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Batuğhan Karaer

Second Half of the Year will be Financially Turbulent for Airlines!

Issue 5 - 2020
Second Half of the Year will be Financially Turbulent for Airlines!

Although the world is still struggling with COVID-19, the resulting economic circumstances have made normalization unavoidable. Despite concerns about the second wave of the pandemic, many countries have already launched normalization processes and sectors are slowly gaining dynamism as time progresses. 

Unfortunately, tough times will continue for the aviation sector. Ambiguity concerning the relaunch of flights and business trying to return to normal will continue until the elusive fight against COVID-19 is over. However, the following point should not be dismissed: Yes, the virus rapidly spread across the world via airline travel and companies and global trade suffered a major blow as a result.  To be able to facilitate the revitalization of global trade, the aviation sector needs to be revitalized as well, this is an inevitable fact. 

In its statement, the IATA underlined that the sector will face a loss of over $84 billion this year and around $16 billion in 2021, adding that the worst collapse in global traffic would be over if the second wave of the virus does not occur. Flights decreased by 90% from the day the first effects of the crisis emerged and almost stopped during the months of April and May; the financial flow of the sector has been significantly disrupted accordingly. Aircraft manufacturers, leasing companies, sector professionals, suppliers and many companies in the sector failed to either partly or completely fulfill their financial liabilities as revenues fell due to an insufficient amount of inflow of funds; these companies will not be able to cover these liabilities for some time. 

The shares of all airline companies started to fall in the second half of March across the world. The market value of Lufthansa fell by 40% in six months and decreased to $5.5 billion (as of June 12 THY’s market value is $2.6 billion and the market value of Pegasus is $878 million). Besides, one of the world’s greatest airline companies, Lufthansa is set to be removed from the DAX stock index which represents Germany’s 30 biggest companies with the highest level of liquidity. Lufthansa is amongst the founders of the Frankfurt Stock Exchange and its shares are traded in this market. Lufthansa is subsequently being included in the list of medium scaled companies.  

COVID-19 caused many companies in the airline sector to change their individual game plans and retreat to a commonly adopted approach coined the “Strategy of Survival”. In order to achieve this strategy, companies launched many solutions and implementations that cover the finance sector, suppliers, and employees. Above all, they have been searching for ways to emerge from the crisis in stronger positions and to obtain competitive advantages.

The IATA underlines at every opportunity that problems cannot be feasibly solved in the short run and that direct funds, credit, and tax exemptions should immediately be made available to the sector. Companies have tried, and in some cases have been successful in receiving support and aid from their partners as well as their states. The support received by Lufthansa from the state is the most striking one. While Germany’s fund of stabilization WSF contributes € 5.7 billion including the equity capital to the assets of the company, the banks will be granting credit support of € 3 billion with a 3-year maturity.

In addition; 

• Air France & KLM receive the support of € 11 billion from their respective states.

• Alitalia will become nationalized in June; an aid package of € 2 billion is expected but no sufficient financial support has been provided yet.

• As part of the COVID Corporate Financing Facility (CCFF) provided by the British Government, EasyJet received credit worth $750 million.

• Ryanair which has one of the best financial accounts in the sector announced that it would be objecting to the state aid provided to other airline companies. The company also declared that it would cut up to 3,000 jobs and decrease payments by 20%.

• 56% of Finnair is state-owned and the company decided to launch a €500 million rights offering to rebuild its equity.

• American Airlines received $5.8 billion in payroll support and the company has carried out negotiations for a loan of $4.75 billion. 

• SAS airlines received $ 446 million in support from Sweden, Denmark, and Norway.

• By taking over the shares against the liabilities of Norwegian Air, the aircraft leasing companies owned over 50% of the company. Moreover, the company launched a convertible bond issue of NOK 400 million.

• Though it received $5.4 billion from the US Government, Delta Airlines also applied for a loan of $4.6 billion. The company will be asking for certain flexibilities by also negotiating with creditors. 

• United Airlines has also been conducting negotiations for additional loan support of $4.5 billion in addition to the previously granted $5 billion.

• While receiving support of $600 million, Virgin Atlantic has been endeavoring to obtain certain contributions from its partners.

• Cathay Pacific is seeking a contribution of $5 billion from the government of Hong Kong and its shareholders. 

• Singapore Airlines has prepared a plan to raise $6.3 billion under the guidance of its greatest shareholder Temasek Holding which is owned by the Government of Singapore. 

• The Malaysian Government announced that it has worked on providing $352 million in aid to three local carriers including Air Asia. Meanwhile, Air Asia has been working on strengthening its financial position by increasing its capital.

• International Airlines Group (IAG) incorporating airline companies such as Aer Lingus, British Airways, Iberia, LEVEL and Vueling received credit support of €1.1 billion through aid programs provided by the Spanish Government. 

• The Thai Government transferred a part of its shares to the Vayupa Fund owned by Krungthai Asset Management as part of the restructuring of Thai Airlines and thus abandoned its majority shareholder position. This has turned Thai Airlines into a business enterprise acting on business decisions instead of political decisions. While there are discussions to nationalize airline companies around the world, the Thai government’s decision to reduce its shareholder position to a ‘minority’ stake is a noteworthy development.

• Furthermore, in the US, to protect qualified labor, the Senate has been working on a plan to support the aviation and aerospace industries with a public & private partnership.

• It was announced in Turkey that support to the tune of $30 million would be granted to four tour operators owning airline companies. Certain discounts and postponements in airport payments and rents, as well as income support, postponement of taxes and social security expenses for 6 months have all been implemented. 

However, despite all the aforementioned support and loan facilities, aviation companies did not stop reducing their fleet and staff numbers and decreasing salaries. With each passing day, we hear downsizing news in the sector. Without a doubt, certain airline companies will gain an advantage from the opportunity of aid and incentives and will come out ahead of competitors. We will keep an eye on the effects of this situation and observe upcoming activities such company acquisitions, staff transfers, and investments in the days to come.

The impact of awarded incentives and aid will show whether the companies in Turkey can return to previous positions observed before COVID-19 or to higher level or a diminished level. Whatever the case may be, many companies in the sector will transform and end up holding considerably different positions than before the crisis. 

The aid and incentive programs provided both in Turkey and around the world are all focused on airline companies, no efforts have been exerted for other companies in the sector so far. 

Though the impact of the crisis have not fully been reflected the financial data of 2020 Q1, as it can also be seen from the table that a critical increase in the EBIT loss occurred compared to the same period of the previous year. It is not difficult to estimate that the table indicating the change in losses of a few airline companies will become far worse toward the end of the 2nd quarter. In the report published on the profitability of the sector, the IATA forecasts EBIT company margins to drop by the end of 2020 to -23.4% and to -4.2% within 2021.  

While the net debt of the airline companies was 4.6 times the EBITDAR (Earnings before Interest, Taxes, Depreciation, Amortization, and Restructuring or Rent costs) in 2019, according to the IATA, this ratio will increase to 16 in 2021 after the losses experienced / to be experienced due to Covid-19 and it predicts that this debt situation is not sustainable. In other words, we can say that airline companies need about 16 years to cover their debts (if they do not encounter any other problems).

In my previous article ‘Financial Impact of Coronavirus on Aviation Industry published in April, 2020, I discussed the “insufficient financial structures of airline companies.” I would like to take a moment again to revisit this topic in more detail by assessing the statement I made with the matrix which I’ve presented again in this article, based on data of the airline companies.

First of all, the key aspects I consider in the financial outlook of airline companies are the status of their financial structures/leverage ratio, the sufficiency of the working capital, and liquidity ratios. The assets of a company could be financed by foreign assets or equities and the rates of these two demonstrate the strength of the financial structure of the company. Though there is no single rule applicable for all the airline companies in the world, in my opinion, I would expect a company to finance at least 25% of its assets from its equities. According to my analysis, the financial structure of the company weakens as this rate decreases. In other words, a leverage ratio over 75% or the assets of companies are financed by foreign assets, these should also be evaluated as indicators of higher risk. 

On the other hand, the availability of a sufficient amount of working capital and the capacity of companies to cover short term liabilities for the continuation of activities are among priority issues. Though they had robust financial structures and sufficient profitability, we witnessed the insolvency and even bankruptcy of many airline companies in the past, due to payment difficulties as a result of insufficient working capital. Therefore, in addition to strong financial structures, I would expect airline companies to have positive net working capital, a current ratio of minimum 1 (though ideally 2), and a liquidity ratio of over 0.50 (in other words acid-test ratio of ideally 1).

The changes in the financial structure, net working capital, and liquidity ratio of certain airline companies including THY and Pegasus since 2016 are provided in the graphs. When these graphs are examined, the effects of COVID-19 can be clearly observed for the first quarter of 2020. As I mentioned previously, the figures for the second quarter of the year will not be favorable. 

Again, the graphics assure that THY and Pegasus clearly have more positive conditions compared to Lufthansa and Air France-KLM. We can observe that the financial status of THY and Ryanair remained well despite the crisis and Pegasus remained strong in the short run in terms of working capital and liquidity. The reason why Lufthansa has been included in the €9 billion aid package after its net working capital went from positive to negative of over $8 billion is clear. Of course, the same applies to Air France-KLM. 

It is surely not possible to evaluate an airline company or any company over a few percentages and figures; however, I believe that the financial leverage ratio, sufficient working capital, and liquidity position are points to be considered in principle with the evaluation of financial risks. 

As part of the steps towards normalization, airline companies have been gradually increasing their flights. The lower oil prices, the discounts availed in personnel costs, the support, and premiums granted by suppliers will be a critical contribution to the activities of airline companies. On the other hand, flexibilities such as the discount unwillingly accepted by suppliers, postponement of receivables during the period where activities were suspended may be replaced by a stricter approach with the relaunch of flight operations. Moreover, a rise in costs will be inevitable as part of the measures adopted due to COVID-19. The operators wishing to execute operations without any interruptions will have to manage relationships with their suppliers and their cash flow with more caution, discretion and finesse.  These are uncharted waters.  Besides, with the relaunch of activities, some pressures will emerge for the readjustment of staff salaries and rights towards the level they had been before the COVID-19 pandemic. We will surely hear more about upcoming financial bottlenecks that many companies will face and the myriad of new issues that will arise as the number of flights increases in the second half of the year  


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