Global air demand could take two years to recover from Covid-19

In the first quarter of 2020, Covid-19 sparked an unprecedented slump in international tourism (see Figure 1), throwing the global transportation sector into chaos. Air passenger demand nosedived by -53% m/m and by -22% 3m/3m at the end of Q1. For 2020 overall, we expect global air passenger demand to slump by -38% y/y. Global air cargo has suffered slightly less, (-15% m/m and -7% 3m/3m in Q1 2020), likely helped by the urgent need to deliver masks and medical supplies across the globe (see Figure 2).

Figure 1: Global air passenger demand and international tourist arrivals (yearly data, in millions)

Figure 1: Global air passenger demand and international tourist arrivals (yearly data, in millions)
Figure 1: Global air passenger demand and international tourist arrivals (yearly data, in millions)

Sources: OMT, FactSet, Allianz Research, Euler Hermes forecasts

Figure 2: Global demand in passenger and freight air traffic (monthly data):

Figure 2: Global demand in passenger and freight air traffic (monthly data)

Sources: IATA, FactSet, Euler Hermes, Allianz Research

The year 2020 is expected to be an annus horribilis for the air industry. Our calculations made using a panel of around 80 major airlines show a collapse in revenues of more than USD300bn and a tumble in operating income of more than USD100bn in 2020. Even worse, the operating loss could top a terrible USD60bn this year (see Figure 3). We expect the air sector to retrieve USD205bn and USD75bn of revenues in 2021 and 2022, respectively, following the recovery in the world economy and international tourism. However, this will not make up for all the lost sales in 2020 alone.   

Figure 3: sales and operating income of the air transport sector

Figure 3: sales and operating income of the air transport sector

Sources: IATA, FactSet, Allianz Research, Euler Hermes calculations.

Though lockdowns are now gradually being lifted around the world and borders are starting to re-open, our central scenario  anticipates a progressive exit lasting another six months, leading to a U-shaped recovery in 2021. Combining this GDP trend with historical air traffic data and airlines’ poor activity in the first half of 2020, we find that global demand in air transport will not return to its pre-crisis level before 2023.

In our U-shaped scenario (see Figure 4), demand in global air transport should fall by -37% (4q/4q) in 2020 before rebounding by +39% and +10% in 2021 and 2022, respectively.  At the very beginning of 2020, before the pandemic, global revenue passenger kilometers (RPK) reached 2,169. According to our calculations, we expect it to top this level again only by May 2023.

In the case of a second wave of infections, the global economy would face an L-shaped scenario, in which demand in global air transport would not reach its pre-crisis level before mid-2025. It would take years to catch up after a -50% collapse in air transport demand in 2020 alone (4q/4q), especially since this demand would be expected to rise only by +20% and +24% in 2021 and 2022, respectively.  

Figure 4: World GDP and global air traffic (quarterly data, in billions)

Figure 4: World GDP and global air traffic (quarterly data, in billions)

Sources: IATA, FactSet, Global Insight, Allianz Research, Euler Hermes estimations

Airlines have taken harsh restructuring measures to curb cash outflows

Airlines have been forced to adjust their costs down to their much lower levels of revenue to mitigate the risk of running out of money and going out of business. The Q1 earnings announcements of major airlines revealed restructuring measures including:

  • Grounding of planes: In March and April, Cathay Pacific, for example, cut capacity by -65% while United Airlines reduced international schedules to Asia and Europe by -20%. European airlines, such as Ryanair, Lufthansa, EasyJet and British Airways, also stepped up flight cancellations to reduce capacity, slashing more than 400 flights last month to countries including Italy, Germany and the U.S. It is estimated that up to 75% of the world’s overall fleet could have been grounded as a result of Covid-19 travel restrictions over the two-month lockdown period.
  • Vouchers for future travel instead of refunds for cancelled flights: Total refunds still to be paid by airlines were estimated at around USD28bn as of May. It’s no surprise that most airlines have urged the European Commission to temporarily suspend the law granting customers full refunds for cancelled flights.
  • Temporary furloughs: Several airlines have responded to the crisis by imposing unpaid leave and freezing pay to employees. In February for example, Cathay’s CEO asked its near-30,000 workforce to take unpaid leave on a voluntary basis to help the airline preserve its cash. About 100,000 workers at the four largest U.S. carriers (American, United, Delta and Southwest airlines) were asked to take voluntary unpaid or low-paid leaves.  
  • No dividends or stock buyback programs: The strings attached to the USD50bn aid package enacted to help America’s stricken airlines have forced major U.S. carriers into ceasing any stock buybacks and dividends, their main channels for rewarding investors, which has made their shares less attractive. Other major carriers around the world face the same situation.

The measures taken to withstand the current storm in a longer-term context are equally severe:

  • Massive lay-off plans loom ahead: Airlines are running up losses partly because they can’t furlough or cut their staff more deeply than their bare-bones flight schedules. So, permanent cuts in the well-paying jobs found across the air sector are inevitable and coming soon. British Airways has already planned to remove around 30% of its workforce, while Ryanair could lay off 3,000 employees – mainly pilot and cabin crew jobs – starting next July if Covid-19 restrictions continue to batter the travel industry. In the U.S., deep job cuts are coming after October 1 as the federal bailout for the airline industry covers around two-thirds of overall labor costs through September. Estimates suggest that up to a third of the sector’s jobs – roughly 750,000 pilots, flight attendants, baggage handlers, mechanics and others – could disappear.  
  • Postponements of rents to aircraft lessors: Airlines who lease aircraft have approached their lessors for rent or loan payment holidays or waivers in order to preserve cash. Some airlines are looking to enter into loans or sell assets quickly in order to raise cash, for instance by the sale and leaseback of aircraft. Most lessors and banks have sought to work with their airline customers and agree to rent holidays or the restructuring of payments. Indeed, if the fundamental business of an airline is sound, it is better in the long term to ensure an airline’s survival than to risk its failure and to have to go through the process of repossession, which typically results in losses such as rent arrears and transition costs. In any event, many lessors consider that it makes little sense taking back aircraft at a time when demand is low, and placing them at all, let alone at a similar rental, will be difficult. More broadly, younger, fuel-efficient narrow-body aircrafts are best positioned to be key for airlines and lessors post-pandemic.   
  • Delays (if not cancellations) in new aircraft orders: This has been the main transmission channel through which airlines’ hardships have passed on to upstream aircraft manufacturers. Boeing and Airbus have been forced to temporarily suspend or slow production at many facilities as a result. For example, the A320 production rate has been reduced to 40 aircraft per month, down from an average of over 53 aircraft per month in 2019. The A330 and A350 programs are reduced to a rate of two and six aircraft per month, respectively. Turning to the orders race, Boeing reported 31 gross orders in March and 150 cancellations for a total of -119 net new orders. Year-to-date, Boeing has accumulated 49 gross orders (196 cancellations, -147 net new orders). On the other side, Airbus booked 60 gross orders last March and reported 44 cancellations for a net of 16. Year-to-date, Airbus has accumulated 356 gross orders (66 cancellations, net of 290). 
  • Fuel-hedging optimization: Fuel accounted for about a fifth of operating costs on average at the big four U.S. carriers last year. So Brent priced at USD38 a barrel would lower the cost per gallon of jet fuel for U.S. airlines by as much as 55%, according to Moody’s calculations. The problem this time is that the revenue falls outweigh fuel savings, while airlines that use hedges to lock in fuel costs cannot cash in on lower prices immediately. With no hedging or change in the crack spread, a 20 USD/b lower fuel price could shave off USD65bn from the industry’s 2020 fuel bill, based on our average 41 USD/b oil price forecast. However, many airlines will have hedged 2020 fuel so this benefit could be delayed for some.   

It is very difficult to provide a global estimate of these cost savings for the entire air industry, but available information suggests that they could help airlines hold back cash exits for one more quarter once lockdowns end. Although lower jet fuel prices may provide some offset to airlines’ extra costs to keep running, the collapse in travel demand over the first half of the year will have a huge impact on profitability.

As of mid-May, governments had dedicated USD123bn to propping up the air transport industry (see Figure 5). Year-to-date, public support to airlines can be broken down into loans (USD60bn), employment aid (USD35bn), secured loans (USD16bn) and public funding (USD11bn). However, this support has been distributed unevenly. Unlike Asia, Europe or the U.S., the Middle East and Latam’s airlines have barely benefited, with public support accounting for less than 5% of airlines’ yearly revenues. This partially explains why two of the largest Latin American airline companies (AVIANCA, LATAM) recently filed for bankruptcy. They did not receive support mostly because air transport in the region is positioned as a luxury good for people who usually prefer road transport.    

The U.S. government struck first with its Coronavirus Aid, Relief and Economic Security Act, better known as the CARES Act. It has provided a total of USD50bn in assistance for passenger carriers, split between a USD25bn Payroll Protection Grants package and a USD25bn Loan and Loan Guarantees facility. This represents 25% of U.S. airlines’ yearly revenues. Europe comes in the second position with public support amounting to 15% of the yearly revenues of airlines in the region. Asia is in the third position, with public support accounting for 10%.

The massive scale of state support raises concerns about whether the cash windfall is standing in the way of a a necessary thinning out of the sector by supporting weak airlines – among which some are state-owned or flag carriers – that are highly leveraged or unprofitable.

Figure 5: State-aid and layoffs for global airline companies

Figure 5: State-aid and layoffs for global airline companies

Sources: Bloomberg, national sources

The legacy of the outbreak is likely to reshape air transportation supply

Airlines have favored their liquidity positions over profit to attempt to survive this historic crisis. As travel bans are lifted, we expect increased price competition to revive air demand as airlines, especially low-cost ones, are rushing to get their planes filled and back in the air. Airlines will have to strike the balance between the need to preserve their cash positions and the risk of lost market share because of the extended grounding of their planes. This is particularly true for transatlantic routes considered as the most profitable segment in air traffic.

We expect two changes to take place in the sector in the three years to come:

  • A major blow to private low-cost airlines: These companies depend on being able to transport as many people as possible, so complying with social distancing is likely to hit profitability. Besides, they will not escape state pressure to reduce their carbon footprints, while flag carriers might be subsidized to do so. Lastly, they are likely to be the first to suffer from possible postponements of air travel by passengers. More broadly, we expect the low-cost solution to become less attractive when not linked to a flag carrier airline. Companies such as Eurowings (Lufthansa), Vueling (British Airways) or Transavia (Air-France KLM) are able to better take advantage of the growing demand for point-to-point flights with no connecting services.
  • A new wave of consolidation in air transport: Except for closing up or filing for bankruptcy, there aren’t any other means for highly indebted airlines to escape a market suffering from over-capacity. From this point of view, it is interesting to notice that the most indebted airlines are all Chinese – Air China, China Southern and China Eastern airlines. Taken together, they total an impressive amount of USD70bn of financial debt. The Chilean Latam airline that went bust last week was plagued with USD9.5bn in debt, while Thai Airways and Norwegian Air Shuttle have been struggling against USD5bn and USD6.5bn of debt, respectively. More importantly, Cathay Pacific and Turkish Airlines are both financially indebted to the tune of around USD12bn each. Overall, it is worrying to notice that the level of financial debts exceeding USD10bn applies to the following airlines: American Airlines (USD24bn), IAG, United and Korean Airlines (USD15bn each), Air France-KLM (USD13bn), Lufthansa and Delta airlines (USD11bn). Middle Eastern airlines are to be put under scrutiny as well despite the fact that they cash in on very low jet fuel costs. Indeed, they are facing a problem with their plane fleets being less adapted to the lower air demand in relation to wide-bodied aircrafts, which are no longer preferred for long-haul flights and have too high maintenance costs.  

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