Attention has shifted to airline cash positions as the industry struggles to right itself, reports Chris Tarry and Dominic Edridge at Commerzbank Securities
Suddenly it is cash which is the focus for airlines everywhere. It is an old economic truism that while a high level of operational gearing is beneficial in an upswing, its financial consequences are damaging when markets slow. In the case of the current precipitous decline the consequences could be catastrophic. Today cash is truly king.
Of course, carriers have announced severe cuts to capacity and, in most cases, labour, after 11 September. In fact, it seems increasingly likely that some of those cuts were needed in any case. A future issue may yet become one of whether airlines will be prepared to cut again if circumstances dictate. Last month we highlighted the need that airlines have to preserve cash, and suggested that the principal focus in evaluating a carrier should be based upon measuring the liquidity that it has both within the business and that to which it also has access .
Rolling forward the position from the last reported results gives a perspective. What is more difficult to gauge is the actual cash depletion. It is easy enough to estimate what the cash requirements of any business are if its inflow of revenue stops and it takes no action to reduce its costs. Indeed there has been some rather simplistic analysis of the current situation that use these extreme assumptions. In reality, revenues have not stopped entirely and actions have been taken on cost - although the reduction programmes will not take effect immediately (or for free) so there is a lag in offsetting the revenue shortfall.
There is a further factor in this crisis, too. That is the difference in the support given by governments to offset the financial effects of the fall in the demand for air travel in the wake of the terrorist attacks and indeed the military action against Afghanistan. For the US airlines the support is in respect of the direct effects of the "grounding order" and also for "incremental losses" from 11 September through to the end of the year. In essence it appears that the US Government will make good the shortfall against previous forecasts and compensate for the estimated losses. Indeed $2.42 billion has already been paid over to the industry.
This clearly provides an immediate easing of any liquidity pressures for the US airlines. A back of the envelope calculation suggests that as a result of not operating for the four days in the aftermath of the attacks the revenue loss was in the order of $1.1 billion
Estimating the cash loss, even at a rough level, is more complicated. Although carriers would not have incurred variable costs associated with direct operations, there were clearly significant additional costs that were incurred. However the suggestion is clearly that there is already, in effect, an advance payment in place, with the prospect of perhaps a further $2.6 billion in direct cash aid to come, plus other support in kind. The potential consequences of this have not been lost on the other side of the Atlantic.
In Europe, although the effects on international traffic appear similar, the initial level of government support sanctioned by the European Commission fell far short of the US legislation. In particular, it proposed that only the shortfall as a direct result of the terrorist attacks ($30 million a day) be made good. Europe has had to steer a path between, on the one hand, avoiding a rush to prop up carriers that were already facing a questionable future and on the other ensuring that the support given to the US airlines does not distort competition on the North Atlantic.
Clearly the extent of the financial support has a bearing on the liquidity test that applied to all airlines. Although virtually the entire industry in the USA warned of bankruptcy in the post-11 September environment, it is clear that some groups were in a better position than others. Analysis of the latest available balance sheets as on 30 June 2001, shows the different levels of financial resources that already existed (see table right). AMR and UAL were the most stretched in terms of cash cover for their short term debt repayments.
In fact, the working capital characteristics of the airline industry is an additional threat as airlines operate with negative working capital. Thus as their business slowed and stopped post-11 September this is likely to have partially reversed, resulting in a cash outflow. A prime example of this would be refunding of pre-paid bookings to passengers unable, or unwilling to travel. The European majors also show marked differences in cash cover (see table above).
Overall, however, while some may still focus on debt and balance sheet gearing in the current circumstances these are second order issues. The key words are cash and survival. When some semblance of order returns the focus will turn to balance sheet repair and equity issues. But for now it would appear that, in the eyes of government, some airlines are more deserving of support than others.
Source: Airline Business
