Airlines around the globe are in uncharted financial and operational territory due to the Coronavirus COVID-19 Pandemic. Normally they would be enjoying a period of record low oil prices and what was a strong economy. Now, the only thing certain is that many of the world’s airlines will be unable to survive in their current form once the crisis passes, and there is not yet any idea when that will be.
Finance Colombia arranged a meeting with key analysts with Standard & Poor’s to understand how this might play out for LATAM and Avianca, the two full service carriers that operate domestic routes in Colombia. Other airlines that operate domestic routes such as Viva Air are privately held and thus not covered by the ratings agencies, and SATENA is government owned.
Finance Colombia’s Executive Editor Loren Moss spoke with key Standard & Poor’s analysts to address the health and survival of these two key Latin American airlines.
Finance Colombia: We know that LATAM of course was losing money already, even though they have had some help with Delta Airlines coming in and I’m sure you’re aware of the interest that Qatar Airways has expressed in them. Obviously with Avianca the situation is a little bit different. We have the situation that they had with United Airlines and Kingsland Holdings and all that, they already were facing challenges and then this pandemic has hit and the airlines of course are all grounded here and pretty much everywhere, so I would like to get your expertise: first if you can introduce our panel of Standard & Poor expert analysts.
Flavia Bedran So we have Amalia, who is the analyst for LATAM. I work as a backup for LATAM Airlines here based in South America and then we have Humberto who covers Avianca, and then we have Fabiola who covers Avianca and Aeromexico for example. I think we can cover any of your questions on the airlines.
Finance Colombia: When you look at the situation here in the northern Andean region, obviously Colombia, what do we know about the relative positions of LATAM and Avianca before this pandemic and then how has this changed the game? obviously it is hard for all the airlines but if we look specifically to their relative position how has this changed their viability in the medium-to-long-term in this pandemic?
Amalia Bulacios: We can start with LATAM. I think you’re most focused on the Colombian market, right? So, just to give you background there, LATAM has a strategy I would say like at least for the past 2 years more or less with a focus on growing all the Spanish speaking countries in South America but I guess particularly the focus was on Peru on the first place and then second place in Colombia. In any case although they have a strategy to bring relatively good growth in the market, the Colombian market was still a very small one for them. When you look at the revenues for LATAM, the major market for them of course is Brazil, which is between 35% and 40% of the revenues, then Chile and then Peru and Colombia is probably less than 5% of the ASK (Available Seat Kilometers, or capacity), so yes, it’s a small country, but yes they had a good growth prospect for Colombia and they work to have greater share in that country.
Just to give you some example, of what the strategy was before this pandemic started, of course as you just said this this expansion of COVID-19 has changed everything for the companies, not just for LATAM, but all of the companies in the region.
I guess South America particularly because probably with the exception of what we have seen in Mexico for instance, but the South American governments were very strict at the beginning and moved very rapidly in terms of closing borders and even not allowing domestic flights at all in any country, the same in Peru and Argentina and even in Colombia. At this point LATAM is only flying, but of course with little frequency with empty aircrafts we would say, just in Chile and in Brazil and basically I think that elsewhere they have most of their aircrafts grounded. So the situation the company has right now, this is a very challenging environment for LATAM–. I sent you our last report last week for LATAM, that we downgraded to B from the double B minus (BB-) and the reason we did this is because of course there will be a much weaker performance for the company this year probably than what we expect for a double B minus (BB-) falling…they’ll probably need new financing so we will probably see by the end of the year and even with an almost…I wouldn’t say full recovery next year but with strong recovery next year we will still see the company more leveraged than what it was in the past right? So, that’s what our rating is reflecting now.
Finance Colombia: Great, thank you, now, if we look at Avianca in the past year they had to renegotiate their financing. They were technically insolvent for a time. They just took on a significant amount of additional debt they’ve got debt coming in from I think Citadel Capital in the US as well as obviously United and Kingsland and some other investors, and not necessarily the best terms, so obviously aside from having to deal with this debt and then this significant event to cash flow structurally my question to analysts like you would be: What resources can they draw upon when we look at their long-term survival?
One of the things that we’re seeing in the market here in Colombia is a large growth in the amount of low-cost carriers coming in. We obviously have home grown Viva Air, that’s not publicly traded, so they are backed by the people behind RyanAir in Europe, they have a lot of planes on order, they seem to be expanding they just opened routes to Cali and they put significant negative pressure on the legacy carriers, especially domestically, they don’t really fly much internationally except for between Colombia and Peru, they do have one route to Miami but now we have JetSmart coming in from Chile, we have Plus Ultra coming in from Spain, Spirit is from the US and expanding here in Colombia and even though they’re not necessarily playing domestic routes, like Viva, this has to be putting pressure on the traditional carriers like LATAM and Avianca, and my question is how does this affect their ability to generate enough margins in cash flow from operations to service their debt?
Humberto Patiño Last year was a rough year for Avianca regarding its financial obligations, as it had limited time to complete its refinancing strategy within the expected timeframes. This environment and this scenario led the company to adjust its operating strategy going forward. In 2019, the company mainly focused in profitable routes, mostly international. The domestic market was being taken a bit by low cost airlines, so the company shifted to increase its trans-border market, mainly through its Bogota hub, to continue increasing its international participation. Therefore, what Avianca was mainly focusing on was in reducing the domestic participation, for example in Peru, where the company reduced significantly its domestic frequencies, as well as between some local Colombian cities. Avianca increased its international participation, for example, increasing frequencies between Colombia and the United States, and if passengers were to fly to a southern American country, they would have first stopped in Bogota and continued the journey to increase load factors and profitability.
By the end of 2019, the company finalized its refinancing strategy. The company received $250 million from Kingsland and United, now the company’s main shareholders, another $125 million dollars from additional investments from multiple Investors as a loan to the company and additional cash inflows from its sale and lease-back agreements; basically entering into this economic downturn with approximately $540 million dollars in cash. Once the company gradually resumes its operations, we expect the company to continue benefiting from its international market presence, gaining higher contribution margins. That is how we believe the company will shift its operating strategy in order to withstand to economic downturns.
Finance Colombia: That’s interesting because reminds me that a long time ago, Copa abandoned its domestic flights that you used to have a model that looks like Avianca with domestic flights and international, then Copa just said look we’re going to move directly to International in and that seems to have worked very well for them, I think if I remember correctly they have a pretty strong balance sheet going into this crisis, at least relatively speaking and they had a very focused strategy: they don’t run any transatlantic routes, they really stick to Northern Andean countries and the Caribbean, they’re dominant here in Central America and that just seems to be their operating model.
With Avianca Express, Avianca kind of shifted some of their domestic operations especially into smaller cities here in Colombia into a subsidiary, and that reminds me a lot of what Telefónica has done when they are obviously preparing to shed off their Latin American operations except for Brazil, they’re starting to separate those operations and I’m speculating and I don’t know if you guys have spoken with Avianca; if that’s something that that maybe is part of their strategy because it does seem that are struggling domestically and so they can focus on their international routes, doing some transatlantic routes that Copa is not doing and is not interested in, and Avianca is obviously key to the United strategy coming here into Latin America.
Delta is moving into the area, American Airlines who knows what’s going to happen with them, they’re kind of left out in the game, but can we speculate and say that Avianca in order to stay profitable, is going to cede a significant amount of market share on the short-haul domestic routes to some of the low-cost carriers?
Humberto Patiño At this point, I’m going to try to say that this operating strategy could result in positive operating results for the company. I just want you to go back to 2019, when the company started shifting to this new operating strategy and basically the company was getting negative contribution on its cash generation for example, and once the company started shifting into the international market decreasing its domestic presence the company started increasing its contribution to the positive side. I do not know what happened to the other airlines coming into this competitive environment, but as of today what we know, is that Avianca has this strong participation on international flights as you were mentioning and continues benefiting from routes that no other airline has right now. Therefore, what we will say is that the company will continue increasing its market share and its International presence deriving in positive results. Due to the economic downturn, it is a little bit hard to say that this will occur in 2020 but we believe that the company not only benefits from Bogota’s hub as a transborder hub but also El Salvador and Panama, so we believe the company will remain profitable if this strategy continues going forward.
Finance Colombia: We don’t know obviously what’s going to happen with this pandemic, we don’t know what the mechanics of this recession are going to be. Goldman Sachs has estimated a 24% decline at least for the US, negative growth in the second quarter I don’t know if Standard & Poor’s has any projections that they would like to share but let’s suppose that we are in a no-growth or negative growth atmosphere for the remainder of the year, slightly longer than expected but certainly in the realm of possibility and we don’t know of course how long the airlines are going to be grounded either, nobody knows. But I would ask who is in the better position to weather this, I guess who has the most cash and is in the best position to weather the storm?
And then number two, if we look at a lower slow growth environment going into 2021 what are things going to look like for LATAM and Avianca in the next year? Are they going to be able to survive? Do we expect to see potential mergers with foreign carriers or what would a worst-case scenario look like? I know I’m asking you to speculate but if you could give me some conceivable outcomes?
Flavia Bedran All the companies that currently are credit watch negative, which means that at least a 50% chance of a downgrade in the next I don’t know, 3 months, 6 months, depending on how we see this recovery coming in the second half of the year and for 2021…well this industry is already highly volatile so we usually determine our forecast for the next 12 to 24 months, not much more than that because it’s too volatile. We have been analyzing airlines in this scenario of uncertainty, we are looking at it short term, so as Amalia said in the beginning, we put basically everyone in credit watch in the first week after the barriers in terms of flights had started to be closed in South America and then two weeks after that the downgrade is it by two notches go into the quarantine, each of them, all of them keep continuing in credit watch so we might continue to revise it every two weeks every month, depending on new information flow.
Amalia Bulacios: Just to complement briefly, I’m probably not going to tell you anything new but particularly if you if you were asking between LATAM and Avianca, LATAM was standing, at least from our credit perspective on a stronger position right? It was rated higher, it was rated stronger and had a healthier balance sheet, it had gone through a period of good cashflow…very slightly but at least slightly reducing debt that’s so they were something relatively strong but I would say this has changed everything, and like you said and we will continue reviewing them constantly, I think they kind of brought all of the airlines closer to each other (in terms of circumstances), we would probably have seen much more difference between the airlines a few months ago and they think this has kind of weaken the whole market and bringing them all to a much weaker position.
Humberto Patiño In terms of Avianca, after the refinancing strategy back in November 2019, the company still had $60 million approximately in US dollars that has to be paid in May 2020, and we believe that right now the company is in a weaker position than LATAM. This is also due to higher debt service from lease payments expected in 2020. Considering that the company had $540 million dollars in cash, and expected contracting strategy to allow cost reductions to preserve as much cash as possible, we believe the company will be able to fulfill its $60 million maturity of unsecured notes in May 2020, around $60 million in lease payments each month, and in some extent, the remaining fixed costs for the period the company remains with no operations (administrative, aircraft maintenance, among others for example). We believe Avianca’s liquidity position is somehow weaker than LATAM, as Amalia was mentioning, therefore the rating for Avianca is CCC suggesting that the company faces a possible downfall scenario within the next six months.
Finance Colombia: Yes, I do think it is going to be tough. If we look at it and you guys have done the math, I haven’t—but I can just say intuitively that even if this didn’t happen if you look at for example the debt service was and what the payments were that were coming due and as the regular periodic debt service it was I think they were something like six times (debt to cash), but now we’re looking at a lower demand even if we come into a recovery but that’s still there in and probably this situation puts them even behind, they have already announced that they’re deferring payments with their long-term real estate leases so I would imagine facilities or offices or hangars that kind of thing, so I would imagine that’s going to even complicate things going further. They just finished getting a loan from United Airlines (UAL), so I don’t know if that means you’re getting another round of funding, because United is going to have their own struggles in the US and globally dealing with this as well. But I think what you all have told me and the consensus here is that there is a lot of uncertainty which is negative, but we don’t know what’s going to happen and it will be good to have Standard & Poor’s doing the research so that investors and journalists like me can continue to monitor the situation and gain insight over the coming quarters. I’m appreciative of what you all are doing.