The results for the grounding phase are now in

We have now had the Q2 results for the three big European airline groups (Air France-KLM, IAG and Lufthansa) and the three big low cost carriers (easyJet, Ryanair and Wizz). Most industry experts would agree that these six companies will survive the pandemic, but as we leave the grounding phase and enter the restart, how are things looking for these companies in comparative terms?

There is an old joke about a tourist in Ireland who asks a local how to get to Dublin and is answered “Well sir, if I were you, I wouldn’t start from here”. This is wise advice, so let us look first at what kind of financial state each airline company was in going into the crisis.

Not everyone was in great shape before this

In terms of profitability, Wizz, Ryanair and IAG were earning healthy margins before the crisis hit, with easyJet trailing a bit. The other two network airline groups were in difficultly before the pandemic, with margins that would not be sustainable over time.

Who had money put aside for a rainy day?

In terms of balance sheet metrics, all three of the low cost carriers were very well placed. EasyJet were less well endowed in terms of cash, relying instead on headroom to borrow against their unencumbered assets.

The big three network airline groups all looked pretty similar in terms of net debt / EBITDA, the main debt affordability measure that they all target. At 1.5x, most analysts would say that is a comfortable level of debt. However it is quite a bit higher than the low cost carriers. Air France-KLM’s history of weak profitability had left it with a weak equity base, making it quite stretched on a debt/equity gearing basis. Lufthansa’s main weakness was a very low level of cash, leaving it very dependent on debt markets remaining open, something it would come to regret when the COVID 19 tsunami arrived.

*All metrics are for the most recent full financial year.*

The millstone of fuel hedging

When the pandemic struck, two things happened. The first was the mass grounding of aircraft and reductions in capacity plans for the rest of 2020. That hugely reduced future fuel requirements.

The second was the collapse in the oil price, which halved from the levels at which carriers had placed hedges before the pandemic. Normally, lower oil prices would be a good thing for airlines, but for those that had forward hedged the price of their fuel, their hedging losses suddenly became a pure loss without a saving to go with it.

What had been put in place as an insurance policy had turned into a financial millstone.

These losses were provided for by carriers in the profit and loss account in Q1, with adjustments each quarter as usage expectations and the forward oil price move around. In cash terms, they hit during Q2 and beyond. IAG has the biggest issue, for reasons I don’t completely understand. Normally, it would hedge fuel on quite a similar profile to its main European competitors. Ryanair also has quite a big issue relative to its size.

I think it is best to think of these losses as an additional debt on the balance sheet that each company took into the pandemic. In the case of Ryanair it roughly doubles its net debt if you think of it that way, but it is still one of the least indebted companies here.

Containing costs and generating revenue in Q2

With Europe in lock-down, most airlines grounded their fleets and hunkered down with a focus on minimising costs. However, one or two pursued a more aggressive approach and flew a bigger programme. Which approach worked best?

In the chart below, I’ve plotted the Q2 declines in cash costs and revenue versus last year, together with a ranking of who got the best outcome, considering a balance of both factors. I’ve done the rankings based on Q2 2020 EBITDA (a measure of cash burn) divided by Q2 2019 ASKs (a measure of size going into the crisis).

For this, I’ve split out the constituent airlines of the multi-brand groups where I have the data to do so, as I think there are some interesting stories which aren’t clear at the group level.

Q2 Reduction in Cash Costs vs Revenue.png

The green line shows points where cash operating costs reduced in line with revenue. Nobody managed to hit that benchmark, although the two “ultra low cost” players, Ryanair and Wizz, came closest. Wizz marginally pipped Ryanair to first place in the rankings, flying more than twice as much capacity as Ryanair in the quarter and making it work with 55.5% load factors and RASK actually up 13.6% VLY.

The other two low cost players, easyJet and Vueling, were essentially grounded for the quarter. Whilst not up to Ryanair’s standards, easyJet did an impressive job taking out cost and earned themselves third place. By the standards of the low cost players, Vueling did not do a great job on cost reduction and with almost no revenue in the quarter, trailed in eighth overall. Eurowings is positioned as a low cost carrier, although it isn’t actually low cost and Q2 did nothing to improve the situation. Overall it came bottom of the rankings.

The red line shows points where costs fell by 20 points less than the revenue decline. Points on this line represent approximately equivalent outcomes in terms of containing losses, although the unit cost starting position in 2019 matters too. That is why Air France comes in 9th place in the rankings despite not looking too bad in terms of change VLY.

All of the long haul players were close to the red line, struggling to bring costs down as fast as the low cost short haul players. That is due to the fixed costs that come with a lower level of outsourcing and a lot more hub infrastructure. Lufthansa network airlines came bottom of the rankings. That is partly because of the way Lufthansa splits out its business units, which keeps most cargo revenues separate. If you were to include the full cargo results in the network airlines figures, they would have performed somewhere between Air France and Iberia but still close to the bottom of the rankings.

KLM deserves a special mention for having found a successful strategy which got it into fourth place overall. It flew the most capacity of anyone in the quarter and found enough passenger and cargo revenue to get a better outcome on cash burn for its size than any of the other network players.

Liquidity

The other main activity since the scale of the pandemic impact became clear has been finding sources of liquidity. All the airlines in this sample have secured government backed sources of liquidity to some degree. The UK provided guarantees to support £1.8 billion of loans (€2 billion) for four carriers (£600m each to Ryanair and easyJet and £300m each to British Airways and Wizz). The Spanish government provided €750m for Iberia and €260m for Vueling. The German government stumped up €9 billion for Lufthansa, half in quasi-equity and half in loans and guarantees, although some of that has now been offloaded to the Austrian, Belgian and Swiss governments. Air France got €7 billion of loans and guarantees from the French government and €3.4 billion from the Dutch.

On top of that, EasyJet completed a £419m (€464m) rights issue and IAG announced that it would raise up to €2.75 billion from its shareholders in September.

There have been many other liquidity measures completed such as deals with loyalty card partners and sale and lease back transactions. At the end of this blizzard of liquidity activity and after the cash burned in the first half, where does it leave all the players at this important checkpoint for the European industry?

I’ve shown below the estimated liquidity positions for each carrier as at their Q2 results date. I’ve included deals that were announced but have not been completed at the end of Q2, such as the IAG rights issue and the Amex deal. Lufthansa quote a headline figure which only includes centrally available cash, but I’ve included all cash (adding about €0.8 billion) so as to be comparable with other airline groups.

Overall it shows that the carriers are all in reasonable positions for the next phase of the journey to recovery. The network airline groups have more cash in absolute terms, but they are going to need it. For those who have taken on a lot of additional debt without also raising equity, that will need to be resolved in time.

However, the most striking differences between carriers is how much of the current liquidity position has been achieved with the support of governments, compared to reflecting a strong going in position or “self help” actions.

The next phase

All of this just sets the stage for the next phase. The restart.

How the restart goes will be hugely influenced by developments in containment or spread of the virus, and by government policy actions on travel restrictions and quarantine requirements. That may affect each carrier differently. Equally critical will be the progress each airline makes on cost actions and the capacity and network strategies they pursue. We have seen from the lock-down phase that being bold on capacity can pay off, at least in relative terms. But if carriers start ramping up capacity and incurring additional costs without the revenue to go with it, this could be an even more costly phase than the last one.

I guess we will see how everyone gets on when the next quarterly results come in three months from now.

Place your bets.

Europe’s big airlines clear the first hurdle