A person watches as a Southwest Airlines plane arrives at a gate of Pittsburgh International Airport (PIT) in Moon Township, Pennsylvania, the United States, Tuesday July 2, 2019.
Justin Meriman | Bloomberg | Getty Images
Airline stocks have been hammered even worse than most of the stock market in the past few weeks, dropping 30% due to fears that the new coronavirus will lead to mass defections by customers who break into their world. It got so bad that United Airlines canceled a 5-day investor day, saying that the COVID-19 problems meant that United would not receive any attention to the long-term plan it wanted to present.
But for a combination of reasons, American carriers may be more resilient than they appear, that is, if the global health crisis doesn’t last too long or spread too widely. In this case, the high fixed costs of the airlines will mean that profits will be hit hard even by medium-sized drops in revenue. And weaker couriers abroad will be hit hardest: British regional courier Flybe announced today that it is about to enter the British equivalent of the bankruptcy court, even though it had serious problems before the coronavirus epidemic.
The two main reasons for being cautiously optimistic are that US carriers entered into crisis in good shape and that during this time the airline fuel price crashed, cutting one of their biggest expenses. Energy consultant IHS Markit now predicts that world oil demand in the first quarter of 2020 will decline by the largest volume in history, even surpassing declines during the 2009 financial crisis. OPEC has agreed to a massive cut in supply, although Russia still disagrees, as Brent crude oil prices are trading around $ 50 and WTI crude oil below that.
Until last week, airlines thought that the drop in fuel alone would make up for the loss of business from Asia, but with the virus spreading to Europe and making its way into North America, fewer investors are willing to bet that costs can decrease faster than revenue.
Just today, Southwest Airlines announced that business has plummeted in the past week, enough to force the Dallas-based airline to cut its first quarter revenue guide from $ 200 million to $ 300 million, about a 5 percent drop. %. This follows yesterday’s move from Chicago-based United Airlines Holdings to cut 10% of its domestic flights and 20% of its international routes due to lower demand. But Southwest’s filing also claims that cheaper fuel will save him $ 1 billion this year, giving him a cushion against falling profits.
Sentiment has been strongly oriented towards airlines in the past three weeks and even the past few days.
Recently, on February 11, Moody’s Investor Service published a report stating that fuel prices alone were more than compensating for the impact of activities lost due to the cancellation of flights to Asia. But Thursday, the International Air Transport Association is sending out an alarm, claiming that coronavirus could plunge industry revenue worldwide from $ 63 billion to $ 113 billion this year. Two weeks ago, IATA thought the number would be $ 29 billion and the impact would be limited to airlines operating in the “associated markets of China”.
“There are many airlines that have relatively tight profit margins and a lot of debt, and a cash flow shock like this could definitely put you in a very difficult situation,” IATA economist Brian Pearce told reporters in Singapore Singapore. according to Reuters.
Moody’s analyst Jonathan Root says the latest news is threatening.
“All bets are turned off if this becomes a widely dispersed virus,” he said in an interview Wednesday night.
Meeting of airline CEOs with Trump
Airline executives met in the White House on Wednesday with President Donald Trump, letting both sides inform the other about preparations for coping with the virus. Vice President Mike Pence told the group that passengers on the remaining flights from Asia are screened before entering the United States, while the President blames his predecessor Barack Obama for imposing regulations. Trump’s statements made it more difficult to rapidly develop coronavirus test kits.
“This was a disagreement decision, I don’t think we would have made it, but for some reason it was made but we canceled that decision,” said the president.
After the meeting, CNBC’s Eamon Javers reported that CEOs privately warned White House officials not to speak in a way that discouraged people from flying. They urged White House chief of staff Mick Mulvaney to “talk about the facts, not about the fear,” Javers said, citing a person familiar with the conversation.
NYSE’s ARCA airline index has fallen more than 30% since February 12 due to widespread fear of coronavirus. Among the biggest drops: American 40% and 39% drop in Spirit Airlines. The southwest, which has no flights to Europe or Asia, is down 21%. Alaska Air fell 27% and Delta fell 23%, while United 28% and JetBlue Airways’ 26% decline are almost in the center.
How to financially analyze an airline
Airlines are simple enough to analyze financially, so the reasons for caution are not difficult to understand.
Airlines have such high fixed costs for planes and staff that even a small loss in business causes a much bigger gap in profitability, as carriers pay as much to run a half-full flight as one that is full at the same time. 84%, the industry average last year, said CFRA research analyst Colin Scarola. Until recently, US airline planes were much fuller than before. The average “load factor” of 84% in 2019, according to data from the United States Department of Transportation, increased by more than 10 percentage points compared to 15 years ago.
Preliminary January government data indicate that passenger traffic increased 5% over the previous year.
Apparently things started breaking in February, but nobody knows for sure, said Root. In the southwest, the crack has occurred in the past week, the company said in a SEC filing today.
“The Company reported good growth in passenger bookings and revenues for the first two months of 2020, with year-over-year increases in operating revenues per mile of available seat (RASM) that were in line with the Company’s expectations”, said the document. “However, in the past few days, the Company has experienced a significant drop in customer demand, as well as an increase in travel cancellations, which are assumed to be attributable to concerns related to the reported cases of COVID-19.”
The biggest thing that changes revenue is how complete the planes are and their higher costs are fuel and labor. Fuel accounts for 15% to 20% of the airline’s costs, according to data from the United States government. Fuel prices have fallen 33% since fall 2018, according to the U.S. Department of Energy, half of that since December.
While airlines and budgets and recent free cash flow trends may look great, things can change quickly.
CFRA research analyst
United is an example of how airlines have planned to cope. In a securities and exchange commission filed on February 28, the Chicago-based carrier said that the impact of the loss of international business in the first quarter would likely be offset by fuel costs and payments under a renewed credit card partnership with JPMorgan Chase. But United also withdrew its lead by 2020, stating that the range of potential outcomes was too broad to make any predictions possible. If COVID-19 were to run its course by May, United said, it would likely meet its previous profit forecast of between $ 11 and $ 13 per share. United shares are currently trading around $ 56.
“The company remains confident in its long-term outlook, including adjusted diluted earnings by 2022 share interval, [and its] 2022 and 2023 adequate free cash flow targets [announced on] February 24, “said United in the filing.
Of course, airlines have done very well recently, with big profits and even greater cash flow, as well as manageable debt loads.
Despite IATA’s assessment that many global carriers are wobbly, major U.S. airlines made $ 335 million (at Spirit) with last year’s $ 3 billion in net income. Furthermore, thanks to heavy non-cash expenses such as depreciation, which reflects the gradual devaluation of airplanes – mainly for accounting purposes – the operating cash flow is even better. This ranged from $ 1.44 billion at JetBlue down to $ 6.9 billion at United.
Most U.S. airlines have about $ 3 billion in cash in their balance sheets, with Spirit and JetBlue smaller with $ 1.1 and $ 1.3 billion respectively, as of December 31st.
Debt is not a problem for most major US carriers, particularly with low interest rates. The average airline has 15 times the cash flow needed to cover interest payments, said CFRA Research’s Scarola. Indeed, the American was able to sell $ 500 million in full-value debt until 20 February, but Scarola issued a cautionary note against the American, whose cash flow is only about four times. higher than his interest.
Nonetheless, Scarola recently cut its investment rating on United, American and Delta stocks to keep from solid buying or buying. For Scarola, the problem is that the high fixed costs of the airlines mean that any drop in business will almost immediately cause an oversized impact on profits.
To the American, where he expected the impact to be limited until recently because he has few flights to Asia, a drop in revenue from 10% to 15% could wipe out net profits, he calculates. Delta is vulnerable because over a quarter of its revenue comes from international flights, mainly to Europe. United is expected to hold up relatively well, but has cut its 2020 earnings forecast by $ 1.30 a share to $ 11.45.
“Although airlines, budgets and recent free cash flow trends may look great, things can change quickly if demand drops sharply,” Scarola said in an email.
For now, the math for large US carriers points to a lower drop in revenue than the double-digit drop that would wipe out profits for some airlines, with fuel savings that would nullify much of the damage. How long does this bet last?