A "Swoosh-Shaped" Recovery

The rapid global spread of COVID-19 has encouraged most governments to impose mobility restrictions including blanket bans on incoming travelers or two-week quarantine requirements. Now that the peak of the virus spread appears to have passed in many countries, several governments are looking to slowly and selectively open their borders. The path to air traffic recovery will depend not just on the pace of these border openings, but also on airline fleet capacity and route planning, passenger demand, and the economic burden resulting from the severity of the coronavirus pandemic.

As a result, we now expect a "swoosh-shaped" recovery for aviation--a slow climb back after a rapid decline. It will be a much more protracted recovery than the rebounds observed after 9/11 terror attack, the SARS pandemic of 2003, and the 2008/2009 global financial crisis. Over the longer term, we believe that air travel will eventually return when current health and safety concerns have been meaningfully addressed by the industry and consumer confidence rebounds, supported by steady historical growth rates in air traffic of 4%-5% per year. However, a more widespread adoption of remote working and virtual meetings could have a lingering impact on business travel, which has been the more lucrative passenger segment for the airlines.

Table 1

We now estimate that global passenger air traffic will decline by between 50% and 55% this year (see table 1). This takes into account almost three months in which traffic dropped below 90% in comparison with the same period in 2019 because of the lockdown measures. This decline may vary across regions depending on the mix of domestic and international traffic. For example, we think European air traffic will be the heaviest affected, dropping by at least 55%. Our estimates for 2020 and 2021 are relatively closely aligned with IATA's latest air travel outlook for the next five years, published on May 13 (see chart 1). Still, we expect a more prolonged recovery, possibly stretching through 2023, reflecting the many operational challenges and consumer behavior unknowns.

Chart 1

The example of mainland China, where the lockdown is now over and only sporadic new domestic cases of COVID-19 are being reported, gives some insight into the shape a global recovery for airports might take. Air traffic in China is gradually recovering, more recently to 40%-50% of 2019 traffic levels from a low point of minus 90% year on year in mid-February (see chart 2). However, almost all current travel is domestic because China has significantly slashed international flights, prohibited entry of foreigners, and requires mandatory quarantine measures for returning residents.

Chart 2

Post-COVID-19 Aeronautical Revenues Will Be Significantly Lower

In the post-COVID-19 era, airports will operate under a "new normal". They will have significantly higher spare capacity than in the pre-pandemic period, and will have to compete in a universe of a smaller number and financially weaker airline companies. This will increase their exposure to volume risk and put pressure on their aeronautical revenues, which generally represent over 50% of total revenues (see charts 3 and 4). We believe airports could ultimately face additional pressure to alleviate aeronautical charges. Many airports in the U.S. have offered airlines a deferral in rentals and other fees in the short term under the assumption that traffic levels will rebound.

Chart 3

Chart 4

Even though cargo flights transporting essential goods are on the rise, they do not make up for the loss of passenger traffic because the overall volumes are not material. Most airports charge parking fees for grounded aircraft, but these revenue streams are also relatively small. Moreover, airports could suffer from the debilitated credit quality of airlines. We have already seen measures to alleviate the airlines' liquidity squeeze, such as the European Commission's decision to defer air traffic control fees for several months, which are adding to the woes of the airport industry.

In theory, single-till regulatory regimes--in which all airport activities, including aeronautical and commercial, are taken into consideration to determine airport charges--allow for charges to be reset to adjust for drops in passenger volumes, albeit with a time lag to the next reset. However, this business model has not been designed to adjust tariffs in the face of a massive drop in volumes or to determine whether airlines could afford them. We believe that financially weakened airlines may have stronger negotiating power in the face of lower supply, and may be unable or unwilling to pay higher aeronautical fees. In EMEA and other regions, weighted average cost of capital (WACC)-based regulatory frameworks are likely to bring little value in the new post-pandemic reality. We expect airports may be allowed to enter bilateral commercial deals with airlines, under which aero charges are dictated by market demand, discounted, and sometimes waived.

Non-Aeronautical Revenues Are Also Struggling

Retail revenues, the share of which have risen in recent years to 45%-50% of most airports' revenue mix, will likely be even more heavily hit than aeronautical revenues. This is not just because of the drop in passenger numbers, but also because of lower purchasing power due to the global recession, which will cut average spend per passenger. Furthermore, revenue that airports previously expected under minimum guaranteed volumes from retail partners may be delayed, or not come at all, if calculated as a percentage of sales. Alternatively, tenants may request rent waivers and deferrals or, in the worst case, may not survive the disruption. Commercial and food and beverage services are all challenged: social distancing does not work for catering services, while various safety protocols could restrict retail opportunities.

Airports Under Pressure To Reduce Costs

Although the credit quality of airports tends to be significantly more resilient than that of airlines, one weakness for airports is that they have largely fixed cost structures. As long as an airport is open to flights, even if only cargo flights, it has to maintain firefighting, maintenance, and operating staff to ensure safety. If an airport also serves repatriation planes, it has to keep its terminals open and maintain light, heating and air-conditioning, as well as other utilities. Operational, maintenance, and utility costs, as well as personnel costs (detailed below) usually correspond to about one-half of an airport's costs.

Chart 5

Personnel costs.  These usually make up about one-third of total operating costs. Any reduction tends to be very limited, usually restricted to cutting executive salaries and making redundant the middle management layer. Similar to other industries, some airports are benefiting from wage subsidy or furlough schemes that should allow for a rapid return to full operations. Once the furlough schemes are over, however, the airports may start thinking of resizing their businesses. Two recent examples of government-owned airports adopting harsher measures to minimize cash burn include Tocumen International in Panama, which applied a 50% cut in wages, and Dublin Airport in Ireland, which is seeking to cut potentially a significant number of its 3,500 workforce.

Concession fees and taxes paid to governments.   These represent 10%-20% of costs. In Latin America, some governments have provided liquidity relief by granting deferral of the annual concession grant payment. However, most governments elsewhere have not felt the need to do so, as international airports that we rate started from a position of strong financial strength.

Capital expenditure deferment.  To alleviate immediate cash burn, airports will likely defer major capital expenditure as expansion plans are likely pushed back. A number of rated airports have already reduced their plans for 2020 and 2021 while waiting to assess the speed of recovery. Given the weak state of the airline industry, any capex that is dependent on higher charges may not eventuate until there is confidence in economic returns through appropriate charges. It remains to be seen whether the £14 billion (in 2014 prices) investment in a third runway at London Heathrow Airport will get the green light, following an appeal for climate-protection reasons. The only exception is Hong Kong International Airport, where we expect the airport authority will continue the three-runway system project through to completion in 2024 given its advanced progress (construction started in 2016). In addition, a more material cost increase is likely to come from a need to invest in technology to ensure contactless check-in and luggage handling, or face-recognition at security.

Liquidity Is Crucial

While airports generally have stronger cash positions than airlines, the pre-pandemic boom in traffic has left many airports currently highly debt-leveraged. This has two consequences. First, the ongoing cash burn for operations and servicing debt interest leaves them in need of ensuring adequate liquidity. While some governments are providing loans and/or guarantees, many others have been clear that airports must first exhaust commercial sources of support, including shareholder capital, before appealing for government help. In EMEA, major national airports are still comfortably able to access financing. However, secondary regional airports may struggle. On the other side of the globe, in Latin America, Aeropuertos Argentina and ACI Airport Sudamerica, respective concessionaires of the Argentina and Uruguay international airports, have already announced distressed debt exchanges to preserve liquidity. This has highlighted the limit in offsetting revenue decline and led to a rapid transition of ratings.

Second, we expect some airports to breach covenants depending on the severity of the deterioration of financial metrics. In general, we expect debt providers to be willing to cooperate and waive covenants as long as the breaches are related only to the effects of COVID-19 rather than underlying business weakness. Nevertheless, creditors may attach more onerous requirements to accept waivers.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

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Related Research

• Six European Airlines Downgraded As COVID-19 Impact Erodes Credit Metrics; Majority Still On Watch Negative, May 20, 2020