Winter arrived early: the hard reality of the aviation industry in Europe

The European commercial aviation industry has remained somewhat

Airlineoptimistic - or defiant, depending on one's perspective - about it's perceptions of the COVID-19 pandemic. But, it seems the what all feared and hoped would not happen, has happened. The second wave has hit the continent hard, and with new restrictions added for travel, the already very depressed demand is, again, shattered.

And this spoiled the plans of the airline conglomerates in the continent, which planned for a stabilized recovery by the end of the 2020. Deutsche Lufthansa AG (LHA.DE), for instance, publicly commented talked about a 4th quarter capacity, equivalent in relation to 2019 figures, of 55% for the continent and 50% on intercontinental routes. In its second-quarter results presentation, it mentioned “recovery” in the quarter following.

With the spread of COVID-19 in Europe picking up again from September and October, such plans were grounded. Just three months after, in its third-quarter results presentation, Lufthansa estimated the group capacity in 2020’s last quarter to be at a maximum of 25%. Lufthansa is not alone in these challenges. As one of the largest carriers in the world, and one with a diverse business model amongst its plethora of ever increasing airlines in the Group, Lufthansa Group provides a great barometer for the whole industry.

Even with the prospect of vaccines, the industry once again seems to be pinning it's hopes far too optimistically on a quick vaccine-driven recovery in early 2021. Yet, this seems, again, to be a pipe dream. We, at Aviado Partners believe that the day the population is immune to an extent that makes the feeling of travel safe again for the masses and for regulatory barriers to be lifted..... is far away.

This is even more true for airline groups that rely more on long-haul and corporate travel, two of the travel segments that may take years to reach pre-pandemic levels, even after mass vaccination and economic stabilization.

Winter is coming

With that, and with winter known as the most difficult season for airlines on the continent, it’s time to face the hard reality that very few are talking about: in Europe (as in most of the developed world), very few airlines seem to be restructuring at a pace that matches the medium and long-term necessities.

That is: most of the companies are finding short-term solutions, such as raising funds for short term liquidity via state bailouts, instead of more succinct slashes on the cost side of their operations, most likely hoping for a quicker rebound. Officially 9 months into a global pandemic, few airlines have restructured or show signs of entering a real reorganization. Delta Air Lines, Inc. (DAL) is one of the few bright lights which acted hard and fast assuming the worst would come.

"The best indication of an effective leadership team geared or a crisis, is one which sees the signs early, makes decisions and acts quickly to get ahead of competition"- Shakeel Adam, Managing Director Aviado Partners"

Airlines are not stressed, they are distressed

From the start of the crisis, airlines should have been quickly adjusting to deal with the fact fewer passengers means unit costs cannot possibly be covered.

"It is not a time to focus on optimizing unit costs. it is a time to slash fixed and overhead costs on a massive scale." - Shakeel Adam

Meanwhile, at the end of Q3/2020, none of the continent’s three big airline groups had reduced their workforces by more than 13% versus the same period of 2019, according to Gridpoint Consulting. And even with the aim being to avoid layoffs, the most that one of the three groups managed to cut in labor costs (ex-government programs) was International Consolidated Airlines Group, S.A. (IAG.L) , at just over 20% versus 2019 figures.

Such cost figures should raise serious concerns for shareholders - as well as governments - since demand continues depressed and is expected to remain depressed for the foreseeable future. Reuters reported that Lufthansa did not expect air travel to return to pre-COVID levels before 2025.

With the V-shaped recovery now more a dream than a reality, costs must be slashed more aggressively to meet the “new normal” revenue standards. This is easier said than done, however.

"At the start of then pandemic I assumed that the airline sector will manage this better than others. I was wrong." - Adam

Airlines should have been well suited to deal with this crisis. No industry has been more exposed to crises in the past 20 years than aviation. Airlines and airports endured 9/11, SARS, MERS, the GFC and many other challenges. All of which provided the training necessary for this situation, albeit at a different scale and duration. Yet, only Delta has acted swiftly. Why?

Why airlines haven't managed the crisis well

It seems much of the institutional knowledge within airlines from past crises has been lost. Ben Smith's arrival at Air France-KLM SA (AF.PA) while already a great boost for the airline group before the pandemic, will probably be now be more fortuitous than the Board could have ever imagined, His experience with many of the past crises and steering a global carrier such as Air Canada will no doubt help the group. Combined with Dutch pragmatism and the long standing leadership of Pieter Elbers, the group will no doubt emerge from the crisis stronger than others, if past political challenges amongst ownership groups don't again come in the way.

The second deep challenge, and equally damaging for the industry is the scale of government bailouts handed to airlines. With impending elections in the US, upcoming elections in Germany and overall concerns about losing the support of labour unions, governments throughout the EU, back by very liberal policies fron the European Commission, have been dishing our support for airlines like candy. According to Greenpeace’s Transport & Environment tracker, by the end of November, almost 30 billion euros of liquidity transference to Europe’s major companies were agreed. In some cases, the bailout per employee far exceeds the average GNP / person or GDP / person in that country. Thus, the general population is subsidizing the airline far beyond its means.

The burden on the national economies to save a bloated industry will cost future generations. In addition, most bailouts need to be repaid and airlines won't be able to do so. That will lead to a further destruction of shareholder value, subsidized by tax payers.

On the flip side, such bailouts provide an unfair competitive advantage to airlines that already had a lower debt structure before the pandemic, especially Europe’s LCCs, and Lufthansa Group, with a strong balance sheet gains a dramatic competitive advantage. The significant downside is that these bailouts remove the incentive for the industry to restructure. It delays the inevitable at a horrendous cost to tax payers, and leaves the subsidized businesses weaker after the pandemic than before.

Although bailouts may have seemed the right path to follow at the start of the pandemic, airlines from countries with little to no state aid, such as Mexico and Brazil, may very likely emerge from this crisis in better shape and leaner.

Restructure in winter, emerge in Spring

A more aggressive restructuring is precisely what airlines in Europe should do now. Urgency is needed to reorganize these airlines in Europe to determine how 2021 will be for these companies, because it’s clear now they cannot rely as much on significant revenue growth.

While the large carriers continue to resist restructuring, they leave the door open for regional LCCs such as WIZZAIR (WIZZ.BD), Ryanair Holdings plc (RY4C.IR), easyJet plc (EZJ.L), airBaltic and others to step in to markets where they should not be. That will only distort the market more and cause more damage for all shareholders and cost governments more in the long run.