Cash-strapped airlines’ mounting debt levels will lead to a rise in air fares and greater government involvement in the sector, according to research by McKinsey & Co.
Airlines are likely to increase ticket prices by about 3 per cent as they take measures to repay debt amassed during the Covid-19 crisis, assuming a 10-year repayment window for only the additional debt taken on during the pandemic, McKinsey said in a report on Friday.
Travellers can expect higher fares when demand for air travel returns as it will likely outpace capacity initially.
“We see a glut of latent demand of people eager to travel. It will take time for airlines to restore capacity, and bottlenecks such as delays in bringing aircraft back to service and crew retraining could lead to a supply–demand gap, resulting in higher short-term prices,” McKinsey said in its Back to the future? Airline sector poised for change post-Covid-19 report.
Airlines were forced to borrow heavily to cope with the staggering rates of daily cash burn during the pandemic that closed borders, withered revenues and grounded aircraft. The industry collectively amassed more than $180 billion in debt last year – more than half of its total annual revenue – through state aid, credit lines, and bond issuances, according to the International Air Transport Association. Repaying these loans is made even tougher by deteriorating credit ratings and higher financing costs.
Government bailouts of the struggling industry come with strings attached, often in the form of shareholding, leading to a re-emergence or increase in state ownership and influence.
“Instead of seeing this as a necessary restriction to access much-needed funds, airlines can treat it as an opportunity to shape how the sector evolves with a key stakeholder,” McKinsey said.
Airlines can work with regulators on committing to reduce carbon emissions in return for more labour flexibility, increasing the cash-on-hand requirements to make airlines more resilient against future shocks, changes in ownership caps to allow greater inflows of foreign capital and reducing the reliance on state capital further down the road, McKinsey said.
The increase in ticket fares was one of five fundamental shifts the industry is experiencing as a result of the pandemic, the consultancy said.
A disparity in performance among airlines in the future, depending on how they responded to the pandemic, is another.
Airlines that are not proactively transforming will risk failing to set the business up for longer-term structural value creation, the report said.
Carriers that have an opportunity to transform their business include those with access to a restructuring process, such as Chapter 11 in the United States. These carriers can renegotiate mid-life leases, shed excess debt, emerge leaner and become fierce competitors going forward.
“Even though many airlines find themselves in financial straits, we recommend investing more in IT and digitalisation, not less,” it said.
Investing in analytics will allow airlines to use data in smarter ways to improve decision-making, which will require some spending but will yield “significant payoffs”.
Another shift identified in the report is that the market for aircraft will remain oversupplied for some time. Prior to the pandemic, plane makers had ramped up production in anticipation of continued growth, leading to a glut in aircraft availability. Now, some airlines are returning relatively new jets to lessors while the prices for used aircraft leases have plummeted and are likely to stay low, the report said.
“If finances permit, carriers can consider acting countercyclically: locking in orders for new aircraft or confirming operating leases now when demand is low,” McKinsey said. “Inking deals during a crisis could allow carriers to enjoy a cost advantage for years to come.”
The consultancy also noted that demand for air cargo will outpace supply for some time. Cargo has been a lifeline for airlines during the pandemic, as e-commerce sales soared while many passenger flights – which are responsible for delivering around half of total air cargo – remained grounded.
In response, “carriers could investigate short- to medium-term opportunities to boost their cargo services”, it said.
This includes the deployment of so-called preighters, or passenger airplanes that are used to transport cargo. Airlines may look at freighter conversions, especially as their passenger fleet shrinks.
The report also echoed industry predictions that leisure trips will drive the travel recovery while business trips will take longer to rebound.