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Should US Airlines be bailed out?

25032020_US airlines

Should US Airlines be bailed out?

Due to the rapid spread of COVID-19 globally, Airlines are facing serious disruption from an unprecedented demand contraction, and many US airlines are on the brink of bankruptcy.

Airlines typically are highly levered businesses with many fixed assets, meaning that any contraction in demand is sure to hurt due to a lack of variability in costs. In the US, airlines are seeking at least US$54 billion from the government to deal with the disruption caused by COVID-19.

The last time the US Airline industry required a bailout was back in 2001, following the September 11 terrorist attacks. Congress passed the Air Transportation Safety and System Stabilization Act in response to a severe liquidity crisis. Recognising the essential national economic role of a stable aviation system, the federal government provided US$4.6 billion in one-time, subject-to-income-tax cash payments to 427 US Air Carriers. Essentially money from the pockets of taxpayers, as it came with no provision for repayment.

This time however, things are different. The public, as well as many key influential politicians are criticising a potential “free” bailout due to “poor” capital allocation decisions from airline management. Over the last decade, the US airline industry has cumulatively spent 96 per cent of free cash flow generated to repurchase their own shares, despite understanding that they operate in a highly cyclical industry.

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Of course, their management could not have foreseen a Black Swan event like the COVID-19 crisis, however it could be reasonably expected that management teams would not squander the entirety of their free cash flows to repurchase shares. In fact, good management teams only repurchase stock when they believe their shares are materially undervalued – never before has the procyclicality of buybacks been so nakedly exposed. At the very moment whilst markets are down almost 30 per cent year-to-date you expect to see repurchases, corporations are pulling back to preserve cash for emergency.

Despite the poor judgement of airline management teams, it seems almost inevitable that a bailout will occur, due to the essential nature of air travel, however we ask readers, what form of bailout would you like to see? Financing for an equity stake? A non-provisional loan?

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Phillip joined MGIM in May 2019 as a Research Analyst and is currently completing a double degree in Actuarial Studies and Commerce at the University of New South Wales. Prior to joining MGIM, Phillip’s experiences included several investment banking internships.  

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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9 Comments

  1. Nothing should be bailed out ever, it won’t disappear some one will just buy it at market value and sack the foolish management, and off it goes again, bailouts are the problem, it’s part of their business model now, poor management needs to be discarded, my small business won’t be bailed out and won’t need to be, I have saved for a rainy day, they still do actually happen.

    • I can definitely understand your point of view Andrew. Bankruptcy should be declared and the capital structure restructured, seeing creditors become equity holders whilst the equity is wiped. Unfortunately, the management teams of these businesses don’t want to take the loss.

      Thanks for your comments.

  2. Steve Greenwood
    :

    Definitely an equity stake. Much like a Cap raise. Or alternatively let them go to the market for a CR. See what the response to that is.

  3. Warren Buffet recently increased his stake into Delta airlines. I wonder how he has made his analysis on airline stocks despite the poor capital allocation decisions from management

  4. Why do they buy back their own shares? Is it to boost the share price upon which management bonuses and largesse are based? Surely it would be better to pay down some of their enormous debt and have the ability to borrow themselves against their assets in tough times! Surely they have learnt from past disasters and major disruptions to the world economy. Evidently not.

    If they have been this badly managed, they don’t deserve to be bailed out by the taxpayer yet again! Sadly they will be due to being essential!

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