Corona sledgehammer hits travel sector - part 2

Sydney Airport (SYD:ASX)

As discussed in part 1, the banning of international and domestic flights in Australia has meant airport stocks have a high exposure to the COVID-19 crisis.

The uncertainty of how long these travel restrictions will be implemented alongside how quickly people will return to flying once borders open again highlights that investing in airport stocks is a day by day proposition.

We can see in the graph below, the significant hit Sydney Airport has already taken in March in terms of scheduled flights compared to tracked flights, which is an indication of just how much revenue is being lost and will continue to be throughout the COVID-19 pandemic.

Source: flightrader24
 

While already pointing out the decrease in passenger activity at Sydney Airport, Credit Suisse analysts have also looked ahead to the passenger traffic recovery post COVID-19.

Given much of its market is Chinese tourism, analysts said they expect the pace of recovery in outbound tourism from China after COVID-19 to be “slow and moderate” compared to the post-SARS period.

Sydney Airport’s revenue also relies heavily on property leases in the form of retail, car hire and offices, which made up a third of its revenue last year. Credit Suisse reported it’s expecting airport tenants will seek rent relief given current circumstances or face the possibility of defaulting. 

Just last week, Qantas announced it has deferred aeronautical payments for February and March, telling Australian airports that discussions regarding repayment will occur after the COVID-19 crisis eases. It’s also chosen not to pay rent on leased areas including lounges, office space and staff rooms from February 1 this year.

Morgan Stanley has estimated a 25 per cent reduction in property and rental income for Sydney Airport this year, leaving room for further downside if rental payments are written off.

Credit Suisse has said it doesn’t expect a dividend in 2020 and only forecasts a 17.5 cent dividend in 2021, less than half the 39 cents paid in 2019.

It also cut its 2020 EBITDA forecast by 33 per cent to $595 million as a direct result of lower passenger traffic forecasts and the assumption that some level of rental relief will be provided to tenants.

This led to Credit Suisse lowering its rating of Sydney Airport from neutral to underperform and decreasing its target price from $5 to $4.50.

Stockbroker Morgans, released its autumn 2020 investment watch report on Monday and presented a bullish outlook for airport stocks over a two year-plus investment horizon. The report said Sydney Airport “represents outstanding value at current prices.”

This was due to the $2 billion of available liquidity it has with undrawn bank facilities, unrestricted cash and US private placement (USPP) bond market debt which is due to be funded in June this year.

Morgans said the cash and undrawn debt facilities would be sufficient to refinance debt due in FY20-21 and to meet the company’s reduced capital expenditure requirements for 2020.

The company will only proceed with “critical” projects and defer others, meaning it no longer expects to spend its previous forecast of between $350 to $450 million this year.

Morgans also noted that even a harsh one-year earnings decline would only have a small impact on its valuation, assuming however, earnings steadily recover once the COVID-19 crisis passes.

Auckland International Airport (AIA:ASX)

The latest company to jump on board the capital raising deluge has been Auckland International Airport, which has moved quickly to reinforce its balance sheet in preparation for a rough few months.

Like Sydney, Auckland Airport has seen a sharp fall in scheduled departures as seen below and has responded by going to the market to enhance liquidity via an equity raising.

Source: Flightradar24

This consists of a NZ$1 billion ($980 million) fully underwritten placement at NZ$4.50 per share and a NZ$200 million share purchase plan.

Additionally, numerous cost cutting initiatives have been launched including reducing remuneration of board members and executives by 20 per cent, reducing most employees’ pay by 20 per cent and putting them on four day working weeks, and suspending bonuses for FY20. Capital expenditure projects with an estimated completed value of over NZ$2 billion have also been suspended or cancelled to reduce short term funding obligations.

The NZ Herald also reported last Tuesday that AIA had applied for and been paid out NZ$4.3 million under New Zealand’s wage subsidy scheme and was the only company listed on the NZX50 to have been paid out under the scheme. It allows the company to claim NZ$7,029 in payments per worker to cover 12 weeks of employment.

AIA has also received support from lenders, which have provided it with an extension of all bank facilities maturing in the period to December 31, 2021.

UBS commented that while cost cutting measures point to lower cash burn, the sheer size of the equity raising indicates AIA is preparing for “a potentially longer period of border closure and deeper reset in medium-term international passengers and profitability.”

UBS has its 12-month rating of AIA at neutral and its target price at NZ$5.95.

The uncertainty in investing in the travel sector currently, is illustrated by the contrasting view presented by Macquarie – it seems to be very much a case of beauty is in the eye of the beholder.

It commented that AIA has “moved decisively to address its balance sheet and liquidity under a scorched earth scenario.” The bullish outlook also forecast that AIA’s liquidity would be sufficient to meet all operating, investing and financing cash flow obligations until December 31, 2021.

While warning investors to take a medium-term view to look through the COVID-19 impact, Macquarie’s glowing analysis ended with “AIA remains a quality business”, a rating of outperform and a 12-month target price of NZ$9.40.

With AIA’s share price now hovering around NZ$5.75, the disparity between the two investment banks’ valuation is proof enough of the difficulty investors are facing in finding value in the travel industry.

AIRLINES

Qantas (QAN:ASX)

The ASX’s highest profile company in the travel industry is Qantas Airways and the airline’s share price tells the story of what a bleak two months it has endured.

Starting the year at $7.16, sliding to as low as $2.14 and now hovering around the $3.56 mark, Qantas has virtually pressed pause.

As mentioned earlier, airlines are particularly exposed to the COVID-19 crisis, even once it’s over, for a number of reasons.

Planes will have been sitting idle for months and will need checks and repairs; pilots, crew and staff will need training refreshers and the confidence of travellers is expected to grow slowly. Then there’s the dreaded possibility of repeated outbreaks.

Last week Qantas revealed that over Easter this year (Thursday to Easter Monday included), it will fly just 32,000 people, a 95 per cent reduction from the 705,000 passengers carried across the group during the same period last year.

Credit Suisse has estimated that sustainable maintenance capital expenditure is $2.2 billion per year. However, once recovered from the impact of COVID-19, Qantas is expected to ramp up expenditure for fleet renewal, meaning Credit Suisse has forecast capital expenditure of $2.7 billion per year, between FY23-26.

It means just like those companies mentioned earlier, Qantas has needed to implement significant cost cutting measures and also maintain high levels of cash to make up for lost revenue and costs incurred.

Around 20,000 staff, which makes up two-thirds of Qantas’ employees, are temporarily out of a job. Alongside this, all international flights are grounded until at least May and domestic services are barely operating.

On top of this, it has postponed its interim dividend to September, cancelled a $150 million share buyback scheme and cut its executive team and board members pay to zero.

As mentioned earlier, Qantas has also deferred payment of recent aeronautical charges and has halted paying rent as part of its cost cutting.

In order to enhance its liquidity, Qantas announced a new round of debt funding in March, securing $1.05 billion in debt against seven of the company’s 11 wholly owned Boeing 787 planes.

This is set to coincide with an additional $1 billion undrawn facility which is available to Qantas, taking its available cash balance to $2.95 billion as announced on March 25.

The announcement also revealed the company’s net debt position remains at the low end of its target range, at $5.1 billion, with no major debt maturities until June 2021.

With a further $3.5 billion in unencumbered assets, Qantas has remained steadfast that it has the flexibility to increase its cash balance if needed and therefore is backing in its balance sheet, choosing not to ask for a bail out from the government.

The Federal Government in March already agreed to waive $715 million worth of fees for domestic airlines by refunding and excusing aviation fuel excise, air service charges and domestic and regional aviation security charges.

Further help to Australian companies has come in the form of the Federal Government’s massive JobKeeper subsidy, which Credit Suisse estimates will provide Qantas with a further $290 million benefit, to be mostly received in FY21.

With all this in mind, Credit Suisse has lowered its rating of Qantas to underperform and maintained its 12-month price target of $2.20.

Virgin Australia Holdings (VAH:ASX)

Perhaps the most vulnerable travel company entering into the COVID-19 crisis was Virgin Australia, which is now in serious danger of collapsing.

Unlike Qantas, Virgin has pleaded with the Federal Government for a $1.4 billion loan facility should the impact of COVID-19 become prolonged.

Over the weekend, Deputy Prime Minister Michael McCormack said the government hadn’t ruled out providing further aid to airlines in order to keep them operational, despite reminding them it has already provided $1 billion for the sector.

This morning, Virgin entered a trading halt, telling the ASX it was continuing "discussions with respect to financial assistance and restructuring alternatives." 

It comes as industry experts and analysts alike, have given three to six months for Virgin to find a solution or otherwise face going under.

While Qantas boss Alan Joyce is asking why the government should bail out what it sees as a poorly managed business, on the other hand, Virgin has threatened that should it collapse, Qantas would be left with an unhealthy monopoly over the market.

The reason for Virgin approaching the government is, they are 90 per cent owned by foreign airlines including Etihad Airways, Singapore Airlines, Virgin Group, Nanshan Group and HNA Group.

These airlines are in enough trouble as it is and therefore are unwilling to exacerbate their own cashflow problems by helping out Virgin, which already had issues prior to the COVID-19 outbreak.

Indeed, the cracks were already beginning to form with Virgin prior to the pandemic.

The Sydney Morning Herald reported Virgin holds just over $5 billion of debt with $1 billion in cash and no significant debt maturities until October 2021.  

It has gone through significant cost cutting measures including temporarily standing down 80 per cent of staff, suspending its budget airline Tigerair’s services and grounding its entire domestic operation except for a Sydney to Melbourne return service, flying daily apart from Saturdays.  

Credit rating agency Fitch Ratings recently downgraded Virgin’s long-term foreign-currency default rating to ‘B-‘ from ‘B ’ and placed the rating onto rating watch negative.

As discussed earlier, Fitch Ratings agree that the survival of Virgin revolves largely around how long the COVID-19 pandemic continues to impact travels bans:

“The longer restrictions remain in place, the larger the impact on VAH. In particular, VAH’s liquidity could come under pressure quicker than we previously anticipated should the restrictions on travel be longer than three months or demand remains subdued over the longer term, without the airline obtaining additional liquidity over the coming months.”

Clearly, the future of Virgin lies in its ability to organise additional liquidity whether that be through a government bailout, which at the moment looks unlikely, or against the odds, going to the market like we’ve seen other companies in the sector do.

Regardless, it would take a brave investor to hop on board Virgin now at a mere 8.5 cents.

Wrap up

While certainty is hard to come by in these COVID-19 times, there is one thing that investors can believe and that is, the longer this pandemic continues, the worse off the travel industry will be.

As we’ve seen across all the companies discussed here, significant cost cutting has taken place and for the most part, it isn’t enough to get them through the medium-term.

Half of the companies in this article have undertaken capital raisings, one has gone to the government for a bailout and the pictures of grounded fleets, empty airports and employees out of work is becoming ubiquitous.

While for the moment things seem doom and gloom, investors should remember that there will be an emergence from the travel bans and quarantine being faced in Australia and around the world.

As we’ve seen, what’s most important is that travel companies have available liquidity to cover costs in the medium-term without relying on revenue and also to be prepared for a gradual return to normality once travel bans are lifted.

Clearly the risks are massive investing in an industry that is so exposed to COVID-19 but once things get back to normal, it helps to remember the important role the travel industry will play in stimulating the economy.

For this reason, it’s worth keeping a close eye on developments in the COVID-19 situation over the coming months if you’re at all considering investing in the travel industry.