The author is an analyst of NH Investment & Securities. He can be reached at firstname.lastname@example.org. -- Ed.
Impacted by unprecedented flight disruptions and reduced passenger demand, sales decline at domestic airlines appears inevitable. With fixed cost burden intensifying, large-scale 1Q20 operating losses are predicted for all domestic players. While government liquidity support is expected, given that the air transportation industry was facing oversupply even before Covid-19, the sector as a whole looks vulnerable in the absence of restructuring.
Facing unprecedented crisis
Amid the spread of Covid-19, passenger numbers are forecast to drop 39% y-y in 2020 due to reduced passenger demand and flight disruptions. In 1Q20, RPK and won-based yield likely fell 49% y-y and 15% y-y, respectively. We note that the decline in international oil prices and the government’s support of airport usage fees and labor costs are unlikely to cover fixed costs in most cases. We expect the decline in domestic airline earnings to worsen in 2Q20 on an increase in flight disruptions.
Our earnings estimates rest on the assumption that Covid-19 effects will peak in 2Q20, followed by a gradual recovery in 3Q20 and normalization in 4Q20. But, this timeline may change down the road. With liquidity crisis risks coming to the fore at foreign airlines, liquidity concerns are rising towards domestic plays as well. Currently, we view low-cost carriers (LCCs) as being more vulnerable than full-service carriers (FSCs).
Despite expectations for recovery, fundamentals look precarious without restructuring (even after Covid-19 disappears)
We downgrade our rating for Korean Air (KAL) and lower our TPs for all domestic airlines under our coverage. In calculating our TPs, we applied a three-year historical average P/B and weighted average of 2019~2021E BPS. Considering liquidity risks, additional discounts are applied to each airline.
Factors with the potential to improve sector valuations include: 1) government liquidity support; and 2) supply reduction due to industry restructuring. While government liquidity support is anticipated, the scale is uncertain and expectations have likely been reflected in share prices. Considering that the industry was seeing oversupply even before the outbreak of Covid-19, supply restructuring looks essential for fundamental improvement even once the Covid-19 issue dissipates. Even for those airlines which survive the crisis, deterioration in financial structure looks inevitable due the projected increase in debt burden. In other words, lacking genuine supply restructuring, government support is unlikely to resolve current industry vulnerabilities. Given the current situation and heightening uncertainties, we advise refraining from any hasty investment decisions prior to confirmation of restructuring.