It is a proven fact in the aviation industry that “what takes off, must land” and sometimes that landing might not be smooth. 2020 so far has not been a good year for the industry as the COVD 19 pandemic has wreaked havoc across the sector. The industry which has already been struggling with high operational costs amidst an economic slowdown is now faced with mounting debt and billions in losses and lost revenue. As per the International air transport association, airlines this year are set to suffer approximately USD 84 Billion losses and see a 50% reduction in revenue from USD 839 Billion in 2019 to a mere USD 419 Billion in 2020.
Some of the Aviation industry's biggest names including Avianca, Air Mauritius, Flybe, German Airways, and Virgin Australia have already proceeded to file for Bankruptcy as debts continue to rise and cash flow continues to shrink. According to CAPA aviation consultants, most of the world’s airlines will be forced into Bankruptcy or Administration (as it is known in the UK) if there is no government intervention in the industry. It was in response to this that the US government bailed out US airlines with USD 59 billion packages to save its already fledgling industry. With a surge in a rate of Bankruptcy in the Industry, we should perhaps take a look at what makes the airline industry vulnerable to Bankruptcy.
A Brief of History of Bankruptcies in the Industry.
The Aviation industry is no stranger to Bankruptcy. For instance, in the US four of its major airlines, Continental, Eastern, Pan Am, and TWA all had either filed for bankruptcy or had been liquidated between 1980 to 1992. For those who had observed the airlines during their prime and during their dying years, it came as no surprise that these airlines essentially fell victim to their own devices.
A series of bad investment decisions made by overambitious management led to the company incurring heavy debt. This was further compounded by the deregulation of the aviation sector in 1978 which resulted in serious competition for the aging airlines. This competition particularly in the airline's most lucrative route drove down the fares further compounding their cash flow problem. Ultimately the four airlines which once reigned supreme in the skies crushed with the weight of debt and heavy operational costs.
In India, Kingfisher and Jet Airways met the same fate in a similar situation. Heavy debt, increased competition, and high operating expenses ultimately led to the demise of two of the country’s most iconic airlines.
However, these were not sudden demises, they were gradual and took place over a period of time with the airlines getting multiple opportunities to recoup and restructure their operations. Pan Am for instance had received a financial lifeline from Delta airlines but ultimately collapsed in 1991. Similarly in 2013 Jet Airways which had been plagued with financial troubles was bailed out by Abu Dhabi based Etihad airways which picked up a 26% stake in the company. Despite this, jet airways continued on its downward spiral. Finally, in 2019 the airline collapsed into Insolvency proceedings which ironically happened to be a result of Etihad refusing to bail them out again.
With the COVID situation, the spiral has been rapid, and it has affected almost every airline in the world in one way or another. Airlines quickly responded to this by cutting back on jobs, reducing pay, retiring aircraft, and in cases like Qantas completely reorganizing its operations. However, for some, they simply did not have the financial resources to see them through the pandemic and eventually collapsed.
Why are Airlines so prone to Bankruptcy?
Airlines are notoriously expensive to run which makes the bottom line ever so important for them. In a typical airline company, 35% of its cost is incurred on labor, another 10 to 12% on fuel costs. Further, most airlines given the cost involved in purchasing an aircraft prefer leasing them rather than purchase one. For an airline to recoup its investment it will have to ensure that its aircraft are in the air for as long as possible and are able to carry the maximum number of passengers per flight. Airlines also take great care in ensuring that their flight routes are profitable.
The economics of the airline industry is extremely complicated but one conclusion that can be derived from it is that in order for an airline to remain profitable they have to be able to maximize their revenue all the while ensuring that their operating costs remain well within manageable limits. In most cases however airlines have to borrow heavily to service the operating costs thus making them prone to default if steady cash flow is not maintained and ultimately this can either lead to restructuring or Bankruptcy.
Another reason is that competition drives down the price of Airfare which becomes difficult to sustain for some airlines. This is particularly relevant for traditional airlines that were competing against budget Airlines.
Budget airlines that focussed more on cost efficiency rather than comfort were able to minimize operational costs. This was not the case for most traditional airlines. As prices were driven down which made flying more affordable to the common man, it reduced the profit margins for traditional airlines and led them to lose their market share.
In India Jet Airways fell victim to Low fares offered by low-cost budget Airlines like Indigo and Spice jet and was forced to lower fares to compete with them. This didn’t bode well for an airline that was already plagued with financial difficulties ultimately causing its Bankruptcy.
The third reason and perhaps the most important one is the failure to recoup the bad investment. This is something that in India both Kingfisher and Jet Airways experienced. Ever since its inception, Kingfisher constantly faced losses and to make matters worse, acquired another loss-making airline. The acquisition of Air Deccan perplexed many as the losses and debt kept piling up until Kingfisher had to cease operations in 2012. Jet Airways went through a similar situation when it acquired Sahara Airlines (subsequently Jet lite). Many believed that Jet Airways overpaid for the same, which further contributed to its worsening financial situation.
Losses, Bankruptcy, and debt are the legacy that the COVID pandemic will leave behind for the aviation industry. IATA predicts that in 2020 the total debt in the industry will increase by 28% to USD 550 Billion a USD 120 Billion jumps from last year. Ultimately this will further burden an already overburdened industry. Even if normalcy resumes it will take the industry a while to get back on its feet. If the present situation persists the damage will be even more devastating as more airlines will file for bankruptcy.
Some analysts have suggested a bailout for the industry in other countries like the one in the US, but in many countries, who are already struggling financially due to the economic standstill this option does not seem plausible. Thus, ultimately this episode becomes one of wait watch, to see if the industry can weather out the storm and ultimately “go wheels up again”.