Indigo Partners MD, Bill Franke, and COVID 19: LCCs best placed

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Summary

• Breakeven cash flow should be the first objective for airlines.
• The world is not evenly divided, as airlines seek financial assistance from their respective governments.
• There is a lack of industry coordination regarding steps to take in order for airline passengers and employees to feel safe.
• Indigo believes Australia needs two airlines, and is working to finalise its bid for Virgin Australia.
• There will pressure on aircraft pricing in the near term, but airframers and lessors are attempting to find viable solutions for everyone.
• Not surprisingly, Indigo remains bullish on the ULCC model, and asserts that its portfolio of airlines will continue to offer fares 30% below their competitors.

Airlines need to reach breakeven cash flow to withstand the COVID-19 crisis

As the COVID-19 crisis appeared more quickly than anyone anticipated, the airlines in Indigo's portfolio - the ULCCS Frontier, Volaris, JetSMART and Wizz Air - immediately focused on cash burn, said Mr Franke.

Those airlines had significant unrestricted cash on hand, which is part of Indigo Partners' strategy, "...but you have to measure the burn of that cash against a timeline, and in our case, we made the assumption just out of lack of knowledge that 85% of an airline might be on the ground for up to a year, and on that basis, we tried to calculate cash burn against cash availability and position the airlines for survival", he said.

The good news, Mr Franke stated, is that is "what happened in the portfolio".

Mr Franke's own expectation is that until there is a treatment or vaccine available for COVID-19, "we're all going to be dealing with waves of events", and that leads to a question of when revenue will rebound to a standard that permits breakeven cash flow.

"If you're running an airline today you want to have cash against your objective of when you will be able to have load factors of 50% to 60%, which should provide you with breakeven cash flow, and that needs to be the first objective", he said.

Governments are adopting wide-ranging views on providing aid to airlines

The US ULCC Frontier, which is owned by Indigo, has stated that it could be operating close to a full schedule in Jul-2020.

It is tough to determine if Frontier will revive its schedule that quickly, but Mr Franke explained that Frontier, based on its position in the marketplace and its pricing and the market perception of the product, has recently experienced a recovery in travel, on a route-selected basis.

"I think the important thing is there is progress being made on a weekly basis in terms of recovery at the airline", Mr Franke stated.

See related report: COVID 19: Frontier Airlines has a more bullish view than most

Frontier is getting assistance from the US government in the form of payroll grants and potentially a direct loan.

Mr Franke stated that the world is not evenly divided with respect to government assistance to airlines. In the US there is an overarching view of the need to protect the airline sector from the standpoint that it is a public necessity.

In Europe, he stated that countries were tending to be protective of their own domestic airlines (for example, Lufthansa in Germany and Air France in France). That approach "defies gravity from the standpoint of trying to have airlines be successful and properly positioned in the market place", he said.

There will be some airlines that will encounter financial difficulties without government support, said Mr Franke, which is just a fact of life.

He believes it is useless to try to predict who will and won't survive. It is all a function of an airline's local market, local government support, and passenger support for that particular airline, he stated.

There is a lack of coordination in working to make passengers feel safe

Beginning on 1-Jun-2020 Frontier will begin taking temperatures of passengers boarding its aircraft, and Mr Franke said that the airline had moved forward with that decision "simply because we could never get the regulatory side sorted out".

He stated that it was not a new concept, since other airlines had initiated the practice, but said that it was a simple process to reassure a passenger that he or she is not boarding an aircraft with someone that has an active temperature.

Airports and airlines needed to convince the traveller through a series of actions, before any vaccine is available, that it is safe to travel, said Mr Franke.

"I think the airlines and airframe manufacturers have done an imperfect job of explaining air filtration inside the aircraft and the degree of cycle of air and the benefits that has", he said. Passengers also need to feel safe at the airport, said Mr Franke, which includes crowd management and managing baggage in different ways.

There should be some coordination in the industry on issues such as wearing masks, and other changes necessary in a post COVID-19 environment.

"Individual airlines are taking steps to fit what they think the market wants", said Mr Franke. In some cases there have been false starts with empty middle seats, and that has resulted in politicians jumping on the issue, he remarked. There are also mixed messages on requiring passengers to wear masks. "There is a lack of integration around opportunities to manage the process with the passenger", Mr Franke said, with everyone trying to find their own path forward.

"The last thing we want in the US is some Congressional decision on how we are all going to fly", he said.

Obviously there is a cost to ensure passengers and airline employees feel safe, but Mr Franke said that was part of the process to provide customers and crews with a safe experience. "If there is an increased cost with reaching that point, it is what it is and you have to pay the cost", he said.

Indigo is in the process of examining consumer preference in Australia's market

Indigo is also being opportunistic during the COVID-19 crisis, parenting with Oaktree Capital Management to make a bid for Virgin Australia, which voluntarily sought restructuring last month. Mr Franke characterised Australia as a very interesting market, with a competitive duopoly between Qantas and Virgin Australia.

He remarked that Indigo would like to have an Australian partner, and "that it is the right thing to do".

It is yet to be revealed what strategy Indigo would adopt for Virgin Australia if it emerged as the winning bidder. Mr Franke remarked that the airline had a domestic and international network with widebody aircraft featuring a business class.

"We have to make an analysis to determine whether that travel is important to Australia and important to the success of the airline", Mr Franke said. "We have not made that analysis yet."

He explained that Indigo would need to examine the Australian market in terms of what the consumer wants in the product, and "it is a process in development at this point in time".

The deadline for final bids for the airline is early Jun-2020.

See related reports:

• Why Australia needs Virgin Australia to survive
• Covid 19: Virgin Australia to survive, but in what form - and name?

Indigo remains comfortable with its significant aircraft order book with Airbus

Airlines worldwide are deferring aircraft deliveries and cancelling orders so that they can rightsize their operations in preparation for a slow recovery in demand.

The deferrals and cancellations by customers of Airbus and Boeing are creating several pressure points for the airframers and the leasing companies, said Mr Franke. Airlines are attempting to manage their fleets against their expected new models, and that is resulting in a sense of uncertainty and distress within the aircraft purchasing and leasing sectors, Mr Franke said.

Mr Franke said that, in his own view, there would broadly be a two-year period where aircraft would be available, and depending on the model, "there will be pressure on prices" until the situation is sorted out.

In 2017 Indigo placed a massive order with Airbus for 430 narrowbody aircraft, for operation across its four airlines. Mr Franke remarked that delivery of those aircraft would not start until mid-2023, and Indigo has flexibility to move the aircraft around airlines in its portfolio.

"I feel reasonably comfortable with that order and where we are, and Airbus has been quite helpful in terms of dealing with the current order book and in terms of deferring deliveries", Mr Franke stated. He said that both Airbus and Boeing had had their own issues in manufacturing and delivering aircraft on time, due to plant closures driven by COVID-19.

"Everybody's trying to work together here to get through this problem", Mr Franke said. "It's not adversarial, it is generally an open discussion with leasing companies and with airframe manufacturers trying to find a solution that works for everyone".

Indigo is being both pragmatic and opportunistic in the COVID-19 crisis

The COVID-19 crisis has taken governments and business completely off guard, and two to three months into the crisis airlines worldwide are working to craft strategies to navigate a recovery that will take two to three years at a minimum.

It seems the airlines that make up the portfolio of Indigo Partners are in solid shape as they work through the challenges created by the pandemic; the company is also being opportunistic during the crisis, reflecting its bullishness in the aviation sector for the foreseeable future.