Leaving behind the billions in losses they racked up over the
past two years, major domestic carriers are queuing up not just profits in
2010, but the prospect of longer-term profitability and, perhaps, a structural
shift toward financial sustainability. In the past decade, domestic airlines
have shed 150,000 jobs and posted losses nearing $60 billion, and dozens of
them filed for bankruptcy, some the kind you don't return from. What emerged,
carriers and analysts said, is a leaner and smarter, albeit smaller, industry
ready to manage through the next decade thanks to lessons learned in the last
one.
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"What we know with certainty," United Airlines
executive vice president and CFO Kathryn Mikells said this month, "is that
in our hyper-competitive industry, the future must look significantly different
from the past in order for us to break the boom-and-bust cycle that's been the
norm."
As airlines learn time and again, however, the industry's
outlook changes in real time, bending with each spike in oil costs, each
economic downturn, each new entrant, each new presidential administration and
each world event.
"We have long struggled to find a healthy equilibrium
between supply and demand here in the United States," American Airlines
CEO Gerard Arpey said this month. "If we assume the current economic
recovery has legs—and perhaps that's a brave assumption—then I think as an
industry we are much better positioned to leverage the upturn than we have been
in previous recoveries. There are far fewer seats for sale in the marketplace
today than there were five years ago. There are also signs that the industry
has learned its lesson about keeping capacity growth in line with demand and
will continue to apply that lesson even as the economy comes back."
When the International Air Transport Association in March
released its annual forecast, the association targeted U.S. carriers to rival
2009 with yet another $1.8 billion in losses. All it took were a few months for
IATA to reverse that outlook, and this month the association said it now
expects North American carriers to count $1.9 billion in profits this year.
That reversal reflected not just what's going on the economy
at large, but also what has taken hold within the airline industry, as
companies maintain capacity discipline, bring in new sources of revenue, find
new partners and carefully watch every penny that makes its way onto the
balance sheet. Morgan Stanley aviation analyst Bill Greene this month said, "The
airline industry is firmly in the recovery phase of this upcycle."
JP Morgan aviation analyst Jamie Baker has taken IATA's
outlook and Greene's assessment a step further, saying he remains "bullish"
on the domestic airline industry as airline managements and economic trends
have coalesced to the benefit of the industry for more than just a year. "Manageable
fuel, tight supply, incremental revenue streams, disciplined managements and
rapidly recovering demand portend a multiyear profit run for U.S. operators,"
he said in a recent research note.
UBS aviation analyst Kevin Crissey also is anticipating at
least one profitable year for U.S. airlines. "If this is a cyclical
recovery that lasts multiple years, the airline industry could be in position
for the best run in a long time," he said.
US Airways president Scott Kirby this month said he sees the
current recovery that is brewing not as just a cyclical, but a structural,
change. "The industry appears to be turning a corner and hopefully it
really is different this time," he told investors assembled this month at
the 2010 Bank of America Merrill Lynch Global Transportation Conference in New
York. "One of the things I've become really fond of saying in my meetings
with investors recently is you never should say it's different this time,
because it very rarely is. But the environment does seem different this time
around and for some real structural reasons."
Among those, Kirby pointed to the sustained capacity
discipline that started with the legacy carriers a couple years ago, spread to
the once growth-happy low-cost carriers and has been maintained on an industrywide
basis, even as demand has picked up in recent quarters.
The second major structural change, he said, is the industry's
embrace of ancillary pricing, which has lifted passenger revenue at a time when
base fares were doing everything but growing. "It's hard for me to
overstate the importance of that to the industry and what a structural change that
is," Kirby said of the blossoming a la carte pricing options with which
airlines continue to experiment.
The CFO-Led Industry
While the shift from billions in losses to the prospect of
multiyear profits is no doubt a positive development for a dysfunctional
industry, a few years in the black hardly is the measure of a sustainable
industry, said UBS's Crissey, who for years has peppered his research notes
with the warning that "trading airline stocks may be hazardous to your
wealth."
By way of an introduction during a presentation at the
Business Travel News/National Business Travel Association Strategic Travel
Symposium in March this year, he said, "This is a bad business."
Considering domestic airlines have lost so much in the past decade, Crissey
said, "Someone has to be subsidizing these airlines into existence, and
that's the investor base."
To Crissey and other investor advocates, that is a troubling
reality. "The thing about large losses is the owners of the company aren't
happy, labor can't be happy because they can't get the pay increases and the
opportunity for growth that they want, and suppliers aren't as happy because
they're not selling as many planes," he said.
While profitability is a start, what investors ache for are
companies that deliver a return on invested capital, generally a measure of how
well a company is at steering investment into returns. Airlines don't even
calculate their return on invested capital, Crissey said, as even the most U.S.
profitable carrier hasn't gotten that far. "Southwest posts profits every
year, but profits aren't the measure by which I measure. I look at everything
relative to the return on invested capital relative to the cost of capital."
The Air Transport Association, in a report this month, similarly noted, "Even
profitable years have been inadequate to cover the cost of capital."
Though he's not changing his "hazardous to your wealth"
warning, Crissey said the underlying fundamentals of the industry have
improved. He and others, meanwhile, have spoken of yet another change: Major
domestic operators largely have gone from marketing-led organizations to
CFO-led organizations, making them more investment-minded and focused on
earning their cost of capital and returning investments. "In the past, you
had so many aircraft coming that airlines had to be marketing machines to fill
their planes," he said.
US Airways' Kirby noted a similar shift in how airlines are
run. "The industry by and large is led by CEOs who have a different view
of the industry than perhaps the CEOs of yesteryear. They're much more focused
on returns and financial performance than they are on empire building. Today's
crop of CEOs are mostly former CFOs or general counsels—people much more
focused on finances and on return than they are on, ‘How big is my airline? How
big is my marketshare? How many cities do I fly to?' " That, investor
advocates said, is a good start toward long-term financial health.
Delta president Ed Bastian agreed. "You've got
managements across the industry that I believe are much more focused on
shareholder return," he said this month. "You've got companies that
have gone throughout the bankruptcy process and are highly sensitized to
delivering and generating the level of return that's required."
What The Airlines Can't Control
There are many things these new investment-minded CEOs can
control. They get to determine what cities they fly to, what their capacity
levels will be, when they initiate a fare sale or, conversely, when to raise
the price to check a bag. However, airline management controls only a portion
of their fate.
As such, they remain wary as ever of a spike in fuel, a
second dip into recession or some other, unforeseen exogenous event. Such a
thing is all it takes to upend their steps toward profitability. As summed up
by airfare analyst and CEO of FareCompare.com Rick Seaney, the airlines are
rightfully suspicious of seemingly good times.
"Airlines are like the whack-a-mole game," he said. "Every
time they stick their heads out, they get smacked with a mallet—whether that's
$145 barrel of oil or a recession."