Airlines: The Painful Valley Days Ahead

It’s the classic supply versus demand problem.

On March 1st, the airlines had a big supply to meet a big demand. They woke up one morning two weeks later, looked around and discovered the demand had disappeared overnight. Also, perhaps, had the viability of most of their business models.

By mid-March, the majors were entering a valley which was dark and looking very long. The “knowns” were bleak, and few in number. Demand was gone. Most of their jets sat parked on airport ramps across the nation. Most of their costs were still with them.

The known unknowns added to the problem. No idea of when demand would recover appreciably, or if it would ever fully recover. Were new and long-term costs going to be added to their shattered business plans? What to do with their long-term fleet management plans – defer aircraft deliveries, cancel them outright, accept and try to lease the aircraft to someone else, accept, sell and lease back from the new owner?

And what of Donald Rumsfeld‘s famous unknown unknowns? Surely any sudden and massive disruption of a systems complex as a major airline operating model, not to mention the overall economy of United States, it’s bound to produce unexpected and potentially significant consequences. What’s in front of the majors today will probably be added to in coming months as the pandemic and its long-term effects play out. 

Dynamics:

Airlines are now shrinking their fleets and will continue to do so.  With far fewer planes needed, airlines have parked aircraft on ramps across the nation. Many of those jets will continue to sit idle, while airlines will defer if not outright cancel aircraft orders.

Noted: The U.S. majors operate nearly 3,000 aircraft and have over 1,000 new jets on order.  They are unlikely to  need any of those aircraft in the next 2 years, perhaps longer. Someone will be left holding that bag before this all ends.

Query: Will lower jet fuel prices allow them to keep some aircraft longer, further exacerbating deferral of cancellations of new aircraft orders?

Sub-Story:  Aircraft manufacturers Boeing and Airbus will see further reductions in production rates. This will drive for the layoffs in that industry and related ones.   The OEMs will go from the top of a super-cycle, years of backlogged work at full production, to struggling to keep their production lines warm and not lose the talent they will one day need again.  Is there a real risk to the U.S. losing at least part of a key industrial base? A story for a different day.

Even as passengers return, profits will be smaller because of fewer passengers and specifically fewer business travelers who account for most airline profits.  This will force the airlines to be merciless in pulling every cost from their systems.

Empty center seats will push shields down, or force an increase in ticket prices, or both; selling center seats may push load factors up or down depending on how would-be passengers perceive the move; filling center seats may push loads down if passengers perceive the airline not to be concerned about passenger safety.

Query: Will COVID-19 add long-term costs to the costs of flying? Will one airline may take the plunge and mix in the book and changes to the aircraft interiors because of COVID-19?  

That would increase costs, weight and maintenance, potentially pushing price is higher. However, that decision will probably arise from whether a vaccine appears in the near-term (what is near-term?), is effective and excepted widely. The timing of such a decision will be difficult and potentially risky.

Query:  Will airlines attempt to distinguish themselves with their “safety” practices?  Will they cut corners in other areas to pay for those practices?  How will passengers respond?

There may not be enough international flying returning soon enough to support all the majors who most of that business. Here Southwest may have an edge with their current business model. They may be in a better position in the likeliest recovery models since they have a far less international-centric model. The other majors may be able to adjust and survive, but the damage and drag on their economic and operating pictures will probably hurt their financials for a very long time.

Noted: Maturing markets often drive “commoditization” of products and services. To some extent that has already happened with airline travel.  Southwest was a part of this dynamic, and may have the high ground initially at least as the major airlines struggle to cope with the effects and impact of COVID-19.

Query: Recessions in the past have constrained growth of the airline passenger market.  Has COVID-19, a different beast altogether, created an interim zero-sum game?

In the current environment, many flyers may simply avoid flying, especially the longer flights. Having to wear masks, having essentially no in-flight services and fear of being cooped up in a flying aluminum to for an extended period may simply make the experience one people avoid unless necessary.  If those reasons are not enough, rolling and little or no-notice quarantine requirements will often make travel impractical.  Thinking about a vacation to Hawaii?  Not so much.

Query: Will the sudden and forced widespread adoption of technology such as Zoom permanently eliminate part of the airline’s most profitable demand segment, the business flyer? Will companies decide that a portion of business travel really isn’t necessary and simply not return that cost to their business model?

If one airline initiates a fare war to claim a larger share of the passengers as they return, the systemic financial damage to the industry may hasten consolidation; the major with the best balance sheet may inflict pain first, then eat the weakest of its competitors. 

Query: Will one of the majors initiate, directly or indirectly the acquisition of one of its rivals; Can the airline industry thrive without the disappearance of one of the majors amid what appears likely to be a long COVID-19 inspired depression in the industry?

It seems likely the federal government will provide additional help before the election, but once that aid ceases, significant airline layoffs are coming.  Alternatively, the government could at least partially nationalized airlines and perhaps mitigate the layoffs.

Query:  Is the airline industry employee count, usually good paying jobs, about to experience a permanent reduction?  A structural job loss due not to off-shoring but to a fundamental change in the demand side?

On the bright side, and any pilot shortage may just have been resolved.

How Does One Exit the Valley?

With a likely recovery period of 2 to 4 years in front of them, the U.S. majors face a log slog in the valley. If they are lucky, more profitable business travelers will return sooner than normal following business declines and help their financial recovery along. If the government provides long-term subsidies, even perhaps keeping downward pressure on fares to stimulate air travel and its knock on industries (think hotels, restaurants, destination vacations, etc.), the valley may be shorter. 

In the meantime, in the valley next door, Boeing (and Airbus) is living proof of “it all rolls downhill,” and at the end of day, a lifeline, or the absence of one, from the government to the airlines may its only hope as well. Or to put it a bit differently, got room in that lifeboat for 1 more?

A Closing Query

Prior to 9/11, travelers did not have to go through intentionally time-consuming security, did not have to worry about how many ounces of fluid or gel they had in their bag and could have friends and family see them off at the gate. Post 9/11, the front end of the aircraft is like a small vault a passenger can plan on being admonished for standing near the restroom waiting in line to be the next occupants and frequently one encounters lengthy security screenings.  For shorter trips, flying is no longer worth the hassle. 

If COVID-19 similarly reshapes air travel significantly, the flying experience, already having gone from good to tolerable, will continue to degrade toward a point where it becomes exception rather than the rule for planning shorter distance travel. If the Green Movement succeeds in pushing alternative modes of transportation, especially in high volume corridors, and virtual meeting technology has staying power, will the COVID-19 be seen in retrospect as the moment the airline and airliner businesses changed forever?

Joe Huertas

August 2020

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