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Airlines to burn US$61bn of cash reserves in a quarter as costs remain high

Cost-cutting measures are not enough for airlines, which are left with inevitable fixed costs

International Consolidated Airlines Group - Airlines to burn US$61bn of cash reserves in a quarter as costs remain high

Airlines globally are expected to burn through US$61bn of cash reserves in the quarter to June, a study shows.

The International Air Transport Association (IATA) said quarterly net loss could be US$39bn if severe travel restrictions last for three months, with demand tanking 71%.

READ: No free lunch: easyJet and IAG downgraded as state intervention "an inevitability"

Airlines make millions, if not billions, of annual profits. So why are they in such big trouble?

These businesses have high operational gearing, meaning they are bound to pay for fixed elements, independent of revenue. In short, profits aren’t necessarily based on performance.

Fixed costs can be significant for airlines as they are related to hiring, buying or maintaining aircraft, as well as reserving slots in airports.

A flight at full capacity will cost roughly the same as an almost empty one, but it will be more profitable.

Last year, British Airways owner International Consolidated Airlines Group (LON:IAG) spent €7.5bn in operating costs such as landing fees and engineering against €6bn for fuel.

According to IATA, semi-fixed costs will be reduced by a third, although some resources, such as part of the workforce, will have to be preserved for future recovery.

Ticket refunds are another big issue, coming in as a US$35bn liability in the second quarter.

At the moment, most of the flights are cargo shipments, though they aren’t enough to offset the losses of passengers.

The mix of fixed costs and vulnerability to external events makes the sector extremely volatile and risky for investors.

A "dreadful investment"

“Traditionally, airlines were a dreadful investment,” Russ Mould, investment director at AJ Bell, told Proactive.

“The upturns would always encourage more capacity which was then added at the wrong time, when a cycle was about to peak.”

The consistent and growing profitability seen in the last ten years has been unusual, Mould commented.

It was due to consolidation following the financial crisis, paired with greater capital discipline.

The sector had been doing so well that they started paying dividends and engaging in share buybacks, which some of them may now regret.

However, some companies have shown signs of trouble well before the coronavirus pandemic.

easyJet PLC (LON:EZJ), for instance, has been struggling for a while, with profits down 26% to £427mln last year, despite effectively flying more people.

What next?

Although some countries have already been injecting cash to save their national airlines, it is unclear what will happen in the UK.

There is a “moral” issue, explains Mould, as a government bailout for listed companies could be seen as saving those investors who should have known where they were putting their money in the first place.

However, intervention from above “seems an inevitability” according to Citigroup.

Westminster may take the hardest stance in Europe, according to a report from Sky News, with an expectation “that all companies [pursue] all possible actions to preserve cash and maximise liquidity, including engaging with shareholders, lenders and the markets and utilising all available assets and facilities”.

Quick facts: International Consolidated Airlines Group

Price: 162.25 GBX

LSE:IAG
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Market Cap: £8.06 billion
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