Will the new year be a happy one for aviation?
As we draw close to the end of what has been the worst ever year for global aviation, we are all hoping for a better 2021. Boutique executive search firm Venari Partners has asked me to give my thoughts on what the new year might hold for the industry. So I’ve dusted off my crystal ball and made some predictions.
Vaccinations and the timing of recovery
The best news of 2020 was the stunning success of the scientists in coming up with effective vaccines in record time. The first of these have already received regulatory clearance in the UK, USA, Canada and a few other countries, and vaccination programmes have started. The big question now is how fast people can be vaccinated across the world and how quickly that will lead to a recovery in travel.
Once vaccines are approved and vaccinations programmes start, the key constraints will be vaccine supply and the logistics of getting it into people’s arms.
On the logistics of vaccinations, we got the first data point this week from the UK on how many people had been vaccinated in the first week. 137,897 shots were delivered between the 8th and 15th of December. At that rate, it would take 18 years to vaccinate the entire UK population, given that two doses are required. We’d better hope that the pace can be picked up as the programme gets into full swing. There are plenty of reasons to believe that it can. 10 million people were given the ‘flu jab in September and October for example. The government has indicated they hope to vaccinate the 25m people considered a priority by Easter, which is April 4th next year. At that rate, the whole UK population could be vaccinated by the end of the summer. The United States has said it believes it can vaccinate most of its population by the middle of the year.
At least initially, vaccine supply is likely to be a bigger constraint than logistics. Initial expectations of 10m doses of the Pfizer vaccine for the UK by the end of December have been reduced to 4m, due to raw ingredient supply issues. I believe that the Oxford University / Astra Zeneca vaccine will get approved by the UK shortly and that would massively boost supply as well as being much easier to deliver from a logistical point of view.
Governments will remain in “lock-down” mode until high-risk people have been vaccinated or case numbers drop to low levels, neither of which I expect to happen until at least the end of March in the UK, Europe and the USA. But by April, I believe that more vulnerable groups will have been vaccinated and with around 50% of populations having received the vaccine (see chart below from Goldman Sachs), case levels should be well down too as herd immunity levels begin to be approached.
So my prediction is that travel will remain subject to heavy restrictions until the end of the first quarter. But shortly thereafter, governments will start to relax travel restrictions and as vaccine supply constraints ease, they will begin to actively cooperate with industry efforts to get travel moving again. I therefore expect a strong recovery in short-haul leisure demand in Summer 2021, perhaps reaching 80% of 2019 levels. Long-haul and business traffic recovery will be slower, but even there a solid recovery should be in place by the second half of the year.
Testing to the rescue?
Rather than wait for the vaccines to come to the rescue, the industry has been pushing testing as a means to restart travel on a faster timeline. I’ve covered the issues of testing in earlier blog posts, such as this one. But the bottom line for me is that governments will only relax restrictions when the political pressure to do so is greater than the political risks of importing cases. Testing can reduce those risks, but much less than the proponents of testing would like you to believe. Testing is also expensive and inconvenient for passengers, although this situation is improving. So my second prediction is that whilst there will continue to be a lot of noise about testing, in reality it is likely to make little difference to the timeline of restarting travel, which will be driven by the vaccine timeline that I have already covered.
I think the industry would be well served by switching its lobbying focus from testing to arguing the case for travellers to get priority access to vaccines, after high-risk and other priority people have been vaccinated.
I do believe that there is a role for testing, but it will be a niche role, plugging the gaps in vaccination availability and take-up. Which brings me to my third prediction.
Will vaccinations be mandatory for air travel?
As a general rule, I’m sure the answer to this will be no. Qantas have said that they will require proof of vaccination to allow people to fly, but I don’t believe this will be the approach of most airlines. The issue of mandatory vaccination is a political hot-potato in many parts of the world, and I think airlines will defer to government guidelines rather than risk getting mixed up in the debate. Likewise, most governments will not mandate vaccinations, so what I expect is a dual system. If you have a vaccination certificate, or are travelling from a country with low prevalence, you will be able travel without restrictions. Otherwise, you will be required to undergo some combination of testing and quarantine. Probably both.
Can passengers expect great deals?
The simple answer to this is yes, especially if people are willing to book early. We have seen average prices being down 10-30% during the recovery phase in parts of the world where the recovery has already started. Airlines will be desperate to stimulate early bookings to bring in cash during the dark days of winter. I expect 2021 to be a period where airlines prioritise getting their aircraft flying again and filling seats. Bringing yields back up will be a job for 2022, unless pent up demand provides an opportunity to get started on this closer to departure.
Will more airlines go out of business?
The next few months will continue to be dark days for airlines in many parts of the world. There are some brighter spots, notably in Asia and a handful of airlines are doing surprisingly well. But for the vast majority of airlines, the next few months will be all about minimising cash burn and trying to stay alive.
There will be more bankruptcies of course. There always are in this business. But we are now past the traditional time of the year when airlines go bust. If people are making bookings for next summer, which I think they will be, cash will be coming in. For the most financially stretched companies, the credit card companies may withhold the money for new bookings, so there could still be bankruptcies. But with the timeline of recovery now being much clearer thanks to the vaccines, I believe that most airlines that have made it this far will manage to make it through until the summer. Some will need to raise additional capital and secure more financing. Some of that will come from governments, but capital (at a price) will also be available from the private sector for airlines with fundamentally sound businesses, now that uncertainties about the timing of recovery are dropping.
There are of course airlines that haven’t done enough to adjust their fleets and costs for the new reality and further painful restricting will be required, with more job losses to come. Given how much debt the industry has taken on, I also think there is still pain ahead for debt providers and lessors, who may need to take haircuts to avoid being landed with aircraft assets that they won’t be able to place elsewhere. The current situation at AirAsia is a good example.
But overall, I expect to see retrenchment and restructuring, rather than “full exits” where airlines simply cease to exist.
The restructuring and refinancing action won’t be restricted to airlines by the way. The whole value-chain has taken a huge hit and airports, handling companies, leasing companies and other suppliers have all been under massive financial pressure. As the industry starts to gear up activity next year, I expect some issues to emerge caused by failures and constraints at key suppliers.
Will we see more consolidation?
Even before the pandemic, most industry observers would agree that more consolidation was likely in what is quite a fragmented industry in many part of the world. The reduction in demand caused by COVID, which is likely to persist for some years, should increase the case for consolidation. However, I believe there are two significant barriers to further consolidation in 2021.
Firstly, financial capacity. Even the strongest airlines have taken on substantial additional debt and run down their cash reserves during the crisis. Balance sheets are not in a position to absorb additional liabilities. Even a rescue takeover at €1 involves taking on liabilities and requires cash to fund restructuring and integration costs. Airlines that have received state support will have political or legal restrictions on making acquisitions.
Secondly, management bandwidth. Almost all airline management teams are fully occupied with job cuts and cost reduction programmes. It would be very hard to take on new employees and new industrial relations challenges at the same time.
So overall I do not expect to see many airlines buying other airlines next year, even if that would help the industry adjust to a lower demand environment.
Which airlines are best placed to win in the recovery phase?
I’m not going to stick my neck out and give you individual stock recommendations. If I felt fully confident in my ability to do that, I’d be spending my time trading stocks rather than writing articles. But I will share a few thoughts.
The easiest to predict set of winners is of course the low-cost carrier category. Short-haul leisure will come back first, and they will be best placed to start making money in an environment of aggressive price competition and weak business travel demand. In Europe, Ryanair and Wizz are the picks here as the lowest cost operators. But the downside is that the stock market is already betting on that. Ryanair’s shares are 14% above where they started the year and Wizz’s are up 18%. They were pretty fully valued pre-pandemic and I really can’t see why these companies should be worth more than they were before the crisis, on any kind of fundamental value basis.
I argued earlier that the timing of the recovery by country will be mostly determined by the speed of vaccination rollouts. Looking back at the Goldman Sachs chart I showed earlier, the UK has a couple of months advantage on most other countries, with the US close behind. With a high exposure to both markets, that could favour British Airways. What is two month earlier recovery worth? Well, IAG lost €1.3 billion in Q3, so getting to breakeven two months faster must be worth something like €0.9 billion, which represents 10% of IAG’s current market capitalisation. Despite a big recovery recently, IAG shares are still down 63% on the start of the year. Lufthansa’s losses during the crisis have been very similar to those at IAG, but their shares are only down 42%. IAG shares have suffered from a poorly-timed, deeply-discounted rights issue, something that was avoided by Lufthansa thanks to help from the German government. I’m sure the valuation is also suffering from a Brexit risk discount. Perhaps that will be resolved soon? Perhaps the UK Government will start being more helpful to its airline industry? I certainly hope so. But I’m not brave enough to predict either of those, I’m afraid.
My final thought is that cost competitiveness, market leadership positions and capable management teams all matter in the airline business. Airlines that have all three are well placed. Those that have none are probably toast. One of the “good” things about the crisis is that there are plenty of capable airline managers out there looking for new opportunities. If management capability is where your airline is falling short, I’m sure my friends at Venari will be very happy to help you fix that.
Have a great Christmas and a Happier New Year.