What the fuel is going on???

Transcript

John Heimlich:All right, good morning. Good morning. Good morning. We'll hear from everyone what the fuel is going on out there, right? So, uh, yeah, Corinne said, what would you like to call your session? And I gave that, and I was delighted not only she'd take it, she took all 3 question marks. So I should have pushed the envelope a little harder. Okay, let's get into it. So you hear a lot of the— on the earnings calls, some of the C-suites talk about this, but this is the— was sort of the backdrop for hitting into the crisis in terms of context, at least in the United States, for the basket of goods or major products and services purchased by consumers. This is what the US Consumer Price Index components did From— and there are many more at the sublevel, but from calendar 2019 to calendar 2025, and the black bar kind of in the center is the all-items headline inflation number. So overall inflation in the US rose 26% from 2019 to 2025. The CPI's airline fares component, meanwhile, at the bottom there, actually fell in nominal terms 3.5%. That includes— I've got some notes here— but all applicable taxes, fuel surcharges, first checked bag fee on 80% of the itineraries. One, it excludes frequent flyer discounts and some other stuff, but it's also a— tends to be a leisure-oriented pricing methodology, so it doesn't fully capture the fares that are designated as business. Of course, the poster child for the major increases in inflation are eggs and some other grocery items, electricity, and vehicle maintenance repair. But this is the backdrop. A lot of— you hear a lot of CEOs saying, you know, we haven't participated in this same increase. So that's some of the pricing backdrop. Now, here we go. We start the year again, renewed optimism. That's kind of where we started 2025. Before a lot of policy disruption, and this year it's been, I suppose, a combination of policy and commercial forces once tied to one another. And from January to April, we saw jet fuel prices double. A couple of things here, and by the way, I don't show it here, but I looked at this on a daily basis, and it was really within a 43-day calendar span that prices doubled. So it was even more of a sudden increase than the monthly portrayal suggests. Now, we've come down a little bit in May in the last couple days with renewed optimism about an end to the conflict in the Gulf. The US here is in the kind of lighter blue bar, and of course those who operate extensively in Europe and Asia and to some extent Brazil have seen higher prices in those regions. And David was right earlier this morning talking about the crack spread, which I think on one day it was around $100 per barrel. So it's been excessive. Jet fuel has increased really the most, and we can see that here in one respect. So from— this is indexing everything to calendar year 2019 equals 100. And so that's some context. So we have the CPI all items in the green. We have the CPI's airline fares component in the blue, not surprisingly the one at the bottom. I put on unleaded regular gasoline in the United States as the gray and the Argus Jet Fuel Index in the red, which is a simple average of refining prices, spot prices in Chicago, Houston, New York, and LA. From— as I say in the header here, from January to April, The monthly average of jet fuel rose 94%. The gray line, gasoline, went up 44%. The airfares went up 13.8%. So the fuel versus fares ratio of increase here is 7 to 1, or maybe 6.8. So there's a lot about— yes, so the blue line has narrowed the gap to the green, or it's sort of making some real advances in ticket pricing, but lacking what we've seen from jet fuel, trailing, I should say. So Michael Lindenberg at Deutsche Bank, he published a note where he compared his late February pre-war forecast to his, I think, April 7th is when he updated this. last, and he said, well, relative to my pre-war forecast for the U.S. publicly traded airlines, I expect they will pay $24.1 billion more in fuel— for fuel over the calendar year than I had anticipated, but they will be able to make up $14.4 billion through higher revenues. There'll be some adjustments to profit sharing. The net financial impact will be and— or to the operating line will be an $8.4 billion hit. Now, that coincidentally works out to exactly a 60% recapture of the revenue versus the fuel, which is pretty consistent. Keep in mind, that's over the course of the calendar year. It's one thing to say, well, right now we're capturing, you know, 30% to 50%. It's another thing then say by the— by exit, 4th quarter, we hope to be 85 to 100. So this is a calendar year average 60% estimated recapture on his part. So given that you have sort of this $8 billion hole still, as you know, the airlines have to pull other levers because your customer base, particularly when they themselves are facing inflationary pressures for all the other items, including their household energy costs and other things, on an uncertain job market, then they, they go to the capacity lever, and there becomes a situation where the marginal benefit of incremental flying is— turns out to be a disbenefit, negative. The more you fly, the more you lose. And sure enough, if I look at the pre-war published schedules and I compare to this past weekend's upload, May 22nd, particularly focusing on the 2nd and 3rd quarter to-be-flown schedules. Domestically on the left, in the US, we've gone from 2.8% scheduled growth to just 0.4%, and the quarter is not even over, of course. And then for the 3rd quarter, more dramatic reduction from 4.6%, again loaded in the published schedules, has fallen to 0.9% growth. And as not surprisingly, each week I look at this, it tends to be more dramatic revision. International, we've gone from 3.3 to 0.6, and when we go to the 3rd quarter, it's actually turned negative where we actually see contraction. Now, I'll point out that on the right here, the international, as I note, is just for the U.S. carriers. I think if we included foreign flags here tuned from the U.S., it would be more extreme because I think their cuts have been even more dramatic. Just for some context here, this is one of my favorite charts of my member carriers. Like, like to borrow this one quite a bit, but we can take Department of Commerce data and look at the average pretax profit margin for all U.S. companies, and it is remarkably consistent through recessions and upcycles. That's the black line, and the average last year was 19.8%. For the US passenger carriers, it was 3.2%. If you take out— this is all on an unadjusted basis— if you take out Spirit, it was 3.6%. So not a huge difference. The blue line has never ever reached the US average. The closest we got was 2015. Interesting, I recently looked at the Wall Street consensus I think on May 15th, I took a look at this for the U.S. carriers for the year, and as I say in that blue shaded ribbon at the top there, the projection was for a 3.4% pretax margin. What's interesting is the dispersion of results around that, that mean, from -11% all the way up to 7%. So the averages won't tell you everything. So with that context, We then, I think Lori was absolutely right, this becomes a second half story. Will we see signs of demand destruction? Clearly the low income, lower income clientele is hurting the most. Here I'm just using Betsy's alma mater Standard Poor's for their US GDP growth projection, and here again we see revisions. So February 6th, pre-war, they said the US will grow in real terms, 2.7% this year versus last. By March 4th, they had shaved a couple tenths of a point, and then again in April, and as of May 6th, they were at 2.0%. That is a significant reduction to their outlook at the beginning of the year, and similar what the airlines have lessened their optimism about this year. They say this really hinged on oil prices. Even if this, this quote, even if the ceasefire holds indefinitely, we now expect supply to remain tight enough for long enough to keep oil prices well above the levels shown in last month's forecast. And this, I think, you know, every pretty much energy analyst says there will be this overhang for a whole bunch of reasons we could talk about, but this is not something— there will be some easing of pressure, but there will be a sustained Certainly high elevated price for the rest of this year. Now some of the positive forces, how are we able to even pass along 60% over the course of the year? So wallet share becomes an important factor and this is not a brand new story, but if you look at the red line on the left chart here, this is US consumer expenditures, the share of those expenditures going to services generally. is now exceeding 69%. I think it was 69.3% in the first quarter. So even from 2025 to the first quarter of this year, the share that US consumers are spending on services has risen. This data allows you, again, Department of Commerce data allows you to drill down further to an air travel component. And this would include foreign flags and such. That in the first quarter was an all-time high, 0.96%. And this is consistent with things you hear out there, the prioritization of experiences, the value of services, that FOMO, fear of missing out, feeling that I think is a residual in part from the pandemic and the recovery. And generally people say, you know, I have this one summer vacation or this big international trip plan, and I think for the most part They're sticking with it, and all those hard durable goods they bought during the pandemic still last. So the it's even if people have inflationary pressures, how they're choosing to spend their money is important. And that, by the way, that's that 0.96 percent may not sound like a lot, right? Almost one percent. But that's applied to a $21.7 trillion. denominator of US consumer spending. So as I say there in the, in the subheader, it's— that's $208 billion worth of spend. Okay. The other factor here, and this goes to the term people use, premiumization of the business or a lot of the models, right? So this is fascinating. Moody's Analytics has showed the, the top 10% of US income earners last year accounted for 46% of all US consumer spending. Top 10%, almost half of the spending. If you add the second 10th percentile, you get the top 20% account for 60% of spending. So those are the customers that a lot of people are going after. And you've seen every business model across the spectrum. sort of adjust to this, wrestle with this. And again, these folks, it's more wealth-driven and asset-driven than it is, you know, wage-driven. They face inflationary pressures too, but not to the same that some of the spill model carriers are dependent on. So that's another big factor. I'm going to close with this slide, something to watch. This also got some press because I think the May number came out this past Friday, May 22nd. The, the quote from the CNN.com article: High gas prices and cost of living send U.S. consumer sentiment to an all-time low. Also says Americans are feeling worse now than they did during wars, the 1970s oil crisis, 9/11, Great Recession, the pandemic, inflation surge afterward. Some of the sharpest declines in sentiment came from lower-income consumers and those without college degrees. And every airline has to think about its core clientele or where it has been, where it wants to go. And this is something I think— this helps explain why the surge in fuel prices is accelerating some of the restructuring in the business. The U.S. consumer sentiment data published by University of Michigan allows you to break it out by income tier in 3 groups, the top third, middle third, and bottom third. And if you go back to, say, the core middle of summer, fall 2022, there's a strong convergence, harmony around those lines. But in 2024 and 2025, we see a divergence where there's really, even though they generally move the same directionally, there is a gap between the top third sentiment and the lower third. And this is really— and there's a 1-month lag in seeing the income data break out from the headline. That's why that blue line extends further. This is something to watch because if inflation doesn't ease, and of course last month it went the other direction from 2.4% to 3.8%, and we see a dip in the stock market, which we haven't, of late. It's gone the other direction. But if sentiment continues to fall, then some of that, I think, wealth-driven spending will fall off. So this is where fingers are crossed for the second half, and I will close with that and see if we have time for any questions. Thank you. Thank you, John.

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