Credit Insights 04/22: Croatia Airlines – how long can it go?

Devastating effect of the pandemic on the CA’s operations…

Airlines industry is one of the riskiest industries, even in the absence of major negative events. It is highly cyclical and susceptible to a plethora of the so-called event risks such as the pandemic, volcano eruptions, plane crashes, geopolitical risks, etc. In addition, the pressure on profit margins can be extreme both from the sales side due to a generally strong competition, and from the cost side due to fuel price volatility and high fixed cost base. To make things worse, recent stronger headwinds from the policy makers in terms of the climate sustainability could further impede the industry’s attractiveness.

Since the outbreak of the pandemic, CA’s operations have been severely negatively impacted. In 2020, the number of passenger kilometres went down sharply by 74,2% and the passenger load factor decreased from 73,6% in 2019 to only 49,6%. The CA’s revenue fell by 2/3, and the adjusted EBITDA, which was at around 8,3% three years prior to the pandemic, recorded a flat zero. This of course means that the net losses were immense, reaching HRK 361,5m, heavily impacted by an impairment of CA’s key assets (HRK 127,2m). Net operating cash flow (NOCF) came in slightly negative at HRK -19,7m, however significantly below the 5y pre-pandemic average of HRK 160m. Free cash flow (FCF) was highly negative at HRK -169,3m due to the aforementioned negative operational result exacerbated by high adjusted CAPEX which includes operating lease payments. The negative cash flow was fully covered by the equity increase of HRK 350m, and debt intake in a form of two Covid loans worth HRK 360m, creating a cash surplus of HRK 540m for the year, probably to build the liquidity buffer for 2021 due to high uncertainties at the time.

…but it’s not all about the pandemic

While the pandemic had a huge negative impact on the CA’s business, the pandemic itself cannot be blamed for everything. Namely, at least five years prior to the pandemic the company was struggling to generate cash. 2015-2019 cumulative negative FCF amounts to HRK -238,3m. The chart below depicts the cash flow sources and uses in the 2015-2019 period.

Looking at this chart, it is easy to conclude that CAPEX is the main driver of the CA’s cash outflows, which clearly shows the capital-intensive nature of the industry. CAPEX relates mostly to the investments in the aircraft / engines overhaul, in addition to operating leases for leased aircraft. However, during the 2015-2019 period, the company had to sell assets for HRK 188m and take additional debt of HRK 78m just to cover its CAPEX requirements, but the company was not undergoing an investment cycle. What cannot be seen on the chart is the absence of more sustainable funds from operations (FFO) level, which should have been higher to guarantee the sustainability of the CA’s business model.

Preliminary accounts for 2021 – no sign of major improvements

The preliminary accounts for 2021 show a pick-up in revenue of +27,6%, however, still 57% below the 2019 level. The company offered more seats in 2021, which translated into higher sales, however, with no impact on the passenger load factor (49,9%, +0,3p.p. vs PY). Adjusted EBITDA was worse than in 2020 despite better operational results, due to the phasing-out of the Covid support measures. Net losses continued for the fourth year in a row now, with accumulated losses level exceeding capital and reserves despite the HRK 350m equity increase the year before. Although the company has cut investments significantly to preserve cash, it was not enough to offset a weaker result from operations, and the FCF in 2021 reached HRK -251,4m level. The cash buffer from the previous year was approx. 50% utilised, bringing us to the last, key point.

Negative outlook, with likely need for more external support

The outlook on the CA’s business remains negative. The pandemic started to ease with the omicron variant, however, the Ukraine-Russia war could severely impact the bookings for this year. Uncertainty remains a common denominator for many industries, including airlines and tourism, which is another relevant aspect of CA’s business due to its high seasonality linked to Croatian tourist season.

Should the negative trends continue, it is likely that the company will need more external support to stay afloat. This year the company will likely have to invest more, as we think that CAPEX of approx. HRK 17m as in 2020 will not be enough to cover the whole fleet. One of the Covid loans was supposed to mature in January this year, but it remains unclear whether the loan was refinanced or repaid. Liquidity will likely remain stretched during this year absent any additional external support. Unfortunately, the company is running out of acceptable collateral, as only one Airbus remained unencumbered at the end of 2020. This could significantly limit the company’s future access to capital, in addition to the likely near-term end of the Covid support schemes to the airlines industry allowed by the regulators.

For more information, feel free to get in touch by e-mail to mario@creditanalyst.eu, the contact form on https://creditanalyst.eu/en/contact/, or call us on +385 98 920 17 13.