One factor that could spur the number of airline bankruptcies
As the global outbreak of COVID-19 expanded its horizons, the plethora of problems for airline executives also expanded. Carriers aimed to reduce their cash burn in every way possible, including the retirement of older or inefficient aircraft, grounding the majority of their fleets, furloughing employees – the list goes on and on. But there is one factor that airlines have no control over, which could potentially spur the number of announced bankruptcies if travel around the globe becomes limited once again due to the current pandemic.
Undoubtedly, the bread and butter of air travel is the passenger and their flight ticket. A passenger pays for the ticket, covering the airline’s expenses for the flight. If an airline seats enough passengers to cover its costs, it makes a profit. While it is a very simplistic way to look at the way the industry operates, it is no less true.
Airlines rely on passengers to make money, while passengers rely on airlines to satisfy their need to travel from point A to point B. And now, air carriers could rely on passengers not to run them bankrupt if travel is still crippled due to the pandemic.
As COVID-19 spread and governments closed down their borders in order to reduce the spread of the virus, airline revenues depleted. For some, their income was reduced to literally zero. Cargo and repatriation flights became the only saving grace to keep the rivers of revenue flowing. But without any regularly scheduled flights in the air, airlines were forced to break their promise to transfer passengers from point A to point B.
Companies had no other choice but to get creative to keep their liquidity intact. The complex combination of loans, lease payment and delivery deferrals, sale-and-leaseback transactions, and other financial measures were combined with the question of what to do with those passengers, whose flights were canceled.
Cash became the king that had to be saved – in order to save cash, airlines introduced flexible travel options, including travel vouchers in exchange for a canceled flight. While these measures are associated with the beginning of the coronacrisis, airBaltic, for example, introduced a new temporary policy on August 5, 2020, allowing passengers to change their final destination 14 days prior to departure.
The airline’s customers are able to rebook their flight onto another final destination on another date without any additional fees. But the Latvian flag carrier also highlighted another option. Passengers, booked in business and premium economy have the choice to cancel their flight and receive a refund in the form of a gift card.
It is worth pointing out that airBaltic is not offering cash, but a gift card. For regular economy passengers, the choice to cancel a flight and grab a refund in the form of a gift card costs an additional €19.99 ($23.7). So, not only the airline is looking to preserve its liquidity, but to also bolster as much as possible, by forcing travelers to pay to cancel the flight.
As of December 31, 2020, the airline had €31 million ($36.7 million) of deferred income from ticket revenue.
Incomplete flight revenues
Deferred income from ticket revenue means that the company received money from a customer for a service that is yet-to-be delivered. In the airline industry, this usually means a flight. While €31 million ($36.7 million) might not look like a lot, for a company that had €123.8 million ($146.6 million) of cash reserves at the end of 2019, it is quite a hefty sum. The same story repeats itself throughout the major airline companies and groups around the world.
Ryanair, for example, booked €546.5 million ($646.9 million) of unearned revenue as a liability at the end of FY2020 (as of March 31, 2020. The Irish airline had a liability of deferred revenue of €6.1 billion ($7.2 billion) and opening contract liabilities of €1.9 billion ($2.2 billion), partially offset by recognized revenue of €7.5 billion ($8.8 billion), making up the €546.5 million ($646.9 million) total liability related to its unearned revenue.
Its cash reserves stood at €2.8 billion ($3.3 billion), a similar number to the one reported as of June 30, 2020, when Ryanair presented its Q1 FY2021 results.
International Airlines Group (IAG), the parent company of airlines such as British Airways, Iberia, and others, reported its H1 2020 deferred ticket sale revenue as €4.6 billion ($5.4 billion). Its cash reserves stood at an eerily similar level of €4.6 billion ($5.4 billion).
Delta Air Lines, which faces a steeper hill to climb during the crisis due to its investments in foreign airlines, including Chapter 11-bankrupt Aeromexico and LATAM, reported its air traffic liability at $4.6 billion as of Q2 2020. The U.S. based company characterizes its air traffic liability as to the fact when it receives cash for a ticket, records it as cash received on forward-looking bookings, and marks it as revenue when the flight is completed.
Reliance on passenger goodwill
“However, the current reduction in demand for air travel due to the COVID-19 pandemic has resulted in an unprecedented low level of advance bookings and the associated cash received,” noted Delta’s Q2 2020 report. Due to the number of canceled flights, the carrier refunded $2.1 billion of cash to its customers throughout 2020, of which $1.3 billion was during Q2 2020.
Much like everyone else, including airBaltic, Delta also offers credits to use on later flights on the airline. The main goal is, of course, to preserve cash during a volatile situation, where the future is uncertain. The air traffic or deferred ticket revenue liabilities, theoretically, could all turn into negative cash flow if worst comes to worst, and lawmakers from every corner of planet earth decide to completely shut down air travel.
Then, combined with the fact that forward-looking bookings have dwindled down to unprecedented lows, airlines would rely on passengers to take credits or vouchers, rather than cash. Already cash-strapped, many carriers in the industry took out loans or debt facilities to cover their short-term expenses as revenues were the only ones who went on a vacation. With looming debt maturities, a potential second wave of massive capacity cuts and cash refund pleas might spiral the sector into a bankruptcy rollercoaster, which so far was avoided.
However, that scenario is a big pot of what if’s – what if travelers do not mind taking vouchers? What if there is no second wave of massive capacity cuts? Nevertheless, a threat looms if demand for air travel does not pick up, or even in a worst-case scenario, plummets further.
For example, United Airlines highlighted that in the light of the pandemic, the airline has seen an increasing demand for refunds, which lowers United’s “liquidity and put us at risk of triggering liquidity covenants in these [financing and credit card – ed. note] processing agreements and, in doing so, could force us to post cash collateral with the credit card companies for advance ticket sales.”
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