S&P on COVID-19 impact: airports' long haul to recovery

Summary

Standard and Poors projects:

• Air passenger numbers to drop by up to 55% in 2020.
• A slow, anaemic 'swoosh-shaped' recovery is anticipated.
• Return to normality based on satisfying passenger concerns.
• 12 lowered airport ratings Mar to Jun-2020.
• Negative -5% to -10% passenger traffic anticipated even in 2023.
• Post-COVID-19 aeronautical revenues will be significantly lower.
• Other income will be insufficient.
• Single-till regulatory regime no longer appropriate?
• Non-aeronautical revenues also struggling.
• Airports under pressure to reduce costs.
• Concession fees and taxes paid to governments not being reduced.
• Liquidity Is Crucial.

Airport financial strength and flexibility will be eroded over the foreseeable future

According to the credit ratings agency Standard & Poors (S&P), airports across the world face a long, slow climb to recovery from the fall in traffic and revenues due to the COVID-19 pandemic lockdowns and travel restrictions.

S&P estimates in a recent report that the global air passenger numbers will drop by approximately 50%-55% in 2020 compared with 2019 - a far steeper decline than it anticipated two months earlier. It expects passenger numbers will stay below pre-pandemic levels through to 2023.

At the time of the report (end May-2020) S&P said that since Mar-2020 it had lowered the ratings on 11 airports and assigned negative outlooks or negative CreditWatch placements to a total of 128 issuers and transactions. S&P believes additional rating downside is possible over the next few months and there was a further one in June, although the rate of such downsides has lowered considerably.

S&P added that, notwithstanding the long term infrastructure significance of airports, it expects their financial strength and flexibility will be eroded over the foreseeable future by the magnitude and duration of the current airport sector shutdown, an anaemic recovery, capacity restructuring, and heightened counterparty risks of airlines.

A "Swoosh-shaped" recovery

The rapid global spread of COVID-19 has encouraged most governments to impose mobility restrictions, including blanket bans on incoming travellers or two-week quarantine requirements.

Now that the peak of the virus spread appears to have passed in many countries, several governments are looking to open their borders slowly and selectively. The path to air traffic recovery will depend not just on the pace of these border openings, but also on airline fleet capacity and route planning, passenger demand, and the economic burden resulting from the severity of the coronavirus pandemic.

That economic burden is yet to hit home in most countries and there is little talk publicly of the political burden flow-on, which could be equally significant, or even more so.

Air travel will return when health and safety concerns have been "meaningfully addressed"

As a result, S&P now expects what it calls a "swoosh-shaped" recovery for aviation - a slow climb back after a rapid decline, and one that will be a much more protracted recovery than the rebounds observed after the 9/11 terror attack, the SARS pandemic of 2003, and the 2008/2009 global financial crisis.

Over the longer term, S&P believes that air travel will eventually return when current health and safety concerns have been "meaningfully addressed" (not defined) by the industry and consumer confidence rebounds, supported by steady historical growth rates in air traffic of 4%-5% per year.

However, a more widespread adoption of remote working and virtual meetings could have a lingering impact on business travel, which has been the more lucrative passenger segment for the airlines.

S&P has substantially revised downward its base-case assumptions for global passenger air traffic volumes (from 2019 real traffic)

Year	New estimates (versus 2019 actual)	Previous estimate (as of Mar-2020)
2020	Negative 50%-55%	Negative 20%-30%
2021	Negative 25%-30%	Negative 10%-15%
2022	Negative 15%-20%	Negative 10%-15%
2023	Negative 5%-10%	--

S&P now estimates that global passenger air traffic will decline by between 50% and 55% this year (see the table above).

This takes into account almost three months in which traffic dropped below 90% in comparison with the same period in 2019 because of the lockdown measures. This decline may vary across regions, depending on the mix of domestic and international traffic. For example, European air traffic will be the heaviest affected, dropping by at least 55%.

Estimates for 2020 and 2021 are relatively closely aligned with IATA's latest air travel outlook for the next five years, published on 13-May-2020 (see Chart 1 below).

S&P expects a more prolonged recovery, possibly stretching beyond 2023, reflecting the many operational challenges and consumer behaviour unknowns.

Chart 1: comparative S&P and IATA air travel outlook, five years

Source: S&P.

The example of mainland China, where the lockdown is now over and only sporadic new domestic cases of COVID-19 are being reported, gives some insight into the shape a global recovery for airports might take.

(NB this statement was made before any 'second wave' was identified in China.)

Air traffic in China is gradually recovering, more recently to 40%-50% of 2019 traffic levels from a low point of minus 90% year-on-year in mid-Feb-2020 (see chart 2).

However, almost all current travel is domestic, because China has significantly slashed international flights, prohibited entry of foreigners, and requires mandatory quarantine measures for returning residents.

Chart 2: China's air traffic slowly recovering

Source: S&P.

Post-COVID-19 aeronautical revenues will be significantly lower

In the post-COVID-19 era (although no one has yet identified when that is likely to be), airports will operate under a "new normal".

They will have significantly higher spare capacity than in the pre-pandemic period, and will have to compete in a universe of a smaller number of - and financially weaker - airline companies. This will increase their exposure to volume risk and put pressure on their aeronautical revenues, which generally represent over 50% of total revenues, despite consistent efforts to boost non-aeronautical revenues (see charts 3 and 4).

Chart 3 suggests that the aeronautical revenue part of the mix is slightly reducing in most regions, but slightly increasing in Latin America. Overall, there has been little change over five years.

S&P believes airports could ultimately face additional pressure to alleviate aeronautical charges. Many airports in the U.S. have offered airlines a deferral in rentals and other fees in the short term under the assumption that traffic levels will rebound.

Chart 3: pre-COVID-19 aeronautical revenues as percentage of airports' revenue mix

Source: S&P.

In Chart 4 there is no clear pattern to average aeronautical revenues per passenger in any region.

Chart 4: pre-COVID-19 average aeronautical revenues per passenger

Source: S&P.

Other income - cargo flights, charges for parked aircraft etc. - is insufficient

Even though cargo flights transporting essential goods are on the rise (CAPA comment: along with passenger aircraft temporarily converted), they do not make up for the loss of passenger traffic because the overall volumes are not material.

See an associated CAPA report: Air cargo revenue to grow in 2020, as total airline revenue halves).

Most airports charge parking fees for grounded aircraft, but these revenue streams are also relatively small.

Many airports have been offering one or more runways for parking where they have multiple runways, but there is a growing preference now for the use of smaller regional airports for longer term parking. For example, the disused Ciudad Real airport in central Spain, where temperatures can be similar to those of Arizona, is suddenly popular.

Moreover, says S&P, airports could suffer from the debilitated credit quality of airlines. We have already seen measures to alleviate the airlines' liquidity squeeze - such as the European Commission's decision to defer for several months air traffic control fees, which are adding to the woes of the airport industry. The single-till regulatory regime's weaknesses have been laid bare - time for change?

In theory, single-till regulatory regimes - in which all airport activities, including aeronautical and commercial, are taken into consideration to determine airport charges - allow for charges to be reset to adjust for drops in passenger volumes, albeit with a time lag to the next reset. However, this business model has not been designed to adjust tariffs in the face of a massive drop in volumes, or to determine whether airlines could afford them.

S&P believes that financially weakened airlines may have stronger negotiating power in the face of lower supply, and may be unable or unwilling to pay higher aeronautical fees.

In EMEA and other regions, weighted average cost of capital (WACC)-based regulatory frameworks are likely to bring little value in the new post-pandemic reality. S&P expects airports may be allowed to enter bilateral commercial deals with airlines, under which aeronautical charges are dictated by market demand, discounted, and sometimes waived.

Non-aeronautical revenues are also struggling

Retail revenues, the share of which has risen in recent years to 45%-50% of most airports' revenue mix, will likely be even more heavily hit than aeronautical revenues. This is not just because of the drop in passenger numbers, but also because of lower purchasing power due to the global recession, which will cut the average spend per passenger.

Furthermore, revenue that airports previously expected under minimum guaranteed volumes from retail partners may be delayed, or not come at all, if calculated as a percentage of sales.

Alternatively, tenants may request rent waivers and deferrals or - in the worst case - may not survive the disruption. Commercial and food and beverage services are all challenged: social distancing does not work for catering services, while various safety protocols could restrict retail opportunities.

Airports under pressure to reduce costs

Although the credit quality of airports tends to be significantly more resilient than that of airlines, one weakness for airports is that they have largely fixed cost structures.

As long as an airport is open to flights, even if only cargo flights, it has to maintain fire-fighting, maintenance, and operating staff to ensure safety. If an airport also serves repatriation planes, it has to keep its terminals open and maintain light, heating and air-conditioning, as well as other utilities. Operational, maintenance, and utility costs, as well as personnel costs, usually correspond to approximately one half of an airport's costs.

In fact, many multi-terminal airports have centralised their operations in one terminal, or even used VIP facilities instead of main terminals.

Chart 5: operating expenses the larger part of airports costs (2018)

Source: S&P.

Personnel costs - some airports taking harsher measures

Personnel costs usually make up approximately one third of total operating costs.

Any reduction tends to be very limited, usually restricted to cutting executive salaries and making redundant the middle management layer.

Similarly to other industries, some airports benefitted from wage subsidy or furlough schemes that should allow for a rapid return to full operations. Once the furlough schemes are over, however, the airports may start thinking of resizing their businesses.

Two recent examples of government-owned airports adopting harsher measures to minimise cash burn include Tocumen International in Panama, which applied a 50% cut in wages, and Dublin Airport in Ireland, which is seeking potentially to cut a significant number of its 3,500 workforce.

Concession fees and taxes paid to governments not being reduced

These represent 10%-20% of costs. In Latin America, some governments have provided liquidity relief by granting deferral of the annual concession grant payment.

However, most governments elsewhere have not felt the need to do so, as international airports that S&P rates started from a position of strong financial strength.

Despite representations made by trade bodies such as ACI, airports are in fact behind airlines in the queue for the receipt of any kind of 'state aid' and, it would seem, are generally well towards the back of that queue, owing to previous highly positive financial reports. Sometimes it pays not to be too successful?

Capital expenditure deferment

To alleviate immediate cash burn, airports are likely to defer major capital expenditure as expansion plans are likely pushed back. A number of rated airports have already reduced their plans for 2020 and 2021 while waiting to assess the speed of recovery.

Given the weak state of the airline industry, any capex that is dependent on higher charges may not eventuate until there is confidence in economic returns through appropriate charges. It is yet to be determined whether the GBP14 billion investment in a third runway at London Heathrow Airport will again get the green light, following an appeal for climate-protection reasons.

The exception is Hong Kong International Airport, where S&P expects the airport authority will continue the three runway system project through to completion in 2024, given its advanced progress (construction started in 2016).

In addition, a more material cost increase is likely to come from a need to invest in technology to ensure contactless check-in and luggage handling, or face recognition at security.

(See also an earlier CAPA report: Many major airports not delaying capex despite COVID-19).

Liquidity Is Crucial

While airports generally have stronger cash positions than airlines, the pre-pandemic boom in traffic has left many airports currently highly debt-leveraged. This has two consequences.

Firstly, the ongoing cash burn for operations and servicing debt interest leaves them in need of ensuring adequate liquidity. While some governments are providing loans and/or guarantees, many others have been clear that airports must first exhaust commercial sources of support, including shareholder capital, before appealing for government help.

In EMEA, most major national airports are still comfortably able to access financing. However, secondary regional airports may struggle (note: especially those that are still operated by local, regional or national governments).

In Latin America, Aeropuertos Argentina (Corporacion America, which listed on the New York stock exchange) and ACI Airport Sudamerica, respective concessionaires of the Argentina and Uruguay international airports, have already announced distressed debt exchanges to preserve liquidity. This has highlighted the limit in offsetting revenue decline and led to a rapid transition of ratings.

Secondly, S&P expects some airports to breach covenants depending on the severity of the deterioration of financial metrics. In general, it expects debt providers to be willing to cooperate and waive covenants as long as the breaches are related only to the effects of COVID-19 rather than underlying business weakness.

Nevertheless, creditors may attach more onerous requirements to accept waivers.

Global economic recession imminent. And a high degree of uncertainty

In conclusion, S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about mid year, and S&P uses this assumption in assessing the economic and credit implications.

It believes the measures adopted to contain COVID-19 have pushed the global economy into recession.

Indeed, S&P Global Ratings anticipates a deep recession in 2020, with GDP set to contract by 7.8% in the EU and 5% in the US.