How the industry will recover from COVID-19

Now that is has become evident that the aviation industry as we know so far will no longer look anything like it did, the average traveler might be wondering how their pocket is going to suffer in their future voyages.

One of the two Privilege Style Boeing 757-200s. Photo by Jero Vida | AeroNewsX

In the following article we are going to try to alleviate (or irritate) frequent-flyers’ economic concerns as uncertainty over the future of aviation industry reigns. To shed some light on the matter, some relevant information will be covered and an overall conclusion will be expressed which, of course, is susceptible to subjective interpretations.

So, here’s the key concept that (almost always) will help companies establish the price of tickets: The Supply & Demand Relationship. This primordial relationship serves to maximize profitability, which the industry has proven to use effectively over the past few decades by implementing the “Airline Revenue Management” strategy. This algorithm-based strategy allocates a different price depending on how much a customer is willing to pay, whether they are business professionals or infrequent leisure travelers. However, the metrics implied in this money-making formula will surely be altered with the unparalleled decrease in air-travel demand. That being said, let’s analyze which factors will affect this pricing system:

To start with, there’s the first and most expected reaction from major airlines amid this stormy context: bringing forward their plans to phase out the remaining colossi of the skies – the Boeing 747 and Airbus A380.

Air France's Airbus A380-800. Photo by Karam Sodhi | AeroNewsX

However, this gradual farewell of the usually less-efficient aircraft represents the much needed response from airlines to adapt to the new scenario in which such aircraft would represent a financial black hole.

The positive thing is that fleets around the world will be greener, which is ultimately related to greater cash savings for companies, as well as for customers. While doing so, we should also mention the long-awaited lift on the Boeing 737 MAX’s ban.

On the other side of the coin, orders for new aircraft will decrease and a full conversion of state of the art machines will be postponed while manufacturers suffer dramatically.

But fleet and consequent route reductions aren't done just to adapt to demand levels. In fact, if the liberal laissez-faire idea were left to act with no intervention at all, most airlines would probably disappear causing a drastic decrease on supply and therefore making flying less accessible.

As announced by various governments, this doesn’t seem quite the case. Interdependence between the prosperity of the industry and local economies is tight (some airlines are just too big to fail).

It is true that some will definitely fade away due to past mismanagement, but on the contrary, flag carriers in particular will see state-backed loans or even direct interventions.

To cite some, Air France-KLM is in talks with their respective government administrations to ensure short-term operations (it is said US$6.5B is at stake, according to “Les Echos”). Furthermore, Singapore Airlines has been strongly backed by public institutions. Finally, the Trump Administration approved a $50B package which is worth triple that of the one announced after the 9/11 terrorist attacks. Owing to this US$50 billion package, the Fitch Rating agency downgraded the North American airline sector as a whole. Even though aid packages are not applicable to every airline (for instance, Ryanair has a strong financial position as it counts on US$4.3B cash reserves which is enough to stay afloat for 18 months), it is becoming a very common occurrence.

KLM's Boeing 747-400. Photo by Andrew Pries | AeroNewsX

After conducting a general analysis of their expected liquidity and debt levels at the end of 2021 when the pandemic is foreseen to be contained and recovery set to begin, Fitch states that most airlines will exit the crisis in a much more vulnerable position. A prolonged crisis would therefore put excessive financial pressure and little flexibility would jeopardize a sustained recovery of the industry in the long-run despite cost-reduction measures having already been put in place.

However, parallel to what Barclays had pointed out last week, Fitch also believes that 2019 demand levels will be fully regained by 2022 or 2023.

Remarkably enough, relatively low fuel prices ($1.50/gallon and $1.65/gallon in 2020 and 2021 respectively are predicted) could prompt a quick recovery of the airlines in the following year, again having a meaningful impact on the consumer.

Fitch’s final concerns suggest that the possible change on air-travel structure could adversely affect airlines such as Hawaiian who largely depend on less-essential leisure trips.

Hawaiian's Airbus A321neo. Photo by Brandon Ravelo | AeroNewsX

It is then a consensus that these financial relief plans come into place, although it is widely known that the industry comes from a golden period. As the former CEO of Spirit Airlines Ben Baldanza states, the consolidation that took place in North America from 2008 to 2012 led to better-shaped balance sheets compared to those the airlines had when the terrorist attacks of 9/11 occurred (an appropriate reference for the current downturn).

Moreover, Business and First-Class tickets have also become, in the past two decades, the main source of income for American carriers. Delta, who has been leading the sector in the United States, recorded $4B worth of revenue from their Business Cabin & Premium products on the Jul-Sep Quarter in 2019, while Economy-class accounted for $6B in revenue. This gives us a sense of how Business travelers may have even been subsidizing economy seats - and the fact that major airlines are willing to keep loyalty program benefits during this period denotes their valuable role in keeping ticket prices stable in the years to come.

Delta Airlines' Boeing 777-200LR. Photo by Karam Sodhi | AeroNewsX

This is the reason why U.S. Treasury Secretary Mnuchin advocates for a partial repayment of the grants Congress passed, even contemplating buying stakes equivalent to 10% of the value of each loan. This suggests that dividends or share buy-backs should be limited while eventually influencing the final price.

Greenpeace’s “Unearthed” publication on this matter reports the opposite: The International Air Transport Association (IATA) is supposedly urging its members to lobby different governments to help them go through the crisis and post-crisis scenario with tax-exemptions and deregulatory measures, which along with low oil prices should easily help to stabilize the industry.

In comparison, the effect the crisis may have in the supporting the “leasing” industry (which may not perceive any state-help) might as well have a repercussion on the overall output. This system contributed to adjust other carriers fleets to seasonality, and transferring spare aircraft in winter to other airlines operating in a different hemisphere, says Jorge Penalba director of “Avion Revue” magazine. The preference for airlines to stick to their own fleets (compressing route supply with fare price implications) will hit these intermediates which were already suffering from the numerous lessors that appeared in the last 10 years. “It went from 6 to more than 20,” and “above 40% of leasing supply it is not a profitable business as prices go too low,” Penalba says.

Following this statement, we have indeed witnessed the cancellation of an order for 75 Boeing 737MAXs from Irish lessor Avalon.

Air Europa's Boeing 737 MAX 8. Photo by Preston Fiedler | AeroNewsX

But now, let’s move on to the most critical concept that gives consistency to the whole analysis. That is: confidence. So far, we know that aviation will be smaller in size in terms of operations, mostly due to the drop in demand. Nonetheless, from previous crises we can extract a useful conclusion: the industry is resilient. And this is a theory backed by many analysts and airline executives alike.

The problem could then reside on the supply-demand disequilibrium once public confidence is reinstated as governmental restrictions are eased. As Andrew Charlton, an independent aviation analyst told Business Insider, “reduced economic activity (…) could cause the collapse of airlines potentially creating a landscape in Europe that more closely resembles the US where the top 4 airlines control more than 80% of the market as of 2018” while “in Europe, they control 40%.”

With less competition, fares go up. This doesn’t look like the best way to boost the industry, though. companies will be lowering prices in an attempt to fill their empty planes, as long as they can afford to do so. An escalation of these reductions could at the same time result in a mis-pricing of tickets entering into a sort of a “price war”, which would further damage competition.

Spirit Airlines' Airbus A319. Photo by Matt Lino | AeroNewsX

Moreover, as less lucrative routes are predicted to lay unserved, it should be expected that other airlines could progressively fill up those gaps. This could affect, mainly, regional or secondary airports.

So, which niche populations will start to fly first?

On the one hand, business travelers have always led the path to air-travel recovery, analysts say. They are willing to pay higher fares than usual (usually last-minute) in order to attend specific commitments in different locations. It is yet to be seen the actual effect that new technological advancements like “remote working” can have, although it still proves to be a market that always benefits airlines.

On the other hand, we encounter tourism which represents a constant cash-flow especially to popular leisure destinations. This will represent the biggest burden of them all since it is the market that is most susceptible to crisis.

Accordingly, in the most likely scenario we will see the application of price-incentive strategies. Airlines are also expected to closely work with other stakeholders in the tourism sector to additionally incentivize air-leisure-travel.

According to Scott Keyes, founder of Scott’s Cheap Flights says that "surveys and polling show that the number one factor on how people decide whether or not to book a flight is price — not schedule, not airline, not amenities.”

Total international tourism exports represented US$1.7 trillion last year only, according to The World Tourism Organization (UNWTO).

Ryanair's Boeing 737-800. Photo by Karam Sodhi | AeroNewsX

All in all, air travel is expected to recover in the coming 3 years until it gets to pre-crisis levels as long as the COVID-19 virus is contained, which is anticipated later this year. Airlines will in all likelihood opt for a low-fare pricing framework in order to ensure future operations promptly incentivizing air traffic, as long as their financial states afford it. Public funding and tax benefits will help, as well as low oil prices.

However, public confidence levels must accordingly follow if we don’t want see airlines go bankrupt due to a prolonged infamous demand. In this regard, Moody’s Chief Economist Mark Zandi expressed that “consumers will be more cautious, particularly baby boomers, those at their 50s and 60s who account for a large share of expenditure”. “They lost part of their fortune and therefore their saving rates will be higher from now on”.

However, less risk-averse populations like the “millennials” could act as counterparts.

Eithad Airways' Boeing 777-300ER in the old livery. Photo by Cole McAndrew | AeroNewsX

In the near-future, fares are expected to be low, predominantly those of international flights as they are perceived as riskier compared to domestic ones, with the main objective set to reignite demand.

Likewise, it is yet to be explored how aircraft disinfecting and social-distancing measures (meaning less seats available per flight) could affect airlines' revenues, ultimately pushing prices up.

These costly but fundamental restrictions would most likely represent the disappearance in the medium-run of Ultra-Low-Cost fares as we know today. However, airlines like Ryanair and easyJet will still be willing to offer relatively low prices, as they will try to perpetuate the business model they have effectively pursued in the last decades.


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