Comparing Best and Worst Case Scenarios for the Airlines

The airline industry is facing a crisis the likes of which it has never seen in its 100 years of existence. Skift Airline Weekly went deep on two scenarios: An optimistic view of the recovery, and the pessimistic. You can watch Senior Analyst Jay Shabat and Editor Madhu Unnikrishnan discuss both scenarios in our recent webinar. 

Part One: Half full, or why the airline industry should be optimistic.

This much is clear: The world’s airline industry is experiencing its greatest crisis ever. Nothing in the past comes even close. But as governments provide massive support to distressed economies, as entire societies mobilize to defeat the pandemic, and as airlines themselves take advantages of unique opportunities presented by the crisis, brighter days might come sooner than later.  

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Two trillion dollars is an unthinkably large amount money. It’s the amount America’s Congress alone is spending to cushion the U.S. economy. That figure doesn’t include trillions more in monetary support from the Federal Reserve. It doesn’t factor in future aid, which will add perhaps another trillion. It ignores the trillions other governments around the world are spending to support their economies. If you had a million $1,000 bills stacked on a table, Harvard Professor Linda J. Bilmes once explained, it would be about four inches high. If you had a billion $1,000 bills? It would be about 350 feet high, which is taller than the Statue of Liberty. And a trillion $1,000 bills? 65 miles high.

The point is, government efforts to support distressed economies have been massive and unprecedented, sure to provide temporary relief to households and companies, including airlines. April 9 marked 100 days since the World Health Organization was first notified about cases of “pneumonia with unknown cause.” Today, even as Covid-19 devastates markets, not a single major airline has collapsed. Temporary government aid, in other words, is doing its job. And besides, this is not a typical recession. The economy isn’t broken, just temporarily switched off to enforce social distancing. The U.S. in particular, entered the crisis with strong fundamentals: low unemployment, low inflation, low interest rates, low oil prices, and yes, a very healthy airline sector. As Federal Reserve Chair Jerome Powell said last week: “When the virus does run its course, and it’s safe to go back to work and it’s safe for businesses to open, then we would expect there to be a fairly quick rebound.”

When will that rebound come? When, in other words, will the economy turn back on? It’s already starting to happen in China, the first country hit with the Covid curse. Cases of infection are now beginning to drop in places like Seattle, Milan, and New York, prompting officials to start plotting the path back to normalization. “Most people,” Powell said, “expect that to happen in the second half of this year.

Not that he expects late 2020 to look exactly like late 2019. But if things really do start to normalize by the fall, and people are starting to travel again, then airlines will be positioned to at least have a decent year in 2021. What they’ll surely find is a world of people with enormous pent-up demand to travel. They’ll want to see their friends and family in other cities. They’ll want to take a break from all the stress the crisis is causing. As Southwest might say, they’ll just wanna get away.

But who will want to travel?

Airlines will find many groups of people unaffected by the crisis financially, like the giant retiree demographic. Consider the U.S, where seniors are still getting their social security checks, plus the additional cash Washington is now sending to every American household. Many are invested in bonds rather than stocks. As much as seniors love to travel, they might be more likely to take an airline trip if alternative forms of leisure like cruising is seen as riskier from a health perspective. And true, Americans might not be ready to take a Yangtze River cruise that ends in Wuhan, but if that means they’ll fly more domestically, then that’s great news for carriers like Southwest and Allegiant.

It’s not just seniors. As the gloom lifts, airlines will find that some of their best corporate customers did just fine during the crisis. Think of the many technology companies providing services like home entertainment, networking, and videoconferencing. Don’t forget about all of that new government money circulating throughout the economy. Some is going directly to airlines and their workers. A lot more will surely be spent on air travel.

Airlines, meanwhile, are already reassuring their passengers with stepped-up procedures for cleaning airports and airplanes. Governments too, just as they did with security after 9/11, will likely impose reassuring new standards and regulations to protect travelers. Will people still be wary of flying? It didn’t take that long for people to overcome their post-9/11 fears. Travel recovered quickly and strongly from past pandemics like SARS, H1N1, and MERS. Malaysia Airlines, which suffered two highly publicized air disasters in recent years, filled nearly 80 percent of its international seats in January. Make no mistake: People will get back on airplanes. Their desire and need to travel is simply too strong to think otherwise. In the meantime, there’s talk now from England that a Covid vaccine could come in just six months.

What are the Upsides to Airlines?

What else will airlines find as things begin to normalize? In all likelihood, they’ll find dirt cheap fuel prices, distressed aircraft prices, less capacity, and diminished competition. There’s no better time to shed unwanted planes, walk away from dubious business strategies, and renegotiate contracts with suppliers, which suddenly have little negotiating leverage to refuse. Banks, investors, aircraft makers, aircraft lessors, IT suppliers, airports, even governments… they all need airlines to survive. U.S. airlines used the trauma of 9/11 and the global financial crisis to drive major reforms, including consolidation, that set them up to thrive throughout the 2010s.     

Airlines will have new negotiating leverage with unions too. Lufthansa already is using the opportunity to ask for long-term contract concessions. Ultimately, if airlines emerge from the crisis with substantially lower fuel costs, aircraft costs, and labor costs, then demand won’t even have to fully recover for them to earn solid profits. They’ll be able to make money with lower load factors and by stimulating highly price-sensitive demand with rock bottom fares. Remember Ryanair CEO Michael O’Leary’s maxim that passengers will “crawl bollock-naked over broken glass to get low fares”?

A crisis always produces airline winners. The post-9/11 era ushered in a wave of all-star low-cost carriers, from Ryanair to JetBlue to AirAsia to Gol. It also preceded a boom in emerging markets, triggering explosive traffic growth in markets like East Asia and the Middle East. U.S. airlines weren’t the only ones to thrive after the financial crisis. So did carriers like IAG, Air Canada, Qantas, Turkish Airlines, and many low-cost carriers. Yes, this is the industry’s greatest crisis ever. But the end is already in sight as countries start planning their switch back to normal. And when that happens, people will be more eager than ever to visit grandpa, the Golden Gate Bridge, and a prospective customer ready to shake hands on a lucrative business deal. O.K., maybe no handshakes. But definitely a meeting in person, courtesy of an airline.     

Part Two: Half empty, or why the airline should be pessimistic.

This time really is different. For all the many shocks throughout airline industry history, never before has every single passenger airline in the world — no exceptions — been turned into overnight Alitalias. Actually, it’s even worse than that. Planes aren’t flying. Revenues are close to zero. Tens of thousands of airline workers are losing their jobs. Does anyone really think the industry can recover from something so traumatic anytime soon?

Economically, what we’re seeing now makes the 2008-09 global financial crisis seem like a mild dip. The rates of joblessness and GDP contraction are just staggering. In emerging markets, conditions are downright apocalyptic, with critical commodity prices and currency values tumbling — more than 90 countries have already approached the International Monetary Fund for desperate help. And many of these countries haven’t even seen the worst of the Covid crisis yet. There’s government aid money, yes, but getting it to the families and companies that need it most is proving both difficult logistically and anything but swift. Besides, governments already heavily indebted pre-crisis are now piling on another giant wave of debt. It’s true in the U.S., China, Europe, Japan, and across the developing world.

Manufacturing supply chains, a staple of the modern global economy, are coming undone. Cross-border commerce, already in retreat pre-crisis due to trade wars, is poised to take a further hit as countries look to repatriate production of critical goods like medical supplies — it’s less efficient and costlier for sure, but also more secure. What’s more, this nastiest of downturns features both a supply shock and a demand shock. Sure, China’s factories are humming again, producing goods. But who’s buying anything?

As former Federal Reserve Chair Janet Yellen said on March 31, the global financial recession caused subdued U.S. economic growth for years, as governments and households de-levered, and as idled workers lost skills. This time, corporations entered the crisis with high levels of debt, meaning they’ll likely spend years avoiding non-essential investments, implying lower productivity growth and in turn lower GDP growth (and lower spending on air travel). This is true even in the U.S. airline business.

Take American Airlines. It’s hard to argue that its pre-crisis borrowing was irresponsible. It was a profitable airline. It borrowed at extremely low interest rates. It kept a substantial cash cushion. And it possessed extremely valuable aircraft collateral. But the current crisis is like nothing anyone could have imagined, where even brand new Boeing 787 Dreamliners have lost their usefulness, perhaps for several years. Suddenly, American’s $21 billion in longterm debt is more problematic. Actually, that number is way up as it borrows billions more to stay alive while grounded. 

Most carriers across the world aren’t nearly as lucky as American. IATA says the typical airline has cash to cover just two months of revenue loss. Back in the U.S., government data last week showed an index of airline fares plummeting 13 percent, year-over-year, in March. When demand does one day recover, it will be a long climb back to 2019 levels of traffic and yields.

Years, not Months

Many airlines increasingly think it will be years, not months, before any such revival. Emerging ideas to reopen the economy typically involve a gradual return to normal, with jobs less risky to public health returning first. Air travel, unfortunately, is perhaps the riskiest economic activity of all in terms of spreading lethal microbes. Business conventions, which typically drive a lot of airline industry revenue, are somewhere near the top of that list too. It was air travel, after all, that allowed the coronavirus to spread so rapidly across the world. Just as the 9/11 shock led to onerous and costly new security procedures to protect travelers, the Covid-19 trauma will surely lead to onerous and costly new health check procedures to protect travelers.

Squeezing more and more people into aircraft cabins, remember, was one of the airline industry’s most successful business tactics pre-crisis. Low-cost carriers started the trend. But densification soon became a staple of virtually all airline business models (even Cathay Pacific moved to 10-across seating on its Boeing 777s). Imagine if regulators mandated inflight social distancing, requiring passengers to be spaced farther apart. That would mean fewer passengers per flight, much higher fares, and by extension, a much smaller airline industry.

Will people even want to fly anymore? It’s one thing to overcome the fear of an extremely rare terrorist attack. It’s another to ignore the much higher risk posed by an extremely contagious pathogen. Governments might even impose new visa restrictions or require traveler health passports. Put another way, even if people somehow find the money to fly again, they might not even want to. For businesses now forced to rely on videoconferencing, costly, tiring, and time-consuming business travel might become subject to the question: Is it really that necessary?

Even the world’s strongest airlines, meanwhile, will emerge from the crisis with sickly balance sheets, demoralized workers, and governments as shareholders and creditors. Some regions like the Middle East and ASEAN regions featured overcapacity before the crisis. In other regions like the U.S. and Europe, carriers bet heavily on expanded premium cabins. The world is now awash in surplus planes and staring at years of depressed longhaul business travel. Think just about energy companies, typically some of the biggest spenders on premium air travel. That’s not something airlines can count on anymore with energy markets in turmoil. 

Not till 2023?

In the meantime, government interventions are warping the post-crisis competitive landscape. Carriers on the verge of disappearing — Alitalia, most notoriously — are now getting taxpayer lifelines. That disadvantages the industry’s strongest players, slows the process of consolidation, and perpetuates overcapacity. So far this crisis, just a few marginal regional airlines have collapsed. Creative destruction isn’t happening. Governments are picking winners and losers based on the amount of aid they decide to give. 

The upcoming peak summer season, by the way, is already a lost cause. Even the brightest-eyed optimist has to concede as much. After all, airlines themselves are planning for demand to stay dormant through much of the summer, extending draconian schedule cuts. At the same time, many are permanently retiring airplanes, approaching unions about long-term concessions, and planning more generally for a long and drawn-out downturn. Lufthansa’s Austrian unit, for one, doesn’t see demand returning to 2019 levels until at least 2023 “at the earliest.” Singapore’s Changi airport is closing a terminal for 18 months, which shows how gloomy it feels. Past crises, after all, including 9/11 and the global financial meltdown, triggered several years of weak demand.

But this is much worse. Economic output is falling far more drastically. And there’s no refuge. Everywhere in the world is suffering. Airlines undoubtedly face years of distress. And there’s no vaccine for that. 

This article was first published in the April 12 edition of Skift Airline Weekly.