Coughs and sneezes spread diseases and
depress airlines Jan/Feb 2020

The past twelve years since the global financial crisis has seen the longest continuous uptrend in the aviation cycle, with growth rates well above the long term average. This has led some commentators to say that is time for a correction. But as usual a correction to stability in this industry comes from an extraneous external event, be it political, financial or — in this case — viral. Will the effects of the novel coronovirus epidemic that has developed with such rapidity over the Chinese New Year period have a lasting effect on the aviation industry?

Much of the press commentary in the past few weeks has concentrated on comparison with the SARS (Severe Acute Respiratory Syndrome) pandemic in 2003 which had such a deleterious effect on air traffic demand, primarily in Asia.

Then, the focus of infection was Hong Kong. The territory registered 22% of the 8,097 cases of the disease, representing the highest proportion per head of population at 259 per million inhabitants and suffered along with Canada the highest mortality rate at 17% of diagnosed cases. The economic impact was significant: it has been estimated that the Hong Kong economy lost $4.1bn (or 2.6%) from what it would have been without the outbreak.

China itself had the highest number of diagnosed cases — 5,327 — but this represented an exposure of only 4 per million inhabitants, and of those who were diagnosed with SARS in the country there was a mortality rate of only 7%. It nevertheless had an economic impact estimated as removing $14bn or 1% from GDP.

Air traffic in 2003 took a significant hit. At the depth of the crisis in May 2003, international traffic in RPK terms had fallen by 50% in the Asia/Pacific region in comparison with the previous year, having the effect of knocking global traffic down by 20%. Notably, domestic China air traffic still grew by 5% year on year in 2003 in RPK terms, but its international traffic fell by 10%.

As the SARS virus spread its course, the hysteria that had dissuaded passengers from travelling dissipated. A year later air traffic had rebounded to resume its inexorable growth trend.

The MERS (Middle East Respiratory Syndrome) that appeared in Saudi Arabia in 2012 had minimal effect on global Aviation, but the outbreak of Ebola in West Africa in 2014 while having a disastrous impact on the local economies and populaces went unnoticed by the mass of travellers. After all, to quote Pliny, ex Africa semper aliquid novi (“there is always something new that comes out of Africa”, or possibly “don’t believe everything you hear”).

But the effect of this current pandemic is going to be different. Firstly its epicentre appears to have been a food market in Wuhan a major manufacturing city in the Hubei province in central China with a population of 55m. Secondly it broke out over a period when the citified inhabitants were preparing the annual migration to celebrate the New Year.

More importantly, China has evolved dramatically since 2003: it now accounts for 17% of global GDP up from 5% seventeen years ago and under one measure is now the second largest economy on the planet. In purchase power parity terms it is now the world’s largest with over 20% share of the global economy. Its relevance to the global supply chain of manufactured and pre-manufactured goods is enormous: it is now the world’s manufacturer. Its share of global trade has doubled over that period (see chart).

China’s relevance to the aviation industry has also grown phenomenally: it now accounts for 18% of world demand in RPK terms compared with 7% in 2003 (see chart). Seventeen years ago the majority of international traffic with China was inbound: in 2019 it was the largest outbound tourist market.

A fourth factor: the PRC has taken some unprecedented steps to attempt to contain the spread of infection, with a blanket ban on travel, extension of the lunar new year holiday, extended closure of schools and factories. The new year “rush” over the second half of January and first half of February saw domestic airline traffic down by 70% year on year and load factors plummet to 40%.

There will be fall-out. Cathay Pacific, already suffering from the effects of civil unrest in Hong Kong in 2019, has slashed its schedules, decimating its routes into mainland China, and has asked its staff to take extended unpaid leave. In China two-thirds of the aircraft fleet has reportedly been grounded. The Chinese Big Three (Air China, China Southern and China Eastern) as the de facto flag carriers of the PRC will no doubt be protected, but it has been rumoured that Hainan province may be in talks to rescue the financially challenged HNA Group (owner of Hainan Airlines among others).

There have also been rumours that some Chinese carriers have requested extended lease payment holidays (is there any lessor that could not agree?) which could have a knock-on effect on the aircraft leasing industry. And there will no doubt be other smaller carriers in the region who may not have the financial resources to outlast the crisis.

IATA has presented a reasonable case that, should the Covid-19 pandemic proceed in the same way that SARS did in 2003, total traffic in the Asia/Pacific region in 2020 could fall by 8.2% compared with an expected growth of 4.8% (ie lose 13% of its annual traffic — see chart) and that this could have an effect of removing $30bn in revenues for the region. The global impact under their analysis could be that world traffic demand this year would be flat at best, but that airlines in other regions would not be affected to that great an extent.

But globalisation and the growth of the Chinese economy has meant that the world is far more connected than it has ever been. The extended factory closures will definitely have an effect of dampening economic growth in China. But it is also going to have an effect on other economies, with vehicle manufacturers in the US and Europe suggesting that they will run out of parts (mostly manufactured in Wuhan); manufacturers in India complaining that they cannot get the denim manufactured in China to make into jeans to sell onto the US and Western Europe; Apple suggesting that production of its iconic iPhone would be disrupted.

Oxford Economics has estimated that the effects of the pandemic could reduce global GDP growth by 1.3% this year. Let’s hope they are being pessimistic.

One key difference this time with Covid-19 has been the authorities’ reaction in China, Asia and Europe, imposing draconian containment policies and severely restricting travel. So the direct impact is clearly on the travel industry, in particular airlines. And the direct impact is compounded by the mass psychologic reaction, which, much more than in previous epidemic panics, is driven by social media.

However, virologists have been almost universally supportive of containment tactics which in their view represent the most effective means of stalling the spread of the virus and reversing the epidemic. As viruses tend to dissipate in the summer the optimistic outlook is that the pandemic could be ended in a few months (as the disease is currently prevalent only in the northern hemisphere).

The impact on airline share prices has been dramatic. The Chinese Big 3 and Cathay collectively saw their share prices lose 20% in value in January. This was mirrored at the end of February with similar blanket declines in the US and Europe on the news that Italy was introducing containment measures in certain towns in Lombardy and Veneto. Air France-KLM and easyJet so far have registered falls of 28% from their highs in January, Lufthansa 26% and IAG and Ryanair 23%: in the US, Delta and Southwest are down some 20-22% and United and America by 28% and 32%.

The implication is that airlines are disproportionately exposed to the short term economic impact of this novel coronavirus but, assuming the containment policy works, normal service will be fairly rapidly restored, and there will be a V-shaped recovery. It is somewhat risky to health to try to catch a falling knife, but has the crisis created a buying opportunity in airline stocks?