US airlines wait for yields to turn a corner as load factors remain at record highs
Solid demand trends that prevailed in the US market for much of 2012, and are continuing into the beginning of 2013, have yet to produce significant yield traction for the majority of the country’s airlines. But while some executive management teams at the country’s major carriers believe it is just a matter of time before robust load factors translate into favourable yield increases, the reality is domestic fares adjusted for inflation continue to decrease.
As some economic uncertainty continues to linger, the country’s airlines may encounter resistance if they try to bolster yield through fare increases. Network carriers also continue to feel pressure from ultra low-cost carriers that attempt to stimulate traffic by introducing measurably lower fares into their markets, which also creates a challenge in lifting yields.
The average yields for the full year 2012 recorded by seven US carriers – Alaska, American, Delta, JetBlue, Southwest, United and US Airways – was roughly 3%. Those results are somewhat skewed given the broader international networks operated by American and Delta. United also has a robust international offering, but merger integration challenges pressured the carrier’s yields throughout much of 2012, which resulted in yield growth for the full year of 1.2%. Yields for airlines with more limited international networks – Alaska, JetBlue, Southwest and US Airways – averaged 2.4%.
US carrier yield increases: 2012
|Carrier||2012 year-over-year increase|
During a recent discussion with investors, US Airways president Scott Kirby remarked that the carrier expects unit revenues to increase by 3% in Jan-2013 and 2% to 4% in Feb-2013 and Mar-2013. He stated both business and leisure demand remains strong; however, “it hasn’t yet led to increases in yield”. Mr Kirby concluded that a robust load factor environment is historically a precursor to rising yields, and he expects an industry-wide improvement in yields.
The US Bureau of Transportation Statistics (BTS) in analysing data from Oct-2012 (the latest available) concluded that the 84% domestic load factor recorded for the month was a record level for Oct-2012, which falls in the lower-demand shoulder season in the US. The average load factor in the domestic market during Oct-2012 was 83%, and also the same for the 12 months ending in Oct. The loads in Oct-2012 were a 4ppt rise from the 79% load factors recorded in Oct-2008 and a 3ppt increase over the 80% for the 12 months ending in Oct of that year.
Inflation-adjusted airfares fall far behind rapid increases in loads
US domestic airfares adjusted for inflation have not kept pace with the steady rise in load factors. BTS data shows that from 3Q2000 to 3Q2012 inflation-adjusted airfares fell 18% while overall consumer prices increased by 33%.
US trade group Airlines for America (A4A) estimates between 2000 and 2011 domestic fares adjusted for inflation decreased 16.4% while the country’s consumer price index increased by 30.6%. During that time nominal fares rose roughly 9.2%.
US airline fare increases relative to other commercial goods and services: 2000 to 2011
While carriers had some success pushing through fare increases in 2011 and 2012, the pricing traction they enjoyed during that time appears to be weakening. Executives at Southwest Airlines recently stated that four system-wide fare increases during 4Q2012 helped to contribute to a 2.3% rise in passenger unit revenues for the last three months of 2012, but “the benefit from recent fare increases has been less than what we’ve historically realised and this is a testament to a challenging yield environment”, remarked carrier CFO Tammy Romo.
The CEO of Southwest, Gary Kelly, stated that while load factor could be one indication of an opportunity for pricing to strengthen, it is not always an effective indicator given the disparate travel habits between business and leisure travellers. However, the higher loads are a fairly good indication of the overall health of the industry, he stated.
Fuel compounds efforts by airlines to raise fares
Obviously the largest variable airlines face in attempting to push through higher fares is volatile fuel prices that a significant number of carriers attempt to manage through hedging. Hedging in and of itself is a gamble as many airlines regularly record losses from their hedging portfolios in their financial results. Carriers also face the added challenge of rising crack-spreads – the cost of refining crude into jet fuel.
A4A concludes that during 2011 and 2012 rising crack-spreads diminished the efficiency of fuel hedging for some carriers. The association estimated refining costs of USD34.31 for West Texas Intermediate during 2012 versus roughly USD3.29 for 1991-2000. The refining cost of Brent crude during 2012 was USD16.72 compared with a price of approximately USD4.77 between 1991 and 2000.
Crack-spreads for WTI and Brent Crude: Jan-2000 to Jan-2013
A key factor in Delta’s decision to purchase the Trainer refinery near Philadelphia, Pennsylvania in 2012 was the ability Trainer allows the carrier to rein in refining costs. Previously, Delta management has calculated that the cost of crude oil per available seat mile has grown 10% since FY2009 while the crack-spread has jumped 73% during that same time. Delta management believe that crack-spreads could not be hedged in a cost effective manner, which resulted in the carrier looking for ways to more effectively manage rapidly rising refining costs.
Tossing out junk fares
Some opportunities exist to improve yields by cleaning so-called “junk fares” from the market, according to Mr Kirby. He concluded there are customers purchasing a lot of those lower fares who end up travelling during the high demand times during a given day. If a given carrier has a USD99 fare in circulation, “some of it is going to find its way onto your aircraft”, he explained. The remedy is an industry that does a better job of keeping the fare structure clean.
Mr Kirby admitted managing fares in the industry is complicated. “We file tens of thousands of fares and stuff falls through the cracks,” he explained. On many occasions airlines are unintentionally keeping low fares in the market.
But other carriers intentionally circulate low fares into the market place as part of their strategy to build revenue by charging for unbundled products. Ultra low-cost carrier Spirit Airlines has built its business plan around charging rock-bottom fares and then allowing customers to select other aspects of the travel experience to purchase – including water. During 3Q2012 Spirit’s average base fare per flight segment fell 12% year-over-year to USD72 while its average non-ticket revenue per segment jumped nearly 12% to USD50. Spirit during the last year has invaded legacy fortresses including Dallas/Fort Worth, Chicago, Denver, Minneapolis and Los Angeles. Spirit could be responsible for some of the lower fares surfacing in those markets that are pressuring yields.
Spirit contends that legacy carriers essentially let it be due to the low-cost carrier’s ability to stimulate traffic rather than steal passengers away from network airlines. But in some cases legacy airlines have responded to Spirit’s entry into their markets, signalling that perhaps network carriers felt some threat from Spirit. Delta Air Lines during 2012 tested a basic economy fare in markets where it competed with Spirit, which automatically assigned seats at check in and prohibited changes to itineraries.
It is not clear how much time will pass before strong load factors posted by US carriers will result in follow-on increase in yields. But as oil prices per barrel of more than USD100 becomes the new normal, those airlines need an accelerated increase in yields to manage those perpetually higher fuel prices. A first step could be clearing the junk from the market place to create a more rational fare environment.