Nick Oxford/Reuters
- The coronavirus pandemic is beginning to look worse for US airlines — especially American Airlines — according to a new report from JPMorgan.
- Revenue is only expected to recover to 75% of 2019 levels by 2021 — and that's in a best-case scenario.
- In the report, analysts wrote that bankruptcy, which could help American reduce the size of its labor force and fleet more easily, is emerging as a possible outcome for the airline on the other side of the crisis.
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The situation for airlines in the US is beginning to look even more grim, analysts for JPMorgan wrote in a research note on Monday.
When the airline industry initially began to see the impact of the novel coronavirus, the damage was expected to be mainly contained to the China market, and eventually the larger Asia region. Impact to the US was expected to mainly take the form of a decrease in visitors from China, while a recovery was expected to be V-shaped.
The situation changed rapidly, with a quick devolution to what stands today — subsections of airline fleets grounded at airports and storage facilities around the world, while the planes that continue to fly are doing so with few passengers on board.
Now as evidence of a prolonged recovery for the airlines becomes increasingly evident – paired with the reality that smaller carriers with tight margins may not survive – the tone among industry analysts has changed.
"In a best-case scenario, warming weather and slowing case growth result in demand returning to the pre-outbreak trend by mid-2021," Stifel's Joseph DeNardi wrote in an April 1 research note, outlining a worst-case scenario that saw resurgences of the virus in the fall, effective suspensions of flying, and a deterioration of airlines' finances as they take on increasing amounts of debt to weather the storm.
"Currently, the bearish scenario is playing out," he added. The firm downgraded several airline stocks, including American Airlines and JetBlue, from "Buy" to "Hold."
In an April 6 note from JPMorgan, the severity of the situation became even clearer.
"We are growing increasingly convinced that industry recovery to 2019 levels of output will be a multi-year affair, resulting in the material shedding of aircraft and headcount along the way," JPMorgan analysts led by Jamie Baker wrote. "Our revised base case now assumes 2021 EBITDAR" — earnings before interest, taxes, depreciation, amortization, and rent or restructuring costs — "will recover to within only ~75% of 2019."
"Whereas we once expected 2021 industry recovery to within sight of 2019's result, that's no longer the case," he added. "-80/-45/-25% is our 2Q/3Q/4Q20 revenue cadence (roughly 10 points worse than earlier), and we now expect 2021 revenue and EBITDAR to emerge no better than ~25% below 2019."
The JPMorgan report focuses primarily on American Airlines, but notes that the same trends in the analysis and modeling apply to numerous US airlines.
The analysts wrote that they expect to see demand among corporate travelers begin to recover sooner than leisure travel because "businesses are expected to put workers back on the road before families develop the same confidence." However, they said, the ultimate recovery of corporate-traveler demand will likely be slowed by the fact that remote work has been proven feasible during the pandemic, which could prompt companies to question the value of flying their employees for business purposes.
With workers achieving productivity from home and through video conferencing, the expenses associated with in-person meetings could be cut for longer than the airlines would like to see.
According to Helane Becker, an analyst at Cowen, business travelers only make up 15-20% of airlines' traffic, but provide half of their revenue.
The federal CARES Act — the coronavirus stimulus bill — offers US airlines up to $29 billion in loans to help weather the crisis, and an additional $29 billion in payroll grants to continue paying workers through at least September, albeit generally less than they were making before the crisis.
By accepting either form of aid, airlines are required to not lay off or furlough workers until at least September 30. However, assuming the crisis of reduced travel demand lasts beyond that date — which analysts, airlines, and epidemiologists are all increasingly expecting — airlines have warned that staff reductions would be practically unavoidable after that point.
Expecting a slow recovery for American, combined with a projected $10 billion in additional debt taken on by the airline, the report portends a recovery that will likely be difficult, even compared to other airlines.
While the analysts wrote that American is not necessarily "mortally wounded," they went on to explain that the risk of a bankruptcy is, arguably for the first time in the crisis, becoming more pronounced, given the fact that the airline will likely need to significantly downsize its staff and its aircraft fleet.
There are "five, and basically only five, reasons why airlines file for bankruptcy," the report said: Labor costs above what the airline can afford, and an inability to negotiate a way to lower the expenses; pension costs, which can be shifted under the federal Pension Benefit Guaranty Corporation to reduce outbound cash flow; fleets filled with older, no-longer-needed or wanted aircraft given a resizing or restructuring, or a significant debt load on newer planes; high cost "other" debt, or just too much debt, such as what the airline could emerge from the current crisis with; and dangerously low levels of liquidity.
Given those historical reasons for past bankruptcies, the report says, it's theoretically possible that a bankruptcy would be the most effective play for the airline following the crisis.
"We were initially focused on a brief 8-16 week dislocation and a relatively quick snap back to some degree of normalcy," the report said. "This no longer seems likely to us given the depth of the crisis."
In the past few weeks, "managements here and abroad appear to be targeting much smaller footprints than we first factored into our modeling," the report added.
The report cautions that this is only one possible scenario: "We don't think management is rushing to file for bankruptcy. We also don't think it's inevitable."
However, the uncertainty of the situation means that it's becoming a larger possibility.
"We simply do not know the degree to which Washington will have the industry's back if more support is necessary to prevent bankruptcies – and further action could mean the difference between American seeking court protection or not, or at a minimum could influence the timing."
But even though the airline could manage to raise more cash without debt — for example, by pre-selling frequent-flyer miles to credit card partners, or other methods — and even though much of the debt is relatively low-cost, the debt remains concerning to the analysts.
"It's the sheer amount of debt that we are worried about, and the cost of carrying this debt against a top line that could potentially emerge 20-30% smaller," the report said.
"In our opinion, the margin for error for American management to navigate this crisis outside of the courts is growing uncomfortably thin."
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