Budget best placed to withstand airline turbulence

By John Plassard, deputy director at Mirabaud Group

The severe turbulence experienced by global airlines as a result of the pandemic continues, with the International Air Transport Association expecting the stricken industry to burn another $75bn to $95bn of cash this year.

European airlines have been among the hardest hit, with Italy’s Alitalia receiving €3bn in the form of a bank loan guaranteed by the state, which in effect has become the owner of the company. In Germany, the government intends to acquire a 25% stake in Lufthansa, while Air France-KLM is also not optimistic about the months ahead.

While Airbus recently announced the aviation sector was beginning to recover from the Covid-19 crisis, the Delta variant has once again clipped the wings of an expected business travel recovery – with business travel and events now not expected to return to pre-pandemic levels until 2024. This is devastating news for most airlines, where profits are dominated by business class travel.

Business still grounded

Airlines make almost 60% of revenue directly from passengers, with the largest share coming from business travellers. Even though business travellers account for 12% of airline passengers, this segment is generally twice as profitable. On some flights, business passengers account for 75% of an airline’s revenue.

However, business travel has understandably fallen significantly over the past 18 months, due to the proliferation of Zoom meetings and the fact most corporate employees have been working from home.

To attract new passengers, many airlines have launched innovative services or refurbished aircraft to provide more legroom in business and first class. Even so, it is only a matter of time before airlines are forced to reduce business and first-class prices until an appropriate level of unsubsidised demand is found that eventually fills the classes.

Money in miles

The remaining 40% of airline revenue comes from the sale of frequent flyer miles to credit card companies and travel partners, such as hotels and car rental agencies. As passengers link credit cards to these programmes, companies can track spending and consumption patterns. In fact, some frequent flyer programmes are now worth many times the value of the airlines owning them, which means investors value the passenger business at less than zero. For most airlines, frequent flyer programmes are a key source of revenue and profitability, enabling the offering of better ticket prices and more routes.

American Airlines recorded $5.6bn in frequent flyer and related revenue in 2019, including sales to the carrier’s credit card partners. Delta Air Lines recorded $9.1bn in similar revenue, and United Airlines $5.3bn. In a mid-June 2021 investor statement, United valued its MileagePlus programme at $21.9bn, using a 12x multiple of the programme’s 2019 earnings. In the case of United’s programme, MileagePlus received 71% of its 2019 cash flow from more than 100 third-party partners, and only 29% of its cash flow from United itself. No matter how it is broken down, loyalty programmes made a significant contribution to the bottom line of these airlines.

Atlanta-based Delta is the industry leader in loyalty monetisation. In 2019, the airline renewed its partnership with American Express, in a deal it predicts could generate about $7bn in annual revenue by 2023. This would represent a 75% increase on the $4bn in revenue Delta generated from the relationship the previous year. Unsurprisingly, low-cost carriers have been increasingly embracing frequent flyer programmes.

Budget best placed

The decline in business class revenue, coupled with the increase in frequent flyer programme revenues, favours low-cost carriers. In addition, it is the short and medium-haul segment of the market that has recovered fastest in recent months. This is good news for low-cost airlines, which are entirely devoted to this market. The likes of easyJet, Transavia and Ryanair are far less dependent on business customers than rivals such as Air France, Lufthansa and British Airways.

Consolidation in the low-cost space could also be a feature of the months ahead, as evidenced by the unsolicited approach for easyJet from an unnamed bidder – rumoured to be Wizz Air – earlier this month.

The Covid-19 pandemic is forcing numerous industries across the globe into fundamental change – aviation included. With uncertainty surrounding the return of business passengers and continued Covid-19 travel restrictions in many parts of the world, investors should brace for a bumpy ride for the foreseeable future.

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