Global carriers: How real is the bankruptcy threat? Jul/Aug 2009

There is growing speculation not just about the fate of aircraft orders but about liquidity issues and even bankruptcies this upcoming winter.

“Could British Airways really go bust or not?” asked the headline of a (serious–sounding) article on the UK Sunday Times’ website on June 21st. Who would have thought that question would ever be asked about BA, one of the world’s most profitable global carriers in recent decades, given its unbeatable Heathrow hub and uniquely strong route franchise and market position.

BA is now incurring heavy losses and is aggressively trying to restructure its labour costs. Chief executive Willie Walsh warned dramatically in June that the airline faces a “fight for survival” and is pushing through a cost cutting package that includes salary reductions for the pilots (which has been accepted by BALPA), about 3,000 redundancies throughout the company and a voluntary scheme whereby employees are encouraged to take unpaid leave or, in a very limited number of cases, work unpaid for a month.

The other former leader in the global airline profit league, Singapore Airlines, while not actually a potential bankruptcy candidate, has also seen a shocking deterioration in its financial fortunes. SIA has seen its profits evaporate and may post losses for the June and September quarters, in part because its “luxury brand” business model is totally inappropriate for the current environment.

Japan Airlines, Asia’s largest carrier (though never consistently profitable like BA and SIA), is now seeking ¥100–200bn (US$1–2bn) in state–guaranteed emergency funding to cope with financial losses this year.

In the US, there are fears that United Airlines, in particular, could face liquidity pressures this winter. UAL is expected to incur the legacy sector’s steepest loss this year, reflecting its extensive global route system and greatest exposure to the premium sector. UAL also has heavy debt and capital lease obligations — $650m in April–December 2009 and another $1bn in 2010. Of course, the global airline currently most at risk is Air Canada, which is scrambling to put together a package of measures to avoid a second bankruptcy filing in six years (see pages 16–19). Air Canada faces a potential cash crunch and needs to raise at least C$600m in new liquidity to satisfy conditions in new labour deals and to make it through the winter.

What these airlines have in common is heavy exposure to global premium (business and first class) traffic, which has fallen sharply in the recession. Some — in particular SIA and other Asian carriers — also have heavy exposure to cargo traffic, which remains extremely depressed as it closely mirrors GDP growth.

In a cruel twist in late April, just as the global airlines thought that the worst was over and were looking forward to a reasonable summer season in which to build cash reserves for the winter, serious new challenges emerged. The impact of the H1N1 influenza, a sudden upward swing in fuel prices and a lack of any sign of improvement in the global economy combined to make May/June a miserable start to the northern hemisphere’s peak season.

In June IATA doubled its global airline industry loss forecast for 2009 to $9bn, up from an estimate of $4.7bn in March. This would be almost as large as last year’s loss of $10.4bn. IATA expects industry revenues to decline by an unprecedented 15% this year, much more than the 7% fall in the aftermath of September 11.

IATA expects Asia–Pacific carriers to account for $3.3bn of this year’s industry loss, with European and North American airlines losing $1.8bn and $1bn respectively. The North American loss is relatively modest, and much narrower than last year’s $5.1bn loss, in part because of US carriers’ aggressive domestic capacity reductions in the past nine months.

In mid–June Bank of America/Merrill Lynch lowered its 2009 US industry earnings forecast from an operating profit of $4.7bn to $1.8bn; the net income forecast went from a profit of $1bn to a loss of $2.3bn.

On July 14th BOA/ML estimated that the eight largest US carriers had a combined $1.2bn net loss and only broke even on an operating basis in the June quarter, which is one of the industry’s strongest periods seasonally. It would represent a tripling of the year earlier net loss. Although jet fuel prices are 55% lower year–over–year, that nowhere near compensates for the estimated 21% decline in industry operating revenue.

Although fuel prices have somewhat eased up in the early part of July (a trend that could easily reverse), it is shaping out to be a weak summer demand/revenue–wise for airlines all around the globe. Also, prospects of any meaningful economic recovery this year look slim.

Consequently, the past couple of months have seen a frantic effort by airlines around the world to slash capacity, costs and capital spending. Even US airlines have modestly added to their already–significant capacity reductions, this time focusing more on international routes. But, in IATA’s estimates in late June, capacity cuts globally so far this year have been only about half of the decline in volumes flown, forcing fares and yields to fall sharply in the past couple of months.

Impressive liquidity raising

One of the brighter spots has been the airline industry’s ability to raise significant new liquidity, despite the supposedly tough financing environment and the lingering banking and credit crisis. The past few months have seen an impressive array of financing transactions.

May and June saw a number of convertible stock and debt offerings – easier to do than pure equity offerings. The process was started by the primarily–domestic US carriers: US Airways raised about $234m and JetBlue $265m, with Lufthansa reportedly participating in the latter to maintain its current 15.6% stake in the US carrier.

In late June Air France–KLM completed a highly successful €661m convertible bond issue, mainly to finance its fleet. The French government reportedly participated in the offering, to maintain its stake at 15.7%.

In mid–July there were reports that BA was considering joining the convertible bond bandwagon to boost cash reserves. The leadership told shareholders at the company’s AGM that tapping the convertible market was potentially one of the best options when there were still a “number of key issues” to be revolved (especially a pension deficit of more than £1.74bn).

As of mid–July, ANA was in the process of selling stock for the first time in three years. The airline is offering new shares to raise up to ¥141.7bn ($1.5bn), mainly to fund new aircraft. This may seem amazing, given that ANA has been posting losses and faces very uncertain economic conditions, but Japan has seen a resurgent equity market in the first half of 2009 and ANA has a good growth story to sell. But it certainly contrasts with JAL having to seek an emergency loan from the government.

In the US, the legacy carriers have raised significant funds through secured debt financings in recent months. In June Continental completed a $390m EETC, the industry’s first in nearly two years. Later that month, American issued pass–through certificates to finance 16 new 737–800s and refinance some existing aircraft; the deal was apparently structured in such a way to increase the likelihood that American would continue to pay on the certificates in bankruptcy. Even United was able to raise $175m from the sale of senior notes backed by aircraft spare parts in late June. However, the airline paid a very high price: the notes were issued at a heavy discount to their face value and carry a 12.75% interest rate.

Of course, none of this guarantees that the airlines will not end up in bankruptcy. With UAL the key concern is the potentially large amount of additional cash that needs to be raised if the recession lingers on, given the $1.7bn of scheduled debt and capital lease payments between April 2009 and the end of 2010.

The existence of the Chapter 11 – and the Canadian equivalent CCAA – processes, which facilitate restructuring under protection from creditors while allowing operations to continue normally, obviously make it easier in theory for North American airlines than, say, BA to file for bankruptcy. However, there is another key difference: the strength of balance sheets. Unlike UAL and Air Canada, BA and the other leading European carriers still have solid balance sheets. Even now, in the depths of the worst ever global recession, their credit ratings are only 1–2 notches below investment grade.