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What Global Risk Managers Can Learn from Recent Airline Turbulence

Posted by Dylan Dao on August 01, 2019
 
The last 18 months have presented the global airlines industry with 
many great challenges and changes. Prominent bankruptcies such as WOW air, rapidly increasing aircraft fuel prices, and most notably, the two fatal crashes of the 737 MAX plane that reverberated shockwaves throughout the industry. Moreover, based on a recent financial health review of global airline companies, it’s clear the group is financially declining. Where there’s this type of financial deterioration in any industry, risk of disruption will lurk around every corner. What can risk managers in the space glean from the recent airline trends to understand if the industry is financially prepared to handle the potential turbulence in its path? 


Global Airlines Financial Health Declining

Figure 1 displays annual changes in individual airlines’ financial health ratings, which are analytics measured numerically on a scale of 0-100 indicating the financial viability of any given company. While the global airlines group holds an average FHR of 60, placing them in our Low Risk category, from 2018 to 2019, the global airline industry’s downgrades far outweigh the improvements. Not only were there three times as many airlines on the decline as there were airlines improving, but their FHR downgrades were much larger in magnitude: 24 airlines had a drop greater than 10 points and 12 airlines had a drop greater than 20 points.

                                                               Figure 1: Annual Change in Financial Health for Global Airlines

Annual Change in Financial Health for Global Airlines

 

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Volatile Jet Fuel Brings Uncertainty

 

To better understand the significant decline in global airline financial health, it’s important to consider the external factors that typically affect airlines’ underlying operation and financial results. After salaries, wages, and benefits, changes in price of aircraft fuel is usually the second largest operating cost. Figure 2 clearly demonstrates that when the average U.S. Gulf Coast Kerosene-Type Jet Fuel Spot Price began to decline in 2014, the average FHR steadily increased to its peak of 68. Similarly, when the Jet Fuel Spot Price began increasing in 2017, the average FHR began to decline from its peak. With peak summer travel season in full swing, if fuel price is to rise to similar or higher levels in the second half of this year, we may see further decline in overall financial health of the global airlines group.

Figure 2: Global Airlines Financial Health Trend

2-1

US Airlines Financial Health is Robust

While the global airlines industry overall is declining, breaking down this group further reveals a clear bifurcation between the US airlines and international airlines’ financial health picture. The US airlines’ average FHR is an impressive 77 for the financial period ending March 31, 2019, placing the airlines in the top half of our Low Risk group. Companies with this financial profile have a very promising short and medium-term outlook and low default risk. On the other hand, the international airlines’ average FHR falls lower at 56. This FHR puts the international airlines group in the top half of Medium Risk Group. Companies in the Medium Risk group have an acceptable risk of default in the next year combined with satisfactory medium-term prospects. However, these companies are often more susceptible to external headwinds and less competitive than companies in the Low Risk group.

Deeper analysis of key financial ratios confirms that US airlines group is superior in terms of financial health over international airlines, consistently outperforming and demonstrating:

  • Robust operating margin (Figure 3: Operating Margin)
  • Declining leverage (Figure 4: Total Debt to Equity)
  • Stronger ability to meet short-term obligations (Figure 5: Cash from Operation to Current Liabilities)

Figure 3: Operating Margin

Figure 4: Total Debt to Equity

Figure 5: Cash from Operation to Current Liabilities

 

Current Industry Headwinds to Monitor

While the global airline industry sits comfortably at an FHR of 60, the negative trends coupled with the potential for more industry bumps indicates that disruption could be on the horizon. In order to pilot uncertain times, risk managers first need to understand the potential risk scenarios that lay ahead and their impact on the current financial landscape:

  • US – Iran escalating tension and uncertainty over the trade war between the US-China could create more volatile energy prices, which have a direct effect on airline financial health
  • Prolonged grounding of 737 MAX planes hits profit and dampens capacity growth of Global Airlines, meaning the already declining financial health will be less likely to turn around
  • The difference in US vs. international financial health means impending corresponding geopolitical events could affect one area more than the other (Brexit, for instance)

When working with companies in industries dealing with large external pressures, leveraging financial health to increase visibility can help identify risks early on and determine its long-term viability and resilience.

                                      For a deeper dive into a company's ability to weather future storms, request a free FHR Report:

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Topics: Supplier Risk Management, Risk Assessment