Chart 1

Clear Skies: Strongest Airlines Recovered Swiftly From The Pandemic

Our global rated airlines portfolio has demonstrated a remarkable recovery, following several years of lockdowns and travel restrictions.   Global industrywide air passenger traffic (measured in revenue passenger-kilometers, RPKs) finally exceeded pre-pandemic (2019) levels in February 2024, as per the International Air Transport Association (IATA). This was the first occurrence of a full recovery in international travel (1% above February 2019 levels) on a global basis, with domestic travel up 14% (versus February 2019). Total traffic for the month of February was up 21.5% year over year, supported by a strong performance in all main markets--particularly in the Asia-Pacific region, which was the last to lift travel restrictions--but also the U.S. and India. However, we expect the pace of global air-passenger traffic growth will slow as the recovery plateaus and capacity growth is constrained. That said, our global economic outlook remains resilient, and we forecast global GDP growth above 3% in both 2024 and 2025.

Travel demand has so far appeared largely resilient in the face of prevailing macroeconomic headwinds.   These include intense pressures on consumer spending, higher-for-longer interest rates, cost inflation (particularly increased staff costs), staff shortages, fuel price volatility, and geopolitical instability amid the Russia-Ukraine and Israel-Hamas wars. We continue to monitor booking trends--which are typically short-term so revenue visibility is low--because sustained inflationary pressures and unexpected increases in unemployment levels are notable risks that could further weigh on consumer spending going forward. Globally, unemployment rates remain at historic lows, which supports demand for air travel; conversely, there have been industrywide shortages in staff across the supply chain and record-high labor costs persist.

Airlines continue to benefit from elevated ticket prices.   We have seen a shift in consumer behavior toward experienced-based expenditure. As a result, consumers (typically the wealthier cohort of the global population that can afford air travel) have been willing to pay higher airfares, which have been necessary to cover inflated costs, particularly fuel and labor. The current aircraft capacity shortage has also supported strong prices. We think this will persist for some time given lengthy order books and that Boeing has slowed production of its Max aircraft and some Airbus A320 NEO aircraft have been grounded due to Geared Turbofan engine issues.

Most of our outlooks on our global rated airline portfolio are stable, despite notable downside risks.   This takes into account the high industry risk that we already factor into our ratings. The aviation industry is highly cyclical, and airlines are especially susceptible to geopolitical risks. Additionally, ongoing hostilities or escalation of current conflicts could affect travel demand and may further increase volatility, oil prices, and disruption to global supply chains. Furthermore, with a record number of elections to be held this year, the political backdrop is highly uncertain.

Following a high number of downgrades throughout the pandemic, on average ratings remain one notch lower than in February 2020 largely due to higher debt levels, and we now have several ratings below 'B+'. We also have a material number of positive outlooks--almost 20% of our global airlines' portfolio including one company on CreditWatch positive. Two-thirds of our ratings have a stable outlook.

Chart 2

Chart 3

Take Off: 2023 Performance Exceeded Our Expectations

The speed with which our rated airlines recovered was partly dependent on the travel restrictions of their operating region and the amount of government support provided.   The COVID-19 pandemic was the biggest shock the industry has ever experienced, but our highest rated airlines returned to profitability more quickly than we had previously anticipated (see chart 3). However, weaker airlines (particularly those that received less government support) struggled, and many smaller players exited the industry. Regionally, North American airlines benefited from a relatively early easing of travel restrictions; hence, on average, our rated airlines in the region were profitable even in 2021. Europe followed suit, and as such, our rated European airlines were typically the next to recover.

In contrast, certain border restrictions in the Asia-Pacific region (particularly within the important Chinese travel market, though we maintain no public airline ratings in the region) were only relaxed at the beginning of 2023. The slow international air traffic recovery in China due to the weak state of the economy as the result of the property crisis, continues to derail the Asia-Pacific region's air traffic uptick. This delayed profit recovery for carriers in the region, as well as some carriers in other regions. One example is Finnair Oyj, which had high exposure to the Asia-Pacific region and was forced to adjust its network; however, the company has now reported EBIT margins exceeding its 2019 levels.

Latin American airlines did not benefit from the government support that was made available to many other regions.   Thus, our ratings remain low. For example,our rating on Latam Airlines Group S.A. is 'B+' with a positive outlook after emerging from Chapter 11 proceedings. Gol Linhas Aereas Inteligentes S.A. filed for Chapter 11 recently because it had still not been able to adjust its capital structure and lease burden.

We assume slightly lower-to-flat ticket prices in 2024 and note our forecasts are highly sensitive to these assumptions.   Furthermore, airlines' ability and willingness to sustain fare levels, implement cost-saving measures, and expand capacities (via new aircraft deliveries and by adding more seats to aircraft) to offset cost inflation will be key to preserving their profit margins. Airlines have a long track record of being able to absorb higher costs in the past, such as when oil prices have spiked. This could help cushion potential downside to profitability if passenger demand unexpectedly diminishes in a downside scenario.

Diversification also typically adds stability to earnings under normal operating conditions. For example, Deutsche Lufthansa AG and Air France-KLM S.A. both operate air freight and maintenance repair and overhaul (MRO) businesses. MRO business are typically performing well at present given robust air travel demand and recent engine issues. Although cargo operations tend to be more volatile than passenger air travel (and freight rates and demand were weak in 2023), during the pandemic freight businesses benefited from the extraordinary demand for goods.

Potential Turbulence: Downside Risks To Our Base Case

Wage pressure persists across the aviation network due to an inflationary environment, labor and skill shortages, and low unemployment rates.   Airlines rely not only on their own employees (such as pilots and cabin crew) but also on airports, air traffic control, and others support services (such as ground handling). In this inflationary environment, there has been intense pressure on wages. For example, pilots of certain larger North America airlines received an immediate pay raise of over 20% on ratification of deals last year, with annual increases that will boost wages by well over 30% over the next few years (and higher for longer-dated contracts).

Fuel costs remain high.   We estimate jet fuel cost by using our current base oil price assumptions of $85 per barrel (/bbl) and $80/bbl for Brent and West Texas Intermediate, respectively, in 2024 with both $5 lower in 2025 and beyond. To this, we add the crack spread, which is the difference between jet fuel cost and oil. This was typically (and is currently) below $20/bbl, although this widened following the start of the Russia-Ukraine war (even spiking above $60/bbl at most and was around $30/bbl in Q4 2023). These prices are well above historical average levels.

Of course, jet fuel prices will remain unpredictable, but if the Israel-Hamas or Russia-Ukraine wars escalate further, oil prices could become even more volatile. Because fuel costs are one of an airline's biggest expenses, airlines continually invest in more fuel-efficient aircraft to reduce costs, and some hedge fuel costs (particularly in Europe where these airlines would have some advantage over their U.S. counterparts in the event of a further spike in prices).

The main environmental regulations that will raise operating costs are carbon regulation and mandates to use more sustainable fuels.   Sustainable fuels are typically at least two to three times more expensive than jet fuel and in some cases many multiples of that. We expect scaling up the use of sustainable aviation fuels and associated research & development costs (some of which hope to reveal break-through technologies) will have an inflationary effect on airfares as airlines pursue their longer-term path to net zero emissions. Investment in more fuel-efficient aircraft will also raise costs in the short term, but will likely reduce related operating costs over the medium term. We believe the mobility transition will continue to be focused on short-haul journeys but do not expect long-haul air travel to be replaced in the foreseeable future, despite rising environmental pressures.

Chart 4

On The Horizon: Increased Capital Expenditure, Capacity Constraints, And Steady Debt Levels

Airlines across our global rated portfolio have large capex plans for new, more fuel-efficient narrowbody aircraft in 2024 and beyond as they catch up on spend following the pandemic (see chart 4).  Our base-case forecast shows that capital expenditure (capex) will make up a big proportion of airline profits, but this is an area of uncertainty and capex could be materially lower than our base case. Delivery delays, particularly for narrowbody Boeing aircraft, could reduce spending and boost credit metrics. As a recent example, United Airlines Holdings Inc. now expects its planned capex in 2024 to be $6.5 billion (from $9 billion previously) for this reason.

Airlines continue to modernize their fleets in a quest for lower fuel consumption and reduced carbon emissions.   Newer aircraft models offer better fuel economy and operational performance, and more capacity (additional seats), resulting in cost savings and lower CO2 emissions. Given the significant cost of aircraft, airlines often also lease some of their assets (with about 58% of the total global aircraft fleet leased at the end of 2023 as per IATA), and if new deliveries are delayed, they may choose to extend leases or continue to utilise existing (less efficient) aircraft. We note airlines with younger average aircraft fleets (around 10-12 years old or less) will likely benefit from more competitive positions and profitability, particularly given stricter environmental regulations.

We expect capacity growth will be more subdued this year, following large capacity increases last year.   Restricted aircraft supply (order backlogs are at record highs), delays in new aircraft deliveries, parts and maintenance constraints, heighted engine reliability issues, and labor shortages have all kept capacity tight. Additionally, during the pandemic, many carriers shrunk their fleets. We believe these dynamics will support high ticket prices and load factors.

In Europe, it has more typically been the low-cost carriers driving the most capacity growth (subject to the timeliness of aircraft deliveries). In North America, low-cost carriers are typically underperforming because they don't have a meaningful presence in international travel and have limited loyalty programs or premium seating that generate more income.

Many higher-rated airlines have been somewhat sheltered from rising interest rates because debt tends to be fixed rate and long term. However, costs for new aircraft financing and debt refinancing will rise over time, particularly for lower-rated issuers.

Chart 5

Many higher-rated airlines have been somewhat sheltered from rising interest rates because debt tends to be fixed rate and long term.   However, costs for new aircraft financing and debt refinancing will rise over time, particularly for lower-rated issuers. Our rated portfolio of airlines still have about 15% more debt than pre-pandemic on average (on an S&P Global Ratings-adjusted basis which may include netting off available cash) but are keeping more cash on the balance sheet to buffer against future industry downturns (see chart 5).

We expect management teams will maintain more prudent financial policies and long-term debt targets. However, as real interest rates remain higher for longer, there will be a rise in average financing costs across the sector. Most airlines predominantly hold fixed-rate debt, but lower-rated carriers facing debt refinancing requirements will be subject to sharply higher interest costs. Airlines that rely on aircraft leasing will also face higher cost of capital as lease rates continue to catch up with inflation.

Upcoming deliveries of new aircraft will constrain further balance-sheet deleveraging.   Absolute debt levels have reduced materially and more quickly than we had first anticipated given the high levels of debt accumulated during the pandemic, for our strongest rated airlines in particular. Of course, there was extraordinary government support offered to many across the sector (through payroll support and government-backed loans and grants), without which many--perhaps most--airlines would have gone bankrupt (as in Latin America). We think the focus on debt reduction will ease in 2024 in most regions, and absolute debt levels will increase for some airlines given higher capex related to new aircraft that will lead to free cash flow deficits. In North America, however, the pace of deleveraging for the larger carriers has lagged that of the larger European airlines over the past two years, and debt reduction from free cash flow in 2024 remains a key strategic focus. In APAC, deleveraging for most carriers remains steady, given the continued recovery in air traffic, particularly for Chinese carriers.

We anticipate shareholder returns will resume prudently and financial policies remain relatively conservative, which underpins our stable outlooks.   Many airlines have entirely or significantly cut back on dividends in the past three years to conserve cash. While we expect most airlines to gradually resume dividend distributions, they have demonstrated the flexibility to reduce payouts when liquidity tightens. We expect financial policies to remain relatively conservative given the lessons learned during the pandemic, which supports our global airline ratings.

Chart 6

Table 1

Related Research

• Research Update: Boeing Co. Outlook Revised To Negative On Delay Of Credit Metrics Restoration; 'BBB-/A-3' Ratings Affirmed, April 25, 2024
• Credit Conditions Europe Q2 2024: Credit Heals, Defense Shields, March 27, 2024
• E-fuels: A Challenging Journey To A Low-Carbon Future, March 25, 2024
• Industry Credit Outlook 2024 - Transportation, Jan. 9, 2024
• Asia-Pacific Aviation Is On A Recovery Runway, Nov. 2, 2023