Those Underestimated Airlines

The market for air travel has undergone a seismic shift since the beginning of the year as demand plunged when COVID-19 began spreading. At the low point in April, traffic had fallen 95%—a level at which no commercial airline can survive for very long. We started to see some green shoots in June as people started flying again, but that upward trend has since plateaued.

What happens from here? In the near term, no one has precise answers. We probably need a widely distributed vaccine, and timing on that is difficult to predict. As we look out over the next several years, we’re asking ourselves whether the lockdown and remote working trends will cause a secular shift that has an impact on long-term demand patterns. Which sectors of the market are most likely to return to pre-COVID levels?

We believe it is reasonable to assume that business travel will be impacted in the long run. Everyone has learned all together how to do remote working, and many businesses are already seeing the positives from drastically lower travel costs. There will likely continue to be instances where a face-to-face meeting is preferred, but the broad adoption of videoconferencing is undeniable. Vacation and leisure travel—what the industry calls VFR for “visiting friends and relations”—is hard to envision going away, and in fact could come back quite strongly.

In a year full of surprises, there have been two factors that surprised industry observers since quarantine began. First was how long it has taken for demand to recover. Back in March, most estimates had demand down about 50% by the end of summer, and yet we are still down about 75%—it’s taking longer for people to get back to flying than the market originally thought.

Second, and more positively from a shareholders’ perspective, is that cashflow has come under control faster than predicted. Management teams acted quickly and implemented cuts to capital expenditures, reduced route networks, and anything that isn’t nailed down has been sold. A significant amount of capital has been raised. The businesses overall are fundamentally in better shape than the market thought they would be, given demand has still underperformed.

Looking forward, how should investors respond? Our approach is to identify businesses that are resilient enough to weather a longer downturn, with solid balance sheets and a line of sight to being cash flow positive in the near future. Given all the uncertainties about when a vaccine may be approved and distributed, we are focused on maintaining a margin of safety on the recovery and lag time to get there.