Coronavirus: Will airlines survive the current crisis?

Thursday, 5 March 2020

With airlines globally cutting routes and slashing profit forecasts, aviation companies look as though they're battling for their financial lives.

Airlines worldwide are being forced to cut flights, firstly because of travel restrictions around the coronavirus, and then as passengers increasingly reconsider flying.

New Zealand's air links are also affected. While the country has only had three confirmed cases of Covid-19, Korean Air and local airline Air Chathams have both just axed New Zealand services.

Air New Zealand moved quickly to stop flights to Shanghai, and has temporarily trimmed its number of flights to Hong Kong.  

**READ MORE:

* Air travel slump 'tip of the iceberg' as coronavirus disruption hits

* Coronavirus 'could take $100m off Air New Zealand's profit' 

* Virgin Australia announces trans-Tasman cuts as coronavirus takes toll

* Coronavirus: Air NZ should prepare for 'prolonged financial damage'**

Overnight, anxious US airlines met with President Donald Trump, seeking reassurance in case of a collapse in travel demand. 

And the industry's main body, the International Air Transport Association (IATA), has called on governments to start thinking about relief, such as lowering airport fees.

Aviation stocks are known for being 'high risk, high return'. Vulnerable to oil shocks and economic conditions, they are often supported by a major government shareholder, lessening the odds of their collapse.

Matthew Goodson, managing director of Salt Funds Management, said the key to airlines' survival was leverage.

'Your costs hardly vary whether you're 30 per cent full or 90 per cent full. It's that extra revenue that flows through to bottom line profits or losses'.

The finance arrangements around planes, whether they were leased or bought with debt, was also vital.

'When things go well for an airline, you get the operational and financial leverage compounding and driving very strong profits for the capital you've employed.

'But when you have a left-field shock like this, conversely it tends to have an outsized impact on profits, relative to other companies with less leverage.'

Frank Jasper, chief investment officer at Fisher Funds, said his company tended to avoid airline stocks because of their volatility.

'We're looking for companies that have long-term growth ahead of them, and I think aviation probably does tick that box,' Jasper said.

'But very importantly, we're looking for companies that have a moat around their business – that thing that protects them from competition and gives them pricing power and defensive qualities.'

 Airlines were 'hyper-competitive'; a competitor only needed to buy another plane and add it to a route.

'It's a really, really hard industry to make money in.'

However, he still rated tourism-related stocks. Airports, hotels, cruise companies and even-cross border payment businesses were often long-term performers and their share prices were looking comparatively cheap.

Even before Covid-19 emerged, airlines were hurting. Virgin and Qantas both flagged big redundancies last year, and several airlines in the swamped European market failed.

Air France is reportedly considering 1500 redundancies by 2022, and the head of Air France-KLM, Ben Smith, said on Tuesday that he expected the virus would lead to more industry consolidation. 

And Hong Kong Airlines is to slash its workforce by 10 per cent, thanks to democracy protests and Covid-19 cancellations.

US airline stocks have plunged and global air traffic is on trend for its first annual drop in 11 years because of the coronavirus, according to IATA.

It estimates the virus will cost the industry US$1.5 billion so far, particularly in Africa and the Middle East.

Yet Joel Szabat, the US Transportation Department's acting under-secretary for policy, said he believed a quick rebound was possible.

'At the peak of Sars [in 2003], US travel halved. Within two months, it was back to normal.'

Like other listed airlines, Air New Zealand's shares have fallen 20 per cent since February 21 and the airline has already slashed its profit forecast.

It also released a string of ultra-cheap fares this week, which were quickly snapped up. But the fact that many travel insurance policies are not covering the coronavirus may make many travellers think twice about taking an overseas flight.

Aviation specialist Irene King has said that Air New Zealand's axed Shanghai route was probably not that profitable. She was more worried about the virus' impact on inbound tourism and export cargo.

And on the trans-Tasman route, Air New Zealand, Qantas and Virgin Australia have all trimmed flights, a route which already had too many seats, according to the Australian-based Centre for Aviation (Capa).

'The true test will be how they react when the coronavirus emergency eases'.

But Capa's general view was that airlines were still 'likely to experience prolonged financial damage' and Goodson thought it was too hard to tell.

'I think you'd need a crystal ball to know how the crisis will evolve. It may well be that Air New Zealand is attractively priced down here, but that depends on how long the crisis lasts, what restrictions are put on flying, and the shape of Air New Zealand's balance sheet when they get through that period.

'Airlines have lots of cash on hand but a lot of that is tickets bought in advance, so it's not exactly unencumbered cash.'

Another risk was that oil prices, which are currently well down, might rise again after the crisis and hurt the airlines, Goodson said.

Idle planes were expensive, Jasper added. 'If your plane is not flying, you still have to pay for it.'

But ultimately, he did not think the basic fundamentals driving aviation would change.

The rising number of middle-class consumer meant people would eventually revert to pursuing their travel dreams.

'It's hard to imagine that ultimately those volumes won't return.'

- additional reporting from Bloomberg.