International aviation industry consultant and Aviation Festival Americas Chairman René Armas Maes outlines ways airlines can execute a cost cutting plan to effectively tap private and public funding.
As airlines continue observing a significant global reduction in passenger demand, capacity is being cut and routes continue to be canceled.
Amid government actions to limit travel to contain the global COVID-19 pandemic, on average airlines have slashed from 50 percent up to 96 percent capacity both domestic and internationally as an initial measure for the next 2-3 months.
Besides, Emirates and Etihad have grounded 100 percent of their fleet for the next 3-to-4 weeks. Likewise, EasyJet has grounded its entire fleet of more than 300 aircraft effective March 30th due to COVID-19 and announced no forward visibility by when flights will be resumed.
As this pullback in capacity accelerates, we can observe lower ticket sales per day, fewer airline fee collection, and more credit being issued to customers due to travel cancelations.
The higher-than-normal cancelation rates have put the entire air transportation ecosystem on its knees. At the same time airlines’ revenues are being slammed, carriers’ high fixed costs and other expenses remain intact. Simply put, the expected surplus of the revenue minus cost equation is not there anymore.
The Decisions Airlines Face Now: How Much To Cut
Unprecedented times require drastic measures. Cutting capacity as aggressively as possible is one of them, as, unfortunately, both gross and net global bookings continue showing a downward spiral (and the few ones are at lower fares) as demand has evaporated.
If demand does not pick up in the next 3 months, the problem can escalate very quickly up to the point where we might observe closings, potential acquisitions of weaker carriers, and bankruptcies.
Furthermore, mature markets, one of them being the Europe, appears up for an important survival test and shake-out. Many European airlines might not have enough cash and liquidity to survive. Price wars and overcapacity have led to pricing/margin pressures and unprofitable operations.
Consequently, global airlines need to cut costs as aggressively as they can to survive. Many airlines have expressed their current weak financial situation and the need for government assistance. It’s clearly understood that aviation jobs are at stake, but other key industry jobs are as well, including agriculture, auto, financial, cruise ships, hotel and tourism, among other as the global economy starts to shrink.
Finding Funding Sources
To improve airlines’ opportunities to tap both private and public funding, a robust and aggressive internal cost-cutting plan needs to be in place. The focus should be in pursuing all potential avenues to enhance liquidity under these uncertain times. A number of potential measures follow:
1. Improve liquidity position
a. Evaluate and appraise assets that could be put up as collateral to raise cash. These include aircraft, spare parts, engines, specialized tools & equipment, real estate, etc.
b. Investigate intangible assets and think about partners in your frequent flier programs and co-branded credit cards as they could be a source of cash
c. Use bank revolving credit facilities and letters of credit to preserve financial flexibility
2. Sale of assets including aircraft and Sale and Lease Back (SALB):
a. Selling an asset and SALB deals can provide airlines with immediate access to cash
b. SALB deals can improved working capital position, bring predictability to fixed monthly payments, eliminate residual value risk while providing tax advantages and improved balance sheet benefits among others. They also bring extra flexibility to airlines when market conditions shift.
3. Execute commercial renegotiations and contracts
a. Discuss more flexible payments, conditions and potential price reduction
b. Negotiate aircraft financing conditions and/or get refunds on aircraft deposits. As a solid demand rebound might occur in the next 12 months (yes, that far and it will be covered in a follow-up article), airlines especially those with large aircraft order backlogs could put pressure on OEMs to delay, renegotiate or get aircraft deposits
c. Consider Force majeure clauses. Look for opportunities to defer payments, aeronautical taxes and other fees. Understand what a failure to meet obligations means in terms of contract default
d. Review contract notification clauses (and its related payment delays), mitigations and what are the liquidated damages if a contract is terminated
e. Moreover, negotiate special concessions from the entire air transportation industry ecosystem and supply chain focusing on liquidity flexibility
4. Cash flow management
a. Manage and prioritize key suppliers’ payment obligations, can you defer payments? Get a 30-day extension? As you might plan to defer payments, evaluate the impact of insolvency and contractual risk
b. Find out what suppliers and lessors’ is keeping them awake at night and determine a plan vs. your financial needs. Think in terms of how they plan to protect themselves against extensive insolvency in the industry and if a large quantity of second-hand aircraft hit the marketplace at once, what would it do to aircraft rental rates? Most likely they will be depressed impacting a lessor business heavily. Therefore, your opportunity to negotiate looks brighter.
5. Leaner human capital cost structure
a. Consider voluntary unpaid leave for up to six months. Incentive perks such as the possibility to retain health benefits and travel privileges can be valuable to maximize the number of participants. Eleven percent or 10,000 Delta Airlines employees have signed-up for it
b. Evaluate changes to pay rates. In addition, consider other opportunities to reduce headcount such as unpaid vacation, reduced work time and furloughs
c. Consider strategic layoffs
6. Workforce salary cuts, bonuses, recruitment, dividends and consulting work
a. Consider executive management cuts and start form the top. Executives cuts can range from 15 percent to 50 percent for a number of months and as high as 100 percent as recently stated by Qantas CEO for the remaining of the year.
b. In addition, consider no fee (or reduction of) payment to the Chairman and the Board, no annual bonuses for fiscal year
c. Evaluate directors, managers and operational staff pay cuts
d. Stop dividends payout. As an example, Lufthansa just did it to preserve cash on hand
e. Finally, discontinue all non-essential recruitment and consultancy work
7. Review of ongoing capital projects
a. Consider reviewing capital expenditure projects and deferring the purchase of new equipment but look carefully at those multi-million dollar cut cutting projects as they can save you important resources during this crisis. Therefore, you might need to renegotiate key capital projects in order to further reduce costs.
8. Rescue package - Government aid and other incentives
a. Consider and negotiate cash advances, subsidized state guarantees on loan banks, grants. In addition, access to public and private loans with subsidized interest rates
b. Evaluate tax relief opportunities including complete removal of aviation taxes (airline tickets, payroll, etc.) for a limited time
c. Investigate opportunities related to business tax deferrals (or even tax holidays)
d. Consider government equity stake and its implications in terms of shareholders’ interest dilution, right to oversee airline operations and review financial statements. Other limitations associated with a government stake can include no stock buybacks, no dividend payout, no executive compensation increment for a number of years, etc.
Airlines need to look internally first and execute a sound cost-cutting and restructuring plan. It starts from the very top. It must include cutting salaries and bonuses from group CEOs, unit CEOs, and the board. Those reductions should be followed by other measures described in this article.
To conclude, airlines will need prove greater focus among the CEO and senior management in terms of commitment, talent and great teamwork to get out of this crisis. In addition, it is key to continue evaluating all opportunities to reduce costs to secure the financial viability of the businesses. Moreover, it should be a continuous companywide exercise, one where multiple rounds of major cost-cutting efforts are expected. Perhaps, a second, third and a fourth cost-cutting exercise or even many more will be needed.
Finally, and in order to survive, airlines need to be aggressive and firm in those decisions to be made. Under this crisis, it might be prudent to be too aggressive as rather looking back and wishing harder measures had been taken sooner. Otherwise, one risks putting a business at a competitive disadvantage in terms of funding accessibility or even worst yet a closing or takeover.
About our guest author, René Armas Maes:
René is an International Consultant and manages several global consulting projects with a key focus on revenue optimization, cost reduction, business restructuring and strategic planning. René Armas is an airline and airport management instructor . He is a regular contributor to a number of air transport publications including in the US, Canada, Europe, and Latin America. You can reach René through his LinkedIn page.