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Most commercial airline companies declined precipitously after the terrorist events of 9/11 as consumers flew less for business and leisure. As a result of this shock, the industry faced increasing consolidation and key bankruptcies (including United, Delta and Northwest) as the sector struggled to regain its financial footing. Consolidation is beneficial in two ways for airline companies, as it typically reduces redundant operating costs and raises revenues through higher fares.
Compounding the issues around declining consumer demands was the concurrent rise in oil prices, which typically constitutes 30% of an airline's operating cost and is the major expense for commercial airline companies. Some companies such as Southwest had the foresight to lock in low fuel prices using hedging strategies, but most airlines, including the two largest by revenue passenger miles--American Airlines and United Airlines--have no hedging strategies in the foreseeable future and will suffer the most if oil prices continue to rise.
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[edit] Industry Specific Metrics
- Available Seat Miles (ASM): The ASM metric is used to track seat supply among airlines. ASM is equal to the number of available seats times the number of miles flown.
- Revenue Seat Miles (RPM): RPM measures the number of seat miles flown for which the company earned revenues. That is, RPM equals the number of filled seats times the number of miles flown.
- Load Factor: The percentage of available seats that are filled during a specific period is an airline's load factor for that period. In 2007 load factors for major airlines ranged from 72-84%.
- Yield: The amount of revenue earned per RPM is known as the airline's yield. This metric is generally expressed in cents and ranged from 9.8-13.1 cents for the major airlines in the first half of 2007.
[edit] Earnings Drivers
Joseph Weisenthal said in a recent post Airline-In-A-Box: Few businesses have as many variables and challenges as airlines. They are capital-intensive. Competition is fierce. Airlines are fossil fuel dependent and often at the mercy of fuel price volatility. Operations are labor intensive and subject to government control and political influence. And a lot depends on the weather.
[edit] Consolidation
After the events of 9/11, the domestic commercial airline industry went into a precipitous freefall, prompting consolidation of several airlines and bankruptcies of others. Elimination of airlines, through consolidation or bankruptcy, benefit both revenues--through higher fares--and costs by eliminating redundant expenses and routes. Additional terrorist attacks or declines in the overall domestic economy could accelerate consolidation as weaker airlines get acquired by financially stronger ones or become insolvent.
Airlines worldwide have also sought to share costs by creating partnerships or alliances. Through these agreements, airlines can share facilities and operational costs (e.g., maintenance facilities, sales offices) and negotiate volume discounts on large purchases. Passengers benefit from lower prices (due to lower expenses) as well as optimized routes and pooled loyalty rewards, especially in regards to international travel. Since the deregulation of the airline industry begain, airline ownership has been limited to companies and individuals of the operating country. THis has prevented major international mergers and acquisitions from occuring. Recently, the US government has announced its intentions to relax these regulations and clear the way for international m&a deals in the airline industry.[1] This could create significant cost-saving and synergy in the rapidly deteriorating industry. The three major global alliances are:
| Alliance | Passengers per Year (MM) | % RPM Share Approx. (2005) | Key U.S. Airlines |
|---|---|---|---|
| Star Alliance | 413 | 25% | United, US Airways |
| SkyTeam | 373 | 20% | Northwest, Delta, Continental |
| One World | 320 | 15% | American |
[edit] Spotlight on Oil Prices
Jet fuel is a key cost for airline operations. In 2008 fuel is constituting about 34% of an airline's costs, as opposed to about 13% in 2002.[2] For the budget airlines such as Jet Blue and AirTran, this share rises to nearly 50%.[3] The rise has been very drastic just in the first six months of 2008. At the start of the year, jet fuel cost $850 a metric ton. As of June, the cost is now approximately $1300 a ton.[4] Jet fuel is extremely correlated with spot petroleum prices, which have risen significantly over the past several years. On the flip side, the stock prices of domestic airlines tends to be highly negatively correlated to jet fuel prices, indicating the sensitivity of this historically low-margin business to fuel expenses.
In an exogenous event for the fuel procurement of airlines, oil companies are increasingly making airlines pay up front for fuel. In the past, the airlines were allowed to use fuel on credit and pay up to weeks later. Now, the oil refiners are eliminating this free credit line and making the carriers prepay. This will cause a negative shift in the short term cash situation for the airlines as they can no longer keep cash from revenues on the books for this credit line period.[5]
On June 4, the International Air Transport Association drastically lowered their profit forecasts for the industry. The group now projects that global airlines will collectively lose $2.3 billion if oil averages $107 for 2008. If the price averages $135 for the last six months of the year, airlines will lose $6.1 billion.[6] However, on 1 October 2008 Northwest Airlines (NWA) CEO Doug Steenland claimed that his company can maintain profitability even if oil stays at $100 a barrel.[7]
Some airlines have utilized hedges to lock in the price of fuel and hence insulate themselves from oil price volatility.
- Southwest was perhaps the most forward-looking of airlines, and has hedged significant portions of its fuel expenses through 2010 at various prices per barrel below the current market rate. The company will reap benefits compared to other airlines if oil prices continue to rise or remain at current levels. On the other hand, if prices fall below Southwest's hedging levels, they will be at a disadvantage to other airlines.
- American Airlines and United Airlines, on the other hand, have no remaining fuel hedges in the foreseeable future as of 2008. Other airlines have limited remaining hedges.
[edit] Business vs. Leisure Travel
Business travel is important to the commercial airline industry for two major reasons. First, it commands a much higher average ticket cost, approximately 5 times higher than the average leisure fare. Second, business travel is less elastic changes in macro-economic trends than leisure travel, which may be considered a form of luxury.
- In the past 24 months, leisure fares have dropped slightly, ranging from $110 to $100
- In the same time frame, business fares have increased significantly, from around $350 to $500
[edit] Domestic vs. International Travel
International travel accounts for about one-third of all traffic and capacity for the major carriers. Comparing 2007 year to date to the same time period in 2006, these major carriers saw international travel increase by about 5% , which is faster than domestic travel, which was relatively flat. Growth in domestic travel has been soaked up in large part by the regional discount carriers such as Southwest and AirTran.
[edit] Dysfunctional Industry[8]
Over the period from 1990 through 2006 the Air Transportation Association of America reports that domestic airlines posted a cumulative loss of $22 billion on cumulative revenues $1,866 billion. Since 1978, when commercial aviation was deregulated, no fewer than 137 carriers have filed for bankruptcy protection. And from the end of World War II, when aviation started to become big business, through 1994, the sum of the industry's profits and losses was less than zero. Warren E. Buffett once remarked that it would have been a blessing for shareholders if someone had thought to shoot down Orville Wright at Kitty Hawk. [9]
One reason the major airlines find themselves in this predicament is that they use huge amounts of fixed capital -- wide-body jets go for $100 million each and can't be readily liquidated. They also depend on a skilled labor force. The two problems exacerbate each other. Since airlines cannot afford to let planes sit idle, they can ill suffer strikes. That makes their unions unusually powerful. Consider some other businesses for a moment: Microsoft has highly skilled programmers but little invested capital. Merrill Lynch has both, but its assets -- stocks and bonds mostly -- could be liquidated overnight. Steel has high fixed capital, but it can replace its workers more easily. This clearly points to a major factor in the airline industry.
Companies in the Airlines Industry (29)
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