Why Good News For Travelers Is Killing Airlin
08-02-2016, 08:33 AM
#1
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Joined APC: Jan 2006
Posts: 1,610
Why Good News For Travelers Is Killing Airlin
Turbulent times might be coming back to airline business.
Last month, Gary Kelly, CEO of Southwest ( LUV -2.92% ) , warned on the carrier’s second quarter earnings call that “now we’re seeing softer fare trends” that are “disappointing.” As a result, America’s most profitable airline forecasted an additional 2 percentage point drop in revenues for the third quarter, pushing the expected year-over-year decline to between 3% and 4%. American Airlines, too, said it’s profits fell 44% in the second three months of 2016.
All told, the Big Four––American ( AAL -4.10% ) , Delta ( DAL -6.18% ) , United Continental ( UAL -3.91% ) , and Southwest—have shed almost $30 billion in market cap since March, a full 25% of their value. That’s big change from just a few years ago when airlines stocks were soaring.
For the past couple of years, airline CEOs and Wall Street analysts have been heralding a new era of big, durable profits for America’s major carriers. Airlines had learned a painful lesson from past price wars. The steep fall in fuel prices was helping things.
Get past the rhetoric, though, and investors will find that the airlines haven’t fundamentally changed their ways. The majors are once again slashing fares to keep such ultra-low-cost carriers as Spirit and Frontier from stealing their customers. As a result, revenues are falling, and the carriers are nevertheless minting expensive new pay deals with their workers, a throwback to the bad old days. Those two trends are already squeezing profits, and the squeeze is only getting tighter. And looking forward, an oil price windfall won’t be there to disguise the damage.
The Big Four’s performance over the past year illustrates why their record profits are destined to fade. To identify the big trends, imagine, with me, that the major carriers were just one huge airline. First of all, Southwest American Delta United, better known as Swadu Airlines Corp., would be one dominant industry player. It would carry around 90% of the nation’s travelers. On top of that it would, at least currently, be super profitable.
Over the past four quarters (from June 2015 to June 2016), Swadu Airlines would have posted combined operating profits of $23.2 billion, a gain of $7 billion, or 43%, over the previous twelve months. Sounds great––until you dig into the numbers.
All of that profit increase, and then some, appears to come from lower oil prices. The combined mega jet would have seen its total bill for fuel oil shrink to $21.7 billion from $35 billion. Call it a $13 billion gift from Zeus, god of the skies. To their credit, the jumbo carrier did a fine job controlling costs excluding labor and fuel, notably expenses for maintaining fleets substantially upgraded with new aircraft. In fact, “all other” costs actually fell by around $500 million.
Swadu, unfortunately, did not do as good a job when it comes to labor costs. All told, our imagined airline saw a lift in labor costs of a stunning 13.8%, or $4.4 billion. The problem: The airline behemoth, despite its size, made some generous deals with pilots and mechanics despite falling revenues. In fact, if fuel prices had stayed at the levels of the 12 previous months, Swadu would have seen its bottom line land below $1 billion.
So what’s causing the severe pressure on prices that, in turn, is shrinking revenues? “The carriers are taking the savings from lower oil prices and investing them in chasing after the ultra-low carriers,” who would otherwise poach far more of their customers, says Bob Harrell, head of Harrell Associates, a travel and aviation consulting firm in New York. “They made the decision to pursue more aggressive pricing about a year ago.”
Harrell notes that the Big Four derive around half of their revenue from business customers, and the other half from leisure travelers. The sharpest competition, though, is for the vacationing and budget crowd. “We do a survey of prices, and leisure prices are down 10% since July of last year,” he says. “The airlines are determined to hold business fares up. They’ve risen around 2% in the past year.”
Discounter Spirit is offering bargain fares in Florida and Texas, and the majors are matching. The fall in oil prices isn’t all a boon: It’s pounded the once thriving Houston market where United Continental, American, and Southwest are all big players. In Dallas, the expiration of a law that banned Southwest from offering most long-haul flights from its home base at Love Field has unleashed a flood of new service to such markets as New York and Los Angeles, lowering fares on those routes.
Keep in mind that revenues are dwindling while planes are packed, and more Americans than ever are taking to the skies. Hence, the airlines badly need rising prices to book good earnings. The reason is disturbingly familiar: They still haven’t managed to surmount their labor cost problem. The wage-and-benefits bill is regularly rising at double digits, while sales trace the opposite trajectory.
Let’s go back to our model of the Big Four as a single carrier. It’s possible that revenues will shrink 4% over the next 12 months, and although that forecast is on the pessimistic side, cautious investors should weigh the risk. If that happens, fuel expense remain flat, and and labor costs once again rise by $4.4 billion, operating earnings will fall from $23 billion to $13.5 billion, or 41%.
So much for the vaunted new age of “discipline.” The airline market is much like any other, when fares and profits are high, discounters flock and ruin the fun. Now it’s happening all over again.
Last month, Gary Kelly, CEO of Southwest ( LUV -2.92% ) , warned on the carrier’s second quarter earnings call that “now we’re seeing softer fare trends” that are “disappointing.” As a result, America’s most profitable airline forecasted an additional 2 percentage point drop in revenues for the third quarter, pushing the expected year-over-year decline to between 3% and 4%. American Airlines, too, said it’s profits fell 44% in the second three months of 2016.
All told, the Big Four––American ( AAL -4.10% ) , Delta ( DAL -6.18% ) , United Continental ( UAL -3.91% ) , and Southwest—have shed almost $30 billion in market cap since March, a full 25% of their value. That’s big change from just a few years ago when airlines stocks were soaring.
For the past couple of years, airline CEOs and Wall Street analysts have been heralding a new era of big, durable profits for America’s major carriers. Airlines had learned a painful lesson from past price wars. The steep fall in fuel prices was helping things.
Get past the rhetoric, though, and investors will find that the airlines haven’t fundamentally changed their ways. The majors are once again slashing fares to keep such ultra-low-cost carriers as Spirit and Frontier from stealing their customers. As a result, revenues are falling, and the carriers are nevertheless minting expensive new pay deals with their workers, a throwback to the bad old days. Those two trends are already squeezing profits, and the squeeze is only getting tighter. And looking forward, an oil price windfall won’t be there to disguise the damage.
The Big Four’s performance over the past year illustrates why their record profits are destined to fade. To identify the big trends, imagine, with me, that the major carriers were just one huge airline. First of all, Southwest American Delta United, better known as Swadu Airlines Corp., would be one dominant industry player. It would carry around 90% of the nation’s travelers. On top of that it would, at least currently, be super profitable.
Over the past four quarters (from June 2015 to June 2016), Swadu Airlines would have posted combined operating profits of $23.2 billion, a gain of $7 billion, or 43%, over the previous twelve months. Sounds great––until you dig into the numbers.
All of that profit increase, and then some, appears to come from lower oil prices. The combined mega jet would have seen its total bill for fuel oil shrink to $21.7 billion from $35 billion. Call it a $13 billion gift from Zeus, god of the skies. To their credit, the jumbo carrier did a fine job controlling costs excluding labor and fuel, notably expenses for maintaining fleets substantially upgraded with new aircraft. In fact, “all other” costs actually fell by around $500 million.
Swadu, unfortunately, did not do as good a job when it comes to labor costs. All told, our imagined airline saw a lift in labor costs of a stunning 13.8%, or $4.4 billion. The problem: The airline behemoth, despite its size, made some generous deals with pilots and mechanics despite falling revenues. In fact, if fuel prices had stayed at the levels of the 12 previous months, Swadu would have seen its bottom line land below $1 billion.
So what’s causing the severe pressure on prices that, in turn, is shrinking revenues? “The carriers are taking the savings from lower oil prices and investing them in chasing after the ultra-low carriers,” who would otherwise poach far more of their customers, says Bob Harrell, head of Harrell Associates, a travel and aviation consulting firm in New York. “They made the decision to pursue more aggressive pricing about a year ago.”
Harrell notes that the Big Four derive around half of their revenue from business customers, and the other half from leisure travelers. The sharpest competition, though, is for the vacationing and budget crowd. “We do a survey of prices, and leisure prices are down 10% since July of last year,” he says. “The airlines are determined to hold business fares up. They’ve risen around 2% in the past year.”
Discounter Spirit is offering bargain fares in Florida and Texas, and the majors are matching. The fall in oil prices isn’t all a boon: It’s pounded the once thriving Houston market where United Continental, American, and Southwest are all big players. In Dallas, the expiration of a law that banned Southwest from offering most long-haul flights from its home base at Love Field has unleashed a flood of new service to such markets as New York and Los Angeles, lowering fares on those routes.
Keep in mind that revenues are dwindling while planes are packed, and more Americans than ever are taking to the skies. Hence, the airlines badly need rising prices to book good earnings. The reason is disturbingly familiar: They still haven’t managed to surmount their labor cost problem. The wage-and-benefits bill is regularly rising at double digits, while sales trace the opposite trajectory.
Let’s go back to our model of the Big Four as a single carrier. It’s possible that revenues will shrink 4% over the next 12 months, and although that forecast is on the pessimistic side, cautious investors should weigh the risk. If that happens, fuel expense remain flat, and and labor costs once again rise by $4.4 billion, operating earnings will fall from $23 billion to $13.5 billion, or 41%.
So much for the vaunted new age of “discipline.” The airline market is much like any other, when fares and profits are high, discounters flock and ruin the fun. Now it’s happening all over again.
08-02-2016, 12:59 PM
#3
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Joined APC: Jun 2005
Position: Under the Frog
Posts: 1,125
08-02-2016, 04:23 PM
#5
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Joined APC: Oct 2005
Posts: 900
When Spirit and JB raise their pilot pay (they'll have to in order to stay alive), ticket prices will be adjusted accordingly and this article will be nothing more than myth. Ultra-low cost carriers have flurrished in the post-9/11 market, but I'm not sure that business model can last forever. SWA is no where near the low-cost carrier they used to be.
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08-02-2016, 07:39 PM
#7
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Joined APC: Jun 2016
Posts: 629
The legacies are boxing themselves into a corner again. A spike in fuel will be crushing.
08-02-2016, 08:17 PM
#8
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Joined APC: Feb 2016
Posts: 377
Exactly, crew costs are only a very small fraction of an airline ticket as explained here:
https://www.youtube.com/watch?v=6Oe8T3AvydU
https://www.youtube.com/watch?v=6Oe8T3AvydU
08-02-2016, 10:00 PM
#9
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Joined APC: Apr 2005
Posts: 1,497
The stocks are pulling back because the prices are based on what analysts see in the future right or wrong. There have been record profits and revenue recently, it is harder to have bigger gains on these.
The airlines themselves are doing better than ever, but it is harder to increase profit margins so the stocks pull back. Not bad news for employees, though investors may start to look elsewhere.
The airlines themselves are doing better than ever, but it is harder to increase profit margins so the stocks pull back. Not bad news for employees, though investors may start to look elsewhere.
08-03-2016, 10:06 AM
#10
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Joined APC: Apr 2013
Posts: 3,720
Airlines have become investor ATM machines in the past few years. It isn't sustainable nor should it be. The economy will contract in cycles as it has always done, capacity will be adjusted, fuel prices will go up and down. In the end, the big airlines as we know them will survive just fine.
This article was written by and for investors who would just as soon move their money to the next payday. They have no loyalty to the companies they invest in. SWA just announced more stock buybacks for a total of 5.7B. Their share price is way down. Not so sure that money was put in the right place, but I am just a pilot.
This article was written by and for investors who would just as soon move their money to the next payday. They have no loyalty to the companies they invest in. SWA just announced more stock buybacks for a total of 5.7B. Their share price is way down. Not so sure that money was put in the right place, but I am just a pilot.
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