Airlines, What Does the Future Hold?

COVID is taking a massive toll on the airline industry. The chart below shows the fall in U.S. passenger traffic and airline values.

Finding the right space and conditions for 62% of the world’s planes and keeping them airworthy have suddenly become priorities for 2020. Not only do aircraft need dry climates, which makes finding space difficult, but they need constant attention. Tires need to be rotated, engines run, and aircraft powered up, flight controls checked, and sensors and engines covered to protect inner workings from sand and dust. Hydraulic fluid is put on the landing gear to protect against rust, and giant silica moisture absorption sachets are placed inside engines to keep them dry. At the same time, covering all external holes on the fuselage to block insects and nesting birds entering. All of this costs money, and storing one Boeing 737-800 costs around $3,100 a month, while a 777-300ER is $6,377 a month. Delta could pay $2.0 – $3.5 million a month for the storage of its approximately 600 aircraft. As a result, with all its other expenses, Delta is currently burning through US$60 million a day, and Jet Blue $10 million. Delta just announced a Q1 net loss of $534 million.

As of last week, the inactive fleet of aircraft was approximately 14,400, over two-thirds of the 22,000 mainline passenger airliners, leaving 7,635 in operation. In Europe, less than 15% are operating, while in North America, 45%, and or Asia 49% are working respectively. Narrowbody aircraft are less affected, 37% are operating vs. widebody aircraft 27%. In the U.S., domestic flights are averaging just ten passengers while international flights average 24, according to a trade group.

These costs have already had an impact.

  • Air Canada announced a temporary layoff of 5,100 employees, suspending most of its international flights.

  • Air New Zealand cut its long-haul capacity by 85%, suspending several long-haul routes, and reduced domestic route capacity by 30%.

  • American Airlines is cutting its domestic flight schedule by 80%–90% in May, with only a “handful” of international routes to stay in operation.

  • Cathay Pacific canceled three-fourths of its flights in March 2020, and 96% of passenger flights in April and May, but continued flying some passenger planes empty to transport cargo.

  • Delta suspended about 70% of its flights across its network from the end of March.

  • Emirates stopped all passenger flights from March 25, 2020.

  • Ethiopian Airlines reported a 30% reduction in passenger traffic in March, and in April, the suspension of flights to over 80 countries.

  • Finnair reduced its flight capacity by 90%, starting from April 1.

  • FlyBe, the U.K.’s most significant domestic airline, collapsed last month.

  • International Airlines Group (including British Airways, Iberia and Aer Lingus) announced a 75 percent reduction in passenger capacity for two months in mid-March 2020.

  • Lufthansa grounded its fleet of Airbus A380 aircraft and cut long haul travel capacity by 90% and intra-Europe flights by 20%.

  • Qantas suspended about 60% of domestic flights and all international flights. It put two-thirds of its employees on leave.

  • RavnAir, Alaska’s largest regional airline, collapsed.

  • Singapore Airlines cut 96% of its flights up to end-April.

  • South African Airways has shut down laying off nearly 5,000 people.

  • Southwest Airlines has suspended about 40% of its flights and expects to suspend 50% in June. Also, it stored 50 Boeing 737-700 aircraft

  • Swiss International is taking half its fleet out of service

  • Virgin Atlantic has asked for U.K. Government aid. It is 49% owned by Delta, but Delta cannot help and is expecting a $200MM payment from Virgin Atlanta this quarter.

  • Virgin Australia Holdings Ltd. was Asia’s first airline to fall.

Centre for Asia-Pacific Aviation, a Sydney based global airline consulting and analytics firm, concluded without government financial aid, half of the world’s approximately 800 airlines would be bankrupt by the end of May. Based on its analysis of cash flows. CAPA estimates that in less than 75 days, half the globe’s airlines will be technical insolvency.  Airlines, because of their financial structure, are heavily dependent on cash flow. Their primary assets, aircraft, are 20-plus year assets, financed via 20- to 25-year term loans or 12- to 15-year leases. As a result, airlines must receive enough cash to meet their monthly loan or lease payments. To cut costs, airlines are cutting fleets and other expenses.

American Airlines is accelerating the retirement of its oldest planes, Boeing Co. 767s and 757s, and it’s fleet of 20 Embraer SA E190s and some 50-seat regional jets. It’s also considering to retire its oldest Boeing 737s. Delta is studying the early retirement of its oldest Boeing MD80 and MD90 aircraft, while United expects its oldest Boeing 757s and some 767s to be grounded permanently. As a result, U.S. airlines could shed 800 to 1,000 aircraft, which could result in a reduction of 95,000 to 105,000 airline jobs. In the U.S. under the terms of the $50 billion government bailout, airlines are barred from cutting jobs through September 30; however, airlines are warning staff that cuts are coming. Southwest has said that it will be a much smaller airline going forward and for the foreseeable future.

If the airlines get through the next 75 to 90 days, what then? Well, the initial news from China is not favorable. According to Bloomberg, around 35,000 domestic flights are operating in China daily, compared with 80,000 before the COVID-19 crisis, according to the International Air Transport Association. The figure has been stalled at that level since services resumed in early March. While there was an increase in business confidence and journeys to visit friends and family, there’s been no resurgence in the vital tourism market, according to Brian Peace, IATA’s chief economist.

In the U.S., the future is even bleaker, with a return to travel inhibited by health concerns and the increasing economic impact. An IATA-commissioned survey said that 40% of respondents would wait six months or more to fly again following the containment of the pandemic. From a purely anecdotal perspective, this agrees with the majority of my clients, who are cutting travel budgets and don’t expect them to increase after infections fall. Thus, the high paying road warriors will be MIA for a while as companies have learned to function via Zoom, which is much cheaper than a business class seat. Even when business travel returns, long-haul international flights will take longer to revive. The airlines foresee an uptick in bargain-hunting leisure travelers this summer; however, historically, those seats have been subsidized by the road warriors. Delta’s Chief Executive, Ed Bastian, expects the recovery to take two to three years and that Delta will be a smaller airline for some time.

Since most of the European carriers, i.e., British Airways, rely on long haul high paying passengers to subsidize short-haul flights, their business models will have to change. In the U.S., the major carriers have also built on the ability to connect U.S. second tiers cities with other second-tier cities in the U.S. and worldwide as their business model, with falling business travel and especially international travel, their models will also need a reevaluation.

Overall expect the number of flights to fall and smaller planes on many routes, with overall increased fares. For many people flying will once more become the luxury it was before deregulation. Many flights to secondary markets may disappear altogether. The only upside is that for the moment, the dreaded center seat is no more! While Europe will not be as severely affected due to its rail network, in the U.S., the effects could be devastating for smaller communities that lose all airline service. Loss of airline services to these markets will have many knock-on effects, which will further limit their ability to recover from COVID. How much damage will Congress and the U.S. be willing to accept?

With government aid, comes the question, will we revert to the nationalization of airlines again? Since the 1970s, many airlines were privatized, new airlines entering the market, many went bankrupt, and there was much consolidation. Overall, airlines have been terrible investments, and most have lost money. In the U.S., bankrupt airline corpses litter the aviation sector. However, many countries, including the U.S., have claimed that domestic airlines are essential to national security, so what to do? If there are just bailouts, there will be a public revolt at an industry whose shareholders and management kept the gains and socialized the losses. Many expected a pandemic of some sort, and according to public health officials, COVID is unlikely to be the last. Thus, can airlines survive in a world of shutting down? Airlines suffered from SARS and the eruption of Eyjafjallajökull in Iceland. To have another hit soon after this, it may finish them off for good. If governments take equity as part of the bailout, is this the first step in nationalization?

I think the questions to be asked are:

  • Do we need national/regional airlines?

  • What do we expect from a national/regional airline in terms of service, market coverage, performance, costs?

  • What are we (the government) willing to pay for those needs?

  • If so, how do we structure a private/public model that meets national needs and generate sufficient return for the private market?

  • If we can’t, should airlines be nationalized to protect a vital asset? If so, would we want an airline modeled on Singapore Airlines or Alitalia?

An interesting discussion to be sure, and if we cannot make a private, public model work, nationalization will undoubtedly return. Airlines may return their model in the 70s and before.

 

Copyright (c) 2020, Marc A. Borrelli

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Skytrax

  1. Qatar Airways
  2. Singapore Airlines
  3. ANA All Nippon Airways
  4. Cathay Pacific Airways
  5. Emirates
  6. EVA Air
  7. Hainan Airlines
  8. Qantas Airways
  9. Lufthansa
  10. Thai Airways

AirlineRatings.com

  1. Singapore Airlines
  2. Air New Zealand
  3. Qantas
  4. Qatar Airways
  5. Virgin Australia
  6. Emirates
  7. All Nippon Airways
  8. EVA Air
  9. Cathay Pacific
  10. Japan Airlines

No American carriers again struggled to break into the top-ten rankings this year for either ranking. No US-based airlines made it into the top 35 spots year for Skytrax, for whom JetBlue was the top-ranked US carrier No. 40.

Following the US carriers’ failed attempts at launching budget carriers, remember Song and TED, they are now following a two-prong strategy – mediocre or better in the front and budget carrier in the back. The problem with a two-prong strategy as was discussed above is that you cannot go down two different paths, you are either A or B. The high-end strategy for the front of the aircraft requires different service levels on call centers, lounges, check-in desks, flight attendants, crew, and different investments in IT, fleet types, etc. than for budget carriers. Thus as the company drives down two different paths, the employees and investment decisions fail as it tries to satisfy two different masters and end up satisfying none.

I find it amusing to see Delta’s advertising “Delta, voted the best Business Class Airline,” as often I wonder, by who, obviously someone who does not travel internationally? Although Delta did recently introduce a new all-suite business class last year, albeit long after the advertising started, that didn’t help it move into the top rankings. The reason is that equipment alone is not the deciding factor; it is service levels across the entire client experience. But if the majority of your client service experience is providing a budget carrier experience, it is hard for your employee base to suddenly pivot to offer the superior experience needed for the business class passenger, reinforcing the prior point. Choose your strategic decision and stick with it. For a reminder, look at Joel Spolsky old blog post, “Ben and Jerry’s vs. Amazon.” Joel, who has seen several companies succeed and fail, suggests the worst thing you can do is fail to decide what strategy you will choose.

Another airline that has been following a variation of the two-prong strategy is British Airways (BA). BA, long known as the “World’s Favourite Airline,” has relied on their control at London Heathrow to drive their higher value to their long haul traffic – especially business and first-class, while treating short-haul traffic as a budget airline. While British Airways is very profitable at present, it has failed to invest in IT over the last few years. As a result, this summer, there was the second massive IT outage in two years. While the latest one is expected to cost Brtish Airways about £10 million the first one cost the company about £100 million. Also, BA’s failure to secure customers’ credit card data on its website, is resulting in £183 million fine for data theft. Final, BA”s pilots are upset with the level of profitability compared to their pay offer and are now striking for better pay. The strikes started in September with the cancellation of thousands of flights and cost the company over £200 million.  If the strikes last over the Christmas holidays, the price will rise dramatically! Two-prong strategies that conflict are hard to make work successfully in the long term!

Since the majority of US flyers are flying coach, the consensus will undoubtedly become that the US carriers are really just budget carries masquerading as real carriers. How long will it be before they are all charging for carry-on luggage like Spirit?

While milage points and hub control still make a difference in attracting passengers, it is the budget carrier mentality, cause, vision and focus that allows carriers like JetBlue and Southwest to continue to make inroads into the legacy carriers market and make more money.

In 2018, Southwest was the second most profitable airline in the US behind Delta.

 

Southwest Delta
Revenue $21.96 $44.44
Operating Profit $3.21 $5.26
Operating Margin 14.6% 11.8%

While the US legacy carriers continue to make money, it is only through the consolidation and lack of competition. If competition were allowed to enter the market, then all bets would be off.

For the most part, flying in the US is like Greyhound without the view, and until the government is willing to ignore the lobbyists and allow more competition, and local governments allow more competition at the hubs, not much is likely to change, forcing more pain on the flying public.

Bon voyage!

 

© 2019 Marc Borrelli All Rights Reserved

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