Monday, June 05, 2006

U.S. Airlines Profitability Staging a Recovery – Really?

With the rising price of oil, the airliners must be hurting more than ever. Right? No, see Wall Street Journal June 5, 2006 article by Evan Perez and Melanie Trottman

Major Airlines Fuel a Recovery By Grounding Unprofitable Flights

Despite the burden of record fuel prices, major U.S. airlines are staging a recovery from five years of brutal losses, something many analysts and airlines didn't think possible as recently as six months ago.

The improving financial results posted by seven of the nation's 10 big airlines in recent months reflect a fundamental shift in strategy that goes beyond the efforts of older network carriers to wrest billions in concessions from their unions. The big carriers, which for decades have doggedly pursued market share at any cost, now are focusing just as aggressively on the profitability of each route and flight.

The so-called legacy carriers -- those like American Airlines and Delta Air Lines, with big pension and other obligations that predate the industry's deregulation in 1978 -- have abandoned many of the tactics that have led to their cyclical weakness. They are increasingly unwilling to fly half-empty aircraft to stay competitive on a given route just for the sake of feeding their nationwide networks. Though their recovery is still in its early stages and could be derailed by a further run-up in oil prices or other factors, the airlines' new emphasis on profitability appears to be paying off.

The six largest legacy carriers -- AMR Corp.'s American, Continental Airlines, Delta, Northwest Airlines, UAL Corp.'s United Airlines and US Airways Group -- are putting far fewer planes in the sky these days, streamlining their fleets and pushing up prices where they can. New statistics for 2005 show those airlines had a combined mainline operating fleet of 2,747 aircraft, down 21% from the 3,469 they had at the end of 2000, according to the Air Transport Association.

American, the world's biggest carrier by passenger traffic, recently decided to ground 27 MD-80 aircraft, which it had used for years to help meet peak summer travel demand. It concluded that the cost of operating the older, gas-guzzling aircraft during the rest of the year outweighed the benefit of having the extra summer capacity.

Delta and Northwest, both operating under Chapter 11, shrank their fleets by getting bankruptcy-court approval to return dozens of their aircraft to the leaseholders. Ed Bastian, Delta's chief financial officer, said that until Delta was allowed to break the aircraft leases, it continued to operate many planes on unprofitable routes simply because parking the aircraft was even more expensive than flying them at a loss.

Meanwhile, thanks to a strong U.S. economy, demand for the industry's smaller number of available seats has remained robust. Last year, U.S. airlines filled an average 77.6% of their seats on domestic and foreign flights, up from 75.5% in 2004 -- the highest levels since 1946, according to the ATA. The industry group's chief economist is predicting that the percentage will rise to around 85% this summer, potentially the highest ever recorded. That means that many more planes will be flying completely full.

In the first two months of this year, domestic available seat miles, a measure of U.S. industry capacity, dropped 2.8% to 113.2 billion from 116.5 billion a year earlier, while U.S. airlines filled more seats -- 74.3%, up from 70.7%.

With the cuts in capacity and strong demand, big airlines are enjoying their strongest pricing power in five years, and for the first time the ability to pass on a substantial share of lofty fuel costs to their customers.

As a result, the Air Travel Price Index, a quarterly measure of changes in airfares, rose 9.1% in the fourth quarter of last year from a five-year low a year earlier. The U.S. Department of Transportation's Bureau of Transportation Statistics says the latest number is the highest since just before the terrorist attacks of Sept. 11, 2001, which plunged the big U.S. airlines into a depression. Passenger volume remains consistently above the pre-9/11 level as well.

Airline executives, however, believe the industry still has a way to go. "This industry, just like any other industry that is dependent on oil, has to turn around and pass this cost on to its customer or else it won't be an industry," Gerard Arpey, American's chief executive, said recently.

It's far from certain, however, whether the industry's recovery will continue. A new surge in fuel prices could offset the recent fare increases, and renewed pricing power could tempt airlines to raise fares so high that demand begins falling. For some airlines it still could be another year before the increased revenue translates to profits. And more restructuring is bound to occur.

American's Mr. Arpey has told workers at his airline, which has avoided bankruptcy proceedings, that American needs to make more cost cuts to keep pace with rival carriers that used their stay in bankruptcy court to shed costs. Meanwhile, outside the U.S., where the airline industry began its rebound last year, some European and Asian airlines are trying to offset rising jet-fuel prices by redoubling efforts to cut other operating costs.

Some U.S. airline executives worry that 2006 might be a peak year for their historically cyclical industry, giving airlines little time to prepare for another downturn. William Warlick, airline analyst at Fitch Ratings, says that while capacity is down, the industry still has too many airlines. "In the next downturn, the industry will still be vulnerable to irrational capacity behavior and pricing actions," he said.

Nonetheless, it's clear that a confluence of strong demand and the new discipline among big carriers has altered the competitive landscape. Last week, Delta reported its first monthly operating profit in five years. The U.S. industry, which has accumulated more than $40 billion in financial losses and shed 165,000 jobs since 2001, is expected to see its losses narrow to no more than $2 billion this year.

For the first time since discount airlines began their assault on the major carriers in the 1990s, airlines such as Continental, American, and United appear to be gaining the upper hand against competitors.

At the same time, some of the luster is fading from many discount carriers like JetBlue Airways. Hedging helped some discount carriers insulate their profits from the recent run-up in oil prices. But as those hedging deals have begun to expire, the discount carriers are having to purchase aviation fuel at higher prices.

Squeezed by pricier fuel, Southwest Airlines recently broke through its self-imposed fare cap. JetBlue, which has run into operational troubles as it introduces a new aircraft type, has announced plans to delay delivery of 12 aircraft and sell as many as five others. Spirit Airlines, which has expanded into the Caribbean, has raised prices, initially causing its passenger traffic to fall about five percentage points.

Spirit was "traditionally an irrational low-price player," says Ben Baldanza, chief executive of the airline. "We're trying to be smart about pricing."

Meanwhile, rival legacy carriers showed restraint after the shutdown of upstart Independence Air earlier this year, largely resisting the urge to rush in with new capacity on the routes served by the defunct carrier. In many markets vacated by Independence, other airlines made no effort to grab market share by adding unprofitable new service. As a result, one-way business fares from Atlanta to Washington, for example, are up 52% from a year ago, to $614 from $404.

Last year, Delta, which is based in Atlanta, broke with airline orthodoxy by abandoning its unprofitable hub at Dallas/Fort Worth International Airport, drastically reducing its flights to the city. That not only cut Delta's costs but also improved the fortunes of Fort Worth-based American, which lost a major competitor on those routes.

While economic conditions are the best that major airlines have had in years, the new climate isn't friendly to price-sensitive fliers. This summer passengers are expected to face higher fares, and many flights are expected to be packed to capacity.

Legacy airlines have simplified and slashed their most expensive business fares -- luring back corporate travelers -- but have held back from mimicking the aggressive discounting offered by low-fare carriers. Their renewed pricing power has lifted last-minute fares, purchased mostly by business travelers, by 21% from a year ago, according to Harrell Associates, a New York consulting firm that analyzes fares. Corporate travelers don't appear dissuaded yet because "they understand there is a premium to be paid for holding that seat to the last minute," says Bob Harrell, the firm's president.

Behind the scenes some carriers are further improving margins with more sophisticated pricing strategies and by employing a new generation of so-called origin-and-destination, or O&D, revenue-management systems. Those systems are designed to reduce the number of inexpensive -- and unprofitable -- seats that travelers can find on the Internet. Delta, the third-largest U.S. carrier, credits a computerized system called OMNI, which it launched in February 2005, for improving its revenue.

Scott Nason, American's vice president for revenue management, says American's system helps decide when to sell a seat on a flight from Austin, Texas, to Dallas to a passenger whose final destination is Dallas, and when to save it for a more-lucrative passenger who is passing through Dallas en route to Shanghai. Old revenue-management systems made it difficult for airlines to differentiate between those passengers, costing them potential revenue.


Post a Comment

<< Home