Cash is King but
Debt Rules OK?
Oct/Nov 2021
The Covid-19 pandemic has had a calamitous impact on airline operations and finances. With the closure of borders, mandated cessation of services, a collapse of demand, and an inability quickly enough to halt fixed cost cash burn, all airlines round the world were in desperate need of liquidity to stay alive. Cash was king. Some were lucky enough to get support from their governments. All have had to raise huge amounts of debt. Will the industry ever be able to return to the healthy pre-pandemic financial status?
Analysis from Bloomberg (see chart) shows that the world’s airlines have taken on an additional $140bn liabilities in loans and bonds since the start of the pandemic giving a total of $340bn, 70% higher than at the end of 2019. (These numbers seem a little on the low side for the industry as a whole and presumably only covers public figures in their databases.)
Interest rates may have remained low during this period but airline credit ratings have suffered and the cost of debt will have risen. Pre-pandemic, according to IATA, a third of the top 40 airlines in the world held investment-grade ratings, with only 20% marked as “highly speculative” or below. By August 2020, all but a small handful were rated sub-investment grade or worse.
Top airlines doubled debt
For this analysis we have looked at the top four carriers in North America (American, Delta, United and Southwest), the top four in Europe (IAG, Air France-KLM, Lufthansa and Ryanair), and three top players in the South East Asia/Pacific region (Cathay, SIA and Qantas), as bellwethers for those in the industry that aim to provide returns to shareholders.
Between them these 11 airline groups have doubled their total on-balance sheet debt — from $95bn to $185bn — between January 2020 and end June 2021 (see chart).
Some of the funds raised were at junk bond rates. In 2020 American issued $2.5bn bonds at a rate of 12% (while LIBOR is only just above zero) — although it was able to raised a similar amount in 2021 at 4.2% backed by its frequent flier programme.
Some of the funds raised — particularly the government bailouts of Lufthansa Group and Air France-KLM — contained punitive rates of interest if not repaid within a certain period.
These figures exclude operating lease “debt”. if anything this crisis has exposed the fallacy of IFRS16’s requirement to capitalise operating leases as many airlines have been able to negotiate lease deferrals, renegotiate lease terms, including power-by-the-hour, or just hand back aircraft. In extremis, the lessors have helped.
As a side point, over this period only three of these airlines have increased their operating lease “debt”. Delta, Southwest and, Singapore Airlines added liabilities of a total $2bn (SIA accounting for half of the total). The other carriers in the group reduced their operating lease liabilities on the balance sheet by a combined $3.5bn.
Cash tripled
Over the same period this group of airlines saw cash balances rise by almost three-fold — by $74bn from $42bn to $115bn (see chart). Perhaps surprisingly, Southwest and Singapore Airlines have a net cash position (cash minus debt, excluding operating lease debt).
If demand recovery is slower than expected, this cash will be essential in covering monthly cash burn: if recovery is faster, it can be used to repay some of the mountain of debt.
Equity raises
All (so far with the notable exception of Delta) have raised new equity on the markets averaging $3bn each (see chart).
The real outlier is SIA whose two rights issues of $11bn convertible quasi-equity was fully supported by government holding company Temasek. Cathay Pacific also received above average support for its $4bn rights issue from the government of Hong Kong.
Net asset values have been decimated (see chart) by the extraordinary level of operating losses, write-offs of accelerated depreciation, restructuring charges and uneconomic hedge positions.
The six top legacy carriers in the list each saw their balance sheet net asset value fall by around $7bn (and Delta by $14bn, having had to write down its multitude of minority airline investments) even after raising new equity.
Both Air France-KLM and American bear balance sheets where the equity is severely negative. LCCs Southwest and Ryanair in contrast have been relatively unscathed.
Recovery and required EBIT
The recovery in demand, particularly for cross-border and long haul traffic, is likely to take a long time.
The coronavirus pandemic is not yet over. New variants of the virus, such as the recent omicron variant designated by the World Health Organisation (WHO) as “of concern”, spook nations into reintroducing or intensifying travel constraints extending the uncertainty of bookings; and, the number of potential new harmful mutations is not just limited to the remaining eight letters of the Greek alphabet.
Airlines may well be saddled with this high level of debt for years to come. And they will need to improve operational cashflow to pay for it. The annual cost of the increase in debt (interest and repayment) we estimate equates to 20-25% of the cash flow from operations achieved in 2019 — a modestly good year.
These airlines are all using the opportunity of this crisis to restructure the cost base targeting a return to profitability. The traditional Legacy airline targets of 10-12% EBIT margins to allow a return to shareholders may not be enough in the post-pandemic reality: those targets should perhaps be pushed above 15%. This would mean a need for a strong improvement in unit revenues, difficult though it is to achieve in a commodity business such as aviation — more so for those who rely on premium traffic.
IATA’s October financial forecasts for the industry suggest total net losses for commercial airlines to approach $52bn in 2021 and another $12bn loss in 2022. If these forecasts turn out to be accurate, the industry will have lost $200bn over three years. This is only 90% of the profits it had generated in the 2010s following recovery from the global financial crisis. It is possible that these forecasts are optimistic.
