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John Engle
John Engle
Articles (593) 

Airlines Need More Bailouts to Avoid High Bankruptcy Risk

Even after receiving $65 billion in government support, some air carriers may be forced to seek bankruptcy protection

December 31, 2020 | About:

On Dec. 27, the U.S. government's latest relief bill was passed by Congress and signed by the President in response to the ongoing Coronavirus pandemic. The $900 billion economic stimulus package includes a whopping $15 billion allocation in payroll support for airlines, re-establishing a program that had expired at the end of September.

Having already received $25 billion in low-interest loans and $25 billion in payroll grants, as well as significant tax relief, the price-tag of the airline bailout now stands at more than $65 billion. Yet for all that cash, airline operators have continued to struggle operationally and financially, and I believe there is a significant risk of the financially weaker players still being forced to file for bankruptcy protection in the end.

Low demand creates financial pressure

Despite the generous bailouts they received in April, few airlines have been able to weather the financial damage wrought by the pandemic. While air travel picked up a bit more than analysts anticipated during the holidays, passenger volumes remain severely depressed.

With travel volume down, costs have skyrocketed for many air carriers. According to the latest industry report from Ascend by Cirium, a research firm focused on the airline and aerospace sector, virtually every conceivable scenario analysis predicts that it will take years for air travel numbers to return to pre-crisis levels:

"Ascend by Cirium thus constructed two new scenarios in September. These both assume that traffic will level off at 60-70% down on 2019 during the winter, with little meaningful increase in capacity until the northern summer season commences in April 2021...Once effective vaccines are widely available, perhaps in mid-2021, there is a rapid recovery in international demand, led by leisure travellers. In this case, 2019 traffic levels are exceeded in 2023, at a global level."

The faster the recovery, the faster the financial pressure will be relieved, but 2023 is still a long way off.

Dwindling cash, rising leverage

While industry experts see a rebound in 2022 and a return to pre-crisis demand in 2023, there is no guarantee that things will actually be back to the old normal by then. With U.S. airlines currently burning through $180 million every day, passenger demand will need to rebound strongly if they hope to stay afloat without another bailout.

In the face of a sustained cash crunch, many air carriers have been forced to turn to credit markets to plug their financial gaps. Most have seen their debt balances balloon this year, which may become a significant burden post-crisis, according to Moody's Corp. (NYSE:MCO) in its mid-year industry update:

"The airlines we rate will carry on average 20%-30% more debt in 2023 compared with 2019, with leverage on average 0.5x-1.5x higher."

It is unclear whether some airlines will be able to pay down all the debt accumulated over the course of 2020, even if demand returns to pre-crisis levels over the next few years. A number of major names in the U.S. airline industry, including United Airlines Holdings Inc. (NASDAQ:UAL) and Delta Air Lines Inc. (NYSE:DAL), have already joined the ranks of companies with negative Ebitda. Such "negative EBITDA vampires" are worse even than zombie companies – businesses that simply cannot pay their existing debt obligations from their operations.

Bankruptcy may be a better option

As commercial airline operators have continued to see their cash reserves dwindle and their balance sheets weaken, a growing chorus of analysts and commentators have begun to question the wisdom of the government's decision to continue writing blank checks to the industry. According to an October report by the Mercatus Center, a highly regarded economic policy think tank, it might actually be beneficial to encourage struggling airlines to file for bankruptcy rather than continue to bail them out:

"If private financing were to prove insufficient, some airlines could—and should—do what they have done in the past when in such a predicament: declare bankruptcy. Past bankruptcies by Delta Air Lines, United Airlines, and American Airlines (and of corporate predecessors Northwest Airlines, Continental Airlines, and US Airways) show that airlines can continue flying safely even during bankruptcy, so declaring bankruptcy poses no systemic risk to the economy. If an individual airline were to shrink in bankruptcy, that would benefit the industry as a whole, allowing other airlines to recover more quickly."

If the federal government fails to maintain the same level of generosity it has shown the commercial airline industry to date, many struggling operators may have little choice but to file for bankruptcy.

That may not be a bad thing for the companies in the long run, as it would allow comparatively better-off airlines to recover in a slightly less saturated and competitive environment, while allowing those that cannot continue operations sans bailouts to shed their crippling debts and enter the pre-crisis market stronger.

My verdict

With many U.S. airlines already on a knife-edge financially, this crisis could still prove catastrophic. That makes any investment in airline stocks, even in those of companies with comparatively strong balance sheets, look rather risky in my opinion.

In light of the profound challenges facing the airline industry, as well as the painful and perilous path it must tread on the course to recovery, I am dubious about any investment in the space until a clearer picture of the post-crisis market environment emerges.

Disclosure: No positions.

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About the author:

John Engle
John Engle is president of Almington Capital Merchant Bankers and chief investment officer of the Cannabis Capital Group. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin, a diploma in finance from the London School of Economics and an MBA from the University of Oxford.

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