European Airlines could take a severe hit from 'no-deal' Brexit scenario

The UK's withdrawal from the European Union without a deal to substantially replicate existing aviation agreements would result in a significant hit to European airlines, research suggests. 

In a report for its clients, rating agency Moody’s said a 'no-deal' Brexit scenario remains a threat to the European aviation industry as the March 2019 deadline approaches, and until a withdrawal agreement with transition arrangements is reached.

The agency's central assumption remains that the UK and the EU will reach a deal, minimising the impact on European airlines' business profiles and financial metrics. "However, a no-deal Brexit could be significantly credit negative for European airlines," said Jeanine Arnold, Vice President and Senior Credit Officer at Moody’s. 

"It could compound an airline's ability to increase yields, raise load factors and generate cost efficiencies in what is still a competitive market environment in Europe. Ultimately it could lead to cash flow and liquidity pressures."

Moody's said there are five main risks to EU airlines from a 'no-deal' outcome. These include a loss of traffic rights between the UK and the European Common Aviation Area (ECAA), loss of traffic rights between the UK and other third countries that have aviation agreements with the EU (including the US), and meeting ownership and control conditions to retain valid operating licences (for UK and EU-27 countries).

The UK's continued membership in the European Aviation Safety Agency (EASA) and certifying compliance with internationally recognised safety requirements, and weaker macroeconomic conditions, were listed as the other two risks by Moody’s.

The probability of these risks occurring in a no-deal scenario and their effect on credit quality will differ depending on the political willingness and economic incentives to separate a no-deal Brexit from aviation agreements, as well as contingency plans and past exceptions to rules or regulations, the agency said.

“If the risks materialise, financial implications could be severe in the short term, but modest in the long term because more time should allow comprehensive agreements to be reached and airlines to adjust their operations,” Moody's added.

The agency also said that even in a no-deal scenario, agreements are imperative because the airline industry lacks fallback legislation comparable to World Trade Organization (WTO) rules, which would apply for other industries.

Some of the airlines most exposed to a no-deal Brexit include: British Airways (Rated by Moody’s as Baa3 with a ‘stable’ outlook), easyJet (Baa1 stable), Ryanair Holdings (unrated), Thomas Cook Group (B1 stable), TUI (Ba2 positive) and Virgin Atlantic (unrated).

Broadly speaking, an airline will be less exposed if it has a more flexible operating model and cost structure, greater network diversification and scale, and has begun to implement contingency measures.

“The strong liquidity of British Airways, easyJet and Ryanair should enable them to weather the financial impact of a no-deal Brexit, even if flights are disrupted for an extended period. However, for airlines negatively affected by a no-deal Brexit, a sustained deterioration in liquidity and key credit metrics such as gross leverage or cash flow coverage could lead to negative rating actions,” the agency said. 

Norwegian Air Shuttle ASA (unrated) is less exposed to the risks Moody's has identified, but it’s very weak liquidity leaves it more sensitive to flight disruption or macroeconomic factors.