Question

Airline companies operate in a very risky business that is highly subject to the economy and many have gone bankrupt in the past. For example, the COVID-19 virus has reduced air travel and will result in large losses for airlines. Nevertheless, airlines typically have large amounts of debt in their capital structure. Explain this apparent contradiction.

Answer 1

Airline companies operate in a very risky business as it will be impacted by most of economical and financial changes or challenges. Economical challenges can be like COVID-19 and Financial challenges is because high capital investments which require more liquidity serve capital providers.

As Airline companies require huge capital and everything can not be provided by equity holder, major part of capital structure of most of airline companies will be under debt(including taking flights on lease). In case of debt borrowing we will take obligation to reply on periodical basis irrespective of business condition. That will be difficult in case of company not operating at or above Earning after tax(EAT) level.

As long as economy is going well and businesses are running normal airlines will get at least booking which will be able to service operating expenses and portion of debt repayment. Once competation started increasing no of booking starts spread across the all players in industry then airline companies who were not able to attract customers will start facing financial issues. It will become difficult pay operational expanses and service debts.

On top of above, due to COVID-19 number of people who travels were very less due to restriction by all governments. Because of lower passenger rate financial stress will increase and it will be starting point for most of companies collapse like Flybe in UK very recently.