El Al can manage without state aid

El Al Boeing 787 Dreamliner  photo: PR

The Tel Aviv Stock Exchange is the airline's platform for raising capital or debt to cope with a difficult business situation, argues Yaniv Pagot.

The coronavirus outbreak is striking the global civil aviation sector a tough blow, and the dire effects have extended to Israeli carrier El Al Israel Airlines Ltd. (TASE: ELAL). El Al reported last week that it projected a $30 million drop in its revenue in the first quarter of 2020, mainly to East Asian destinations, which it attributed to the coronavirus. At the same time, El Al predicts that most of the lost revenue will be offset by lower operating expenses.

This revenue warning, which is not a profit warning, is far from dramatic, given the airline's $2.2 billion annual sales turnover, and should not seriously affect El Al's business model. An additional notice to investors this week also indicates no catastrophe on the horizon, but a letter by El Al CEO Gonen Usishkin to the company's employees published in the press shows concern about a severe business impact. Usishkin sowed panic among the company's employees and the entire public, writing, "Difficult days are ahead, and dramatic measures and painful decisions will be required," in a manner reminiscent of Winston Churchill's blood and tears speech during WWII.

It is likely that given the spread of the damage to additional routes and prolonging of the coronavirus crisis, the future damage to El Al will be greater. The gap between the data published to the company's shareholders and the CEO's emergency letter to the company's employees, however, is wide, and requires an explanation to investors. If his comments are merely exaggerations aimed at preparing the ground for streamlining measures at El Al, this is one thing, but if the situation threatens the airline's financial soundness, it is a materially different one.

The statement by Minister of Transport Bezalel Smotrich early this week in a media interview that the damage suffered by El Al as a result of lower demand and cancellation of routes caused by the spread of the coronavirus is estimated at $50 million, and that the state should compensate the airline, constitutes another sign of unreasonable panic.

As I see it, in the current situation, Israel, which has not been responsible for El Al for a long time, should not give a great deal of public money to a company that is listed on the Tel Aviv Stock Exchange (TASE), has a controlling shareholder from the private sector, and has available alternative sources of financing. The TASE is the airline's ultimate platform for raising capital and/or debt in order to cope with a difficult business situation.

In the global capital market, investors act on the basis of a working assumption that the coronavirus crisis is temporary, and its damages are a one-time event. Were this the situation at El Al, the company could issue rights and take other financing measures, such as bringing a partner into El Al's frequent flyers club, instead of becoming a burden on the state budget.

A search of the Internet yielded no cases in the global media of a minister of transport in a Western country offering to transfer state funds to a local airline because of damage caused by the coronavirus, including airlines with very substantial exposure to China. In my understanding, if the state wants to inject public funds into aiding El Al, it should receive generous compensation in the company's shares, and even then, the investment's future success would be doubtful.

Oil prices fell, which should benefit El Al

The coronavirus epidemic has had a severe impact not only on the aviation market, but also on global demand for oil. The price of oil was already falling before the coronavirus appeared because of a supply surplus and slower demand as a result of the trade war. The steep fall in oil prices, however, is a very beneficial phenomenon for the airlines' profits, and constitutes a structural hedge against a slowdown in business activity.

El Al's jet fuel expenses, before hedging expenses, preceding the outbreak of the coronavirus, dropped by $55 million in the first nine months of 2019. This saving in expenses is rolled over to the company's profit, and substantially exceeds the projected damage from the coronavirus, which affects El Al's sales.

The coronavirus currently challenging the airlines is a significant business risk that is likely to materialize once every few years. The business model of an airline, like that of other businesses, must be capable of containing it and dealing with it. The truth must be said: El Al's business situation is difficult with no direct connection to the coronavirus. Its operating efficiency is poor, and it suffers from diseconomies of small scale.

El Al's current losses in the first nine months of 2019 amounted to $27 million, and the company's market cap reflects the collective wisdom of investors concerning El Al's business potential. This indicates the challenges facing the company, and the coronavirus is probably not the most important of these in the medium and long term.

El Al's management is taking significant strategic measures to change the "flight path" of the company and its share price, and I greatly hope that it will succeed in this daunting task. It is best for the company and Smotrich, however, not to cast their eyes towards the public purse; they should let the market forces do their job.

The author is an economic advisor and investment committee member in financial institutions. The author of the article and/or the company are likely to hold or trade in the securities mentioned in the article. Nothing in the article constitutes a substitute for investments marketing and/or investment counseling that takes into account each individual's special particulars and needs.

Published by Globes, Israel business news - en.globes.co.il - on February 23, 2020

© Copyright of Globes Publisher Itonut (1983) Ltd. 2020

El Al Boeing 787 Dreamliner  photo: PR
El Al Boeing 787 Dreamliner photo: PR
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