DALLAS – It’s well known that the COVID-19 pandemic had a devastating effect on the commercial aviation industry. Billions of dollars have been lost, and airlines and others in the sector are still recovering. But just how big was the actual financial toll? And which segments of the commercial sector were hardest hit?
The global consulting firm McKinsey & Company recently published a report on the matter. “Taking Stock of the Pandemic’s Impact on Global Aviation” outlines and gives actual numbers to the damage done to the industry by the virus.
The report discusses the “value” that was destroyed during the pandemic and compares it to industry results in the 2012-2020 period before the virus hit. In cooperation with IATA, it assessed the entire commercial aviation value chain, which includes manufacturers, lessors, air navigation service partners, airports, catering firms, ground services, maintenance/repair/overhaul companies (MROs), airlines, and freight forwarders, and global distribution systems.
The most prominent of those areas are discussed in this article.
The measure of “value loss/creation” used in the report is Economic Profit which the report defines as being “the difference between the returns a company makes after taking into account its invested capital and the alternative returns of equal-risk opportunities investors have access to, measured by the weighted average cost of capital.”
More simply put: Economic Profit = Revenues – Explicit Costs – Opportunity Costs
Opportunity costs are what investors could have made or lost had they put their money elsewhere.
According to the report, the global commercial aviation industry suffered a total value destruction of US$232.9bn during the pandemic. Airlines alone took on US$167.9bn of that. As the chart below (from the McKinsey report) shows, airports suffered the second-largest destruction in value (US$31.6bn) followed by manufacturers (US$12.2bn).
The one bright spot in the industry was, of course, freight forwarders and cargo airlines, which showed a US$3.5bn increase in value.
The degree of loss varied from airline to airline. This is due to the different ways costs were borne by each company. “Companies that relied more on flights for their revenues still made money from cargo flights and half-full passenger flights and were, therefore, less adversely affected than companies that depended more on passenger flows.”
True, the pandemic devastated the airlines. But that doesn’t mean that things were coming up roses prior to COVID. Despite strong economic growth and low fuel prices, airlines were bleeding about US$17bn in economic profit per year (this lends credence to the old joke: how do you become a millionaire? Get a billion dollars and start an airline).
The report reviewed the financials of 122 airlines. Of those, 77 destroyed value in the 2012-2020 time frame.
It is interesting to note that of the 28 airlines that created value in that period, half of the top 10 were US-based carriers. Delta Air Lines (DL), Southwest Airlines (SW), United Airlines (UA), American Airlines (AA), and Alaska Airlines (AS) created a combined total of US$34.4bn in cumulative profit.
Then the pandemic hit, and they lost a combined US$63bn.
Outside of North America
In the 2012-2020 period, airlines outside the US, with the exception of one year in Europe, consistently destroyed value—even during the best of economic conditions. That came at a loss of US$176.6bn.
We do recognize the reasons for this: high capital intensity, low entry barriers, and strong negotiating power held by airports and OEMs. And despite the best attempts to differentiate themselves from the competition, airlines typically lose or gain passengers based on price.
The report also notes that in some cases, national airlines are forced by the government to fly unprofitable routes.
Airlines do not respond nimbly to exterior shocks. The Gulf War and 9/11 sent instant chaos through the industry and it took airlines months to recover. But what can airlines do to respond more quickly? McKinsey suggests that they up their cash reserves which would reduce the need for bailouts following each crisis. Also, they could improve their ability to reduce their supply quickly when demand suddenly falls.
But how airlines could do that is not discussed in the report.
It might seem counterintuitive, at least to those of us in North America, but in the pre-pandemic period, the most consistent builder of value in the industry was airports. The report says that outside of North America, airports created aggregated profits of around US$5bn each year. Airports in the Asia-Pacific zone outperformed due to high demand and a favorable regulatory climate.
In North America, the group of selected airports in the report showed a range from losing over 30% to just barely breaking even.
But again, the pandemic hit the sector hard. With its high fixed costs and collapsing revenue, the sector lost US$32bn in 2020 alone.
The Bright Spot
But let’s look at the one area that actually benefited from the pandemic: freight forwarders and cargo airlines, which, according to the report, generated economic profits of 4% and 9%, respectively. It is noteworthy that the only five airlines that reported a profit in 2020 were cargo carriers: AirBridgeCargo (RU), Atlas Air (5Y), Cargojet (W8), Cargolux (CV), and Kalitta (K4).
Prior to the pandemic, the sector was a reliable generator of profits, averaging US$2bn per year from 2012 to 2019. In 2020, air cargo yields rose 40%, and they were up another 15% in 2021. Initially, strong demand for personal protection equipment and medications drove cargo demand. But then supply chain slowdowns in the ocean-shipping arena, a small supply of cargo space on passenger-carrying planes, and a surge in e-commerce activity caused this segment to boom.
However, this boom may be short-lived. McKinsey expects this segment to fall back some to perhaps 2019 levels as supply chains return to normal as the pandemic subsides.
The complete report is available for download at the McKinsey website.
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