US airlines an utter failure, more bankruptcies, 17% fare increase expected – Hudson Securities


A 12% increase in fares in 2010, followed by a 5% increase in 2011, will be diluted as deferred aircraft deliveries come on line in 2012 and 2013, according to Hudson Securities analyst Dan McKenzie, who testified recently before the Senate Transportation Committee hearings on the United-Continental merger. But he reiterated that consolidation was not a threat to competition. Indeed, he predicted competition will result in at least one more bankruptcy in the next five years, largely because of promises made to labour.

  • Fares in the aviation industry are expected to increase by 12% in 2010 and 5% in 2011, but this growth will be diluted by deferred aircraft deliveries in 2012 and 2013.
  • Consolidation in the industry is not seen as a threat to competition, but it may lead to at least one more bankruptcy in the next five years due to promises made to labor.
  • Fuel price volatility is the biggest threat to the financial health of the industry, with 30% of costs being affected by 50% fluctuations. Another fuel spike could be disastrous.
  • The US airline industry has been a financial failure, with serial bankruptcies and a lack of behavior as a monopolistic oligopoly.
  • Low-cost carriers will continue to undercut pricing and take market share, keeping the industry competitive despite mergers between legacy carriers.
  • The industry has undergone a painful transformation and is currently in the late stages of restructuring, with a capacity bubble deflating due to macroeconomic volatility.

While the industry is on the mend, he said, another fuel spike to economic downturn would be disastrous. "My outlook assumes average ticket prices rise 12% this year and 5% next year, which positions the industry to finally begin reporting modest profits," he said. "My forecast will naturally fluctuate based on the macro backdrop."

While capacity discipline is maintained, the no-growth period will end with deliveries planned for 2012 and 2013 which will be likely to affect fares. "Meanwhile, low-cost carriers will continue to undercut on pricing and take market share," he said. "And separately, as long as management teams make promises to labour they can't keep, we'll continue to see Chapter 11 filings. I predict we'll see another Chapter 11 filing sometime in the next five years."

Fuel price volatility represents not only a wild card but also the number-one threat to the financial health of the industry. "The debate on speculative trading in commodities is not whether it exists, but how best to remedy it," he said. "Unfortunately, the airline industry is a highly levered, high fixed-cost business that is reeling from 30% of its costs getting whipsawed by 50% in any given year. And the threat of another super spike has curtailed plane orders by many legacy carriers. Said differently, speculative trading is perverting capital spending and investment plans and as a result, is ultimately perverting economic growth. Demand is coming back and finances are improving, but there remain a number of structural challenges in place that will continue to make the recovery a slow process."

McKenzie described the industry as largely a basket case. "As has been widely reported and recognised, the US airline industry, with the exception of low-cost carriers, has been a financial failure," he said. "We've seen serial bankruptcies in successive decades. And, if there is one point I want to leave with you, it's this: Despite the fact that the industry is structured as a monopolistic oligopoly, it hasn't behaved as one, and there are a number of reasons for why this behaviour won't change looking ahead."

'Capacity bubble' has burst

McKenzie said industry restructuring is now late in the game. "Just as the tech bubble, the telecom bubble, the real estate bubble, and even the commodities bubble have burst, there has been a capacity bubble in the US airline industry which today is beginning to deflate as a consequence of macro backdrop volatility," he said. "The industry has been undergoing a painful transformation over the past 32 years and I'd say that today, we're probably in the seventh inning."

In addressing concerns that the competitiveness of the airline industry would be compromised by a merger between United and Continental, McKenzie said the low-cost carriers would keep the industry more than competitive.

"There is a 'cost disequlibrium'," he told lawmakers. "As long as there are low-cost carriers with a 20-30% cost advantage, they are going to try and undercut legacy carrier pricing and take market share. And I don't see this changing over my horizon. Or to put it differently, the day we no longer have a competitive industry is the day every airline has the same cost structure. However, low-cost carriers, which today enjoy widespread brand acceptance, have been able to sustain sizeable cost advantages and, through discounting, drive a shakeout among the legacy carriers, a phenomenon that will continue for the next several years."

He cited industry fragmentation, noting the top four airlines in 2000 controlled 66% of capacity which rose to 70% in 2005. With the United-Continental merger it would rise again so the top four carriers would control 81%. Likening the problem to the real estate crisis, where those who would not normally qualify for a mortgage were able to get one, MacKenzie said credit was too easy for carriers for the past 32 years.

"Airlines having a 'junk' credit rating could very easily go out and buy new airplanes and this has led to brutal competition," he said. "Separately, the macro backdrop has hit the industry hard. The reality is, fleet and personnel plans made years ago could not have possibly anticipated the demand shock following the calamity of 9/11; a super spike in crude to USD147; the recent financial meltdown; or worldwide health pandemics."

Despite industry troubles, he opposed re-regulation, saying deregulation 32 years ago was not a mistake. In addition to US deregulation spawning similar moves worldwide, McKenzie cited benefits that flowed to Boeing and Airbus and their suppliers, banks and leasing companies, gaming and lodging industries and travel management companies, calling them big winners.

See related report: Is re-regulation the way out for the US?

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