Last week, two of America’s biggest airlines released their quarterly earnings reports. During the first 9 months of the year, Delta Airlines‘revenue was $ 10.2 billion, a 68% drop from the same period in 2019, while United Airlines“Revenue was $ 9.4 billion, down exactly 68%. Delta and United reported net losses of $ 11.6 billion and $ 5.2 billion respectively. American Airlines, which is expected to release its third quarter financial results this week, probably didn’t do better.
The airline industry is in a worse crisis than anything we have seen before. Demand for global air travel collapsed in mid-March 2020, and while it rebounded slightly over the summer, domestic aircraft departures are still down by more than 50%. International travel is even more affected. And demand is expected to remain depressed for the foreseeable future.
The CARES Act provided the biggest airlines with nearly $ 16.0 billion in grants and $ 6.5 billion in loans to keep them afloat, but it was not enough. In order to survive in such an environment, airlines rushed to banks and capital markets where they issued bonds and tapped into their lines of credit to raise funds. Airlines have since borrowed and issued approximately $ 48 billion worth of notes and bonds; they resorted to secured loans — a practice traditionally used primarily by poorly rated and struggling companies.
All this debt on airline balance sheets has resulted in high leverage ratios. For example, Delta Air Lines’ leverage ratio (measured as the total debt to capital ratio) fell from 0.53 in June 2019 to 0.78 a year later. United Airlines’ leverage ratio fell from 0.64 to 0.73, and Southwest saw its leverage ratio drop from 0.29 to 0.51.
This debt has weighed on the industry’s credit ratings, which are currently at a very low point. S&P downgraded the credit rating of every airline in the United States: Delta and Alaska Air Group were downgraded from BB + to BB, JetBlue and Spirit Airlines from BB to B +, United from BB- to B +, Hawaiian from BB- to CCC +, Allegiant Travel from B + to B and American Airlines from B to B-. These downgrades place most US airlines in the “speculative grade” category – a euphemism used by market participants to describe high risk companies with a high probability of default. The only currently higher rated airline is Southwest, which has been downgraded from BBB + to BBB, but is still above the threshold to be considered an investment category.
So far, thanks in part to CARES spending, the airlines have mostly kept the money they’ve raised. At the end of June 2020, airlines had cash worth more than $ 56 billion, an increase of $ 35 billion from their cash a year earlier. If this could continue, then their future might not look so bleak: after all, liquidity on the asset side compensates for debt on the liability side.
However, unless there is a spectacular second injection of government aid, the airlines will have to spend that money. Industry estimates suggest that airlines have already spent $ 51 billion in cash and are expected to continue spending until 2022.
Some of the costs for airlines can be eliminated or significantly reduced when they fly less. These variable costs include, for example, the amount they spend on fuel or food and drink. The other costs are fixed: Unless an airline successfully terminates or renegotiates a lease, it will continue to pay aircraft rental fees to lessors. But the lion’s share of airline costs fall somewhere between the variable and the fixed: they are semi-fixed costs such as labor and maintenance costs. Semi-fixed costs such as wages do not fully adjust even to a dramatic drop in income such as that caused by Covid-19. For example, in the first 6 months of 2020, salaries represented 56% of American Airlines revenue compared to just 28% a year earlier.
Will the US airline industry survive Covid-19? With all this debt and government aid, the airlines are currently on life support. In order to recover, they will have to significantly restructure their costs and renegotiate their capital structures. In the aftermath of September 11, there was a long and massive wave of airline bankruptcies. Former carriers such as United, Delta, Northwest, and US Airways filed for Chapter 11 and came out leaner and healthier. In doing so, they reneged on their pension promises, cut wages and laid off thousands of employees. Unfortunately, to survive Covid-19, airlines will likely have to do all of the above, and more. With so much debt on their balance sheets, the post-Covid-19 race will be very bumpy.