Delta and Northwest may now be under bankruptcy protection, but talk of US carrier consolidation is premature, writes Chris Tarry of the CTAIRA consultancy, with analyses from Fabrice Tacoun
The news of the Chapter 11 filings by Delta Air Lines and Northwest Airlines came as little or no surprise. Similarly unsurprising have been the inevitable calls for consolidation of the US airline industry.
There are clearly two issues that arise now that 50% of US airline capacity is acting under the protection of the reorganisation provisions. Neither are new, and both we have raised in the past.
Firstly, the ability of management to handle the necessary restructuring against a background where the balance of power in negotiations would appear to lie with labour – a situation that is not unique to the US majors. The result is that labour, for whatever reason, becomes, in effect, a fixed cost. It is a cost base that carriers are generally unable to adjust significantly without resorting to an external mechanism in the form of Chapter 11. Every so often this form of bankruptcy is used to reset the economics of the business.
Secondly, although investment bankers (for their own reasons) believe that consolidation may be the panacea to the problems of this and most other industries, the cost benefits need to be clearly understood. The impact that consolidation might have on costs is crucial as the scope for boosting revenue is negligible.
There is a long-held view that the synergies arising from mergers are generally beneficial. However, there is a plethora of research that suggests the cost benefits of mergers and acquisitions is overstated at the outset and they fail to materialise.
The post-merger cost cutting necessary to realise meaningful benefits in this industry would need a significant reduction in capacity. But putting two weak or poorly performing businesses together is like two drunks supporting each other on the way home – although it might work for a while, it does not look attractive and generally collapses amid recriminations.
Perhaps the key question is whether or not either or both of these actions will solve the fundamental problems of the US domestic industry, which still accounts for three quarters of business for US carriers. Even the most cursory glance at the latest Department of Transportation statistics for the US majors reveals the extent of the ongoing “domestic problem”. For the 12 months to June 2005, the operating losses in the domestic market for this group was estimated at $4.9 billion. This compares with $2 billion for the year to June 2004 and $7.5 billion for the previous year.
In volume terms traffic is at record levels, although sector lengths have increased. This clearly has an impact on yields. Overall, they are currently lower than in the year to June 2001. Adjusted for inflation, the yield picture is even bleaker.
Cost remains the fundamental issue and although fuel has been blamed, it is a factor – but not the root of the problem, either in the US or elsewhere.
An examination of the difference between the achieved and breakeven load factors – the load factor gap – is revealing. In the latter part of the 1990s this gap was positive and ranged between four and seven percentage points. In the immediate aftermath of September 2001 the gap reversed and was negative in a range of 12-14 percentage points. Since then the best performance has been in the year to June 2004 when the gap was 1.6 points negative.
On an annualised basis, passenger load factor to June 2000 was 71%. Over the 12 months to June 2005 the load factor had risen to 76.5%. Tellingly, the breakeven point had swung from 67% to 84.7% and the operating result deteriorated by a huge $9.5 billion.
While the cost reductions under Chapter 11 will assist in moving the industry towards a better performance, the reality is that US carriers overall are still $10 billion away from acceptable returns. This is against a background where the economy may well even have peaked.
Near term the issue is whether there are any other US airlines that believe they will only be able to compete by reorganising under Chapter 11. In fact, only American Airlines among the majors has managed to avoid using its protection. Over the medium and longer term the key issues are the resulting shape, size and sustainable profitability of the US industry. And here the open question remains: whether anything will really change, or whether history will have the unfortunate knack of repeating itself?
Source: Airline Business
