(Bloomberg Opinion) -- The last thing anyone needs in this coronavirus situation is more panic, but there’s a notable gap between the alarms emanating from the airline industry and the sanguine attitude among the companies that supply their spare parts and maintenance work.
Tuesday brought a flood of fresh warnings from U.S. carriers on canceled flights, with Delta Air Lines Inc. and American Airlines Group Inc. following United Airlines Holdings Inc. in pulling their guidance for the year. All three carriers also announced plans to reduce their capital expenditure plans, with United saying spending could be deferred for up to four years. Meanwhile, Southwest Airlines Co. CEO Gary Kelly warned of a sharp decline in bookings and said the company was "seriously considering" reducing its flight schedule, according to a Monday video message to employees viewed by the Wall Street Journal. "The velocity and the severity of the decline is breathtaking," he said. "There is no question this is a severe recession for our industry and for us, and it's a financial crisis." By contrast, aerospace supplier Honeywell International Inc. reiterated both its first-quarter and full-year guidance on Tuesday.
Back in February, when the spread of the virus was escalating rapidly in China but was still mostly contained to Asia, I pondered whether this might be what finally takes the wind out of an aerospace boom that was starting to look overblown. I quoted a report from Vertical Research analyst Rob Stallard who pointed out that, “unfortunately, aerospace companies are normally the last to get the memo.” We may now be seeing that dynamic play out.
Part of the problem is a natural information lag. Honeywell acknowledged that assumptions underlying its numbers – including minimal economic impact in China from the coronavirus and a macro environment consistent with the end of 2019 – were being challenged. But with sales already tending to be weighted toward the last month of the quarter, there’s not enough visibility right now to give a more formal update to the numbers, Chief Financial Officer Greg Lewis said. The implicit takeaway seemed to be that guidance will likely need to be reduced; the company just isn’t prepared to do so today and struck an optimistic tone that the ultimate damage could be relatively contained. United Technologies Corp., which is set to separate its aerospace arm from the Carrier climate and Otis elevator units later this year, also has been mum on the potential hit to its business as the virus has spread beyond Asia. Engine makers Safran SA and General Electric Co. have modeled a financial hit for the first quarter but nothing beyond that.
The steady drumbeat of increasingly dire warnings out of airlines suggests this is going to get worse before it gets better. United President Scott Kirby said Tuesday that net U.S. bookings are down about 70% and the airline expects to see further deterioration. The wave of conference cancellations, including the JPMorgan Chase & Co. industrial conference he was speaking at, which was moved to a virtual format, has wiped out much of corporate travel, while the impact on leisure demand is likely to grow amid mounting public concern, Kirby said. While the Trump administration has pledged fiscal stimulus to prop up the virus-stricken economy — and President Donald Trump on Tuesday indicated specific help to airlines and cruise lines — it remains unclear what that would look like.
The capacity reductions so far closely track the spread and severity of the virus outbreaks. The deepest cuts are still in the Asia-Pacific region, with American yanking routes to Beijing, Shanghai and Hong Kong through October, while Delta plans on Pacific capacity being down 65% versus its original plan. But Europe is increasingly becoming a no-fly zone as well, with American temporarily suspending certain service to Barcelona, Rome, Paris and Madrid, and Delta planning on as much as a 20% reduction in transatlantic flights. If the trend line for the virus holds and cases continue to rise exponentially in the U.S., it stands to reason that American’s 7.5% cut to domestic flights in April and Delta’s as much as 15% reduction in capacity will be the beginning rather than the end of the retrenchment. United, which has cut 10% of its domestic schedule for April, said it would evaluate and cancel flights on a rolling 90-day basis until it sees signs of a demand recovery.
The plunge in oil prices helps reduce one of airlines' biggest expenses, with Delta modeling $2 billion of savings for 2020. But even with that booster, airlines are looking at cutting costs to offset the financial blow from the demand drop. Delta is parking both wide-body and narrow-body aircraft and evaluating early retirements for its older fleet. That will lead to “significant” savings on maintenance, executives said in a presentation Tuesday at the JPMorgan industrial conference. That means significantly less profits for the aerospace suppliers that rely on a lucrative stream of repair and spare-parts work.
More troubling over the longer term is the risk that a sustained hit to demand starts to affect plane orders. Delta is deferring $500 million of capital expenditures largely tied to discretionary projects that can be put off with “no regrets,” executives said. But the company also said it has to take a look at aircraft deliveries, especially if the environment gets worse. Southwest is still planning on receiving deliveries of Boeing Co.’s grounded 737 Max jet in the third quarter, but Kelly cautioned in the employee video that the company will “maintain all options” if demand doesn’t recover. Airbus SE is reportedly weighing whether to lower its target for 2020 deliveries and it’s worth mentioning that the deferral requests so far remain concentrated among Asian airlines.
Honeywell CFO Lewis said the company continued to expect the coronavirus to be a short-term disruption and hopefully he’s right. But in situations like this, it helps to follow the money. And in that light, it feels notable that Southwest’s Kelly is taking a 10% pay cut and United Airlines CEO Oscar Munoz and President Kirby plan to forgo 100% of their base salaries at least through June 30. To my knowledge, no such salary adjustments have been announced on the part of aircraft and parts-manufacturing companies.
(Updates with information from United Airlines in the second and fifth paragraphs.)
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Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.
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