It’s no surprise that the U.S. Airline industry was put into a tail-spin by the pandemic. Early discussions of how the industry might recover were modeled as letters — L, W, V — attempting, without a specific time parameter, to estimate the shape of the demand return. These gave way to broader estimates, such as “back to 2019 traffic levels” or “back to cash neutrality.” One-third of the way into 2021, many of the early estimates clearly did not accurately capture the extent to which this pandemic has changed air travel, and even after a full year since the first signs of this event the future of air travel is still highly uncertain.
As a result, 2021 is now starting to look like a true transition year for the U.S. Airlines. After three government stimulus packages to keep labor employed, and vaccines now being rolled out at a more rapid pace, there are five key trends that define this transition:
Different Capacity Deployment Hurdle
Pre-pandemic, an airline’s capacity planning team would evaluate a route’s performance based on its positive contribution to overhead as a minimum threshold. Routes that were fully profitable including covering all overhead and administrative costs were considered a high-water mark. Well-run airlines would add capacity to routes making money, and trim capacity to routes not contributing as well or at all.
The last year has been different. First, most fleet costs are sunk or have been deferred. Owned aircraft have been used as collateral for extra liquidity. Leased aircraft, in many cases, have had suspensions or reductions in payments for some period of time in agreement with the lessor. Second, salaries for most employees have been subsidized by three successive payroll support stimulus plans. With the fleet costs sunk, and employees paid for by the government, airlines have been encouraged to add capacity that covers only the variable costs of flying. If the plane takes off, and the revenue from that flight can cover the cost of the fuel, airport charges, and the variable costs of sale, the airline adds to their cash balance by flying the flight. This is a significantly lower financial hurdle than typically used and one that will not keep the enterprise sustainable for long. Yet in an environment where cash means survival, this has been the measurement by which airlines decide to fly or not to fly. Several airlines have already claimed a return to cash-positive operations, and others have given targets as to when this will happen. As the employee subsidies end and the airplane costs again need to be fully absorbed, a return to the typical financial hurdles will happen. That’s one reason 2021 is a transition year, as this is a transitional method for capacity deployment.
Increase In Debt Ratios
With uncertain revenue given the reduction in air travel, airlines soundly built up cash balances to ensure survivability during a transition to better times. The industry’s trailing twelve month leverage ratio moved from 2.92 in 4Q2019 to 8.23 in 4Q2020 as a result of this. Airlines have leveraged creative collateral to build their liquidity, including loyalty programs, unencumbered aircraft, and even gates, slots, and brand positions.
This has been good for airlines in that it gives them plenty of runway ahead to deal with uncertain top-line returns. Yet this debt will be a burden to a full recovery, since the airlines will need to start paying down this debt almost as soon as they start generating positive cash flow again. In good times, airlines are strong cash generators and so if the economy sizzles for a few years, this may not be a long-term problem for the industry. If not, however, these higher debt levels could forestall other needed investment or raise the cost of borrowing to an uneconomic point. Transition again, as the airlines will need to move back to something closer to pre-pandemic debt ratios as soon as it is practical.
Limited Investment
Related to this increase in debt and need to preserve cash, airlines have pushed back or fully tabled investment projects that at one point seemed sound. This means a slow build-back once things get normal again, and projects that could have started to provide a return soon will likely not be in this position for a few years. This could mean projects related to sustainability, technology to improve the customer experience or lower some costs, physical changes to airports or aircraft that would be recognized by consumers, and more. More transition until these things can be funded again.
Leisure Travel Leading Demand
It is widely understood that corporate business travelers represent a minority of the volume but a majority, or at least a large plurality, of the revenue for the industry. This is not equally shared among all carriers, as certain business models are built to attract this business while others are not. There is no doubt, however, that without the revenue from corporate business travelers the industry would be smaller, fewer aircraft would be needed, and costs to attract this traffic would seem even more burdensome.
With leisure traffic clearly leading the recovery, this poses a challenge for the models that depend on business traffic. With multiple estimates suggesting that business traffic will not all return, airline fleets, interior configurations, and loyalty programs all find themselves in a transitionary state until this is better understood. This is especially true for wide-body aircraft, as the long-haul traveler is likely also the longest pole in the tent in terms of travel demand recovery.
Talent Retention May Be A Challenge
All businesses need good talent to run efficiently, and airlines are no different. The complexity and challenges of the industry tend to make especially effective airline people attractive to other industries. Also, certain disciplines like Finance, Marketing, and IT use skills that are easier to move among industries. As pay rates have been temporarily cut, government aid has come with limits on how certain executives can be paid, and there is still overall uncertainty in the sector, airlines may be faced with a talent drain right when they need the most effective teams to steer into smoother waters. This transition in the workforce continues in the production side of the business too, as pilot pipelines may change and mechanics may find fixing machines other than airplanes may make for better pay and more stable employment.
The transition underway in the U.S. Airline industry has multiple dimensions, and as the rest of this year plays out some of these issues will be resolved while others may get worse. Because of all of these issues, 2021 can best be characterized as a transition year even though is not fully clear when this transition will end and what form stability will take when it does.
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April 07, 2021 at 05:53AM
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2021 Is Shaping Into A Transition Year For The U.S. Airline Industry - Forbes
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