According to data published by IATA, the outbreak of Covid-19 could result in a 22% drop in passenger volume and a USD 4.4B, ~KRW (South Korean won) 5.4T loss, in passenger base revenue for the Korean air transport market this year. Further effects will inevitably be felt through the whole economy, potentially leading to the loss of around 160,000 jobs and a USD 9B (~KRW 11T) hit to GDP. IATA members have urged the Korean government to urgently extend direct financial support, loan guarantees, support for corporate bond issuance and tax relief to airlines.
This opinion is naturally shared by South Korean airlines. With a global recession affecting the entire industry, airlines have had to rely on external financiers rather than their own revenue and existing liquidity. The government has expressed willingness to offer support, but only after airlines have engaged in self-rescue efforts and explored non-government financing solutions first. By the end of March, the Korean government had started providing financial aid to airlines.
Airline Consolidation in South Korea
The state of oversaturation in the Korean Air Market has triggered a shake-up in the industry, the outbreak of Covid-19 likely to accelerate the pace of consolidation in the airline sector.
Korean Air issues
Hanjin KAL’s listed subsidiary, Korean Air, remains South Korea’s largest carrier financially and operationally. Hanjin KAL’s board was thrown into turmoil in Q1 2020 following a dramatic split inside the Cho Family which created a clear boundary between the roles of the company’s CEO and Chairman.
Korean Air’s 2019 figures were catastrophic, the deeper net loss YoY being attributed to the weaker Korean won, reduced demand and a decrease in cargo revenue. The carrier’s liquidity suffered over 2019, halving to around USD 663M (~KRW 816B). This combined with the fall in revenue raises concerns about the airline’s viability. The company issued KRW 600B (~USD 500M) of notes backed by future ticket receivables in March 2020 and, while a steep underwriting fee was not ideal, the presence of Korea Development Bank (KDB) as an underwriter appears to have offered a degree of comfort. Korean media has reported that the carrier is looking to raise up to KRW 1T (~USD 815M) via a rights issuance, with underwriter syndication already underway.
Korean Air’s LCC (low cost carrier) unit Jin Air received a boost recently when sanctions preventing the presence of a non-Korean on the airline’s board were lifted. The sanctions had barred the carrier from operating charter flights, applying for new routes and had capped the fleet at 28 aircraft. The lifting of these penalties allows Jin Air additional flexibility to deal with the Covid-19 situation, as the carrier seeks board approval for up to USD 24.5M (~KRW 30B) fresh liquidity.
Select carriers’ net profits
The sale of Kumho Industrial’s stake in Asiana Airlines to the HDC Hyundai Development-Mirae Asset Daewoo consortium has been postponed, as scheduled closure has been delayed from the initial Q1 2020 target to an unspecified ‘date agreed by both parties’. The Korea Fair Trade Commission’s (FTC) approval of the deal in April follows rumours in the Maeil Business Newspaper in March that the HDC side of the consortium was considering abandoning the deal, as approval from select foreign countries had been slow to progress. HDC had already requested support from Ex-Im Bank of Korea and KDB for the Asiana deal by way of converting outstanding perpetual bonds or restructuring the repayment profile of HDC’s borrowings. Asiana plans to hold an extraordinary shareholders meeting in June, with the agenda expected to include possible share and convertible bond issuance plans.
2019 saw Asiana’s cash & cash equivalents drop to USD 93M (~KRW 115B) from USD 193M (~KRW 238B) in 2018. The HDC deal was prompted in part by the weakening liquidity position and pressure on Kumho Industrial to reduce the debt burden by existing creditors. The potential divestment of Air Busan has been on the cards for months, with Jeju Air and Jin Air supposedly exploring options to acquire Asiana’s larger LCC unit. Covid-19 will have made the divestment unlikely in the short term however, as potential suitors deal with their own liquidity pressures. As with the rest of the Korean airline industry, Air Busan’s 2019 results were weaker than those in 2018, slipping to a net loss. The entire fleet is leased, which reduces the pool of assets available to borrow against should KDB’s announced KRW 400B (~USD 325M) airline rescue package be slow to materialise.
The announcement of Jeju Air’s planned acquisition of Eastar Jet in Q4 2019 dragged over into Q1 2020, as Jeju Air required additional time for due diligence. While the agreed price had been revised USD 13M (~KRW 16B) lower to USD 45.7M (~KRW 56B), the deal has been delayed in a similar fashion to the aforementioned HDC-Asiana deal. Vietnam and Thailand are apparently yet to approve the deal, although Jeju Air has indicated publicly the deal will close later in May. Jeju Air’s financials have weakened since the deal was first explored, the South Korea-Japan diplomatic issue, weak Korean won and excess seat supply leading to the carrier’s bottom line falling into the red for FY 2019. The Covid-19 pandemic placed further pressure on Jeju Air, the carrier encouraging unpaid leave, senior management taking pay cuts and the shortening of working days and weeks.
The subject of Jeju Air’s acquisition, Eastar Jet, is extremely weak financially (the FTC labelling it ‘unrecoverable’) and is returning a number of 737-800s to lessors. The carrier’s domestic and international services continue to be suspended throughout May and June, and reported cash reserves were just USD 6.2M (~KRW 7.6B) at the end of 2019. KDB rejected Eastar Jet’s application for a loan, citing a lack of ample unencumbered assets for security and weak credit ratings. While KDB appears to have limited appetite for direct lending to Eastar Jet, it has reportedly planned to provide up to USD 163M (~KRW 201B) alongside Ex- Im Bank of Korea to Jeju Air to assist with the deal.
New Airline Entrants
Prior to the outbreak of Covid-19, the Korean aviation market was experiencing significant growth in the form of new airline entrants such as Air Premia, Aero K and Fly Gangwon. Based on available information, KDB has imposed stringent conditions on loans to airlines and has mandated that only airlines in operation for a minimum of three years are eligible.
The six incumbent LCCs include Air Busan, Jeju Air, Jin Air, T’way Air, Air Seoul and Eastar Jet which account for 40% of South Korea’s current total fleet. The full service carriers (FSCs) Korean Air and Asiana Airlines share 58%. The LCCs Fly Gangwon and Aero K are the newest domestic entrants accounting for 1%, while Hi Air Korea and Korea Express Air form the remaining 1%. Notably, the Ministry of Land, Infrastructure and Transport (MOLIT) do not allow Korean companies to establish LCC joint ventures with foreign airlines.
The simultaneous entry of these LCCs into the South Korean market does cause some concern regarding possible oversaturation. Moreover, South Korea had one of the most dynamic and fastest growing aviation markets in Asia, passenger traffic more than doubling from 52.3 million in 2008 to 123.4 million in 2019, according to MOLIT. Despite this significant passenger traffic growth, it seems unlikely the market can sustain this number of airlines and the current situation will probably lead to consolidation or the abandonment of select projects.
Perhaps the most ambitious of these business models is Air Premia’s, which intends to offer Low Cost Long Haul (LCLH) services linking South Korea with destinations such as Los Angeles, San Jose, Vancouver, Munich and Cairns. The LCLH business model has not been without its difficulties as the plight of the Norwegian Air Shuttle and the demise of WOW Air have shown in recent years. With current uncertainty surrounding demand levels due to Covid-19 and fuel price volatility, it is likely the challenging operating environment for the business model will continue.
IBA Scores: South Korea
IBA has recently updated its subscription-based Operator Score Index, the product predominantly used as a comparative reference against airline credit risk. IBA’s scores for more than 120 airlines are available and its Operator Risk Assessments (ORA) dig deeper into airlines’ financial and operational situations, offering a comprehensive overview and opinion.
The IBA Score percentage is a single coefficient based out of 100%, developed through quantitative analysis of various financial and operational metrics, each given a weighting. IBA’s ranking system places the operators in to 10 buckets based on their IBA Score, with the suffix representing IBA’s view of the respective operators’ lease management practices.
The latest update remains cautious on the South Korean operators in our coverage universe. Whilst full audited accounts were unavailable at the time of our initial 2020 update, recent years have seen downgrades for a number of South Korean operators. Initial figures indicate 2019 was a weaker year and, as such, we expect downgrades across the board following the next IBA Score update. Stiff competition had already seen Korean Air and Asiana drop down a notch on the back of considerable bottom line weakness. This looks to have continued over 2019 with KRW weakness and the Japan-South Korea diplomatic issue.
Pre-Covid competition also limited profitability outside the big two carriers, Jeju and Eastar (IBA Scores above with select foreign comparison) plus Jin Air and T’way seeing inflating top lines but sinking bottom lines. Covid has led Korean carriers to cut capacity by 80-90% in many cases, although it appears routes connecting Seoul, Jeju and Busan are starting to regain some traction with select carriers re-introducing capacity. Having said that, we note Asiana has extended periods of paid and unpaid leave for staff and has raised credit line limits with KDB and Korea Ex-Im, which suggests it will be a while before carriers can generate meaningful revenue from their networks.
The airlines shaded in black and grey featured in the table above serve to indicate how other LCCs and FSCs in the Asia Pacific region have performed over the same period.
Korean Aircraft Asset Analysis
According to IBA’s intelligence platform IBA.iQ, the Boeing 737 family makes up nearly 40% of the entire in service South Korean operator fleet, the Boeing 737-800 model playing a predominant role. This is followed by the Airbus A320 family, which consists of 56 A320ceo and two A320neo aircraft. Although narrowbody aircraft types account for most of the fleet, the widebody market in South Korea has been buoyant in recent years.
The large widebody market is currently going through a transitional period. Airbus has announced termination of A380-800 production, Boeing has delayed the debut of its 777X programme and an accumulation of early-build widebody retirements, such as the Boeing 747 family and Airbus A340 family, has occurred. The retirement and phase-out of older and four-engine aircraft has led to an increase in deliveries of new technology aircraft types to South Korean operators, for example the Airbus A350 and Boeing 787.
The large widebody aircraft market has attracted not only Korean airlines but also its investors. Numerous transactions have occurred since 2015 involving Airbus A380, Boeing 777-300ER and Airbus A330 aircraft types to airline credits such as Emirates and Qatar Airways.
The announced production termination of the Airbus A380 in 2021 will influence the future fleet planning decisions of its operator base, with early retirements and assets being returned upon lease end. Two ex-SIA A380s have been undergoing part out since 2018 and Air France scrapped its first A380 in February 2020. ANA and Emirates are still scheduled to take delivery of further A380s. However, we believe Emirates is seeking delivery deferrals on future aircraft. The Covid-19 outbreak has severely challenged the survival of the largest commercial aircraft; 232 out of 239 in service A380s have been parked as of April 2020, including ten Korean Air and six Asiana Airlines examples. Some of the routes previously operated by A380s have been given to other widebodies, one example being Asiana’s switch to a 777/A350 service on former A380 routes. Due to current travel restrictions, the double-decker is unlikely to return to service in the near term, further weakening the A380’s market.
Globally, 97% of in service A380 aircraft have been grounded since the start of the Covid-19 outbreak. German flagship carrier Lufthansa decided to reduce its fleet by permanently decommissioning its six A380s, anticipating that traffic is unlikely to return to Pre-Coronavirus levels in the short term even if lockdown measures are eased. As the impact of Covid-19 deepens, more early retirements of A380s are expected and therefore the destiny of the large widebody type is in limbo.
The Boeing 777 family has dominated the large widebody sector for the last decade or so with 1,372 777s in operation as of April 2020. However, the Airbus A350 family features the largest current order book (571 aircraft) followed by the Boeing 777X series’ 344-unit order book according to IBA.iQ. The Boeing 777-300ER has attracted a total of 887 orders making it the most popular aircraft in the large widebody market. There are currently 814 units in service amongst 47 carriers. This is followed by the Boeing 777-200ER, where 386 examples were in operation with 48 carriers as of April 2020.
Market conditions for the B777-300ER/-200ER had already weakened before the advent of Covid-19 and IBA expects conditions to worsen over the coming months, with downgrades to market values and lease rates. The uncertainty surrounding the long-term future of the Boeing 777-300ER in the passenger market is compounded by its declining order backlog and the concentration of its operators. The profile of lessees who’ve taken secondary 777-300ER aircraft so far is a departure from the Tier 1 credits occupying the primary operator base. The nature and size of this aircraft present some barriers to secondary market placement, reconfiguration potentially an expensive prospect and the aircraft’s high capacity a drawback for some carriers. Although the market condition of the Boeing 777 family has not been hit as badly as the A380 family, a number of B777 aircraft have been parked due to the Coronavirus.
Of the B777 operators in South Korea, Korean Air had parked six B777-200ER and two B777-300 aircraft as of April 2020, according to IBA.iQ. This is followed by Asiana Airlines, which has grounded three out of its six B777-200ER aircraft. In contrast, Korean Air’s 26 Boeing 777-300ER aircraft have continued to enjoy great utilisation and Jin Air has managed to operate without interruption its four B777-200ER aircraft on its Seoul- Jeju route during the Covid-19 period, which remains the busiest domestic route.
IBA anticipates recovery of the Korean civil aviation market, with some signs that international flights will resume in the coming weeks. In IBA’s view most of the Korean Boeing 777 fleet will restart operation post Covid-19. However, some of the early build B777-200ER and B777-300 aircraft, currently grounded, may be vulnerable to phase-out by Korean Air and Asiana Airlines.
Korea Aviation Financing/Lessors
With the advent of the Covid-19-triggered financial downturn, state-owned KDB is playing a crucial role in providing financial aid to troubled companies. As mentioned earlier, KDB was involved in Korean Air’s KRW 600B (~USD 500M) issuance of notes, backed by future ticket sale receivables. Additionally, KDB contributes to funding new start-ups in the Korean airline market. For example, the aforementioned Air Premia, Aero K and Fly Gangwon all of whom to some extent received financial support from KDB.
With respect to the leasing market in South Korea, the first Korean aircraft leasing company, Crianza Aviation (formed by IMM Investment, Cerritos Holdings and EastMerchant Capital in 2016), has made another breakthrough. Crianza teamed up with AMS and EastMerchant to place a China Airlines owned 747-400F with ASL Aviation in late 2019, a placement which earned the Remarketing Deal of the Year 2020 award from Airline Economics. Crianza had previously arranged a lease transaction with Etihad Airways for three 787-9s, in which Crianza sourced senior debt from a variety of international lenders and mezzanine financing from unidentified domestic institutional investors.
Meritz Securities has been active in the ABS market over recent years, their initial acquisition in 2016 alongside Mizuho consisting of a 20 asset GECAS portfolio for around USD 900M (~KRW 1.1T). Meritz acquired 18 aircraft from DAE Capital for a reported USD 540M (~KRW 607B) in late 2018, the portfolio representing exposure to 15 lessees. Meritz’ latest portfolio deal was the October 2019 acquisition of 24 assets from Aviation Capital Group for USD 686M (~KRW 804B), IBA undertaking portfolio due diligence on the assets and credits involved. Equity for this latest deal came in the form of both Crianza itself and preferred shares sold to domestic institutional investors, with particular demand from insurers.
Mirae Asset Daewoo Co. Ltd, another big player in the aircraft financing market, signed a USD 450M deal in late 2019 to acquire three Boeing 777-300ERs from ICBC Leasing and GECAS on lease to China Airlines.
So – will Covid-19 force South Korea’s oversaturated aviation market to consolidate?
Recent LCC projects that cannot access KDB or MOLIT funding may not survive the pandemic, which may go some way to solving South Korea’s oversaturation. As with other jurisdictions, we are likely to see older sub-fleets retired or returned off-lease alongside the disposal of non-core business units by Korean Air and Asiana, as remaining operators enter the post-Covid era leaner than before.
The Covid-19 pandemic has clearly weakened appetite for airline acquisitions, foreign regulatory approval a convenient excuse to push considerable capital outlay further out. All South Korean carriers are seeking funding to carry them through the next couple of quarters until demand reaches more reasonable levels. Initial Q1 2020 results point to net losses across the board and industry players will be looking to MOLIT to offer guidance on post-Covid measures to ensure the aviation sector remains competitive.