Costs continue to decline for US airlines

The US airline cost index, produced by the Air Transport Association, reveals that costs are continuing to decline for the US airline industry for the third consecutive quarter. One of the biggest questions for 2010 is whether security costs, in the wake of the Christmas Day terror plot, will rise substantially to wipe out their progress.

“With heightened security measures in place, security costs looming, a fragile economic recovery and continued job losses reported by the Bureau of Labor Statistics within the past week, airlines remain intensely focused on reducing expenses and pursuing additional sources of revenue,” said ATA Chief Economist John Heimlich. “Cost discipline remains paramount amid historically weak demand for air travel and the return to USD80-plus crude oil.”

The composite cost index fell 36% to 185.3 in the third quarter of 2009, versus 289.7 in the same period of 2008, easily outpacing the 1.6% decline in the US Consumer Price Index (CPI), said the organisation. The three largest components of the index – which includes all operating expenses as well as interest expense – were labour, fuel and “transport-related expense” that majors pay their regional partners.

See related article: A more positive picture for US airlines in Dec-2009, but times remain tough

Squeeze on regionals

Airlines are focusing on this latter expense and have put regional airline partners on notice they will be expected their regional partners to take on additional risk, as legacy airlines have watched the margins for their partners remain steady while their own is in negative territory. As it is, airlines have shaved 18% off this cost base for the third quarter, reflecting dramatic capacity cuts. For further cuts, it is expected that pass-along costs that shelter regional airlines from the full impact of such spikes as fuel will be on the agenda.

Debt and fuel concerns

ATA also reported that fuel and labour combined was nearly half of airline operating expenses and the average price paid for fuel fell from USD3.51 to USD1.94 per gallon in the third quarter. While the lower fuel costs are down, they are still “disproportionately high,” said ATA. Fuel since then has risen. This has to be a continuing concern to airline executives who are swimming in debt, although they have raised enough liquidity to cover their needs for the short term.

With fuel volatility as it is, another hit might become a real threat to legacies and low cost carriers alike, given their highly leveraged positions. Heimlich added that recent "unwarranted" increases in the price of crude oil reinforces the need for Congress to pass financial market reforms to curb energy price volatility while regulatory authorities also take appropriate action.

Without a fuel hike, carriers may be fine until significant amounts of that debt comes due in 2014 and beyond. Interest rate expenses were up 18% in the third quarter.

Staff costs rising, contract negotiations intensifying

The average cost – wages, benefits and payroll taxes – of a full-time equivalent worker rose 7.6% to a high of USD81,235. This, at a time when the legacies are facing contract negotiations on several fronts.

Airport fees, MRO and insurance up

Unsurprisingly, given the losses in the past year, aircraft insurance is up 53%. Rising costs also include maintenance up 17%, advertising and promotion up 5% and landing fees which rose 3% at a time when carriers have cut capacity dramatically.

Professional services were down 16%, communication dropped 9%, non-aircraft insurance declined 9% and utilities and office supplies were down 7%. Property rents and ownership dropped 5% and, significantly, travel agency commissions were down 4%. See related report: GDSs account for USD268 billion of travel revenue

Wall Street analysts often ask when airlines will be able to duplicate the way they handle bookings in the US abroad and judging from CEO responses, it is clearly on their radar.

The drop in the cost index reduced, but did not eliminate, the unfavorable gap between average break-even and actual load factors, which fell from 6.2 ppts to 0.8 ppts. There is more clearly work to be done on the cost front.

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