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Bracing for Bird Flu

By Ted Gogoll The mutation of bird flu into a human virus that causes a global pandemic is still months or years away, if at all. Yet the mere prospect of such an outbreak has led to controlled panic in the worldwide medical community and the corridors of government.

The World Health Organization (WHO) predicts an unthinkable loss of life, perhaps in the millions, should the flu mutate from birds to humans. The World Bank predicts such an outbreak would take a heavy toll on the global economy, based on the economic disruption in 2003 caused by the outbreak of severe acute respiratory syndrome (SARS), despite its rapid containment.

Just gearing up to fight what some medical authorities characterize as an inevitable human outbreak will cost plenty: At a gathering of delegates from more than 100 countries in Geneva on Nov. 9, experts said it would cost $1.5 billion over three years to prepare for a pandemic, and this doesn't include the cost of stockpiling anti-flu drugs.

MIXED PICTURE. The Bush Administration has called for $7.1 billion in emergency spending to create a bird-flu strategy for the U.S., including better early detection of an outbreak and a large national stockpile of vaccines and antiviral drugs, as well as increased capacity for making vaccines.

Such planning implies major consequences for some leading industries should a worst-case scenario develop. Businesses that depend on large numbers of people congregating -- such as airlines, lodging, leisure, and restaurants -- would suffer serious setbacks. So would poultry producers and some insurers, and hospitals would be strained to their limits.

These effects would be offset to some extent by a brightened outlook for producers of non-poultry foods, for drugmakers, and for companies that sell fast Internet access for telecommuting. The bottom line, though, would likely be a decline of $800 billion, or roughly 1%, in global GDP within one year, a figure the World Bank derived from the 2% decline in East Asian GDP caused by SARS in the second quarter of 2003.

NO SARS 2. For the moment, such predictions are purely speculative. Since avian flu, also known as H5N1, appeared in Hong Kong in 1997, health authorities have kept it at bay by slaughtering millions of birds. As long as it remains confined to birds, "the avian flu will have a temporary impact on the economy," says David Wyss, Standard & Poor's Ratings Services' chief economist. He adds that, to date, "It hasn't had nearly as big an effect as SARS."

Analysts at Standard & Poor's say avian flu has had little, if any, effect so far on the credit quality of the sectors that suffered most during the SARS outbreak, notably airlines, tourism, health care, and gaming and lodging. We don't expect to take any rating actions in the near term associated with the possible risk of an avian-flu pandemic, but we will continue to monitor developments and reassess our views as events unfold.

News of a possible pandemic is causing jitters on several continents. "Australia is already instituting infection and quarantine measures, as are many Asian countries," says Standard & Poor's credit analyst Ian Greer, in Melbourne. "That should limit and contain any spread," he says. "We should be careful not to get too bearish."

INSUFFICIENT MEASURES. Meanwhile, some Eastern European countries with bird-flu outbreaks have closed their borders to poultry imports, notes S&P credit analyst Jayne Ross. In Western Europe, consumers are cutting down on poultry consumption -- the sharpest declines have been in Italy and Belgium, according to a recent Wall Street Journal report.

"European Union officials played down the risk of people contracting the disease through food, but the bloc's food agency said poultry and eggs should be thoroughly cooked to eliminate the possibility," the Journal said.

These efforts "should all be applauded, yet filed under 'probably not enough,'" says S&P credit analyst Martin Arrick. "One contrarian note worth mentioning is that the last time there was a big surge to address a public-health issue like this was the swine flu, in 1976. That was an epidemic that never developed. There's a possibility this won't develop, either," Arrick adds. "But I would argue that isn't a reason for governments to stop spending money to reduce the possibility of its occurring."

ASIAN EFFECT. The damage caused by SARS could serve as a harbinger of the kind of damage bird flu could cause: Of the 8,000 people infected with that disease, some 775 died in Toronto, Hong Kong, Singapore, and China. And so far, the number of human deaths from bird flu is a greater proportion of the infected than those who died from SARS.

"This is a difficult issue to make a judgment on at this point," says S&P credit analyst John Bailey, in Hong Kong. "But if the recent experience of SARS is anything to go by, the impact of a flu pandemic could be significant."

SARS led to a sudden, sharp slowdown in some Asian economies that lasted several months, Bailey notes. In Hong Kong, for example, GDP declined 0.5% in the second quarter of 2003, when SARS hit, after jumping 4.5% in real terms in the first quarter.

Airlines on the Front Lines

The relatively limited SARS outbreak caused a brief, albeit severe, plunge in revenues for many Asian airlines, including the normally high-profit carrier Cathay Pacific Airways, which is based in Hong Kong. Cathay's passenger load factor fell to just 41.4% in May, 2003, compared with 77.8% in 2002.

Similarly, "a bird flu pandemic would wreak havoc on the global airline industry," says S&P credit analyst Philip Baggaley. Airlines that rely heavily on international travel, including those based outside the U.S. and, to a lesser extent, large hub-and-spoke U.S. carriers, would likely be affected first. But even airlines that focus on domestic travel, such as budget carriers, would eventually be affected.

"Given the vulnerable financial condition of many large U.S. airlines, such a scenario could trigger bankruptcy filings or even liquidation of carriers that are already bankrupt," Baggaley says.

No Fun for Gaming, Lodging, and Leisure Sectors

SARS also provides a cautionary tale of what could happen to the gaming, lodging, and leisure sectors. "The impact in Toronto was devastating," says S&P credit analyst Craig Parmelee. Hotel-occupancy rates there, normally about 65% to 70%, plunged to 45% during the SARS scare. According to Bailey, SARS cut hotel occupancy in Hong Kong to below 20% in April, 2003, from about 80% in February.

A human version of avian flu might have a similar effect. "You would very quickly see people staying home in front of their wide-screen TVs instead of going out to eat or to the movies," says Wyss. "Telecommuting would increase exponentially." High-end hotels would report significant losses, given their high cost structures, which they would try to adjust by closing restaurants, floors, towers, and, in some cases, entire hotels.

"If occupancy rates remained at or below 50%, it would be difficult for these hotels to make money," Parmelee says. "But, as there are a wide range of scenarios, which are all quite speculative, it would be premature to change our ratings in this sector right now."

JOB HIT. Any hit on hotels would mirror the effect on tourism, which accounts for more than 9% of GDP in East Asia and about 11% in Southeast Asia. As avian flu becomes more entrenched in the region, consumers will probably curb shopping, restaurant dining, and other leisure activities that they see as both high-risk and nonessential.

"The perceived threat to jobs and incomes will add to local consumer caution," Bailey says. "During SARS, weakening demand led to an increase in unemployment and a rise in bankruptcy levels for small and medium-sized enterprises. This was the hardest-hit sector because such companies usually don't have the same liquidity or financial flexibility as the larger companies."

Property/Casualty Industry Seen as Vulnerable

Similarly, a global pandemic could create large insured losses for property and casualty insurance companies and disrupt their operations at "exactly the wrong time," according to S&P credit analyst Damien Magarelli of the Insurance Ratings group.

"Property and casualty companies would be at risk for business-interruption claims [by tourism-related companies], as well as from an operational standpoint in that many employees could be kept from their workplace at a time when the company has a higher volume of business to review, such as after a catastrophe or during renewal season."

U.S. Health-Care System: Ill-Equipped for a Pandemic

According to Bush Administration projections, a bird-flu pandemic in the U.S. would infect about 40% of school-age children and a smaller share of the elderly. Excluding the disruption to the economy, health-care costs associated with a moderately bad pandemic would total $181 billion.

"While the number of human cases is still quite small, there is currently great fear amongst public-health professionals that it could spread," says Arrick. "If there's a spread to, say, a localized village in Asia -- a 'hot spot' -- a massive response could halt things right there. However, if the virus spread to a few sites at once, there's a real fear that a multisite incident could easily turn into a pandemic, hitting virtually every country in the world, given the realities of air travel."

One of the most vulnerable populations to a pandemic today would be health-care workers, who already are in short supply in many places, including the U.S. "The loss of life and work time to illness would be profound, even if fatalities stayed low," Arrick says. "The health-care system would be very poorly positioned to deal with so many really sick people," both employees and patients.

In many U.S. cities, hospital occupancy is already high, and adding capacity at a time of staff shortages would be difficult, if not impossible. Severe shortages of medicine -- rumors of hoarding are already rife -- and other necessities such as respirators would compound the problem.

Pharmaceutical Pricing Limits Would Prevent a Revenue Windfall

Even a hint of a human avian flu outbreak would boost demand for flu treatments and vaccines. President Bush has proposed $4.7 billion in spending to develop and distribute an avian-flu vaccine. However, the likelihood of heavy government intervention in pricing would limit any potential windfall for already highly rated pharma companies.

"Vaccine development and manufacturing are considered the backwater of the pharmaceutical industry, given the limited financial opportunities," says S&P credit analyst Arthur Wong. "Even assuming that an avian-flu pandemic emerged soon and that a flu vaccine could be quickly developed, manufacturing bottlenecks would limit production volume."

The U.S. government's normally limited role in purchasing and administering regular flu vaccines might expand dramatically with a bird-flu outbreak. That would almost certainly hold down prices of vaccine.

To avoid negative publicity and potential weakening of patent protections, pharma outfits are likely to play the role of "good corporate citizens" and negotiate to provide vaccines at prices that limit profitability. Therefore, "we don't believe there will be significant credit-rating benefits for competitors in the field," says Wong. Those competitors include Chiron (which is being acquired by Novartis AG [NVS

]), Sanofi-Aventis (SNY), and GlaxoSmithKline (GSK).

Mixed Implications for the Agricultural Sector

Among poultry producers, U.S.-based companies seem the best-protected against a bird-flu outbreak. They house their hens under cover, where flu-infected migrating birds cannot reach them. Moreover, once the bird is cooked, the virus is dead, making it unlikely that a human would contract avian flu at a restaurant, for example.

Thus, "in the U.S., it's highly unlikely that there would be a national epidemic of avian-flu-infected birds," says S&P credit analyst Diane Shand. She adds that any outbreak would be isolated quickly, and the infected birds destroyed. At least for the time being, adds Ross, the current strain of avian flu shouldn't affect the credit quality of the rated U.S. poultry processors.

"The biggest risk to retailers," Shand adds, "is that media attention around bird flu could make consumers nervous about the food supply." Consequently, "The well-capitalized take-out restaurant companies will advertise or promote heavily to reassure consumers of food safety. This has proven to be successful in the past." The Associated Press has reported that Yum! Brands' (YUM) Kentucky Fried Chicken chain is already filming TV commercials -- to be shown only in the event of a bird-flu outbreak -- to reassure U.S. customers that its chicken is safe.

"SHORT-TERM CHANGES." By contrast, the Asia-Pacific poultry industry (the largest producers are China and Thailand) would be devastated by a pandemic. "But other livestock producers, such as those for beef, may be positively affected as consumers alter their eating habits," says Bailey. Any effect on agribusiness in Australia would depend on how long a pandemic lasts and whether it cuts demand for specific food items or leads to restrictions on trade.

"There might be some short-term changes in eating habits to reduce risk," says S&P credit analyst Brenda Wardlaw, in Melbourne. "Non-staple food products would likely suffer more as people eat out less." Rated Australian and New Zealand companies Fonterra Co-operative Group and AWB should be the least affected, since the milk and wheat they produce and sell are staples.

Smaller Restaurants at Greater Risk

Many large, rated U.S. restaurant chains, such as Burger King, McDonald's (MCD), Wendy's (WEN), and Yum! Brands, use multiple food suppliers. Therefore, their deliveries should not be imperiled if one supplier shuts down because of an avian-flu outbreak.

Smaller restaurant companies, however, could face short-term business disruptions. And a large outbreak that threatened consumers' health would hurt all food companies. Companies most at risk, given their heavy dependency on poultry, would be AFC Enterprises (AFCE), El Pollo Loco, and Carrols Corp.

No one can predict the timing or severity of the next flu pandemic, but governments around the world are taking seriously whatever lies ahead. The last three epidemics, in 1918, 1957, and 1968, killed 40 million, 2 million, and 1 million people, respectively, according to the Bush Administration. "When you talk about pandemics," Wyss says, "the sky's the limit." That's a sobering thought for a disease that, should it materialize, could be so deadly.

Gogoll is a features editor for Standard & Poor's Ratings Services

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