Airline Capacity Plans Have Rattled Investors but Mean Good News for Buyers

For airline analysts, the big headline from earnings season so far has been United's plans to grow capacity aggressively over the next few years. While this likely will keep U.S. domestic fares under control for buyers, an all-out fare war remains a more remote possibility. 

United plans to increase capacity year over year in 2018 by between 4 percent and 6 percent and to implement a similar rate of growth in 2019 and 2020, United president Scott Kirby said. A good portion of that growth will connect regional markets to its hub, like the Rochester, Minn.-Chicago O'Hare service that began in June. Executives see that as a correction to cuts made in recent years, as United had shifted many of its regional aircraft out of those markets to take on American Airlines and Delta on some of their key routes. "The opportunity with United is not about shrinking," Kirby said. "It's about growing back to where United should have been had it not went to negative-8 percent growth the last several years."

Wall Street analysts, whose primary concern is profitability and unit revenue growth, reached for antacids following the announcement. "While the relationship between [capacity] growth and pricing is a bit overrated, it still matters," Wolfe Research's Hunter Keay wrote, calling United's capacity announcement a "dark turn."

So What Should Buyers Expect in Terms of Pricing?

In its 2018 forecast, American Express Global Business Travel projected "only modest rate increases" on domestic routes. They predict that capacity growth and "intense competition" will counteract demand growth, which is projected to remain strong on the corporate side. Delta kicked off this year with its most positive corporate demand outlook in three years, according to Delta president Glen Hauenstein.

In American Airlines' earnings call, which came shortly after United's, CEO Doug Parker said American's year-over-year capacity growth for the year, slated for 2.5 percent, would be strategic as not to dilute profitability. "We're taking existing aircraft, increasing the utilization and redeploying aircraft from markets that maybe aren't doing as well to places where we know we can do well," he said, "We're growing where we have a competitive advantage, and we're creating better connecting markets."

Alaska Airlines, which has been in growth mode since it acquired Virgin America at the end of 2016, will stabilize its growth this year and continue to slow in subsequent years, CEO Brad Tilden said. The carrier last year noted that its transcontinental fares in particular have been under pressure thanks to competition from JetBlue and basic economy fares, which Alaska is considering adding this year.

Meanwhile, other factors will give airlines pricing strength this year. United, for example, has switched to a new revenue management system that should be fully functional by the second quarter. Chief commercial officer and EVP Andrew Nocella had said it would better forecast demand and allow United to attract higher-yielding passengers. Southwest, meanwhile, expects to benefit from the reservations system to which it switched last year.

Fuel prices also could be a big factor in fares this year, according to the Amex GBT forecast. "Industry forecasts for 2018 span a wide range of potential outcomes, but rising U.S. shale production, increased use of [renewable] energy and uncertain capacity discipline among oil-producing nations will likely result in only moderate increases in oil prices for another year," the forecast said. "However, with fewer carriers hedging fuel costs and many having already invested in better infrastructure or increased employee salaries, a major jump in fuel prices would likely result in the return of significant fuel charges and higher airfares."