There were plenty of nuggets at yesterday's JP Morgan Aviation, Transportation and Defense conference on the outlook for the US airline industry, with some revealing commentary on the economic recovery and pricing environment, labor and strike threats, as well as alliances and access to Tokyo Haneda Airport.
Clearly other airline executives were listening when United struck a more severe tone in the industry during its 4Q2009 conference call in discussing the structural industry changes remaining. Yesterday, airline executives across the board echoed comments made by Chair Glenn Tilton and President John Tague on capacity, the likelihood of violating capacity discipline or new entrants – not very in either case. See related report: US airline outlook: Fundamental restructuring is in the wind but will the industry revert to type
Recoupling with GDP
US Airways is bullish that the industry RASM will increase by double-digits this year. “Now this is hypothetical, but if you look back in history at the historical relationship between passenger revenue and GDP, it has held to a tight band between 2004 and 2007 of .65% of GDP,” said Chief Operating Officer, Robert Isom. “In 2009, that relationship fell to .55%. Year over year passenger RASM declined by 13% in 2009, so it doesn’t take much of a recovery to push RASM performance to the double digits.
“But let’s just say GDP is flat with only a modest rebound,” he continued. “That, in and of itself, will drive a year over year PRASM change of 10%. Hypothetically, that is why we think it is in the range of believability that passenger RASM will improve by double digit this year. In February, year over year performance in corporate revenues improved by 35% and we haven’t see it taper off. The trend remains positive for US Airways and that is largely driven through capacity discipline which has not increased at all. We’ve seen changes and improvements in pricing and yield since June and a reduction in the duration and number of industry fare sales. The good news is that a lot of the bottom fare category has been cleaned out. The junk fares have been cleaned out and there is an overall improvement in yield management for all airlines.”
The company’s hypothesis sparked interest from JP Morgan analysts who said that if that were so the pricing targets would be double what they are now with no real threat to realizing that hypothesis.
“The thing that is at the core is this ability to hold revenue performance where it is with capacity at the end of the day,” Isom responded. “Adding capacity back would impact us. There are other issues such as regulation and security. That is why the industry is vocal on these issues and why we want no harm to be done. We have to have a chance to repair our balance sheet and get control of operations and our financial wherewithal to make money in both the up market and the down market. While that may seem far fetched, I don’t see anything out there that would delink from GDP permanently".
United CFO Kathryn Mickells said it will take another year to get back to 2008 revenue levels. “It was critically important to ensure capacity was reduced overall as we went through the recession and now we are getting yield improvement as the premium traffic returns,” she said. “When we see tension on the load factor we can use that tension to put inventory management system to work. People don’t see what we do to improve the mix of traffic. We’ve seen load factor improvements in the last few months. That gives us the platform we need to make inventory management systems work. We are on the right trajectory, but we are not back to 2008 levels. That will take another year.”
Perhaps the best indication of where the industry is today is to look back at last year’s JP Morgan conference, according to its analyst Mark Streeter, who noted to American Airlines CFO, Tom Horton, that the question he was entertaining last year was the attractiveness of bankruptcy. “I don’t think that’s going to come up this year,” said Streeter dryly.
That was the springboard for Horton to point out that American is at a competitive disadvantage, since it was the only legacy that did not enter bankruptcy to lower labor costs. It did its own restructuring and the impact of that could be interesting to watch as industry wide contract negotiations for no less than 19 contracts are now under way.
“The low-cost competitor has a competitive weapon,” he said. “We’ve not had that in our arsenal for variety of reasons. Some are simply the fact we are an 80-year-old company and some has to do with fact we never restructured through bankruptcy court or walked away from commitments to shareholders, creditors, employees or retirees. And it remains a fact we have higher labor costs than our competition. However, our non-labor unit costs are very competitive, which positions us well, as airlines who have used the bankruptcy courts to reduce employee costs now try to reach new employee agreements over the next year or so.”
He was asked whether management will ever be able to convince labor that it is market forces that will ultimately determine work rules and compensation. “I struggle to think of another business that can look a boss in the eye and say that because you paid me more 10 years ago, I am obviously worth more,” asked the questioner. “Is it an exercise in futility to try and get that point across?”
Horton’s answer indicated that it is not. “That the market will dictate it, it is axiomatic,” he answered. “That will happen over time and our objective, as we’ve said to all our union groups, is to ensure that when the dust settles on this current round of negotiations – not just for American, but across the industry – that our costs are competitive. That is in the interest of all our stakeholders, including employees. That is what will allow us to invest, to grow and prosper and be a strong company which is what we all want.”
He indicated that completing the negotiations of all the labor contracts that are now open will be the next big milestone for the industry. “We’ve had a labor cost disadvantage resulting from the fact that we did our restructuring outside the bankruptcy court,” he said. “So everyone else’s costs are lower but there will be a tendency toward labor-cost convergence. History tells us that and we will be well serviced as that happens over time.”
Labor was much on the minds of investors who asked each airline in turn what the status was. They all answered they were in various stages of negotiations, in mediation or have completed negotiations and, obviously, while they have made progress, it is the toughest issues that are still in play. Investors were particularly concerned about American’s flight attendant negotiations since the union has made it clear it wants out of mediation. Horton was frankly asked whether flight attendants would go on strike next month.
“The headline is that all three work groups – the pilots, flight attendants and the Transport Workers Union that represents mechanics, fleet service and others – are in mediation,” he said. “It takes a long time. We’ve been at it since 2008.”
In other words, he doesn’t know any more than anyone else as to whether flight attendants will be released from mediation and will ultimately strike. And if they do, the former TWA flight attendants, who have plainly said they were shafted by the flight attendants union, will step in. Horton did say that pilots and management were far apart.
As for ATI that United and Continental are looking for on the domestic front, JP Morgan suggested that could be jeopardized by the current pilot negotiations at Continental. Continental is already at a significant competitive advantage on its scope agreements which preclude the operation of any regional jet larger than 50 seats. Consequently, as its competitors move to larger regional jets, Continental is stuck with an antiquated agreement that provides little flexibility.
Investors expressed concern about this, asking whether Continental was satisfied with this. CEO Jeff Smizek is most decidedly not satisfied and said so. “No we are not happy and this is one of the many subjects being discussed with our pilots,” he said. “We will also be discussing the fact that they have the right to block revenue sharing with another domestic carrier – United. They have to understand the value of the joint venture to them. The discussions have been fruitful but the outcomes are difficult to predict, but we are generally known for good labor relations.”
On the subject of global alliances, Horton was clearly not willing to talk about the potential monetary benefits from the impending British Airways/Iberia deal, which has received tentative Department of Transportation approval. While noting that the alliance has been in the planning for 14 years and the parties had a pretty good idea of just how to implement the joint venture, he indicated that it would not be until they hammered out the exact deals the likely monetary benefits would be known. He did say that the combined revenue of American, BA and Iberia across the Atlantic was USD8.5 billion, but the synergies would be more on the revenue side.
“We have been at a competitive disadvantage not having anti-trust immunity with our European partners while our competitors have had that,” he said. “But until we meet with them, we don’t know other than it will be meaningful. You should think of in terms of us putting our products together. It will be good for passengers and will enhance our ability to compete more effectively. We are going to do the same over the Pacific with JAL. We expect to be able to implement the BA/Iberia ATI in the second half and the JAL in the first half of 2011.”
United revealed there is a glitch with serving Haneda making interior US markets problematic for the service, since operating restrictions and the close-in Tokyo airport limit departures to after midnight local time. It said it has applied for San Francisco-Haneda service, so that departures can be timed to the dinner-time banks at San Francisco for connecting traffic. Delta, which has also applied for Haneda service, agreed. “It is not optimal for anyone operating a hub in the central time zone,” said Bastion. “It limits the ability to service interior markets.”
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