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US airlines to cover USD9bn in higher fuel costs this year

29-Mar-2011

If fuel remains in the USD105-per-barrel range as average for 2011, the eight largest US airlines will spend more than USD9 billion more on fuel than 2010 and need to increase revenues to break even, according to AirlineFinancial’s Bob Herbst, who released the estimate over the weekend.

In her 1Q2011 outlook, Dahlman Rose Analyst Helane Becker said that while fuel may be up, fares are up “a lot,” suggesting the airlines are now in a race.

“The question will be which gives first, demand or jet fuel costs,” she asked in her latest Takeoffs and Landings report. “Friday marks the end of March and 1Q11. There have been 15 attempted fare increases, of which at least eight fare increases held. This helped offset the 30% increase in jet fuel expenses. February load factors declined by 100 bps, and January was up by 40 bps. March will be reported next week, but so far, traffic declines have been offset by strong unit revenue growth. Airlines will be under significant pressure if the consumer starts to reject the fare increases.”

After analysing the eight largest airlines, their strengths and weaknesses and their relative positions in the industry, Mr Herbst concluded that the eight largest airlines will see double digit year-over-year increases in top line revenues in 2011. But, he added, based on an average crude oil price of USD100/barrel, and all other costs remaining similar to 2010, the “eight airlines will have to accumulate 10% additional revenues to break-even for the year”. In his projections, however, he assumes a 15% increase in operating revenues for 2011 over 2010.

Mr Herbst looked at United, Delta, American, Southwest, US Airways, JetBlue, Alaska and AirTran for a three-part, year-on-year, 2009/10 analysis of the industry. They, and their partners, carry 88% of all US domestic traffic.

Price of fuel means more adjustments

“The recent price of crude oil has been approximately USD105 per barrel,” said Hebst, adding the crack spread ranges from USD8 to USD32. “Last week’s cost for a barrel of jet fuel was a staggering USD132 per barrel. “Last year the average price for crude oil was USD79.48 per barrel. The average price per gallon of jet fuel was USD2.149 or USD90.26 per barrel. That equates to USD10.78 for the average crack-spread. Most airlines currently have 30-50% of their next six months fuel hedged at approximately USD85-90 per barrel of crude.”

He noted that despite US Airways’ strategy not to hedge, it is maintained a fuel cost advantage over competitors. His analysis shows that American’s costs only needs to rise USD320 million before it goes into an operating loss with Delta, of course, in the best shape with cost increases of USD3 billion for an operating loss. Unfortunately, last week COO Ed Bastion indicated that will be exactly the impact of rising fuel costs on the airline.

AirlineFinancials.com’s multiple projections for the 2011 increase in fuel expense over what it was in 2010. Calculations are based on the year-over-year percentage increase in jet fuel price per gallon. Each airline’s total operating revenue and operating income for 2010 is shown with the red highlighted numbers indicating the breaking point in fuel costs, when airlines will begin showing an operating loss. Assumptions are made that each airline's operating revenue will increase by ~15% over 2010. Estimates for each airline's current fuel hedging program have been taken into account.

“Fuel is every airline's highest expense item and covers more than 30% of an airline's total revenue,” said Herbst saying that airlines will have to raise revenues and/or decrease costs to keep up. “Since the airline industry has reduced costs drastically over the past few years and a majority of airline employees are currently working at pay rates and work rules from 20 years ago. It is my bet that air fares are going up and capacity must go down to match a declining demand due to anticipated higher air fares.”

The industry reported the highest profits in over a decade and the second operating operating revenues in airline history, he noted, but that could disappear with rising fuel, he reported.

“As typically seems to be the case for the airlines, just when it looks like the industry is turning things around and making badly needed profits, along comes the mid-east/Africa problems which drive the price of jet fuel up by 40%,” he said. “To add a little more challenge, Japan gets devastated by earthquakes, tsunamis and potential radiation tragedies. The always ongoing question for the airline industry is what happens next? Or more importantly, what should happen next to turn the US airline industry into a strong global competitor? The only ‘fix’ to the US airline industry is high enough air fares to cover the rising and often unpredictable increase in every airline’s fixed and variable costs.”

Fuel issues to continue for a long time

Perhaps the greater question, in terms of fuel urgency, is the schedule for bringing blended bio fuels to the fore, which cannot come soon enough for some. To date, fuel testing challenges resulting from jet fuel contamination have pushed back the expected vote establishing fuel standards until August. With that, two airlines will launch scheduled services: Lufthansa (Frankfurt-Hamburg) and TAM (Rio-Sao Paulo), both on short-haul services. 

While there is no question the industry has achieved a lot in only a few years, getting alternative fuels into aircraft in the face of political and natural disaster shocks driving fuel prices up, remains frustratingly slow. Indeed, it will be well into the next decade before biofuels take a significant role in fuelling the industry. Current goals for commercial aviation call for replacing 6% of demand with biofuels by 2020. For the US military, the goals are much more ambitious and the commercial industry will no doubt benefit from the scalability for military use. The US Air Force wants to have 50% of its fuel derived from non-petroleum-based products by 2016 and the US Navy wants 50% of its total energy consumption from alternative sources by 2020.

“Today, we have tested a range of biofuels in flight, we have made our way through a very tough technical standards process to ensure flight safety and we have been working hard to establish the correct sustainability criteria for the fuels we use,” said a new progress report released last week by Air Transport Action Group (ATAG), a blueprint on how government can speed the process. “We are now getting ready to take the next steps in the journey of alternative aviation fuels: ramping up to get enough of this low-carbon energy into our fuel supply. From a standing start just a few years ago, the aviation industry has embraced the concept of biofuels with enthusiasm and has already completed much of the technical work needed to start commercial flights. Rigorous testing, both on the ground and in the air, has shown that biofuels can deliver equal (and sometimes better) performance than the current fuel.”

The trick is for biofuels to reach cost parity with conventional fuel which is easier said than done for now. However, the rising costs of emissions will ultimately close the gap between bio and traditional fuel, according to ATAG.

“Current estimates for the cost of producing biofuels suitable for air transport, suggest that airlines – and their passengers – would have to pay twice as much as they currently spend on jet kerosene,” said the ATAG report. “However, the economics of aviation biofuels and jet kerosene is likely to change with government-imposed climate policies.The current price of EURO16 for an allowance to emit one tonne of Co2 would add 2-3% to jet kerosene prices, closing the gap with biofuel costs only marginally. Over time this low-hanging fruit will disappear and, by 2050, the cost of carbon is expected to double fossil fuel prices.”

“The next step is production and delivery and that means major investment in the development of sources, supply chains and distribution networks,” said ATAG, adding aviation distribution will be easier than for autos given the relatively smaller number of airport fuel depots: 1679 airports handle more than 95% of the world’s passengers. “When refined, they are virtually identical to the Jet A-1 fuel we currently use. This means that we can simply drop them into the current fuel supply. No new engines, no new aircraft and no separate fuel delivery systems are needed at airports. It is the most practical solution. More biofuel can be added to the system as it comes on stream.”

AirlineFinancials industry analysis

“You have better odds of picking the correct color on the next roulette table spin in the casino than you do of predicting what an airline’s profit/loss will be by the end of the year,” Mr Herbst concluded. “On the revenue side, it doesn’t take much of a terrorist threat, global health event or weakness in the economy to see revenue for airlines drop off a cliff. On the cost side, the drastic volatility of oil prices can easily add billions of (unexpected) additional expense to an airline’s income statement.”

Mr Herbst suggested that, despite all the restructuring of the last few years, more adjustments in capacity and pricing will be necessary if the industry is ever to shed its pattern of losses, punctuated by a few years of profits.

Ms Becker noted that softening demand in the Atlantic prompted several airlines to scale back capacity in the back half. “Trans-Atlantic capacity will see the largest reductions because it is up by 14%,” she told investors. “Delta Air Lines was up by 20% in the market, but now expects to shrink 2H11 trans-Atlantic capacity by 4%. The Pacific region will also see very near-term capacity reductions as the fallout from the recent earthquake in Japan disrupted traffic to the country. Much of the capacity will be re-routed through other Asian hubs like Seoul. The earthquake in Kobe disrupted traffic for two months.”

AirlineFinancials.com key findings:

  • Every airline increased operating revenue all the collective total was still below 2008 levels.
  • 2010 was the first year since 2007 that every airline had positive operating income with Delta the highest.
  • The largest airlines significantly reduced net-long term debt last year from 2009 levels.
  • Cash liquidity increased significantly for United and Southwest but declined significantly for JetBlue and AirTran.
  • Market cap for Delta, United and Southwest were significantly higher than the other five airlines but all eight experienced year-over-year increases in 2010 compared with 2009.
  • Market share was little changed nor was there much change in the total regional/affiliate passenger traffic miles for 2010 compared with 2009. Net market share was increased by adding regional/affiliate traffic, except for American.
  • Delta and American were the only two airlines to increase EBITDAR margins over 2009.
  • Interest expense has increased each of the last three years for the large legacy carriers.
  • Larger legacy airlines have higher future passenger bookings than the smaller carriers.
  • Strong advance bookings should push air fare yields and revenues higher in 2011 than they were in 2010.

Part One: Summary of the industry with noted strength and weakness for each airline

Key metrics for the industry: [2009 data in brackets]

2010 Operating Revenue [1] = $122.2 billion [$106.7 billion]

2010 Operating Expense [2] = $112.3 billion [$106.1 billion]

2010 Operating income/loss and margin [8] = $9.88 billion / 8.08% [$662 million / .62%]

Cash & ratio of 2010 Operating Expense [3] = $24.8 billion / 22.1% [$21.9 billion / 20.7%]

Advance revenue liability & ratio of 2010 passenger revenue [4] = $17.5 billion / 16.3% [$15.9 billion / 16.8%]

Net Long-Term Debt & ratio of 2010 revenue [5] = $22.02 billion / 18.0% [$30.07 billion / 28.2%]

Assets (total) = $136 billion [$136.6 billion]

Market Cap (total for 8 airlines) (Q4 2009 median) = $38.4 billion [$25 billion]

2010 EBITDAR (total for 8 airlines) [6] = $16.9 billion [$9.7 billion]

2010 passenger traffic miles (total for 8 airlines) [7] = 756.3 billion [731.2 billion]

2010 interest paid (total for 8 airlines) = $3.50 billion [$3.16 billion]

United (UAL ) – 27.8% of system market share - Star Alliance

Strengths: Largest US airline with strong global network strengthened with the merger of Continental - relatively low debt

Weaknesses: Relatively low market cap - potential labor issues with most union contracts being negotiated - high debt load - large number of old fuel inefficient aircraft - potential merger issues

Delta (DAL ) – 25.5% of system market share - Sky Team Alliance

Strengths: Strong global network - positive labor relations - industry’s best operating margins in 2010.

Weaknesses: Weakest cash ratio - high debt load - large number of old fuel inefficient aircraft.

American (AMR ) – 17.8% of system market share - oneworld alliance

Strengths: Strong yield management with industry’s highest revenue performance - recent approval for joint business venture with British Air, Iberia and JAL - industry’s highest advance revenue bookings

Weaknesses: Industry’s lowest operating margins and weakest EBITDAR - highest interest cost and weakest market cap - several years of ongoing contentious labor relations with all union contracts being negotiated and under control of the National Mediation Board (NMB) - poor customer service ratings - industry’s highest unit labor costs - pension obligation doubled to over USD7 billion in last three years

US Airways (LCC ) – 9.2% of system market share - Star Alliance

Strengths: Younger fuel efficient fleet - relatively low labor costs - high-yield markets

Weaknesses: Industry’s weakest asset ratio with lowest advance booking revenue - high unit costs ex fuel and labor - relatively weak market cap - integration of 2005 merger with America West still not complete

Southwest (LUV ) – 10.3% of system market share

Strengths: Industry’s highest market cap - lowest debt ratio and lowest interest payments - high cash ratio - positive employee labor relations with industry’s most productive labor force - acquisition/merger of Air Tran will add several high-yield, east-coast markets plus access to close-in international destinations

Weaknesses: Relatively high labor costs and relatively weak advance bookings - future growth opportunities will lead to international operations which increases costs.

JetBlue (JBLU ) – 3.7% of system market share

Strengths: Good employee relations - low operating costs - good customer service - new fuel efficient fleet - financial investment from Lufthansa - major carrier in JFK and BOS - strong interline agreements

Weaknesses: Industry’s highest debt ratio - high interest payments - low yields require high load factor to maintain positive cash flow.

Alaska (ALK ) – 3.0% of system market share

Strengths: Good customer service - high yield markets - good employee relations - high operating margins - low debt - high cash ratio - low interest payments - industry’s best EBITDAR ratio

Weaknesses: Relatively low advance bookings

Air Tran Airways (AAI ) – 2.6% of system market share

Strengths: Low costs - young, fuel-efficient fleet - merging with Southwest

Weaknesses: Low advance bookings

Part Two: Detailed key metrics for each airline

United

2010 Operating Revenue / ratio of industry [1] = USD34.01 billion / 27.8%.

2010 Operating Expense / ratio of industry [2] = USD31.48 billion / 28.0%.

2010 Operating income/loss and margin ratio [8] = USD2.53 billion / 7.45%.

Cash / ratio of 2010 Operating Expense [3] = USD8.68 billion / 27.6%.

Advance revenue liability / ratio of 2010 passenger revenue [4] = USD5.58 billion / 18.7%.

Net Long-Term Debt / ratio of 2010 revenue [5] = USD12.47 billion /11.1%.

Net Long-Term Debt ratio of industry net debt [5] = 17.2%.

Assets / ratio of industry = USD39.60 billion / 27.3%.

Market Cap / ratio of industry (Q4 2010 median) = USD8.68 billion /22.6%.

2010 EBITDAR / ratio of industry EBITDAR [6] = USD5.18 billion / 30.6%.

2010 passenger traffic / ratio of industry traffic [7] = 210.54 billion / 27.8%.

2010 interest / ratio of industry interest = USD993 million / 28.4%.

Delta

2010 Operating Revenue / ratio of industry [1] = USD31.76 billion / 26.0%.

2010 Operating Expense / ratio of industry [2] = USD27.44 billion / 24.4%.

2010 Operating income/loss and margin ratio [8] = USD4.31 billion / 13.58%.

Cash / ratio of 2010 Operating Expense [3] = USD3.61 billion / 13.2%.

Advance revenue liability / ratio of 2010 passenger revenue [4] = USD4.50 billion / 18.3%.

Net Long-Term Debt / ratio of 2010 revenue [5] = USD9.57 billion /30.1%.

Net Long-Term Debt ratio of industry net debt [5] = 43.5%.

Assets / ratio of industry = $43.19 billion / 29.8%.

Market Cap / ratio of industry (Q4 2010 median) = USD10.64 billion / 27.7%.

2010 EBITDAR / ratio of industry EBITDAR [6] = USD4.33 billion / 25.6%.

2010 passenger traffic / ratio of industry traffic [7] = 193.17 billion / 25.5%.

2010 interest / ratio of industry interest = USD969 million / 27.7%.

American

2010 Operating Revenue / ratio of industry [1] = USD22.17 billion / 18.1%.

2010 Operating Expense / ratio of industry [2] = USD21.86 billion / 19.5%.

2010 Operating income/loss and margin ratio [8] = USD308 million / 1.39%.

Cash / ratio of 2010 Operating Expense [3] = USD4.5 billion / 20.6%.

Advance revenue liability / ratio of 2010 passenger revenue [4] = USD3.66 billion / 19.2%.

Net Long-Term Debt / ratio of 2010 revenue [5] = USD4.76 billion /21.5%.

Net Long-Term Debt ratio of industry net debt [5] = 21.6%.

Assets / ratio of industry = USD25.09 billion / 17.3%.

Market Cap / ratio of industry (Q4 2010 median) = =USD2.47 billion / 6.4%.

2010 EBITDAR / ratio of industry EBITDAR [6] = USD2.02 billion / 11.9%.

2010 passenger traffic / ratio of industry traffic [7] = 134.30 billion / 17.8%.

2010 interest / ratio of industry interest = USD766 million / 21.9%.

US Airways

2010 Operating Revenue / ratio of industry [1] = USD11.91 billion / 9.7%.

2010 Operating Expense / ratio of industry [2] = USD11.12 billion / 9.9%.

2010 Operating income/loss and margin ratio [8] = USD786 million / 6.6%.

Cash / ratio of 2010 Operating Expense [3] = USD1.86 billion / 16.7%.

Advance revenue liability / ratio of 2010 passenger revenue [4] = USD861 million / 8.2%.

Net Long-Term Debt / ratio of 2010 revenue [5] = USD2.14 billion /18.0%.

Net Long-Term Debt ratio of industry net debt [5] = 9.72%.

Assets / ratio of industry = USD7.82 billion / 5.4%.

Market Cap / ratio of industry (Q4 2010 median) = USD1.72 billion / 4.5%.

2010 EBITDAR / ratio of industry EBITDAR [6] = USD1.64 billion / 9.7%.

2010 passenger traffic / ratio of industry traffic [7] = 69.59 billion / 9.2%.

2010 interest / ratio of industry interest = USD316 million / 9.0%.

Southwest (LUV ) -

2010 Operating Revenue / ratio of industry [1] = USD12.10 billion / 9.9%.

2010 Operating Expense / ratio of industry [2] = USD11.12 billion / 9.9%.

2010 Operating income/loss and margin ratio [8] = USD988 million / 8.16%.

Cash / ratio of 2010 Operating Expense [3] = USD3.54 billion / 31.8%.

Advance revenue liability / ratio of 2010 passenger revenue [4] = USD1.2 billion / 10.4%.

Net Long-Term Debt / ratio of 2010 revenue [5] = -USD633 million / -5.5%.

Net Long-Term Debt ratio of industry net debt [5] = -3.0%.

Assets / ratio of industry = USD15.46 billion / 10.7%.

Market Cap / ratio of industry (Q4 2010 median) = USD9.95 billion / 25.9%.

2010 EBITDAR / ratio of industry EBITDAR [6] = USD1.78 billion / 10.5%.

2010 passenger traffic / ratio of industry traffic [7] = 78.05 billion / 10.3%.

2010 interest / ratio of industry interest = USD137 million / 3.9%.

JetBlue

2010 Operating Revenue / ratio of industry [1] = USD3.78 billion / 3.1%.

2010 Operating Expense / ratio of industry [2] = USD3.45 billion / 3.1%.

2010 Operating income/loss and margin ratio [8] = USD333 million / 8.81%.

Cash / ratio of 2010 Operating Expense [3] = USD960 million / 27.9%.

Advance revenue liability / ratio of 2010 passenger revenue [4] = USD514 million / 15.1%.

Net Long-Term Debt / ratio of 2010 revenue [5] = USD1.89 billion / 50.0%.

Net Long-Term Debt ratio of industry net debt [5] = 8.6%.

Assets / ratio of industry = USD6.59 billion / 4.5%.

Market Cap / ratio of industry (4Q2010 median) = USD2.05 billion / 5.3%.

2010 EBITDAR / ratio of industry EBITDAR [6] = USD679 million / 4.0%.

2010 passenger traffic / ratio of industry traffic [7] = 28.28 billion / 3.7%.

2010 interest / ratio of industry interest = USD172 million / 4.9%.

Alaska

2010 Operating Revenue / ratio of industry [1] = USD3.83 billion / 3.1%.

2010 Operating Expense / ratio of industry [2] = USD3.35 billion / 3.0%.

2010 Operating income/loss and margin ratio [8] = USD485 million / 12.65%.

Cash / ratio of 2010 Operating Expense [3] = USD1.21 billion / 36.1%.

Advance revenue liability / ratio of 2010 passenger revenue [4] = USD422 million / 12.2%.

Net Long-Term Debt / ratio of 2010 revenue [5] = USD105 million / 2.7%.

Net Long-Term Debt ratio of industry net debt [5] = .5%.

Assets / ratio of industry = USD5.02 billion / 3.5%.

Market Cap / ratio of industry (Q4 2010 median) = USD1.87 billion / 4.9%.

2010 EBITDAR / ratio of industry EBITDAR [6] = USD859 million / 5.1%.

2010 passenger traffic / ratio of industry traffic [7] = 20.35 billion / 3.0%.

2010 interest / ratio of industry interest = USD73 million / 2.1%.

Air Tran Airways (AAI ) -

2010 Operating Revenue / ratio of industry [1] = USD2.62 billion / 2.1%.

2010 Operating Expense / ratio of industry [2] = USD2.49 billion / 2.2%.

2010 Operating income/loss and margin ratio [8] = USD128 million / 4.89%.

Cash / ratio of 2010 Operating Expense [3] = USD454 million / 18.2%.

Advance revenue liability / ratio of 2010 passenger revenue [4] = USD252 million / 10.7%.

Net Long-Term Debt / ratio of 2010 revenue [5] = USD423 million / 16.2%.

Net Long-Term Debt ratio of industry net debt [5] = 1.9%.

Assets / ratio of industry = USD2.18 billion / 1.5%.

Market Cap / ratio of industry (Q4 2010 median) = USD1.01 billion / 2.6%.

2010 EBITDAR / ratio of industry EBITDAR [6] = USD449 million / 2.7%.

2010 passenger traffic / ratio of industry traffic [7] = 19.58 billion / 2.6%.

2010 interest / ratio of industry interest = USD77 million / 2.2%.

Part Three: Three-year history of industry key metrics with airline-to-airline comparisons

Operating Revenue

2008 = USD126.2 billion

2009 = USD106.7 billion

2010 = USD122.2 billion

When comparing 2010 with 2009, every airline had an increase in operating revenue. In general, the larger the airline, the larger the increase in revenue.

Operating Income/loss and margins 

2008 = -USD4.33 billion

2009 = +USD662 million

2010 = +USD9.88 billion

2010 was the first year since 2007 that every airline had positive operating income. Delta had the highest operating income at USD4.3 billion and the highest margin at 13.58%.

Southwest and JetBlue were the only two airlines to have positive operating income for the last three years.

Net Long-Term Debt

2008 = USD32.08 billion (25.4% of total operating revenue)

2009 = USD30.07 billion (28.2% of total operating revenue)

2010 = USD22.02 billion (18.0% of total operating revenue)

Cash liquidity (total of eight airlines) -

2008 = USD17.3 billion (13.2% of total operating expenses)

2009 = USD21.9 billion (20.7% of total operating expenses)

2010 = USD24.8 billion (22.1% of total operating expenses)

Cash liquidity for 2010 compared with 2009 increased significantly for United and Southwest and decreased significantly for JetBlue and Air Tran.

Stock market capitalisation

2008 = USD25.1 billion (Q4 median)

2009 = USD25 billion (Q4 median)

2010 = USD38.4 billion (Q4 median)

Market share of passenger miles

2008 = 768.6 billion passenger miles

2009 = 730.7 billion passenger miles

2010 = 756.3 billion passenger miles

Each airline’s percentage of 2010 passenger traffic was little changed when compared with 2009.

Regional affiliate impact to market share (total of five airlines)

2008 = 68.8 billion (regional affiliate passenger miles)

2009 = 69 billion (regional affiliate passenger miles)

2010 = 72.8 billion (regional affiliate passenger miles)

There was very little year-over-year change in total regional/affiliate passenger traffic miles. For 2010, excluding American, the other four airlines with regional/affiliate partners all increased net market share after including their regional/affiliate traffic.

EBITDAR and margin

2008 = USD5.5 billion

2009 = USD9.7 billion

2010 = USD16.9 billion

Delta and American were the only two airlines to increase EBITDAR margins over 2009.

Interest Expense (total of eight airlines)

2008 = USD2.48 billion

2009 = USD3.16 billion

2010 = USD3.50 billion

Interest expense has increased each of the last three years for the large legacy carriers.

Advance ticket sales (total of eight airlines) -

2008 = USD16.3 billion (14.4% of 2008 passenger revenue)

2009 = USD15.9 billion (16.8% of 2009 passenger revenue)

2010 = USD17.5 billion (16.3% of 2010 passenger revenue)


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