The US majors reported better than expected results in the first quarter but the outlook for the rest of the year is grim.
Summer looks less and less like a holiday for US airlines as they brace themselves for increased delays, rising passenger frustration, sharper labour pains and, above all, slowing consumer demand that could stop their revenue recovery.
This summer of discontent comes after a surprisingly strong first quarter in which some carriers that almost never make winter money posted blossoming profits. Five major carriers were profitable in the quarter and overall US majors posted a combined $44 million net profit before special items, compared to a $1.26 billion loss for the same period last year (see chart next page).
However, US majors are also beginning to warn that the festival is about to end. American Airlines, for instance, made its first first-quarter profit in this century and then promptly warned that things looked grim.
US Airways, which has been a leader in unit revenue increases and had a profitable first quarter, also warned its outlook was dimming. Jamie Baker of JP Morgan voiced long-term scepticism, the first time he has lowered his outlook so broadly in many months. Baker cites "a growing body of evidence that domestic RASM [revenue per available seat mile] is neither up to snuff nor likely to improve soon".
Airline executives were divided over the causes of this affliction, with many blaming over-capacity and some blaming the sluggish domestic economy. Scott Kirby, president of US Airways, told analysts in late April that "we've begun to see a slowdown from the rate of growth that we saw in 2006. As other airlines have reported, we've begun to see a slowdown from last year's rapid RASM growth rates. We believe that this slowdown is mostly attributable to additional industry capacity and, in particular, a more aggressive response from legacy carriers to [our] growth. But we currently expect RASM to be roughly flat for the quarter".
At Southwest Airlines, chief executive Gary Kelly warned in early May of "growing evidence that the slowing economy is dampening demand".
At United, executives blame the economy, other airlines' actions and even United's own planning. United fell flat in the quarter, losing $152 million on shrinking revenues of $4.37 billion (down 2% year-on-year), despite high hopes in its first year out of bankruptcy reorganisation. Although United said the quarter is almost always weak and that bad weather and its own domestic capacity additions impacted its performance, the carrier's executive vice-president and chief revenue officer, John Tague, spread the blame pretty much everywhere, saying: "Domestic fundamentals are certainly being impacted by excess capacity and some slowing of the economy. However, I believe the biggest culprit is undisciplined pricing behaviour, particularly the loss of Saturday-night stay restrictions, weakening advanced purchase requirements, and secondary-airport, low-cost carrier pricing polluting primary-airport city pairs."
Southwest's remedy
Kelly's solution is to increase prices, which the airline is doing through "selective, targeted fare increases" as it prepares to introduce new revenue raisers and ancillary services. While Kelly thinks Southwest can still make its goals of 15% profit growth and says that its 2007/08 growth plan is fixed, he notes that the airline could revise and ratchet down its growth plans after that.
But raising prices may not be the easy-to-use tactic it was last year, when the major carriers pushed through about a dozen broad increases. By mid-May, a broad price hike led by United that carriers had pegged to fuel costs was collapsing after Southwest refused to match it. Once a carrier of Southwest's size refuses to match or respond to a specific fare change, others usually withdraw their price changes to remain competitive. Kelly insists that the airline's fare increases will be targeted and would be in the $1 or $2 range, but analysts say several industry price hikes foundered in the spring after one or another airline refused to match them.
Baker and others see little consumer tolerance for higher prices now, and Kelly reflects that "the industry has been aggressively trying to raise fares for the past 24-36 months, and one would think that there's a logical limit to how hard and far fares can be pushed, so we started seeing some resistance to fare increases as early as the third-quarter of last year and reported that at the time".
For the other side of the equation, the capacity side, the outlook is mixed. Overall, domestic capacity for the first quarter rose by an estimated 3.5%. Lehman Brothers analyst Gary Chase says the industry appears to be moderating its capacity growth. He expects 2.6% domestic capacity growth for the full-year, but if reductions in summer schedules hold and carry into the autumn, 2007 growth could be closer to 2% year-on-year. United, for example, decided in May to cut 2007 mainline domestic capacity growth by 2%.
The looming debut of Virgin America, though, casts a shadow, especially on long-haul transcontinental carriers. United has about 7% of its capacity exposed to the anticipated Virgin routes, while JetBlue would see just over 6% of its routes exposed to the new low-fares competition, according to Goldman Sachs analysts.
Another new source of competition and capacity on the West Coast this summer will come when Southwest resumes service at San Francisco International Airport with one of its largest ramp-ups yet. It will have 18 daily flights to three destinations: Chicago Midway, Las Vegas, and San Diego. The Las Vegas service will go nose-to-nose against both United and US Airways, while the San Diego service will hit Alaska and United.
A few positive signs: US Airways will take seven Boeing 737-300s out of service this summer, and "will be loading additional utilisation reductions beginning this summer", while Frontier will end its short-lived shuttle-type service between Los Angeles and San Francisco. Frontier chief financial officer Paul Tate blames high terminal costs at Los Angeles, but this was the carrier's second try at the route, and it is estimated not to have gained more than an 8% market share against United and American, even with fares a full one-third lower.
Another positive sign on the West Coast: Alaska Airlines is watching its growth plans after a very difficult quarter. The airline's chief executive, Bill Ayer, says: "We see continued flattening in demand in some of our markets, evidenced by somewhat lighter advanced bookings on modestly increased capacity, which has prompted us to participate in a number of fare sales during the quarter. Load factors have begun to build back to prior-year levels in response to the sales".
Alaska cuts costs
Ayer has called for a new round of cost cuts and tighter cost controls as the airline transitions to an all 737-family fleet for mainline operations and to a fleet of Bombardier Q400s and CRJ700s for its Horizon Air unit. Horizon is adding service throughout the Pacific Northwest as Alaska focuses on transcontinental additions, even though its cross-country routes have been among those hardest hit by competition.
And Delta, focusing on its international growth, will probably reduce domestic capacity this summer, says chief financial officer Ed Bastian. At United, even sharper cutbacks are likely. United's chief financial officer and executive vice-president, Jake Brace, told investors: "Frankly, we may find it hard to make the case for some of our utilisation flying against weakening domestic fundamentals. While we have not completed our assessment, it is certainly possible we will be removing some capacity from our domestic system in the back half of the year."
On the East Coast, some observers believe that capacity will be restrained somewhat as they expect JetBlue to draw back as it seeks to restore its operational integrity under its new chief executive. Dave Barger, the airline's number two, took over in early May after founder David Neeleman stood aside in the face of investor displeasure following repeated operational problems. As of late April, the airline had been projecting full-year capacity growth of 11% to 13% measured in ASMs (available seat miles), but observers think that now is unlikely. Calyon Securities analyst Ray Neidl believes that JetBlue, "along with other low-cost carriers, is growing too fast and we may see further reductions in the still aggressive growth rate".
In a sense, the argument about over-capacity versus under-pricing is academic as the short-lived industry recovery seems to be shuddering to a halt. Baker has the last word: "Managements bicker over whether weak demand or aggressive supply is to blame for increasingly poor domestic RASM trends. We don't particularly care in the near-term, as the industry is ill-equipped to respond quickly either way."
Source: Airline Business
