Just as the health and economic impacts of Covid-19 have been asymmetric and non-synchronised in terms of geography and timing, the recovery will be also. From evidence so far and looking into 2021, we regard a reversed and slightly recumbent “L” as the best shape to describe the recovery.
While it is important to focus on the particular circumstances and fundamentals at a country and airline level, there is one common theme: the need to conserve and at the same time increase access to cash, against a background where the summer season is unlikely to contribute much towards winter’s requirements.
Given the still-extensive restrictions on international travel, where a number of markets remain closed not just to travellers from particular origins but for all passengers, the initial focus for the recovery is, and will continue to be for a few months on, domestic markets. While the opening up of international markets is a necessary condition for travel to return it is by no means enough to ensure a rapid recovery to previous levels of activity.
At the time of writing (mid-June) domestic capacity in China for the current week is just 8% below that in the corresponding week in 2019. But in Australia, which in 2019 was the sixth-largest domestic market in the world – and where there are currently 382 cases of Covid-19 of which only four are deemed “serious” – travel across state boundaries is not permitted and capacity is just under 15% of what it was a year ago.
Capacity in the US domestic market, which is still by far the largest domestic market, is 35% of what it was a year ago; on the “other side of the equation”, the number of passengers security-screened on 14 June was 21% of what it was on the same weekday (Sunday) 12 months ago, up from a low point of 3.6% on 16 April. However, even adjusting for the general absence of international passengers it is a very clear demonstration of the current “gap”.
In Europe, where most but not all countries are emerging from lockdown and where borders are open, we are starting to see an increase in activity. This is moving from a position where overall, the number of flights operated by low-cost carriers was just 2% of the level of a year ago and just 9% for the “traditional” airlines.
Traffic levels
There is an increasing consensus that traffic is unlikely to recover to 2019 levels until 2023-2024. Managing the ramp-up from almost nothing is a challenge that cannot be underestimated, not least given that 100% of the costs of flying are incurred immediately while revenues may well lag – and there is a prospect that in some cases more will be lost by flying than by not.
Against this background, it is likely that there will be a bit of a “test-and-see” approach. There is a fundamental need to ensure that the business is “right-sized”, not only for this ramp-up but also for markets that may well be some 30% smaller than they were, at least over the medium term.
Furthermore, the introduction of now-necessary processes will slow down the pace of most, if not all, ground-based activities associated with air travel. This will include the time taken to turn around a short-haul aircraft with a consequent impact on efficiency, cost and of course, the available capacity an aircraft can provide on a daily basis.
Taken together the outcome will be a reduction in the available capacity of aircraft and airports.
But given that all forecasts are inevitably wrong, there is also the need to create some options and flexibility. One well-known former airline chief executive was clear that you shouldn’t waste a crisis – and indeed, it is likely that in some cases we will see deeper restructuring, including process change.
However, it could well be that, in the absence of second or even third waves combined with availability of a vaccine and rapid inoculation, the outcome is a recovery more rapid than currently forecast. Fundamental to any industry recovery will be a combination of the speed of the economic recovery and restoration of customer confidence.
There are a number of inescapable consequences for the wider aviation sector arising from the financial damage and resulting dislocation. The extent of this “balance-sheet destruction” will be unprecedented and is already evident; even at the end of 2019 airlines that were showing a strong balance sheet and/or an attractive set of ratios were in the minority.
On the basis of what we know already in respect of those companies that report to their respective stock markets, it is possible to take a view on the key swing factors and ratios – in particular the levels and changes in operating cashflow; net capital expenditure, changes in debt and retained earnings (or more particularly losses) and the movements on shareholders’ funds are of fundamental importance.
Investment story
For almost all airlines, “trading their way” to restoring the balance sheet is not a reasonable option given the nature of the likely recovery and the need for a sufficiently strong and compelling investment story in what will be a particularly competitive market for new money.
It is clear that the shape and size of the industry will be quite different, but one important aspect will remain unchanged: in the words of a recent IATA director-general, it is simply that revenues need to exceed costs – something which, in the near term, may be all but impossible to achieve.
The magnitude of this present disruption, almost irrespective of how long it continues, means it has to be a catalyst for fundamental change. While travel will undoubtedly recover over time, the economics associated with all aviation businesses are likely to be quite different than they were before; in this respect the importance of getting not only the economics but also the investment story “right” and “right now” cannot be understated.
