As airlines grapple with liquidity issues in the wake of COVID-19 with peak cash burn for US carriers of over $300M per day in early April, they’ve taken on nearly $40B in additional debt and provided the US Treasury with warrants for 1.7% of their equity. Airlines are currently focused on reducing cash burn by 50% by Q3, and investors will expect airlines to rebuild their balance sheets by paying off this 45% increase in debt as rapidly as possible.
Compounding these liquidity issues, airlines face another critical challenge: the need to restore capacity quickly and flexibly to meet demand, while aggressively downsizing overhead in an effort to survive if demand recovers more slowly and unevenly than forecast. This will be especially challenging for global network carriers, given their reliance on international traffic—which is expected to recover very slowly—as well as their expensive hub infrastructure, which will not be fully utilized during the long recovery.
Non-hub airlines like Low Cost Carriers (LCCs) and Ultra Low Cost Carriers (ULCCs) led growth both during the previous downturn recovery (2008-2013) and expansion (2013-2019) periods. They are well-positioned for what is expected to be a domestic- and leisure-based recovery from the current crisis. ULCCs, in particular, have grown since 2013 and now account for 9.5% of domestic RPMs.
However the recovery takes shape, industry leaders will need to adjust to an increasingly uncertain future. This includes operating differently to stay competitive. It also means quickly restoring capacity when demand rebounds, while reducing overhead costs in case travelers return slower or less evenly than expected.
Striking the right balance will be challenging, but airlines do have options. Consider these actions:
Carriers can also explore the possibility of eliminating hubs. While some industry executives are reluctant to do that, here’s what the data tells us about changes in hub structure after the last consolidation wave from 2008 to 2012: Smaller hubs with a higher percentage of connecting traffic were more likely to be “dehubbed” or eliminated as hubs.
To understand the current competitive positioning of US airline hubs, we analyzed 2019 data, identifying which hubs fall above the same trend line. In a shrinking market, these hubs are more vulnerable since the removal of each flight reduces passengers on other connecting flights, creating a downward spiral, as having fewer connecting flights reduces demand on other flights in the hub. While larger cities have more local traffic to weather this downward spiral, reduced traffic may undermine weaker hubs.
Since international traffic is expected to be the last to resume, we also analyzed hub cities with a high percentage of international traffic. These hubs face added pressure as airlines rationalize their networks to survive in a lower-demand environment that will skew more heavily domestic in the next two years.
While connecting passenger traffic and reliance on international traffic are indicative measures, other factors also define hub competitiveness and airline network decisions. Revenue-related considerations include overlap with other hubs and preservation of key corporate markets; cost analyses should include lease commitments, planned capital expenditures, labor costs and airport fees. Ultimately, however, it will likely be necessary to reduce the number of hubs in the US network to help restore and accelerate profitability in a market with fewer passengers.
Looking ahead, carriers will continue to fight for survival, while investors—more cautious today since airlines have loaded up on debt to stay afloat amid the COVID-19 crisis—are being more selective when making their aviation investments. Clearly, the damage to balance sheets is done, and airlines will face continued challenges to financials. This will require bold capacity and network decisions that manage short-term cost reduction without jeopardizing long-term airport efficiency and network growth strategies.