CAPA Chairman’s Lounge: Outlook 2021

Transcript

Diagnose first, then fix

Hello again, I'm going to run through some of my thoughts on the situation as it stands today, looking ahead to the 2021, which has probably got as much uncertainty as we were in 10, 11 months ago.

The key point I want to make here is that there seems to be a failure to diagnose what the problem is rather than rushing straight to the solution for airlines - and particularly international airlines.

So the title of my thesis here is, first diagnose the problem, then find a solution. And to be very clear, in 2021, vaccines are not the solution to the problems airlines face.

So diagnosing the challenge is essential to solving it, without diagnosis there can be no cure. That's a holistic statement, but it certainly applies in this case.

What's happened in 2020 has been that both governments and most established airlines have essentially concentrated on preserving pretty much the status quo - staying alive effectively. They don't really, in most cases, appear to have contemplated adaptation to the new conditions.

The airlines face vastly changed conditions in 2021

And those conditions include, high debt levels and debt servicing levels, a slow and uncertain pickup yearlong recovery, lower revenues for the industry, lower yield demand profile, and difficult economic conditions behind that; uncertain economic conditions anyway. And these all contribute to a very different marketplace in 2021. We need to adjust to it.

The revenue profile for airlines in this first half of 2021 looks something close to catastrophic, given that they've been holding their breath for so many months already.

It should improve in some markets in the second half of 2021, particularly towards the end of the year, but with only modest acceleration after the end of the first half.

So, passenger numbers are going to be down, unit yields are down in almost all cases, load factors are down, the market size is down. Fleet sizes are down to adjust for this. Asset values of the remaining fleets and the existing fleets, which may in some cases be secured, secured values for that debt are down.

Fortunately in most cases, total costs are down significantly, which should at some stage in the future be a positive. But not enough to match the new conditions of today.

What is up? Well, the effect of the unit costs are up because of the underlying features, and certainly debt levels and debt servicing costs are significantly up.

For most of 2021, vaccines will really just be a sideshow for international aviation

For most of 2021 therefore, vaccines will really just be a sideshow for international aviation. Particularly for international air travel, the direct and flow on impact of new vaccines is going to be very limited. For example, the rollout will take many months. We've already seen significant delays and clear indications of difficulties in the supply chain, as it where, and having the human resources to deliver.

Secondly, an interesting point, vaccination priority is going to be given to categories who actually have in most cases, lower travel propensity. The younger, more healthy people will not receive vaccinations till later in 2021, even if they receive them in 2021.

Then there's the point that “no one is vaccinated until everybody is vaccinated”. Many countries will be left out in the first rounds while the rich countries sadly seem to claw the vast bulk of vaccines to themselves.

Next there's the issue of the number of vaccines, recognition of the many vaccines. And the power to apply safety standards remains of course, nationally with national health authorities, whatever the World Health Organization and other bodies might say, that's the last resort.

And these authorities have very varying levels of risk tolerance, and consequently quarantine requirements will persist for many, many months. And again, they’ll go in and out as things change.

Absence of corporate travel will undermine quite significantly the economics of long-haul flying

A topic we've addressed many times, absence of corporate travel will undermine quite significantly the economics of long-haul flying, I should say very significantly, not quite significantly. And we've seen, of course, that borders will close and open unpredictably as circumstances change. Hopefully the rapidity of those closures and the widespread nature will not be as significant as they've been in late 2020, but they will occur we know that.

And exceptions to where the vaccine might help, perhaps - and this is a delicate argument - the transit hubs, the major transit hubs like the Middle East, Singapore, Hong Kong. Their ability to reconnect together with, and importantly, state-of-the-art airport connections, intensive testing may allow them to restore a position in long-haul global travel. They still will be subject to the corporate travel loss and the business travel revenues, yields that come with that, but they do have typically lower costs than the full service carriers elsewhere.

There will be bilateral bubbles, again, only with a combination of testing and vaccination; the vaccination alone is unlikely to provide the solution. Within Europe, perhaps, even though Europe, the EU, is being relatively slow in adopting and allocating the resources for vaccines. The US to Central America, which has held up pretty well so far, again, if both the US and foreign vaccination levels is sufficiently high. Bear in mind we're talking later in the second half of this year, probably the third, fourth quarter.

Within North Asia, where, with the exception of the recent spike in Japan, the levels of coronavirus have been relatively low. And then perhaps, and this is a little more controversial, along China's Belt and Road. China is pushing out the China vaccine to a number of its allies along the Belt and Road, and will certainly be looking to leverage the use of the vaccines in that way to expand it, and so its role in international aviation.

Getting from where we are to where we want to be

So where do we start today, the starting points for 2021 that we need to work from to get to where we want to be? A third of the global aircraft fleet remains inactive. 44% of the US aircraft fleet remains inactive. About 51% of the European aircraft fleet remains inactive, it's a much smaller market, much smaller industry.

I talked about debt and debt servicing costs, future debt servicing costs, not just in this year but beyond, for the debt that's been added since COVID-19 alone will exceed the industry's over profit. Let me repeat thatthe debt servicing costs alone, not the repayment of those debts, but the debt servicing costs, from the newly added debt will exceed the industry's highest ever profit.

That's food for thought in terms of looking to where the industry's base is going to be.

IATA's projected the cash burn will continue, and we're talking to the industry as a whole here, throughout 2021. By the end of the year, the vaccines and other resources may well have helped to end the cash burn. But we're looking at at least another 12 months of burn in cash; that's not sustainable.

A nice little map from EUROCONTROL, which shows that the way traffic has been evolving in the worldwide regions. Of the major markets, only Europe and Asia Pacific is operating at above 50% of 2019 levels. The others are all down, in many cases, much more than that. Looking at North Asia specifically, because this is the market internationally, probably, which is closest to recoverySouth Korea domestic is significantly up on last year's figures, 40% up on last year, or has been. And the other markets, as you can see from this, are recovering fairly well.

CAPA’s Growth projections; Middle East has performed well

We've got some CAPA projections that we've done globally, a fairly intensive model that sits behind these numbers, breaking it down almost by city pair, but certainly by country pair. And interestingly enough, the Middle East has performed extremely well, relative to the others.

Just looking at this graph, the vertical dotted green line is where we are today. And you can see it's in recovery from the time when we were back in the depths of the initial impact of the COVID virus. And we're anticipating that that performance will continue to improve right through to the end of this year. (So the left side of the graph is beginning of 2020, and the right side is the end of 2021). So we're slap bang in the middle of it at the moment. A decent recovery, not up to the levels of 2019, but still getting back there - and that yellow line shows you where the target really is to get back to 2019.

Europe has been much more complex. We had a fairly significant recovery in the summer. And again, this goes back to the risk tolerance by the governments and of travellers. The lump there after the drop and the summer, and then a bit of a recovery in December, which probably foolishly allowed the virus to recapture a significant hold in a number of European countries.

So despite that we do see the likelihood that the level of risk tolerance and the sheer weight of numbers in terms of wanting to get back in the air, will perhaps start to manifest itself towards the end of the year, in the third quarter of the year, and maybe even as early as the summer, the Northern summer. It's a challenging one, but there is that significant probability. Much depends on the levels of risk tolerance of the countries involved – but scarcely if at all on the spread of vaccines until much later.

South America has also performed fairly well, particularly when you consider that countries like Brazil, and Peru, Chile have really been struck hard by the virus; but for some reason, airlines have continued to fly, passengers have continued to fly in many cases.

We don't see that trajectory continuing, but at the same time, we don't really see it falling that much, consistent with the yellow line, which represents 2019.

“The entire aviation sector will continue to need financial support in the years ahead”

Globally we are being reasonably optimistic here in terms of where we're at at the end of the year, the solid line represents, essentially a possible trajectory. As you can see from the bands on either side, the upside is much smaller than the downside potentially. So the downside at the lowest point is pretty much back where we are at the moment, which is not a high level.

A quote from the director general of EUROCONTROL, Eamonn Brennan, which I thought was particularly telling and certainly coincides a lot with our views. He said, just like just last month, he said, "It's clear that the entire aviation sector will continue to need financial support in the years ahead."

Key point, and a major impact on the way the industry will look, we must start tackling core issues such as the way the aviation system is financed, regulated and integrated and how it addresses sustainability.

Environmental sustainability

So let's look at that first one, the core issue, addressing environmental sustainability. In the short term it shouldn't be too much of a problem because air services are going to remain pretty much a shadow of their former selves until well into 2022.

So from their point of view, the reappearance will be significant, but there should not be substantial underlying issues that put constraints on the recovery in 2021.

But as the recovery occurs and extends, the industry will have to make much bolder steps, both to produce new solutions and to show that progress has been made towards a wholly new approach to environmental sustainability. A

nd then of course, we've got governments, businesses, and investors increasingly pressuring the aviation industry to show responsibility. That's going to be hard, it's going to be tough. That's going to have a significant impact on the way the industry operates.

Will there be snap back? Of course, but how big and at what price?

So with the recovery process, will there be a snap back? Yes, of course there will be, because people want to fly. But a snap back from the current levels, when will it happen? How big will the rebound be? And what price are passengers prepared to pay? What will the yield profile be?

It should vary by market. Let's look at short-haul domestic short-haul international, and long-haul international. The first two to some extent go hand in glove, the third one is much more problematic.

LCCs are best poised for recovery

Undoubtedly post COVID recovery conditions will suit the LCCs best. They're usually best positioned to benefit from the recovery process after a major shock.

In these subdued economic conditions, they have lower costs therefore can afford to fly at lower fares. And the recovery will be led by domestic and international short-haul markets, LCC typical markets, VFR and leisure travel, typical LCC markets, and by the fact that there'll be limited business travel demand this year.

Equally, most LCCs have better balance sheets than the full service carriers, and tend to be more

nimble in their approach to getting in and out of markets. A short quote from Felix Antelo, who's the CEO of Viva Airlines, speaking at CAPA Live last month, "When you see what happened after the crisis before 9/11, SARS, H1N1, after every single one of those crises..." he says, "The LCC and the ULCC models got out of those stronger."

To look at some of the numbers, North America's LCC market share grew by 10% last year, 2019, to 34.1% of the total market. This is in terms of seats in the market, but in most cases the low-cost carriers actually had higher load factors than the full service carriers. So that perhaps even understates the irrelevant change.

The Latin American LCC market share grew by 10% also to 44%, nearly 45% of total capacity in the Latin American markets. Likewise, South Asia, 75% in 2020, In 2020, really dominant in that marketplace.

And Southeast Asia grew to 57.5%, even despite the fact that this is predominantly an international market and therefore there's a lot of constraints about market access.

The European LCC market share also grew, again, partly international, partly “domestic”. It grew by 5% in the year to 45, nearly 46% of the market. These are significant changes in a relatively short time in markets that are already fairly well addressed by low-cost carries.

Long haul international will be greatly challenged

But to come to long-haul international, for 2021, it's greatly challenged. Most trunk routes will not be commercially viable. There'll be very limited business travel, perhaps as much as 50% of previous levels in the second and half of the year, but even that's probably optimistic.

And on the issue of trunk routes not being commercially viable, many countries will only allow very limited and fluctuating access, making, scheduling, and pricing the whole array of things extraordinarily difficult.

Most European and US major airlines rely heavily on international profits, especially on the North Atlantic where there's less competition, and there's a lot of business travel. And at the other end of the line, shorter-haul feeder services are increasingly competitive and lower yielding.

So the whole supply chain, as it were of the full service carrier is being very, very significantly attacked in this environment.

Corporate duty of care will be a major limiting factor for corporate travel

Talking for a moment about corporate travel, and more specifically, the key limiting factor will be the corporate duty of care. There's a lot of attention focused, obviously on diversion of corporate travel via online conferencing.

But while that will carry a lot of the prior travel related business for the first part of this year, 2021, the bigger impacts will actually be from that corporate duty of care that I talked about. Companies have to be highly risk averse, whether employees are at risk of infection when traveling.

A somewhat more fuzzy one, but working from home has changed attitudes to travel, I think we'll find that provides a lot of the thinking. A much more harder edged one, budgetary controls are going to be much steeper. Structurally too, within most companies, the travel activity has devolved centrally as corporate travel evaporated in 2019. And in the process it's being merged much closer with the way companies look at their budgets.

Companies are recognising very effectively that great savings can be made on a lot of travel. Amazon, for example, which is a big company admittedly, saved nearly USD1 billion on travel in 2019, and have specifically said they will reduce expenditure in future. So that's the sort of indicator of where we're looking for many companies.

And then you've got the growing corporate responsibility issues, the need to be environmentally sustainable. This feature too and other social measures will reduce business travel, will put a drain on business travel anyway. It'll come back eventually, but not in 2021.

The business travel financial pillar has simply collapsed - requiring a fundamental change in the full service model

So for long-haul international services, the business travel financial pillar has simply collapsed. It's got deep implications for the full service airline model, they need to plan for change. And this is what I was talking about before, diagnose what the problem is, and then try to solve it.

But nobody seems to be planning for that. Undoubtedly business travel will recover, as I've said, in the next few years, but it won't recover to previous levels in 2021 or in 2022. So how do you substitute for that? How do you replace that high yielding traffic, which really underpins the operations? Financial conditions like this are going to require a fundamental change in the full service model.

Government subsidy is going to be needed to maintain core international truck routes

We think, almost certainly, in one way or another, government subsidy is going to be needed to maintain core international truck routes, at least in the short term. Because they're going to be largely unviable at least until well into 2022.

In the meantime, two things at leastpartnerships will be increasingly necessary, and for competition bodies, this may well mean that, for the interim, competition law formula will need to be developed to enable essential services to operate more effectively.

But at the same time, of course, you've got to provide for viable operators to make sure that they're protected effectively and to assure they’re able to survive in the interim.

Secondly, government subsidies, which are already significant, are going to be needed to re-establish and to maintain core routes during this period. Really difficult issues for governments, which can't be dealt with unilaterally, and I don't think really we're at the position where there's a great appetite for multilateral agreement on these things.

But someone's going to have to lead, hopefully the EU and the US can start to restore that leadership role.

The aviation recovery is going to need to be health led

And I think this is a really key issue that the aviation recovery is going to need to be health led. It can't be led by the airlines, it can't be led by pushing capacity into the market. Because internationally, government authorities, particularly health authorities, are going to be slow to reopen, they're going to be the ones who pull the strings.

And that will, of course, effectively mean more of the nationalism that we've experienced today. Not necessarily healthy, but inevitable, perhaps gradually becoming more multilateral with more agreement on broader principles, but that again is going to be lumpy.

I've made the point that no one's vaccinated until everybody's vaccinated. It's an exaggeration, but we know that a lopsided recovery is certain. Any coverage outside the richest countries is going to be slow as a result of vaccination.

How effective will vaccine proofing be for airline operations?

There are other issues too, which I won't go into in detail, but it's still unknown whether the vaccine proofing will actually give governments sufficient comfort. Will the US accept the Chinese vaccine? Will the Europeans accept India's or Russias?And equally, vaccines haven't really been developed to prevent vaccinated people from transmitting COVID, so where does that leave us in terms of allowing vaccinated people access?

Does it really provide the desirable respite, confidence for governments to allow markets to open?

The key to reopening will actually be more effective testing

The key will be improved testing and tracing methods, and those that need to be very much multilaterally agree. It's the medical officers who will determine market access. There'll be the decision makers in opening international markets, and they'll need to be confident of controlling domestic spread should that be the case with international visitors coming in, and even international nationals returning.

We've seen in Australia’s state markets, relatively safe markets like Australia, Japan, Korea, Taiwan, where, (with the exception of Japan, as I mentioned earlier), new daily cases are really in single or double digits, not thousands, not even hundreds. Many of these infections come from nationals returning by air from overseas; even though they're going into quarantine, it's very hard to contain this horrible disease.

So in conclusion, the role of the vaccine in 2021, until its use is ubiquitous, will be limited. Market access through testing will be critical to the airlines' survival - critical to travel, but also critical to the airlines' survival.

And as IATA said back at the end of November, “we expect the availability of the vaccine will allow travel demand to rebound only in the second half of 2021”. (I think “rebound” is an optimistic word.) “And we see the possibility of turning cash positive at the aggregate level only in the fourth quarter of 2021.” Really that's unlikely, but if that's going to be the case, if it's going to take that long, there are going to be a lot of people who just will not ever be cash positive because they won't still be in the market.

The bottom linegovernment support and improved testing to accelerate market opening

But my final pointgovernment support, or progress on the use of testing to accelerate market opening, will be critical for the survival of airlines in many regions - I would say everywhere - over the next 12 months.

That is the issue, we need to diagnose what the real problems are in the market.

We need to diagnose where the real potential is for curing this disease, for the airlines financially and operationally. I think it's inevitable, that the industry is going to have to change; and I really don't think that sufficient preparations are being made to adapt to that challenging new environment.

Thank you for that, I hope that's provided some thought-provoking material and I'm very happy to take questions on it.

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