The distressing economic news this summer made September important in signaling how the US airline industry is performance. Judging from the early operational reports and 3Q2011 guidance issued, traffic and demand are defying the gloom offered by Wall Street and Washington. Indeed, air travel demand is expected to remain strong, which bodes well for the industry's bottom line given the fact capacity continues to tighten.
Still, US airlines are not sanguine about the state of the industry, with most not only pulling capacity in the fourth quarter but signaling the same for 2012 when a number of carriers will be taking delivery of new aircraft but keeping capacity flat. That capacity discipline, in evidence since early Spring when fuel continued its climb, meant the USD6-10 fare hike imposed in mid-September stuck and will likely segue into future hikes as demand remains strong on increasingly tight capacity. For now the hike applies to last minute tickets.
Rising revenues, falling profits
Last quarter’s story, rising revenues and falling profits, is likely to be repeated as carriers expressed universal frustration with both fuel and other costs. Even so, jet fuel came down 14% from its April high of USD3.37 per gallon to USD2.90, which is also expected to contribute to better-than-expected performance. Delta is expecting per gallon averages (at USD3.07) will be 30% higher than the year-ago period and IATA estimates the fuel bill will increase by USD10 billion worldwide to USD176 billion in 2011. Dahlman Rose is predicted an industry-wide increase in revenues of 11.8% compared to a cost increase of 15.6%.
Particularly worrying is the slow down in cargo demand reported by IATA as well as analysts. However, the Global Business Travel Association is expecting strong business demand for the rest of the year with spending expected to grow 6.9%. However, it echoed most forecasts in saying 2012 will be a tougher year, with spending expected to be up only 4.3% or USD260.9 billion. International travel spend will rise 9.1% this year, it said, and 7.7% next year.
The Air Transport Association reported that domestic seat-capacity growth, which has not kept pace with economic growth for decades, is now at its lowest versus GDP since 1979.
Third quarter guidance
United is expecting a 9.5-10.5% increase in consolidated unit revenues, as is Southwest, for the historically strongest quarter which was boosted by the tax holiday that probably netted the industry about USD200 million. Unit costs, ex fuel will be kept in line at 1.7-2.8% with jet fuel expected to be down to USD3.15 per gallon.
Even better is the fact that Delta and US Airways are expecting double digit revenue per available seat mile increases in 3Q2011. Cost discipline remains high on the agenda to offset the fact jet fuel has not fallen as fast the price per barrel has.
Analysts will likely seek clarity on what is happening with pilot integration given the lack of progress on that front. Pilots picketed Wall Street recently and CEO Jeff Smisek has already said reaching an agreement is unlikely this year.
United is one of the carriers expected to keep capacity flat next year. Ancillary revenues are expected to play a major role with the increasing integration of United and Continental a year into its merger. About 15% of United's revenues came from ancillaries last year, compared to 30% at Allegiant and 22.6% at Spirit.
Delta keeps margins in range
Delta, especially, has expressed frustration with costs and plans to ensure expenditure is flat next year. It recently guided that revenues increases will equal about 80% of its cost increases for the third quarter putting its operating margin in the 9-11% range. Its 2-3% capacity cuts next year are specifically designed to shrink its costs.
Delta is still the leader when it comes to ancillaries and expects to top USD1 billion for 2011. It is also being very aggressive on cutting capacity, down 5% this year with plans to cut another 2-3% in 2012. However, it has also been suggesting an expansion in Latin America to level the playing field there between the alliances. Delta is expected to increase third quarter revenues to USD9.72 billion, up from the USD9.95 billion a year ago.
American, which reports on Wednesday, is also expecting robust unit revenue increases between 7-9%, but that was still outpaced by costs despite network adjustments. However, American is still expected to post another quarter of losses. Unit costs are expected to rise between 13.1-13.5% while full year costs will rise 9.2-10.2%.
The rising costs results from the capacity cuts imposed because of high pilot retirements. Those cuts trimmed its original capacity increase estimates from 4.3% announced earlier this year to 1.9% growth for the year and flat in the third quarter. Consensus has it posting revenues of USD6.36 billion compared to USD5.84 in 3Q2010.
The company is expected to be questioned once again on its game plan for reaching performance on par with peers. Its latest capacity adjustment calls for a 3% year-on-year reduction in capacity in the fourth quarter. It is retiring up to 11 B757s next year.
Especially critical is the negotiations with pilots who refused relief on work rules to help American over the higher than normal pilot retirements.
Southwest plans unclear on labour unrest
Labour is also going to be a key issue during the Southwest earnings call. Even so, little can be said since pilots are now in the middle of a vote on a seniority integration plan which won’t close until 07-Nov-2011. The betting is that the realisation of the synergies expected from the AirTran merger will be slower in coming.
Consensus expects Southwest to post USD4.22 billion in revenues compared to USD3.19 billion while AirTran ended 3Q2010 with USD667.9 million in revenues. Unit revenues jumped 12% in September. It is on track to gain a single operating certificate in the fourth quarter which will gain it an estimated USD1 billion in revenues from Atlanta in the next three-to-five years, according to CEO Gary Kelly who indicated the focus will change to the more profitable larger cities and direct flights.
The company’s daily Atlanta departures will drop 13% to 175. Dropping the smaller cities such as Asheville, NC, NewPort News, VA, because of fuel concerns, and moving from hub operations to point-to-point is expected to increase revenues at Atlanta by USD750 million to USD1 billion. That will likely offset the loss of USD152.1 million in baggage fees which will be dropped after the merger. Also part of that strategy is attracting more business passengers with its popular bags-fly-free policy. About 20% of AirTran passengers, who liked its business class section, were business travelers compared to 40% at Southwest.
Recently, Southwest said it would operate the two airlines separately in the event the pilot integration plan does not pass which means it will continue to collect AirTran’s bag fees.
One of the critical items that has been delayed with the AirTran merger is Southwest's much needed new reservations system. However, CFO Laura Wright reported during the quarter that, while it has not even started work on a new system, it is tweaking the old system. The idea is to allow the international itineraries before the replacement which Wall Street has been waiting for. She pointed to opportunities not only in the near-international markets in Mexico and the Caribbean, but in the Alaska-Hawaii market. (NB: See CAPA's analysis in Airline Leader magazine on LCC & Hybrid airline distribution strategy).
It was trying to upgrade its reservations system in preparation for now defunct plans to codeshare with WestJet. So it was a little surprising the company said that Canada holds only a small opportunity as does Latin America. Meanwhile, Spirit is going after that Latin market.
JetBlue continuing to expand
To date, JetBlue has stuck with expansion plans in the Boston and Caribbean markets but, given the economic uncertainties, it will be interesting to see if that holds during the 26-Oct-2011 earnings call. Given the pull backs of other carriers in Boston and the Caribbean, JetBlue is forecasting a few more years of growth so any change in strategy is probably unlikely.
For Allegiant, a key item will be guidance on its Hawaii plans. It is now expecting certification for extended ETOPs next year, after gaining its 757 certificate in July. It must have months of operating experience before it can apply for ETOPs. It is also seeking flag status for Hawaiian operations.
It has been able to put its four B757-200s into service elsewhere or lease them out to date. It is expecting two more before the end of 2011. It is increasing seat counts on its aircraft which may run up against softening demand based on an uncertain economy. However, with demand reported strong across the board, it may not have to face that just yet.
Its plans, and future plans by Southwest to enter the Hawaii market, might signal too much capacity is going into the market. Alaska and Hawaiian have both been adding capacity, although Alaska is holding its own and Hawaiian is trying to balance its mainland-Hawaii service by expanding into Asia. Its Korean service benefited greatly from the elimination of the visa requirement for Koreans and it is pushing, as is the rest of the travel industry, for easing visa requirements elsewhere.
Hawaiian Airlines capacity will grow between 15-17% with its Westward expansion plans. It reported unit costs ex fuel falling 0.5% to 2.5%. Unit revenues will be up 12.5-15.5% for the third quarter nearly double its previous expectations of between 6.5-9.5%. It cited strong yield across its network, especially in the Japan market.
US Airways is also expected to have double digit RASM increases resulting in an increase in revenue to USD3.43 billion compared to USD3.18 in 3Q2010. The airline is already on the record that demand seems to be disconnected to economic headlines.
Worrisome are US Air's plans to expand across the Atlantic which is already suffering from significant overcapacity which has depressed yields this year. Even so, it is expected to get a robust boost from the implementation of its long-awaited slot swap with Delta which recently received Department of Transportation approval. The swap will solidify its position at Washington National at the same time Southwest is becoming more powerful there as a result of its AirTran merger.
The industry was able to get rid of USD3.5 billion in proposed fee and tax increases proposed by the Obama Administration when the Senate cut the proposals from its version of the President’s jobs bill.
Frontier is continuing to struggle with more Milwaukee capacity cuts already announced. Parent company, Republic Airways Holdings, failed to get USD70 million in increased capitalisation it was seeking as part of its restructuring package. Indeed, pilots were forced to waive the requirement which was a part of their latest contract.
Milwaukee departures will be down to 45 from 70 forcing furloughs for 215. Kansas City departures will likewise decline to 20 from 26 as part of its cost-saving strategy.
Regionals expected to regain profitability
SkyWest, which was break even in the second quarter, it expected to regain profitability in the third as is Pinnacle. Expect Pinnacle to continue to tout the improved conditions expected for next year when rate increase and other financial manuevres kick in from its Delta contract. The impact of the Mesaba acquisition is also expected to be interesting as is the progress toward completing the integration between Colgan and Mesaba.
Republic Airways is expected to update its progress on raising the USD70 million needed for the Frontier restructuring.
As the reporting season gets underway with Hawaiian this afternoon and AMR tomorrow, it is clear that the third quarter was good for the US industry. Executives will likely project a cautious approach to the fourth quarter although they have already tipped their hand with good capacity cuts.
The industry is expected to be profitable this year which is no surprise, as is the fact that economic uncertainty is dampening the outlook. This will be compounded next year, an election year when little is expected to get done to address consumer doldrums and job prospects. Still it is heartening that executives continue to report strong demand which is expected to continue, at least through the fourth quarter.