Barron\'s - 16.03.2020

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already looks outdated.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