In early 2020, a previously unknown coronavirus struck Wuhan, capital of Hubei province and the most populated city in Central China with over 11 million inhabitants. Now known as Covid-19, the virus has spread rapidly across China and international travellers have taken it around the world. The National Health Commission of the People’s Republic of China to date disclosed that in China 70,640 people have been infected with 1,772 dead. The virus has yet to be contained and numbers are therefore still climbing.
The following graph shows Covid-19’s severity across China. The darker the colour, the greater the number of people who have been infected:
The purpose of this report is to discuss the impact Covid-19 may have on air traffic, operating lessors, aircraft financing and OEMs. The effects on flight operations will also be estimated based on implicit revenues and expenses.
Air Traffic in China
Covid-19 is thought to have been introduced to human populations from the animal kingdom in November or December 2019. Presently, it seems to spread from person to person by the same mechanism as other common cold or influenza viruses, that is face to face contact with respiratory droplets from a sneeze or cough, or from contact with secretions of people who are infected. It poses dramatic turmoil for the aviation and associated industries.
The significance of the Lunar New Year in China cannot be overemphasised. It is the most important holiday and at its heart is the family reunion: it causes the biggest human migration in the world with people buying plane, train and bus tickets to get home to their towns and villages for New Year’s Eve dinner. Once the festivities are over, they return en masse to their workplaces.
IATA posted the following graph to compare 2018, 2019 and 2020 daily traffic volumes in China. The 2020 data is significantly higher than in 2019, echoing IATA’s growth forecasts, and the traffic peaks before and after Chinese New Year reflect the holiday migration described. However, after the outbreak of Covid-19 during 2020’s Chinese New Year, the traffic data did not rebound as anticipated. In fact, volumes are still much lower than in 2018 and 2019, reflecting that many Chinese have remained at home with their families in accordance with restrictions on movement within the Chinese government’s quarantine policy. We will return to this point in a later section.
If we consider the coronavirus in the context of 2003’s SARS outbreak, IATA data shows Asia Pacific Airlines lost 39 billion revenue passenger kilometres (RPKs) due to SARS with a drop-in revenue of around $6 billion. North American Airlines lost around 12.8 billion RPKs. Taking significantly increased traffic levels around the region since 2003 into consideration, along with the fact that since 2003 SARS the Chinese economy has grown from 4% to 16% of global GDP, it is inevitable that the impact on aviation and airlines in particular will be several times more than 2003 SARS.
As previously mentioned, the Chinese government’s quarantine policy has resulted in restrictions on movement for many workers. As a consequence, Airbus has had to close its single-aisle final assembly line in Tianjin due to a lack of people. The company also has an A330 completion centre in Tianjin and the global production systems for its European and American production lines rely on Chinese suppliers. Their Chinese joint venture in Harbin provides composite components for the A320 and A350 and this could cause a longer-term reduction in Airbus’s monthly production rates. The current production rate for Airbus is 60 aircraft per year with forecasts expecting an increased rate of 72 aircraft annually. A prolonged quarantine will mean this production rate will be significantly reduced. Based on data from IBA’s online intelligence platform IBA.iQ, there are 582 A350s on order and more than 6,000 A320s. Capacity will be constrained by any further delays in delivery and leases will consequently be extended. We expect an active second-hand market for Airbus aircraft, especially narrowbodies.
The impact of Covid-19 on Boeing’s production will be less dramatic, but they do have some affected suppliers and, of course, they have different ongoing problems to resolve. With the 737 Max still subject to a recertification process and the B777-9 experiencing continued teething problems, we don’t foresee the coronavirus having a profound near-term effect on Boeing. However, if Covid-19 cannot be quickly contained and causes a prolonged decline in air travel, both Boeing and Airbus could see a reduction in future orders and possibly cancellations. This would be particularly bad timing for the already weakening widebody market.
For domestic airlines in China, daily cancellations are around 10,900 flights. As of 12th February, according to the ch-aviation database 1,215 aircraft operated by airlines from China, Hong Kong and Macao have been grounded.
Many Chinese operators lease their aircraft and are contractually obliged to continue paying monthly lease rentals even when an aircraft is grounded. Therefore, operators are confronting a hit on cash flow from both reduced revenues and continuing expenses. Since lease rentals are a function of aircraft age, specification and lessee credit risk, we can estimate the cost for each Chinese operator. For example, the following graph shows B737-800 lease rate distribution. It is non-normal (skewed to the left) since there are fewer airline customers with higher credit ratings.
It is clear from the graph that the range is mainly around $265,000 to $309,000 per month. Using the data from IBA.iQ, we can get the same range for other aircraft types as follows:
Based on the number of grounded aircraft, daily lease rate costs among Chinese operators is around $6.5 million to $8.5 million and approximately $195 million to $256 million monthly. This is in addition to insurance, maintenance, airport leases/gates and many other expense categories related to operating the now grounded flights. Together with the huge revenue losses, this is obviously a difficult situation which could lead to bankruptcies among those in a weaker financial condition.
For international carriers, there are 73 operators who have stopped or reduced flights to and from China. They are also therefore dealing with a reduction in their passenger and cargo revenues, a significant drop for some. The opportunity cost for these airlines is more difficult to estimate since they can redeploy their aircraft to fly other routes instead of grounding them. However, this is a major disruption to their schedules which will require substantial efforts to accommodate, both now and again when the situation returns to normal. Similarly, the revenue and lease rate expense relationship is here out of balance and may lead to unexpected real-world stress testing on some of the smaller or less financially healthy airlines.
The Chinese market has been a major focus for smart aircraft lessors for many years. The top four operators in China based on fleet size are China Eastern Airlines, China Southern Airlines, Air China and Hainan Airlines and, together, they have grounded more than 100 aircraft.
The following tables list the 10 lessors with the greatest exposure to these primary operators:
The grounding of so many aircraft affects not only domestic Chinese lessors such as ICBC Leasing, Bocomm Leasing, and CALC but also has an impact on international lessors like ALC, AerCap and GECAS. If the situation continues and eventually causes airline operators to default on their leases, it may well be difficult to repossess aircraft as travel restrictions to China endure.
Asset backed securities (ABS) and Enhanced Equipment Trust Certificates (EETC) are some of the most important ways lessors and airlines finance their aircraft. With decreased revenues and heightened risk in the aviation industry, investors involved in future transactions will demand greater yields to offset their exposure. Evidently, the prospect of increased returns will depend on the containment of coronavirus globally and how long resolution takes to achieve.
According to IATA, Asia Pacific Airlines lost 8% of their annual traffic due to SARS which resulted in the $6 billion revenue losses already cited. North American Airlines lost about $1 billion.
Based on WHO data, the outbreak of SARS occurred in March 2003 with the last cases identified at the beginning of June. The Covid-19 coronavirus has spread far faster than SARS. It took eight months for SARS to infect more than 8,000 people, whereas Covid-19 infected over 2,000 people in just five weeks. The incubation period of up to 24 days also makes Covid-19 harder to detect so it can spread more easily. WHO recently anticipated the first vaccine will be developed within 18 months.
Viruses like Covid-19 have a severe impact on the global economy, affecting a wide range of industries including tourism, construction, manufacturing and food and heavily impeding supply chains. The scale of consequences the aviation industry will suffer cannot yet be known but both operators’ explicit costs and the hidden costs of other stakeholders are likely to be unprecedented. The SARS outbreak ultimately cost the aviation industry $10 billion and with passenger volumes today much higher than in 2003 (tenfold greater in China alone) we should expect the aftermath of Covid-19 to be extensive. Crucially, the cost to global humanity firstly and to the worldwide economy will depend on effective, transparent communication and cooperation between governments and healthcare organisations everywhere.
Please contact Dezhi Zhu, Aviation Analyst, if you have any questions, comments or feedback: Dezhi.Zhu@iba.aero