Vaughn Cordle
AirlineForecasts CEO and chief analyst Vaughn Cordle painted a gloomy landscape for passenger aviation--including an estimated $33 billion rise in fuel costs, more than 84,359 job cuts, a 24 percent across-the-board price increase and a 20 percent smaller industry than today--should oil prices escalate to and persist at $140 a barrel. Speaking during an Association of Corporate Travel Executives meeting here last week, Cordle provided an economics lesson on the forces of oil supply and demand, as well as potential ramifications. Attendees peppered Cordle with questions. An excerpt follows.
What's the bottom line; Is it for the United States to have just two primary carriers?
Using a reasonable estimate of price elasticity of demand, we can reasonably assume that if oil ranges around $130, the industry is going to spend $30 billion more just to cover that gap, and per enplanement fees have to go up $42. What that means is that average fares need to go up 21 percent to 24 percent--and that's across the board, not this headline stuff that only small segments of the market can bear. Now, if that were to occur, the reduction in seat capacity would be 18 percent to 20 percent. That means we're going to have an industry that's basically 20 percent smaller. Today, we only have 8 percent to 9 percent [of capacity] coming out. The best case earnings estimate for 2008 is $7 billion in losses, oil at $130 barrel with some capacity taken out of the system.
Why do you say that these airlines have to start shrinking?
United has lost 80 percent of its value over the past 12 months. Its market value today is about $800 some million; Southwest's is $10 billion. United is going to announce major impairment costs in the second quarter. All these major airlines have negative tangible net worth once you strip out all the goodwill, which has no value. Just to show you the weakness of the U.S. airline industry, if you take a look at Lufthansa at $11 billion, it exceeds the value of all major U.S. airlines [American, Continental, Delta, Northwest, United and US Airways are valued at a combined $6.9 billion]. We've got too many competitors in the U.S. airline industry. And we have government policies that encourage competition. There's destructive fare competition. Real fares are approximately 20 percent less today than they were eight years ago. The entire industry lost 50 percent of its value. It is tough to think that we need less competition, as that means higher fares. But without higher fares, we have a bankrupt airline industry; service quality is going to go down as these guys are going to run out of cash. They've been in a slow liquidation for a very long time, and it's accelerating now. When you've got an airline industry that doesn't properly invest in its competitive resources--physical and human--you've got a problem. This spike up of oil prices pretty much bankrupts everyone.
What can the airlines or politicians do?
If you look at 2007 for all these airlines, they spent $29 billion on fuel. We're estimating that they'll spend almost $58 billion this year--that's $28 billion more for an industry that cannot pass that along to the consumer. There is about $6 billion of [fuel] hedge benefits that I did not include, so it overstates the problem somewhat. One of the things Washington could do is temporarily suspend the domestic fuel tax or suspend some of the departure fees--there are about 10 different fees. For the airlines, it works out to about $11 billion in fees. (The industry is being taxed $8.6 billion for Homeland Security and $11 billion from the Federal Aviation Administration trust fund.) If you'll recall, the bailout after 9/11 was only $5 billion. You have an industry that is going to lose $15 billion to $20 billion over the next couple years. The cash balances will fall down to bankruptcy levels by the end of this year or next. Literally, something has to be done, or give. United can park planes; it extends out the deadline another few months ... maybe six months to a year. By raising cash, hopefully they can actually break even at the industry level if oil prices go back to $100. If oil prices come down to the best case, which is $100, the industry is still destroying economic value. It's still a slow liquidation for most.
The economic model makes a lot of sense, but just recently there have been a couple of fare actions domestically--$50 fare actions. Have we seen anything to suggest that traffic is falling?
Monthly data shows that traffic is falling off--load factors are lower. For the first quarter, I stripped out cargo and nonpassenger revenue items for airlines: American is losing $58 per passenger, Delta [is losing] $43, Northwest $61, Continental $34, US Airways $33. Southwest is making $4.46 and JetBlue is losing $9. United is losing $46 a passenger. If you look at a time series of fare hikes, United is a good example. First quarter ['08] over '07, fares went up 16 percent and fuel costs went up 61 percent, which account for about 45 percent of the average fare. But if you look at fourth quarter '07 versus first quarter '08, average fares fell 2 percent, so we've reached an inflection point. If they raise fares now, the elasticity number is very high. That's why United is going to shrink 22 percent. As they try to raise fares higher at this point, they'll have a bigger falloff in load factor. So they have to follow the load factors and traffic down. United is being quite bold by parking more airplanes.
What happens if and when oil goes to $150 or $200 a barrel?
We stress test the industry all the way up to $200 a barrel. When looking at the magnitude of this cost variable--the gap up--we're in unchartered territories, so this is guess work on what's going to happen. Using reasonable assumptions, we think at $200 a barrel, the industry will be about 35 percent or 40 percent smaller. But it can survive and thrive, we just don't need 40 airlines. We don't need 10 big airlines. The airline industry really never full recovered from 9/11 and the stock market bubble pop in late 2000. Hypothetically, if we kept the same relationship with gross domestic product, the industry would have $20 billion more in revenue today. These top 12 airlines brought in last year $128 billion, but you can see that, in theory, we're coming up $20 billion short on the revenue side. If you look at inflation-adjusted yields, going back to second quarter 1990, yields were as high as 20 cents [per passenger mile]. Now they're down around the 13-cent range. The bulk of that yield plunge occurred a year before 9/11. The airline industry was headed for a recession before 9/11. It really gets down to that business traveler--that full-fare, first-class traveler who used to account for about 40 percent of the revenue. Now it's down to about 20 percent, so that level of traffic has been cut in half since 2000. Why? Travel substitutes, travel alternatives, people conducting Internet business, online meetings, corporate jets--all that stuff.