Airlines set to raise ticket prices to pay mounting debts

The pandemic-stricken industry collectively amassed more than $180bn in loans in 2020

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Mounting debt levels in the airline sector will lead to a rise in fares and greater government involvement, according to consultancy McKinsey & Co.

Cash-strapped operators are expected to increase ticket prices by about 3 per cent to repay debt that piled up during the Covid-19 pandemic.

The forecast assumes a 10-year repayment window for the additional debt, McKinsey said in a report on Friday.

"We see a glut of latent demand of people eager to travel," said the report titled Back to the future? Airline sector poised for change post-Covid-19.

"It will take time for airlines to restore capacity, and bottlenecks such as delays in bringing aircraft back to service and crew retraining could lead to a supply–demand gap, resulting in higher short-term prices.”

Airlines were forced to borrow heavily to meet day-to-day expenses as revenue took a hit after the pandemic closed borders and grounded aircraft.

The industry amassed more than $180 billion in debt last year – more than half of its annual revenue – through state aid, credit lines and bond issuances, said the International Air Transport Association.

Repaying these loans has been made more difficult by deteriorating credit ratings and higher financing costs.

Government bailouts have come with strings attached, often in the form of shareholding, leading to a re-emergence or increase in state ownership and influence.

“Instead of seeing this as a necessary restriction to access much-needed funds, airlines can treat it as an opportunity to shape how the sector evolves with a key stakeholder,” said McKinsey.

The consultancy urged airlines to work with regulators to reduce carbon emissions in exchange for more labour flexibility, higher cash-on-hand requirements to make them more resilient, changes in ownership limits to allow for greater inflows of foreign capital and a reduced reliance on state capital in the future.

The increase in fares is one of five fundamental shifts the industry is experiencing as a result of the pandemic, the consultancy said.

A disparity in airline performance in the future, depending on their response to the pandemic, is another. Operators that are not adapting are at risk of failing to set their businesses up for long-term structural value creation, the report said.

Airlines that have an opportunity to transform their business include those with access to a restructuring process such as Chapter 11 in the US.

These companies can renegotiate mid-life leases and shed excess debt to become leaner and more competitive.

“Even though many airlines find themselves in financial straits, we recommend investing more in information technology and digitisation, not less,” the report said.

Investing in analytics will allow airlines to use data in smarter ways to improve decision-making, which will yield “significant payoffs”.

Another shift identified in the report is that the market for aircraft will remain oversupplied for some time.

Before the pandemic, aircraft makers had raised production in anticipation of continued growth, leading to a glut in supply.

Now, some airlines are returning relatively new jets to lessors while the cost of leasing used aircraft has declined and is expected to stay low, the report said.

If finances permit, operators can consider acting countercyclically by locking in orders for new aircraft or confirming operating leases now when demand is low, McKinsey said.

It said signing deals during a crisis could allow airlines to enjoy a cost advantage for years to come.

The consultancy also expects demand for air cargo to outpace supply. Cargo operations handed airlines a lifeline as online shopping became more popular amid the pandemic.

Many passenger flights, which are responsible for delivering about half of all air cargo, remained grounded.

In response, airlines “could investigate short- to medium-term opportunities to boost their cargo services”, the report said.

This includes the use of "preighters" – passenger planes that are used to transport cargo.

Airlines may look at freighter conversions, especially as their passenger fleet shrinks.

The report also echoed industry predictions that leisure trips will drive the recovery in travel demand while business trips will take longer to rebound.

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