Insight: This time its different

INSIGHT: This time, its different This time, it’s different. Today’s situation is unique. We’re in the midst of an industry recovery but facing a recession when revenues typically fall, and industry earnings suffer. Our thesis is that airlines may actually survive the recession well, potentially with increasing revenues as the final elements of traffic that have not yet returned from the global pandemic kick in. While high fuel prices and higher costs may portend doom and gloom, the counterbalancing forces may result in a more favorable picture for the airline industry. Inflation is at 40 year highs, and the Federal Reserve needs to slow the US economy to tame inflation. Unfortunately, there is a fine line between taming inflation and causing an economic recession. Many economists are predicting a much tougher economy in late 2022 and 2023. We’re certainly expecting smaller GDP growth for the global economy in the fourth quarter 2022 through the entirety of 2023. Meanwhile, the airline industry remains in a long recovery from the global pandemic, impacted by labor shortages both internally and externally, From air traffic control shortfalls impacting United at Newark to KLM stopping new bookings from Amsterdam due to security shortfalls, to pilot shortages across multiple airlines, the labor portion of the industry recovery will be difficult. Add to that supply chain difficulties for ramping up production rates for new aircraft as well as and MRO and bringing back grounded aircraft. There are challenges on every corner. But we clearly haven’t yet fully recovered from the global pandemic, and full recovery expectations have been pushed back to 2023 and 2024 for domestic and international traffic, respectively. The industry is still recovering, it clearly hasn’t fully recovered, particularly internationally. Despite the recovery, some smaller cities have lost their airline service, as regional airlines in the US have grounded more than a hundred aircraft because they can’t find pilots to fly them. Globally, the recovery is continuing, as shown in the following chart that Boeing’s Darren Hulst presented to media in a pre-Farnborough briefing. This time it’s different. On narrow-body routes, according to Boeing, we’ve reached 97% of the pre-pandemic city pairs served. But of those 97%, 21% are new, meaning than 24% of pre-pandemic routes are no longer served. That leaves a large runway for further potential recovery once resource shortfalls can be solved. Opportunities to return past pre-pandemic levels can be quickly solved as constraints are removed and international markets re-open. For wide-body routes, the story is quite different, reflecting the current closure of some Asian countries, notably China. Only 77% of pre-pandemic city pairs are being served, with 22% of those routes being new. That translates to 55% of pre-pandemic city pairs not currently being served. A very strong runway for recovery exists for wide-body flights once more countries, particularly China, re-open their airspace. Airlines have been agile in moving aircraft to new routes and optimizing revenues in their route networks, culling routes that have not yet recovered enough to warrant continued service. With the return of employees to offices and the increasing return of business travel, the potential for some routes that have been culled regaining service exists. Because of that, there is a longer runway for recovery - a key reason this time is different. Traffic in the US is perhaps the leading example of the recovery, and ahead of most of the world. Traffic levels are about 90% of pre-pandemic levels, as shown in the following graph. There is still room for revenue growth, even through a recession, to get back to 2019 plus three years worth of growth, which would be a true recovery. Pent-up demand for leisure travel has continued, business traffic continues to recover, and international markets are slowly coming back. Our optimistic scenario has the industry continuing to grow revenues, even through an economic recession. This industry has always been resilient, and will likely prove that fact again in late 2022 and early 2023.

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