Airlines have always been tough businesses to run sustainably, especially given their focus on high share buyback rates to keep the stock profitable for investors over making sure their balance sheets are stable. The Covid-19 pandemic has made it even harder, as evidenced by the latest calls for a fresh round of industry bailouts.
However, airline investors counting on the infinite generosity of the federal government to save them may end up disappointed this time, in my view.
A different kind of bailout
Government bailouts of struggling industries are hardly a new phenomenon; in the face of the Great Financial Crisis, the American auto industry only survived through the generosity of federal bailouts spearheaded by the Obama administration. However, the rescue package came with stiff conditions, including wiping out most of the equity of the neediest automakers, such as General Motors Co. (GM, Financial).
When the Trump administration prepared its own bailout plan for the struggling airline industry in April, it took a different approach: Unlike the auto industry bailout, which largely wiped out the existing shareholders (meaning they didn't get the bailout for free), the Trump rescue packages largely saved both management and equity from getting the ax (basically a free handout). As I have pointed out in previous articles for GuruFocus, air-carriers such as Southwest Airlines Co. (LUV, Financial) received generous multi-billion dollar bailouts in exchange for just a few warrants that would do little to dilute shareholders even if fully exercised.
Another bailout on the menu
Trump's rescue of airlines in their entirety preserved and even rewarded their debt-burdened and costly capital structures, rather than allowing them to undergo the painful restructuring that is a usual prerequisite for bailouts (but is necessary to make companies stronger). While that has prevented chaos in the short run, it may cause greater problems for the aviation industry as a whole. Signs of this have already begun to materialize, as evidenced by airlines' increasingly vocal requests for another bailout in recent weeks. However, there has been considerably more opposition this time around, especially from leaders in Congress who have questioned the fairness (and lack of effectiveness) of the last generous bailout.
Despite the heightened skepticism in some government circles, it appears that the airlines could get another bailout after all. A new Covid-19 relief bill currently under discussion in Congress could see as much as $1.4 trillion allocated to struggling industries, including $17 billion earmarked for the aviation sector. If the bill passes as expected, it could keep the most stretched airlines from collapse.
A dangerous bet on more bailouts
It now appears that many asset managers have concluded that the federal government will not allow them to fail, or even default. In such a light, one might conclude that the Trump administration's previous generous rescue package demonstrates the government's unwillingness to force the industry into bankruptcy or painful restructuring.
With the government having proved willing to foot the bill for the airlines thus far, many financial operators have reevaluated the risk profile of these companies. For example, asset managers have been plowing into aviation leases, as I discussed in a previous GuruFocus article. Investors seem convinced that the federal government will continue to provide a backstop if things go wrong, making the most poorly-managed companies into the best investments. But that reasoning may be flawed, especially with the imminent transition of a new presidential administration.
My verdict
Assuming that the government will always come to the airlines' rescue, and that said rescue will have terms favorable to existing stakeholders, seems more than a little dangerous, in my view. Having been bailed out at low cost to existing management and equity holders, which provides incentive to keep operating inefficiently, airlines have been grappling with a "new normal" that is likely to see a slow return to pre-pandemic levels of air travel.
In my assessment, investors would be wise to not assume that future airline bailouts will be so generous to shareholders.
Disclosure: No positions.
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