This article first appeared in The Edge Malaysia Weekly on June 27, 2022 - July 3, 2022
THERE is no reprieve for airline operators even as the world emerges from the Covid-19 pandemic. Higher fuel costs are threatening to derail recovery from the pandemic, those attending last week’s International Air Transport Association (IATA) annual general meeting (AGM) in Doha, Qatar, were told.
Airline leaders warned that they may have to raise ticket prices if fuel costs continue to rise. Already, rising demand for flights, together with a shortage on the supply side, has led to increased airfares.
The aviation market has seen jet fuel prices skyrocket amid the Russia-Ukraine conflict. According to S&P Global Platts data, the price of jet fuel had increased 129% over the past year to US$177.1 per barrel on June 17.
Qatar Airways, which recently reported a record net profit of US$1.54 billion (RM6.79 billion) for the 2021/22 financial year, is not shielded from this threat, with jet fuel coming close to 40% of the airline’s cost of operation, said group CEO Akbar Al Baker during a CEO Insight Panel at IATA’s 78th AGM and World Air Transport Summit last week.
While it has oil hedges that will help offset portions of the price increase, he pointed out that these will be insufficient as he expects the price of oil to touch US$200 a barrel amid expectations of a further escalation of the Ukraine crisis. “We will have to increase [ticket] prices to cover the increase in fuel costs,” he added.
Another panellist, Virgin Australia CEO Jayne Hrdlicka, said that with airlines facing higher costs of 50% to 70%, they have been left with “no choice” but to raise airfares. “We have an obligation as an industry to ensure we get the world travelling again and global connectivity back again, but we have to do that in a way that is sustainable. And we had two years where most of us had extreme losses. So, I don’t think there is any choice but for prices to go up and for capacity discipline to remain [in order] for us [airlines] to be able to return to profitability and build a strong cash-generating balance sheet.”
IATA regional vice-president for Asia-Pacific Philip Goh concurs, telling The Edge that air travellers should brace themselves for higher airfares if fuel prices continue to remain high.
Meanwhile, airlines like Malaysia Airlines Bhd (MAB) that have not hedged their fuel costs are instead turning to fuel surcharges. The national carrier is also ensuring that it has a strong cash flow to keep flying.
MAB managing director and group CEO Captain Izham Ismail tells The Edge that the airline’s recovery continues to face strong headwinds from higher jet fuel prices and foreign exchange volatility, as the airline has US dollar exposure in the form of oil prices and leasing charges, maintenance costs and debt.
He adds that the profitability of the airline hinges on the price of fuel this year. Fuel costs, which typically constitute about 20% of an airline’s total expenditure, account for 45% of the national carrier’s operating costs.
However, Izham points out that there are several factors going for it, including a strong balance sheet. “The cash balance that we created last year [following its RM15 billion debt restructuring exercise] should be able to help us weather an economic downturn and we are cognisant that there is a potential recession coming into play. This was very clear in the management’s mind last year — that we need to shore up our finances while things are good.
“Second, we are able to be agile in our cost structure. Third, we must be smart enough to throw capacity at the market where it is profitable. We don’t go in blindly anymore,” he said, noting that some airlines have ramped up their capacity to 60% to 70% of pre-pandemic levels.
“While we are bullish on the future, we are very careful. That’s why our capacity year to date is only 50% [of pre-pandemic levels]. We will only ramp up capacity to 76% by the fourth quarter of this year.”
MAB was the first Asian airline to successfully restructure its debt — it owed 75 creditors about RM15 billion — during the Covid-19 crisis. Its parent Malaysia Aviation Group Bhd (MAG) turned earnings before interest, taxes, depreciation and amortisation (Ebitda) positive to RM433 million in the financial year ended Dec 31, 2021 (FY2021), compared with a negative Ebitda of RM1.76 billion in FY2020.
“Our debt-to-Ebitda ratio has improved 43%. Our debt-to-equity ratio has improved to 35% from 75% previously. Last year, we were also 18% ahead of our target [to narrow our net loss]. In 1QFY2022, we were 23% ahead of our target. We have been cash flow positive since October last year,” says Izham, who is also group CEO of MAG.
Moving forward, as it embarks on a programme to replace some of its ageing planes, MAB will be “very careful in its investments”, he says. The airline currently operates a fleet of 74 aircraft, comprising six Airbus A350s, 21 A330-200s/300s and 47 Boeing 737-800s.
“We must be very clear that every investment that we make must not create structural stress on the balance sheet. There are several options available on the table — direct purchase, finance or operating lease, or a sale and leaseback — all of which are being evaluated now. MAB will only sign [a deal] with a bidder that is commercially viable to the airline’s future,” says Izham, referring to the airline’s selection for the replacement of its fleet of 21 A330 wide-bodies.
Airport chaos to persist with staff shortages
As “revenge travel” is off to a good start, with forward bookings already at 100% loads up to September, staff shortages — which are causing chaos at major airports in Europe, Canada and Australia — have turned into a total killjoy for airlines.
“Nobody expected this chaos to happen at airports because nobody expected there would be a pandemic. Nobody expected millions of people would be made redundant and millions of people would be allowed to work from home when passengers need people to serve them,” said Qatar Airways’ Akbar.
Unlike Heathrow and other airports in Europe, there weren’t these issues at Hamad International Airport in Doha because during the pandemic, its equipment was properly looked after and serviced, he added.
“Our industry was not meant to [operate] at partial pace. Our aircraft were not meant to be parked on runways for months on end. The same thing goes for airports. Nobody has the perfect foresight to figure out who to hang on to, who to let go of [and] how to manage equipment during a period of no use. Every one of us could have done a better job with the benefit of hindsight,” said Virgin Australia’s Hrdlicka.
“It is very frustrating for all of us not to have airports back and functioning as well as they should right now because that seems like the easiest job. But in fact, they are suffering from the exact same challenges we (airlines) all face in trying to get back to very high levels of volume consistently without facing the challenge associated with that quick ramp-up.”
IATA’s Goh expects the chaos seen in airports across Europe in recent months to continue, noting that “it takes time for recruitment, training, certification and security clearance at airports in order to ramp up their capability to handle” the surge in consumer demand. “[For Asian airports,] we have to learn from what’s happening elsewhere, particular in Europe. This is the time to really prepare for when we see capacity come back in a big way. If we are slow to do it, then we will get into exactly the same situation that the European airports are facing today — congestion and a staffing crunch that has forced airlines to cancel flights. We don’t want to be there. We want to go through a recovery more smoothly.”
MAB’s Izham says the airline is fortunate to have made a decision not to retrench its staff during the pandemic. “We did not retrench anyone. What we did was we did not renew employees’ contracts at the end of their term and reduced salaries of the middle management and pilots. That actually saved us today. Today, we have the right number [of staff].”
Is revenge travel sustainable?
A lot of that depends on the risk of the world going into a recession due to high inflation, says Izham. “In my opinion, demand will continue. But in certain pockets of the market, it may be sluggish. It will be like a hockey stick trajectory and the expectation is that demand will taper off by 1Q or 2Q next year. By what percentage points? I don’t know.
“The current revenge travel is driven by the increase in disposable income and the need to reconnect with loved ones. After this, inflation and recession will set in, which may result in a slowdown in demand. However, I don’t think demand will reduce. It is likely that growth will be flat.”
He says MAB’s recovery plan was based on the worst-case scenario, which assumes a market recovery only in 1Q2024 — the same year IATA is predicting that global passenger traffic will return to pre-Covid-19 levels. The Long Term Business Plan 2.0 (LTBP 2.0) envisages the airline achieving break-even in 2023.
IATA’s forecast assumes that China will reopen its borders by early next year at the latest.
“For the whole of 2022, China is not in play for us. We have shifted the capacity to somewhere else, the likes of countries in Asean, North Asia like Japan and South Korea, and Europe, as well as India, Australia and Singapore. Optimistically, I hope China will reopen its borders by the end of this year. Pessimistically, it would be 2Q next year, maybe after Chinese New Year,” says Izham.
MAB currently flies once a week between Kuala Lumpur and Guangzhou. Still, even if China’s borders reopen, the airline will only focus on four key profitable destinations — Guangzhou, Shanghai, Beijing and Xiamen, he says. “We got sucked into disintegration previously because we kidded ourselves by competing with low-cost carriers going into China.”
As part of a new five-year turnaround plan under LTBP 2.0 following its restructuring, MAB received a fresh capital commitment of RM3.6 billion from its controlling shareholder Khazanah Nasional Bhd.
Izham says the airline has to date drawn down about one-third of the funding committed by Khazanah — less than the amount initially budgeted in 2021. “We managed to spend less than the amount we first budgeted as our cash flow turned positive from October onwards. This is despite headwinds, including rising fuel costs.
“I also need to demonstrate credibility — that MAG is an efficient company. But this money will not go away. It is locked down under the agreement of the recent restructuring exercise, which involved 75 creditors. If we don’t take it (all the committed funds by Khazanah) this year, the money will eventually be injected into MAG by the end of 2025.”
Politicians receive flak at IATA’s annual meeting
Politicians were thrust into the global spotlight for all the wrong reasons at the airline industry’s annual conference in Doha, Qatar, last week against a backdrop of rising energy price levels, supply chain strains, net-zero carbon emission talks, the war in Ukraine and continued pandemic lockdowns in some parts of the world.
Airline leaders lashed out at governments for working in isolation and closing borders arbitrarily without consulting the industry for more than two years.
“When Covid-19 hit, governments closed borders and stopped people from flying. They did not consult with the industry. They did not follow the advice of the World Health Organization (WHO). Yes, decisions were based on science, but it was political science, not medical or data science,” Willie Walsh, director-general of the international Air Transport Association (IATA), said when presenting the state of the air transport industry at the airline grouping’s annual general meeting last Monday (June 20). IATA comprises some 290 airlines in 120 countries.
He cited analysis conducted by consultancy firm Oxera and healthcare data analytics firm Edge Health, which showed that, at best, border closures may have delayed infection peaks by just a few days.
“There was one virus, but each government invented its own methodology to control what travel remained possible. This was documented by [IATA’s database] Timatic. At the peak of the crisis, it was registering hundreds of changes daily to entry restrictions. How can anybody have confidence in such a shambolic, uncoordinated and knee-jerk response by governments?” he asked.
Walsh said the cost of government mismanagement has been substantial. “It devastated economies, disrupted supply chains and destroyed jobs. The restrictions even hurt people’s health. Our research shows that two-thirds of people felt their quality of life deteriorated because of the impacts of travel restrictions. And this is confirmed by WHO data showing a 25% rise in mental health issues.
“So, the first lesson is the wisdom of what WHO said from the beginning. Closing borders is not the right response to a pandemic,” he added.
As governments eased Covid-19 restrictions, Walsh said different problems such as delays and disruptions have emerged — many of these could have been avoided.
“Governments had no plan and worked in isolation. They made things up day by day and, in some cases, did complete U-turns — the worst being the panicked over-reaction to Omicron. This unpredictability made the restart much more difficult.
“It’s no wonder there are operational challenges for some airlines and at some airports today. [Thus,] the immediate priority is working together with governments and airports to address capacity issues where they are occurring. Let’s be clear, these problems don’t exist everywhere, and solutions are already emerging,” he said. “The longer-term priority is ensuring that governments work much more closely with airlines in the next crisis — whatever that may be.”
Nevertheless, Walsh conceded that the industry could be partly to blame for being in the current situation.
“I think we as an industry were too sympathetic to governments when the measures were taken to shut down the industry. It is fair to say that, at that stage, we were dealing with an unknown virus and people didn’t really know how it was going to play out. So, we sort of stood back and said, ‘We kind of understand closing borders’.
“But within a very short period of time, looking at the data, it became clearer to us that border closures were causing huge economic damage to the industry. Personally, the mistake I made was that I didn’t push back harder when I was in the role of chief executive of International Airlines Group (IAG) to try to get borders to reopen again,” he said. Walsh became CEO of British Airways in 2005 and oversaw its merger with Iberia in 2011 to form IAG. He stepped down from his CEO role and the board of IAG on March 26, 2020, before retiring on June 30 that year. He became director-general of IATA in April last year.
The industry also saw a shift in decision-making — where transport ministers, who would normally have influence over transport issues, were completely sidelined and decisions were being taken by the health ministers.
When asked if he has the confidence that if a crisis were to happen again, governments would make better decisions, Walsh said: “I do, based on the fact that I don’t think governments can afford to do the way they did in the last few months because the economic cost of what they did was huge. The debts that governments took on [to help the aviation industry] were massive.”
Walsh stressed that IATA member airlines are not against regulations. “But they must create solutions, not add to problems. Unfortunately, that is rarely the case. When it comes to politicians and regulation, let me paraphrase another great Irish writer, Brendan Behan, ‘I’ve never seen a situation so dismal that a politician couldn’t make it worse’.”
According to IATA, global airline losses amounted to close to US$42 billion (RM185 billion) in 2021, but down from the group’s earlier estimate of US$52 billion. Total losses were US$137.7 billion in 2020.
It has narrowed its estimate for losses this year by 16%, with airlines expected to lose US$9.7 billion. The previous estimate was a loss of US$11.6 billion in 2022.
However, industry-wide profit should be on the horizon in 2023, Walsh opined.
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