The rapid spread of COVID-19 throughout the U.S. over the past month has decimated air travel demand, as public health authorities have urged Americans to avoid all nonessential travel. Most people appear to be heeding the warnings. In recent days, passenger throughput at TSA checkpoints has been down 94% to 95% year over year.
Airlines have responded by implementing drastic capacity cuts. Nevertheless, the sudden evaporation of demand is causing airlines to burn cash at an incredible rate. As a result, airlines including United Airlines (UAL 7.68%) and JetBlue Airways (JBLU 8.28%) implemented restrictive new rules over the past month, limiting customers' ability to obtain refunds for canceled flights.
Late last week, the U.S. Department of Transportation cracked down on this practice, issuing a notice clarifying that if airlines cancel flights, they must offer refunds to customers. This ruling is likely to accelerate the airlines' cash burn, highlighting how those with stronger balance sheets are better positioned to navigate the COVID-19 pandemic.
Cash burn accelerating
In mid-March, JetBlue disclosed that it was bringing in only $4 million a day from ticket sales, compared with $22 million on a typical day a year earlier. A few days ago, the airline updated that figure, saying daily ticket sales have fallen to around $1 million. Meanwhile, JetBlue is issuing $2 million of cash refunds a day, so it's burning cash even before paying any expenses. Despite canceling a massive number of flights -- JetBlue has cut its April schedule by 70% -- the airline is burning through more than $10 million a day.
The situation is just as bad at United Airlines, which has cut its capacity for April by 80%, with even bigger reductions likely in May. United recently stated that revenue for March was down by more than $100 million a day. Daily cash usage is likely to be in line with the $60 million-plus that Delta Air Lines says it is burning through on a daily basis.
As of the end of 2019, advance ticket sales stood at $4.8 billion for United Airlines and $929 million for JetBlue, equal to 97% and 70% of their cash and short-term investments, respectively. With this as context, it shouldn't be surprising that many airlines are trying to avoid paying cash refunds unless absolutely necessary. Mass refunds would quickly deplete their cash balances.
Dodgy moves to preserve cash
The DOT's policy regarding refunds is fairly straightforward: "If your flight is cancelled and you choose to cancel your trip as a result, you are entitled to a refund for the unused transportation -- even for non-refundable tickets. You are also entitled to a refund for any bag fee that you paid, and any extras you may have purchased, such as a seat assignment." However, airlines aren't obligated to offer refunds in the case of delays, unless they are "significant delays" -- a term that the DOT has not defined, instead choosing to settle disputes on a case-by-case basis.
This created a loophole of sorts for airlines desperate to preserve cash. United Airlines changed its refund policy several times just in March. For a while, United was offering refunds only if a customer's itinerary was disrupted by at least 25 hours. By mid-March, it had updated its policies to offer credits valid for 12 months from the time of purchase for all international flights canceled by government restrictions. Customers who didn't use the credit within that period would be entitled to refunds after 12 months.
By delaying refunds for up to a year, United hoped to reduce its near-term cash burn. (Most airlines expect ticket sales to start recovering in the second half of 2020, providing cash inflows that could be used to cover any refunds.) Meanwhile, in the domestic market, United has been offering refunds only if it couldn't provide a substitute itinerary within six hours of the originally scheduled flights.
Early in the coronavirus crisis, JetBlue had a very customer-friendly attitude. Most notably, in late February, it suspended change and cancel fees for new bookings. However, with cash burn accelerating, it updated its schedule change policy last week, allowing cash refunds only if a customer's itinerary was disrupted by more than 24 hours.
The DOT cracks down
Airlines weren't just trying to rip customers off with these policy changes. Many carriers, including United, have extended the validity of travel credits to at least two years to give customers more of an opportunity to use them. However, that doesn't change the fact that these policies were unfair to consumers, many of whom are strapped for cash and can't afford to give an airline a free loan for a year or two.
Under pressure from a number of Democratic senators, the DOT issued a notice to airlines on Friday informing them that "passengers should be refunded promptly when their scheduled flights are cancelled or significantly delayed."
The emphasis on prompt refunds clearly rules out United's policy of making customers wait for up to a year to receive refunds. And while there's still a gray area with respect to "significant" delays, airlines will risk enforcement actions if they deny refunds for schedule changes of more than an hour or two. In short, airlines like United and JetBlue must prepare to issue a lot more refunds in the weeks ahead.
Airline balance sheets in focus
The new DOT guidance doesn't mean airlines will have to refund all of their advance ticket sales immediately. Some customers who have already received travel credits despite being entitled to refunds may not care enough to follow up. Moreover, many people proactively canceled their travel plans because of the COVID-19 pandemic rather than waiting for the airline to cancel. Airlines have no obligation to offer cash refunds when the customer initiates the cancellation.
Still, the recent guidance from the DOT could conceivably cost JetBlue hundreds of millions of dollars in near-term cash outflows -- and upward of $1 billion for United. This highlights why having a strong balance sheet is a must in the airline industry.
JetBlue is in much better shape than United in this regard. As of March 6, it had $1.2 billion of cash and investments on its balance sheet, and it borrowed another $1 billion secured by 24 aircraft and 37 spare engines in mid-March. Furthermore, JetBlue still has more than five dozen unencumbered aircraft that could support additional secured borrowings. This gives it plenty of flexibility to cover a potential spate of refunds as well as its other expenses, particularly given that the airline will probably have most of its payroll costs for the next six months covered by the federal government under the CARES Act.
By contrast, while United had $6 billion of cash and an additional $2 billion available on its revolving credit facility as of March 9 -- and borrowed another $500 million later in the month -- it had far more debt on its balance sheet before the pandemic than JetBlue. This could limit its incremental borrowing capacity.
Airline stocks aren't for everybody due to their high risk, especially in the current environment. For investors thinking about buying marked-down airline stocks this month, it would be wise to stick to companies with stronger balance sheets, such as JetBlue.