The financial tables have been turned as network airlines come up trumps, while low-cost carriers report deficits, in the latest financial results from the USA
It seems a reversal of the natural order of things: the darlings of the industry, the low-cost carriers, have reversed roles with those "giant, lumbering, legacy dinosaurs", as discounters report deficits while network airlines make money. This raises questions about the future of the low-cost business model, even as structural questions linger about the network carriers.
But hub-and-spoke airlines such as American and United Airlines, boosted by cost cuts they wrested from workforces and suppliers both in and out of bankruptcy, have shown buoyancy in a robust domestic economy willing to pay a revenue premium while their strong international presence has continued to bring in superior revenues.
Meanwhile, the low-cost players are increasingly competing nose-to-nose as they continue to search for new "underserved" markets. Eager to spread low costs over a larger base, the low-cost carriers have always embraced growth as underpinning their business model, but growth is now the first victim.
JetBlue Airways made clear early this year it would trim its plans and continues doing so, while AirTran Airways has finally stumbled, with a quarterly loss and word that it was postponing aircraft deliveries. Even Southwest Airlines, which has never disappointed with a deficit in any of the past 60 quarters, posted third-quarter results that left much to be desired.
The profit was flat against year-ago results after factoring out a special charge that Southwest had to take on its fuel-hedging contracts, and far short of its goal of 15% annual earnings growth. As Southwest negotiates a new pilot contract sometime in 2007 and gives up a postal service cargo contract, Cathay Financial's Susan Donofrio increased her estimate of the carrier's unit-cost increases to 2.6% next year, up from her earlier 1% forecast, while she sees no savings from "low-hanging fruit" to offset the increases.
AirTran disappoints
Southwest's results were nowhere as stinging a rebuke to the true believers than the results at AirTran. The prime rival to Delta Air Lines at Atlanta, AirTran posted a deficit that may have been nominal but was "especially disappointing after the company appeared to turn the corner in June", says Merrill Lynch analyst Michael Linenberg.
JP Morgan's Jamie Baker was perhaps more pithy: AirTran "decelerated more than any other carrier", largely because of "still-excessive growth". AirTran, which has been growing by 20-25% a year, plans to slow sharply. It may be forced to grow most slowly at Atlanta, where Delta plans double-digit increases at least into mid-2007, says Raymond James analyst Jim Parker. Morgan's Baker says: "Discounters are realising an inconvenient truth: slower growth may in fact improve profitability."
JetBlue's David Neeleman, stung by negative investor and public sentiment since his carrier's growth problems early in the year, insists it will grow. This is in part through new initiatives, although his estimates of as much as $100 million in new revenues as it signs distribution deals with Expedia and Travelocity and returns to global distribution systems in a big way are "frankly ambitious," says Baker. As is an envisaged codeshare with an international carrier, possibly Virgin Atlantic. The drawdowns of competitors on Florida flying from New York and Boston could help JetBlue boost its margins, but that stresses the vulnerability of the carrier's to the whims of rivals.
One brighter - or at least not as dim - spot in the low-cost constellation is Frontier Airlines, the Denver-based discounter that some wrote off as doomed after Southwest entered its Denver hub at about the same time as United, Denver's largest carrier, emerged from bankruptcy reorganisation. Claiming that predictions of its death were vastly exaggerated, Frontier proudly posted a nominal third-quarter profit. But unit revenues on routes where it competes with Southwest have been increasingly negative, calculates Parker.
Frontier's ambitious expansion into Mexico and its plans to grow on shorter, less-competitive regional routes from Denver help it avoid the giants at home. But United plans Denver growth, as does Southwest, with the two putting as much as 12% more capacity on routes to and from the Rocky Mountain city, says Parker. Frontier in a sense sums up the dilemma facing most low-cost carriers in one form or another: "It performs well when fuel is low and United mismanagement high," says Baker, who notes this is "not the current environment".
Indeed, United's advances and strong performance in the quarter, even without continuing drastic cost cutting, suggest the hub-and-spoke, multi-class, differentiated service offering will prosper. And as at American, strong domestic revenue complemented international revenue growth, making it all the more likely that it is the reports of the demise of legacy carriers which were exaggerated.
In fact, legacy revenue growth has been strong enough that they can undercut the discount carriers, notes Calyon Securities analyst Ray Neidl. Their international growth has been robust enough that even bankrupt majors are recalling furloughed employees. Delta plans to recall 1,000 flight attendants next year, while Northwest, which like Delta is in bankruptcy, will add 75 pilots by the year-end and 150 pilots in the first half of 2007.
Source: Airline Business
