Another year, another
aggregate profit among the largest U.S. airlines. Implausible a decade ago,
major passenger carriers in the United States last year as a group locked in
their fourth consecutive year of profitability. Aided by capacity controls, a solid
corporate demand environment, ongoing revenue diversification and supplier
consolidation, the U.S. airline industry is in the midst of not only its
longest profit run since the turn of the century, but also an ongoing
reinvention.
Even if volatile fuel
prices, fierce competition, exogenous factors—including weather—and uncertain
macroeconomic trends create headwinds for the sector, all signs point to yet
another solidly profitable year in 2014.
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Industrywide, 2013 was
just that: According to the U.S. Bureau of Transportation Statistics, the 10
largest U.S. airlines, as measured by passenger volume, reported a net profit
of $11.7 billion for the full year, the group's largest annual profit in the
current multiyear run in the black.
Among the six largest
major U.S. airlines, only American Airlines last year posted a net loss. Yet,
the airline's $1.2 billion in red ink for that period belies its underlying
health—the ink would have been black if not for special items related to its
exit from bankruptcy and merger with US Airways. Indeed, the new AA posted a
combined $480 million net income for the first quarter of this year, the
largest among its peers.
Compared with the
passenger airline industry in the rest of the world, the U.S. commercial
aviation sector has emerged as the financial leader. Sure, the greatest
passenger and demand growth can be found in the Far East, but where solid
financial positioning and sustained profits are concerned, U.S. airlines have
the fundamentals in place to deliver.
The International Air
Transport Association in March pushed down by $1 billion to $18.7 billion its
2014 profit forecast for airlines worldwide, but North American airlines,
anchored by those in the United States, are primed to contribute the largest
share, with an estimated $8.6 billion in 2014 net income.
That said, there are
notes of caution: the U.S. airline sector remains debt-laden, lacks the
creditworthiness of healthier companies and has not achieved profit margins "on
par with or better than the Standard & Poor's 500 average," according
to Airlines For America, a trade group that counts as members several large
carriers.
While its members paid
down $8 billion in debt last year, they still entered 2014 owing $72 billion.
While Southwest Airlines
remains the only airline that Standard & Poor's considers "investment
grade," Wolfe Research analyst Hunter Keay noted that Delta Air Lines and
Alaska Airlines are poised to join the club, especially as they pay down debt
and continue their profit streaks.
Demand: Slow But Steady
The number of passengers
in 2013 flying on U.S.-based airlines for domestic and international trips last
year rose by a modest 1 percent from 2012 levels, according to BTS data. That
growth rate matches the prior year-over-year trend, as passenger demand slowly
but surely continues to rise from its mid-2009 nadir.
Though modestly,
passenger counts this year continue to grow. "Notwithstanding the weather,
we saw more passengers fly year over year in the first quarter of 2014,"
said Airlines For America chief economist John Heimlich, sanguine on the demand
picture for the remainder of the year.
While Southwest and
United Airlines reported modest quarterly declines in year-over-year passenger
volume, other majors saw a boost ranging from nearly 5 percent for Alaska and
2.5 percent for Delta to 0.4 percent for JetBlue Airways.
"The outlook for
demand across the industry is bright and robust both in corporate and leisure,"
American Airlines president Scott Kirby said
in April.
His competitors have
echoed the sentiment. Following earnings calls from major airlines in late
April, Wolfe Research's Keay wrote in a research note that "every carrier
spoke positively about the demand environment, both leisure and business."
The Corporate Tail Wags The Airline
Of course, not all
demand is created equal, and major U.S. airlines have placed laser focus on
what is perhaps the most lucrative of travel segments: the corporate market.
Marked by close-in booking patterns and higher premium-class use, the segment
as a whole long has produced higher-than-average yields to airlines.
Cognizant of the
outsized contribution from the segment, airlines, especially American, Delta
and United, have chased the business with vigor. In fact, last year's merger
between American Airlines and US Airways was in part predicated on winning more
corporate share.
"The corporate
traveler is essential for the success of most airlines," according to Les
Baker, vice president of Sabre-owned Prism, whose software measures corporate
client market share for airlines. "On average, 12 percent of an airline's
travelers fly on a contracted business fare. A 2013 Prism study analyzing
airline financial reports revealed that corporate contracts contribute twice an
airline's average profit," he wrote in a recent Sabre publication.
Last year was a solid
one for corporate revenue growth, according to airlines, and, based on
first-quarter data, the segment continues to increase revenues to airlines at
rates higher than the average passenger.
AA's Kirby for the first
quarter reported "mid-single-digit" year-over-year percentage revenue
growth among corporate clients, Delta reported 6 percent corporate revenue
growth, and, lagging competitors, United reported such growth of 2 percent.
Even so, gains at Delta
and United surpassed changes in overall passenger revenue, with Delta's total
passenger revenue up 5 percent and United's consolidated passenger revenue down
2.3 percent.
Despite the increasing
revenue contribution, corporate domestic fare growth this year has been modest,
up about 1 percent year over year in the first quarter, according to Prime
Numbers Technology fare data on air segments booked primarily by corporate
travel management companies. International fares booked by corporate agencies,
meanwhile, declined 1 percent during the period.
Still, it's been no
secret that airlines have modified their pricing models with an ever-growing
array of ancillary fees and services, lessening their reliance on base fares to
drive revenue.
BTS reported that total
operating revenue among 26 U.S.-based passenger airlines last year hit $199.7
billion, with $120.6 billion, or 60 percent, derived from fares. While the
remaining 40 percent included revenue from "associated businesses"
like aircraft maintenance and the sale of frequent-flyer miles to credit card
companies, it also included baggage fees and change fees, which come directly
from passengers. Illustrative of U.S. airlines' ongoing revenue diversification
since 1990, (the first year BTS reported the metric) carriers that year
realized 88 percent of their revenue from base fares.
Bye, Bye Supply
While many forces that
airlines face remain out of their control—demand largely is driven by broader
economic factors, and fuel expenses ebb and flow as the market bears—airlines
have been diligent in managing their business with one lever they can pull: supply.
With a keen focus on
prudent capacity deployment, this year will bring about modest growth in
overall supply to match the modest growth in overall demand.
Among 11 airlines
(mostly the largest U.S.-based airlines, with Canada's WestJet and Panama's
Copa Holdings included), a recent Wolfe Research analyst note reported that
consolidated capacity, as measured by available seat miles, rose 2.3 percent in
2013, with an additional 2.4 percent rise estimated for this year.
Yet, growth is quite
uneven. For example, the "Big Three"—American, Delta and United—in
aggregate added 0.6 percent in capacity last year from 2012 levels. Even
Southwest, once a consistently reliable supply grower, has moderated expansion,
with capacity up 1.7 percent in 2013, and estimated to be down by less than 1
percent in 2014.
Instead, the industry's
growers are its smaller operators. Among majors, Alaska and JetBlue led in
capacity additions last year, with available seat miles up 7.1 percent and 6.9
percent, respectively, from 2012 levels. Niche carriers—which some have labeled
"ultra-low-cost" airlines—contributed the sharpest percentage
increases in new U.S. supply: Spirit Airlines, for example, grew 2013 capacity
22 percent from 2012 levels and is estimated to further grow available seat
miles this year 18 percent, according to Wolfe Research.
The test of so-called "capacity
discipline" is not based solely on whether airlines grow or shrink, but
how adequately they match supply to demand. In a summer travel forecast issued
in May 2014, Airlines For America's Heimlich said passenger volumes on U.S.
airlines should rise 1.5 percent from last summer, "on par" with 2007
levels but still 3 percent below the 2008 peak.
"To accommodate the
increased air travel demand, airlines are adding seats to the schedule, both
domestic and international, but will keep average load factors comparable to
last summer's range of 85 to 87 percent," he said.
Fuel Tops Costs, Others Lurk
For the 10 largest U.S.
airlines, as measured by passengers, fuel last year represented 28 percent of
the aggregate cost structure, according to BTS. It's an inescapable cost of
doing business—and a volatile one at that.
For the first quarter
this year, pain at the pump eased. Among Airlines For America members, first-quarter
operating expenses rose 0.5 percent year over year, but actually experienced a "4.3
percent drop in our largest expense, fuel," said Heimlich.
Even so, to combat price
volatility, some airlines continue to hedge a portion of their fuel consumption.
That trend appears to be waning, especially as US Airways management—on
principle, long against hedging—now is in charge of the merged American and
plans to discontinue hedge programs there.
Meanwhile, Delta in 2012
took the unusual step of buying an oil refinery, and Delta president Ed Bastian
noted that move has helped raise jet fuel production in the United States and
ease pricing for the industry, even if the business line itself has yet to turn
profitable.
While fuel remains a
volatile line item, Heimlich pointed to growth in other expense categories. For
the first quarter, "wages and benefits, airport landing fees and terminal
rents, and aircraft ownership costs all saw significant increases" from
the prior-year period among Airlines For America members, he noted.
Last year, labor
expenses represented 25 percent of airline costs, according to BTS. "The
industry has to confront its next labor cycle towards the end of the decade,
without consolidation likely to prove an economic panacea as it recently did,"
JPMorgan analysts wrote this month.
Consolidation Nation
Announcing plans to
merge with AA in February 2013, then-CEO of US Airways Doug Parker called the
tie-up "the last major piece needed to fully rationalize the industry,
enabling airlines to be intensely competitive but also sustainably profitable."
Indeed, many have called the deal—sealed in December after a challenge by the
U.S. Department of Justice—the "last merger."
The deal follows other
moves that concentrated the industry, including mergers between Delta and
Northwest, United and Continental, and Southwest and AirTran.
Following consolidation,
JPMorgan analyst Jamie Baker last year noted that the four largest U.S. airline
companies control 88 percent of the domestic market, up from 60 percent in
2005.
The impact of the AA-US
Airways deal will continue to be felt for years, and many anticipate capacity
cutbacks and fare growth. "The airlines have really only benefited from
merger announcements rather than merger synergies," wrote Cowen and Co.
airline analyst Helane Becker in a research note earlier this year. "We
expect United and American to continue rationalizing capacity, helping with the
pricing environment."
This report originally appeared in the May 26,
2014, edition of Business Travel News.