A three-year profit run is a rarity for the U.S. airline
industry, but analysts are projecting just that, with 2012 net income levels
expected to top those reported for last year. It would seem an improbable
reversal of fortune, considering this is the very same industry that lost tens
of billions of dollars during the last decade. Yet, in many ways this is a
different industry—one that analysts and airline management teams say is
transformed by ongoing capacity discipline, consolidation, new means of revenue
generation, aggressive pricing and cost containment.
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Amid that transformation, carriers still must contend with
volatile fuel prices, disruptive world events and poor macroeconomic trends.
Still, barring unforeseen shocks, Deutsche Bank analysts projected that
publicly traded U.S. commercial airlines this year will post $3.8 billion in
net income, following a profitable 2011 for all seven of the largest U.S.
carriers—except bankrupt American Airlines.
Most major carriers rang in 2012 with a profitable first
quarter—no small feat considering the first three months of the year typically
is the weakest seasonal period for airlines. Blocked from first-quarter
profits, United cited special costs "primarily" related to the
integration of Continental, while American faced the high costs of Chapter 11
restructuring.
Despite such one-time expenses, the fundamentals of the
industry have remained healthy. Demand has held up, revenue has continued to
grow—albeit at slower rates—and carriers have mitigated the increased cost of
jet fuel through pricing actions and capacity control. As proof of such health,
the seven largest U.S. carriers in aggregate reported a $247 million
first-quarter operating profit, "which was $267 million better than last
year despite a $1.8 billion higher fuel bill," according to Deutsche Bank
analysts.
"The Wall Street analyst consensus is much more
sanguine on the full year than it was on the first quarter," said John
Heimlich, chief economist for industry trade group Airlines For America. "The
first quarter is typically the weakest, and the second quarter is typically the
strongest. Wall Street is expecting most carriers to report modest
profitability in 2012."
Airlines Cash In On
Fare Growth
Driven by record fare levels, growth in ancillary sales and
strong corporate demand, the seven largest U.S. airlines in 2011 increased
full-year revenues from 2010, some by double-digit percentages.
Carriers as a group in 2011 successfully pushed through nine
domestic fare hikes out of 22 attempts, according to FareCompare.com CEO Rick
Seaney.
"Average fares for the full year in 2011 were the
highest on record at $364, up 8.3 percent from 2010," according to the
U.S. Department of Transportation's Bureau of Transportation Statistics. "The
2011 fares were up 5.2 percent from 2008, which at $346 was previously the
highest year on record since 1995, not adjusted for inflation."
U.S. airlines so far in 2012 succeeded with three
broad-based domestic fare hikes out of six attempts, according to Seaney. He
expected airlines to attempt another broad fare hike before the height of the
peak summer travel season.
Even when broad-based fare hikes fail, airlines have been
aggressive in growing revenue through what Delta executive vice president Glen
Hauenstein called "smaller changes to the fare environment," such as
adding advance-purchase requirements or minimum-stay restrictions. Such
restrictions push travelers, especially those booking on short notice or
traveling on business, into higher fare buckets.
"You have to look at fares in more than just the dollar
amount we are charging but also in qualifications in how you actually get those
fares," said Hauenstein. "That is what is driving industry yield up
across the board. While we have had some resistance to fare increases, we made
some progress on the other side of the fare equation."
Apparently, it has paid off. Passenger unit revenues for
publicly traded U.S. airlines grew by an average of 8 percent in April, and
while May was on pace to grow by less than 5 percent year over year, Dahlman
Rose & Co. analyst Helane Becker expected "to see a rebound in June,"
with year-over-year passenger revenue growth in the 7 percent range.
In Search Of The Next
Big Ancillary
Even as airfares reach new altitudes, they now comprise a
smaller portion of overall airline revenues than in 1990, when BTS first began
keeping tabs. Then, airfares contributed nearly 88 percent to the revenue pool
of major domestic carriers. By last September, however, fares comprised 71
percent of revenue, with ancillary revenues—such as those derived from
cancellation fees, bag fees and the sundry catchall of what BTS called "miscellaneous
operating revenue"—contributing a growing share.
According to Airlines For America data, major U.S. carriers
last year on average collected about $10 from each customer per segment for bag
fees, onboard services, seat selection and other goods and services. While the
absolute per-passenger total continues to grow, the rate of growth in 2011
slowed to 2 percent year over year. Compare that to the 36 percent growth in
ancillary revenue in 2009, when many carriers began charging checked bag fees.
While US Airways CFO Derek Kerr in March acknowledged that
baggage fees contribute the vast majority of ancillary passenger revenue, the
carrier and its competitors have searched for new sources of ancillary
revenues, including fees for seat assignments and expedited airport services.
Corporate Strength
Continues
Perhaps no passenger segment contributed more to the
airlines' good fortunes in recent years than corporate travelers. Demand from
those travelers has been resilient, and, more importantly, corporations have
yet to balk at the higher prices airlines are charging them.
That strength has sustained into the second quarter this
year. US Airways president Scott Kirby noted that leisure demand in the first
quarter "was strong," but corporate demand "was extremely strong"
as corporate account revenue grew 29 percent year over year.
Delta reported that total first-quarter corporate revenue
increased by 11 percent year over year, despite a 3 percent decline in
capacity. "The corporate growth is broad-based, and the industries where
we saw the most significant increases were financial and business services and
manufacturing," said president Ed Bastian.
"As we have seen over the last year, corporate revenue
continued to show steady improvement this quarter," said United chief
revenue officer Jim Compton, who noted that corporate revenue increased more
than 10 percent during the first quarter, with yields—a representation of fares
per mile—"up about 4 percent versus first-quarter 2011."
American, which has lagged its competitors in overall
revenue growth and has acknowledged marketshare losses in the corporate
segment, has not released corporate-specific revenue data. However, vice
president of global sales Derek DeCross told BTN that "if we were to look at the number of corporate
accounts that we've signed, either renewed or added—in other words, won—from
the period of Nov. 29 when we filed [in 2001 for Chapter 11 court protection]
to date, and compare it to a year ago, you would actually see that we've added
or retained more corporate accounts since we've filed."
Fuel Burns
Muting all optimism at all airlines, fuel remains the
industry's arch-villain. It is partially or fully behind every fare increase,
every capacity cut and every newly unbundled item that previously was free. In
sum, it is the difference between profits and losses.
Lately, there has been a slight reprieve in jet fuel prices,
but industry watchers don't expect that to continue. "Over the past month
jet fuel traded significantly lower," according to a May research note
from Dahlman Rose & Co.'s Becker, giving airlines "a break from
constant pressure from the commodity markets."
It may be ephemeral, but by late May, forward jet fuel
prices began trading at under $3 per gallon. "The jet fuel outlook is a
relief to the airlines as many prepared for a jet fuel environment of $3.40 to
$3.50 for the remainder of the year," according to Becker.
Still, Airlines For America's Heimlich during a May 9
conference call said the U.S. Energy Information Administration was "projecting
the highest summer average for jet fuel prices in its history." Jet fuel
prices "year to date are running about 7 percent to 8 percent higher than
the same period in 2011," he cautioned.
Several airlines, including American and United, continue to
hedge some portion of their jet fuel needs, but according to Wolfe Trahan
analyst Hunter Keay, "Airlines, particularly the ones with strong balance
sheets, seem to be pressed more and more by investors about dropping hedging
altogether." That, he explained in a May research note, would be good news
for the industry. Not only do hedge bets sometimes fail to pay off, but they
also unbalance the competitive playing field. Keay noted that "once
airlines stop hedging fuel altogether, the industry's collective ability to
pass through higher fuel prices should increase greatly."
Delta is pursuing a more radical way to mitigate the impact
of fuel spikes. It recently agreed through a subsidiary to acquire a
Philadelphia-area oil refinery from Phillips 66. After investing $250 million,
Delta plans to double the refinery's jet fuel production, eventually supplying
80 percent of its domestic fuel needs. The carrier estimates its refinery
ownership will save $300 million in annual fuel expenses and reduce its "exposure
to fuel volatility." The verdict is out on whether the plan will work,
according to industry analysts.
Unavailable Seat Miles
Hedging fuel and buying refineries aside, one of the most
common defenders against fuel increases are capacity cuts, and airlines
continue to trim away excess seats. Domestic and international capacity for
North America "has been effectively static since 2009," according to
an April data release from OAG, which aggregates airline schedules.
Morgan Stanley analysts reported that publicly traded U.S.
airlines last year increased systemwide capacity by less than 2 percent
compared with 2010. Capacity additions this year similarly should be modest,
according to Morgan Stanley forecasts, which call for less than 1 percent more
industry capacity than 2011 levels.
Some large carriers, including Delta and United, likely will
decrease overall capacity levels in 2012, according to Morgan Stanley, while
the greatest pockets of growth come from smaller carriers. For example, it
projected that Alaska Airlines will grow total 2012 available seat miles by
nearly 6 percent and JetBlue will grow ASMs by nearly 7 percent.
What About American?
When it comes to the reversed fortunes of the domestic
industry, American has been the exception. It has lost cash where its
competitors profited, shed market share where its competitors grew and
increased revenues by single-digit percentages when its competitors counted
double-digit gains.
Undergoing a court-supervised bankruptcy reorganization,
American is poised to emerge a changed carrier—possibly as soon as this year.
It remains to be seen if AA after bankruptcy will be arm-in-arm with would-be
merger partner US Airways or as a standalone entity, freshly unburdened by the
costs that management contends have left it exiled on a different competitive
field.
Skeptical of AA's standalone plan, analysts and US Airways
are hoping for a merger. Only 5 percent of AA's nonstop domestic network
overlaps with US Airways, according to Morgan Stanley airline analysts. Wall
Street sees it as a good fit.
Indeed, consolidation has been key for the industry to
sustain profits, putting capacity and pricing decisions in the hands of fewer
and fewer players.
Is an AA-US Airways marriage the culmination of that trend?
If it occurs, "close to 90 percent of domestic capacity will be controlled
by the Big Three and Southwest," according to JP Morgan's Jamie Baker. "In
2005, the Big Three networks of American, Delta and United—along with
Southwest—controlled roughly half of domestic capacity."
Baker called four airlines with that level of share "the
optimal industry structure, and should allow for consistent return generation
going forward." Optimal for the airlines, that is.
This report
originally appeared in the June 4, 2012, edition of Business Travel News.