24 BARRON’S March 16, 2020
which announced on Thursday it
would lay off half its employees and
ground 4,000 flights, will have a much
bumpier ride.
The World Health Organization has
declared the new coronavirus a pan-
demic, and infectious-disease experts
have estimated global contagion rates
of 60% to 70%. China, India, Japan,
and Italy are restricting international
travel, with other countries curbing
travel or limiting tourism almost
daily—or, in the case of Israel, kicking
out all tourists. This is social and eco-
nomic distancing on a scale never seen
in a globally interconnected economy
so highly dependent on the free flow
of goods and people.
No other modern disease outbreak
comes close to the impact—not SARS,
avian flu, or Ebola. If the closest paral-
lel is the 1918 flu epidemic (when there
was no antiviral medicine or antibiot-
ics), we could see millions of deaths
worldwide, a global recession, and the
end of air travel as we know it. In that
scenario, “we should be talking about
where we take our families and how
many deer rifles we have,” Bernstein
analyst David Vernon tellsBarron’s.
“I’m optimistic the industry will sur-
vive,” he adds, “but I can’t with any
degree of confidence eliminate the risk
of bankruptcy.”
The airline industry will certainly
survive—it has to, if we are to survive.
The aviation industry is the backbone
of global economic growth, facilitating
trade and tourism, and directly and
indirectly employing more than 20
million people. Governments will un-
doubtedly provide relief measures if
the industry appears on the verge of
collapse. And one could map out a
scenario where travel resumes as vi-
rus cases start to peak and then recede
in a few months. Airline stocks got a
lift Friday with Trump’s declaration of
a national emergency.
But the near-term outlook is bleak.
Vernon’s worst-case scenario from
March 5—a total collapse in Pacific
routes, 52% decline in Atlantic travel,
and 50% drop in domestic air travel—
already looks outdated. Investors are
panicking: Airline stocks have col-
lapsed by an average of 38%—more
than double the 16% decline of the
S&P 500—since the start of the year.
The market appears to be bifurcating
between carriers that have the bal-
ance sheets and operations to survive,
and those that may be imperiled.
Spirit Airlines(SAVE), one of the
hardest-hit stocks, has lost more than
half its value, trading at a market cap
of just $1 billion. British low-cost car-
rier Flybe filed for bankruptcy protec-
tion in early March, andKorean Air
Lines(003490.South Korea) warned
employees that “if the situation con-
tinues for a longer period, we may
reach the threshold where we cannot
guarantee the company’s survival.”
Nonetheless, airlines have a long
history of filing for bankruptcy protec-
tion, due partly to their high fixed costs,
like financing planes and employing all
those people, relative to variable costs
such as fuel, which can only be cut so
much and so fast. It’s reasonable to run
stress-test scenarios: Which airlines are
likely to get through the crisis? Which
could see their equity wiped out? And
which may not be flying a year from
now? Every carrier is different, and
some look more vulnerable than others,
based on their balance sheets, routes,
and other factors.
The Good News
Two decades ago, airlines probably
wouldn’t have stayed solvent in this
situation. The industry was more frac-
tured, less profitable, and plagued by
overcapacity. Every major airline, ex-
cept forSouthwest Airlines(LUV),
went bankrupt in the economic down-
turns that followed the 9/11 terrorist
attacksand the global financial crisis of
2007-09.
Yet the industry has consolidated
and become more structurally sound,
making it more resilient to demand
shocks. Airlines have reduced excess
capacity. They’ve found new revenue
streams in areas such as baggage fees,
premium seating, and credit-card loy-
alty programs. They have improved
their credit ratings, labor costs, and
balance sheets. And the industry’s
route structure is deeper—domestic
airlines now fly more than a dozen
flights daily between large cities, en-
abling them to curtail capacity with-
out abandoning the route if demand
falls sharply, Vernon points out.
Warren Buffett, after years of de-
riding airlines, became a fan, amass-
ing an 11% ownership stake in Delta
and 9% of Southwest at the end of
2019, worth nearly $5 billion, through
his holding companyBerkshire
Hathaway(BRK.B). He said on Fri-
day that he won’t be selling any of his
airline stocks.
The balance between fixed and
variable costs still poses hurdles,
though not as steep. Deutsche Bank
analyst Michael Linenberg estimates
that the industry’s cost structure is
now 45%/55% variable versus fixed
compared with 15%/85% two decades
ago, which means they can reduce
costs, and protect profits, more easily.
The biggest variable cost—fuel—has
plunged more than 30% in recent
weeks, and airlines should benefit
since most of them reduced or elimi-
nated fuel hedging programs after
being burned in 2008.
What the Airlines Are Doing
Airlines, meanwhile, are announc-
ing measures to conserve cash almost
daily. Delta is planning to pare 40% of
its capacity, the largest cut ever.Amer-
ican Airlines Group(AAL) says it
plans to cut domestic capacity by 7.5%
in April and slash 10% of international
capacity over the peak summer travel
season. If you’re thinking of flying to
China from Los Angeles or Dallas on
American this summer, don’t count on
it; those routes are now suspended.
American declined to comment.
United has announced a 10% cut to
its domestic schedule and 20% for
international travel in April, and says
it expects an overall cut of 20% in
May. United told analysts this past
week that net bookings to Europe and
Warren Buffett
Isn’t Selling
He owns big
stakes in two
airlines:
11%
of Delta and
9%
of Southwest
Source: Bloomberg
80
60
40
20
0
20%
3
AirlineStocksHave
HadaRoughRide
Airline stocks have trailed the broad market for years, but things got worse when the
Boeing 737 Max was grounded. Things got worse again as the coronavirus pandemic led to
global restrictions on travel.
Jan. F M
2020
Jan. F M A M J J A S O N D
2019
O N D
JetBlue
Delta
American
Southwest
United
Spirit
Oct. 29
Lion Air Flight
610 crash
(^1) March 10
Ethiopian Airlines
Flight 302 crash
(^2) Jan. 21
First U.S.
Covid-19 case
confirmed
(^3) March 9
Italy locks
down the
entire
country
March 11
Trump
announces
EU travel
ban
4 4
12 4
CRISIS PLAYBOOK