Barron\'s 03.16.2020

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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already looks outdated.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

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60

40

20

0

20%

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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

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