation; Kenya Airways, another of Africa’s big three airlines, recorded its second major annual loss, close to US$100 million, before the pandemic even started (the Kenyan Parliament has voted to re-nationalize the carrier); and Philippine Air announced a revenue loss of over $1B. A rehabilitation plan for Thai Airways was approved on May 19, involving the Government of Thailand’s stake dropping below 50%.

Aside from the announced bankruptcies, airlines around the world have shed thousands of jobs, cut salaries and grounded planes. McKinsey estimates airline capacity has been reduced by 75%. This without mentioning the impact on airports and many associated services which have also been deeply affected.

For the most part, bankruptcies are arriving first for Emerging Market-based airlines. While some of these airlines have been recording the strongest growth in the industry, and have the potential for much higher growth in the future than their OECD-based counterparts, there have been two things going against them: thinner equity bases, and the lack of fiscal space in non-OECD countries for supplying financial assistance – as has been the case in the USA, and most recently with Lufthansa.

Avianca, which claims to be the world’s second-oldest continuously running airline, filed for Chapter 11 in New York on May 12, blaming its collapse on the “unforeseeable impact of the Covid-19 pandemic.” While the company stated it is neither in insolvency or liquidation, it did close its Peruvian affiliate, along with cutting its fleet. Avianca had had remarkable growth over the past two decades, but had already been showing signs of stress before the pandemic. Former controlling shareholder German Efromovich was removed in May 2019, after defaulting on a $450 million loan from United Airlines which had been secured by his 51.5% stake in Avianca. While United is now the largest shareholder, it ceded its voting rights to Salvadorean Roberto Kriete (a former chairman of TACA Airlines). Chile-based LATAM had also been growing strongly. It is South America’s largest carrier by passenger traffic, had more than 340 planes in its fleet and nearly 42,000 employees on its payroll, and reported a profit of $190 million in 2019. In December 2019 Delta Air Lines, agreed to purchase 20% of the company for $1.9 billion, and Qatar Airways already owns 10%. The company’s May 25 Chapter 11 filing focuses more on the downturn as an opportunity to reduce its debt. Its three main shareholders have agreed to provide up to $900 million in financing as LATAM makes its way through the bankruptcy process.

Investors, operators and governments are now all asking themselves — what comes next? Here the key uncertainty, as in so many sectors, is what course the pandemic takes. Case and death levels are still rising, though in aggregate significantly slower than a month ago. Many countries have begun at least the first phases of re-opening, and air traffic has shown its first uptick since mid-May. The Pakistan International Airlines crash in Karachi is one of several instances where the re-opening of flights has not started smoothly. So it remains unclear how protracted the decline will be, though it appears that demand is likely to have bottomed out, and unclear whether demand returns to pre-crisis levels and if so, how soon. On the one hand, the post-9/11 experience was one where growth in air traffic resumed strongly, in spite of structural changes in the air travel experience related to security. On the other hand, McKinsey notes that not only may health-related concerns keep passengers out of planes, but climate change concerns had also begun to have some impact.

Keeping these uncertainties in mind, we can hazard some guesses on what kind of structural changes aviation is likely to undergo. Here are some views on what the post-pandemic future may hold:

1. Fewer carriers. Almost certainly we will see fewer carriers, either through the route of liquidation, or through the route of mergers. While EM-based carriers have seen more bankruptcies so far this year, it may be that advanced economy-based carriers see more liquidations. Factors pointing in this direction include growth potential, and there being more merger targets in Emerging Markets today. The post 9/11 crisis in air travel almost two decades ago led to major consolidation among US airlines, with USAIR, Northwest and Continental disappearing, but not much consolidation among Emerging Markets carriers. Granted national interests in flagship carriers will, as always, be a major impediment to such consolidation, yet mergers and acquisitions are likely. Already in Latin America, the path of both Avianca and LATAM over the past decade has shown consolidation to be accepted in the region, and the stakes taken recently by United, Qatar and Delta have shown non-regional ownership has become politically acceptable. In Africa, one of the more surprising developments of the last month has been the announcement by Ethiopian Airlines on May 5 that it is in talks to revive both Air Mauritius and South African Airways. Ethiopian operates Malawi Airlines, had bought 45% of Zambia Airways in 2018, partners with ASKY of Togo, and has previously been in talks to revive Ghana Airways.
2. Fewer passengers. In terms of demand, the COVID pandemic is likely to be a crisis with a very long tail. Most forecasts expect more waves of infection, whether in large re-opening markets such as the USA (or as Korea is currently experiencing), or in markets where the initial pandemic wave had more limited impact. This is likely to keep travel-related concerns high for some time.
3. Pressure to reconfigure aircraft. Proximity to infected people, including those who do not know they are infected or do not show signs of infection, is now understood to be the biggest vector for spreading of the coronavirus. Airlines’ business models have been driven by packing as many people as possible on planes, as tightly together as can be sold. There will be a clear conflict between these two drivers. This week has seen an interesting experiment by Air Canada, which is beginning to offer in effect “all business class” flights, leaving more space between passengers on the entire plane.
4. Higher airport fees and health-related costs. Airports are facing the same issues as airlines: plunging revenues, and pressure to make investments in reconfiguring assets (see note on this in our previous Infrastructure Ideas note). One of the very few directions airports will be able to go to increase their revenues and stay afloat will be to charge higher fees to airlines – all the more as the number of airlines decreases.
5. Higher fares, and a higher premium on efficiencies (including fuel efficiency). Fewer passengers and higher costs. At least in the near-to-medium term, airlines will have little choice but to raise fares. In the very short term some are offering minimal fares to try to re-spark travel, but this tactic will be completely unsustainable. Facing decreased demand and higher costs, as noted above, airlines will have to focus very hard on their P&Ls.
6. Unprecedented government support. Airlines will find it very difficult to square this circle without help. This we already see in many OECD countries. It seems unlikely, however, that the support provided to date will be enough for many carriers, barring an unexpectedly rapid decline in rates of infection and an unexpectedly rapid return of passenger demand. It is likely that politics becomes a big determinant in OECD countries of which carriers get further support, and survive, and which ones do not, and wind up liquidated or acquired. We have not seen as much of this in many Emerging Markets, which has been a factor in why the Aviancas and LATAMs have become early bankruptcy headliners. Many EM countries’ fiscal space is doubly constrained by the economic contraction and pre-crisis indebtedness. Yet airlines also play a role that is in some ways more essential in many EM countries, where road and rail alternatives for transport remain limited. We would therefore expect that, especially as the Multilateral Development Banks ramp up their crisis-related fiscal support, we will start to see a number of EM-based carriers get new government support.