US airlines have turned in an admirable set of second-quarter results but there is trouble ahead. The question is, which will give way first - fuel costs or passenger patience with an increasingly creaky system?
As a summer of passenger discontent rolled on, the US airline industry racked up record loads and profits, with demand continuing unabated by fare increases. For the first time in nearly a decade all eight US majors were profitable in the second quarter.
But even as the benefits of capacity restraints have paid off, airlines face a resurgence in fuel costs, and a new and pressing need: the need to reverse the effects of having cut staff and resources too deeply to handle this renewed demand. And the continued high demand, while increasing load factors, may have begun to eat into the ability of carriers to manage operations.
For instance, US Airways has had to spend to improve its deeply troubled Philadelphia hub, the core of its east coast operations. Spending there, on new hires and new check-in technology, helped trim the airline's second-quarter earnings by nearly 15%. But US Airways chief executive Doug Parker says it was needed. From an on-time rate that was 17 percentage points below the industry-wide rate in March, US Airways was just three points below average by June.
At Northwest Airlines, a pilot shortage in June led to thousands of cancellations that cost it as much as $25 million in the quarter. Northwest is offering a $1,500 one-time "signing bonus" to new baggage handlers at key cities as it moves to beef up its basic operations. Other carriers are cautiously hiring for front-line positions as consumer anger at delays continues to fill the airwaves and newspapers. By mid summer, flight delays, cancellations and passenger complaints were at record levels.
But despite its anger, the public is still in a buying mood. In the quarter, carriers that had lagged behind the industry's upward boom caught up. United Airlines posted its largest second quarter profit in seven years and JetBlue Airways boasted a 50% increase in earnings to $21 million as its operational performance recovered. JetBlue's revenues were rising by as much as 11% by late summer, although the carrier's chief executive Dave Barger says congestion and delays in the New York area airspace were hurting.
Chicago-based United had its best quarter since it earned $408 million in the second quarter of 2000, before it began the lengthy decline that ended in a reorganisation which lasted from 2002 to 2006. United has prospered in part by optimising its network. This effort has particularly showed in the results of United Express. Profit from its regional units almost tripled from $25 million a year ago to $71 million in this quarter.
After cutting domestic capacity this year, United filled 89.1% of its seats in June, the highest ever for that month. International passenger revenue climbed 16% in the quarter while North American revenue fell 2%, for an overall increase of more than 4%. United's chief revenue officer, John Tague, says the carrier has enjoyed some success in "selling up" or persuading passengers to buy a slightly higher fare bucket, into its Economy Plus cabin, which offers more legroom than other coach seats. Merrill Lynch analyst Mike Linenberg expects mainline unit revenues to climb by more than 5% for the rest of the year.
Loads continued to reach record levels and in mid summer, after the quarter closed, carriers posted all-time records. Delta Air Lines, for instance, says its July load factor was the highest in its history, with a load factor increase of 1.4 points to 86.8%. The carrier saw growth in both its domestic and international markets. At AirTran Airways, a 4.7 point increase led to an 86% load factor in July, well above its 75% rate in the first half of the year.
Calyon Securities analyst Ray Neidl believes load factors at these levels "are still too high, negatively impacting service as well as wearing out the carriers' assets, including its people". He adds: "We believe carriers could be more profitable by slightly raising airfares and slightly lowering load factors. This can help increase reliability."
But Neidl's cry, which echoes the rising complaints of passengers, has yet to strike a resonant chord. US majors, while fine-tuning schedules, are for the most part not adding but cutting. Instead, they are moving to trim domestic capacity to take advantage of demand elsewhere in the world for aircraft. Northwest, for instance, sold nine Airbus A319s in the quarter as it turned to 76-seat regional jets for its smallest unit. Elsewhere, JetBlue says it is selling three of its A320s and will take delivery of only seven new aircraft this year instead of the 10 it had originally scheduled. It also will postpone delivery of 16 smaller Embraer 190 jets, now planned for arrival between 2013 and 2015.
Time to calm down
JetBlue's Dave Barger says this was part of an overall slowdown: "Last year, we opened [in] 16 new cities. That's an awful lot of new cities in one year. Let's just calm it down." And Continental Airlines says it too will trim back growth plans. The carrier says it will slow capacity growth next year to 3-4%, down from the previous target of 5-7%, and it will sell 15 Boeing 737s from its domestic fleet through to November 2008.
Southwest Airlines has announced a 15-aircraft decrease in its planned 2008 fleet expansion. Meanwhile, American Airlines says its full-year domestic capacity will be 2.6% below the 2006 level, while United plans to finish the year with 2.5-3.5% less mainline domestic capacity. Northwest sees domestic capacity falling by as much as 5% in the third quarter and between 1% and 2% for the year.
The philosophy would seem to be that passenger discomfort is preferable to carrier deficits, and the airlines certainly have reason to be fearful. Fuel costs have started to reverse their downward trend and are spiralling back up. As Neidl points out: "The gorilla on the back of the industry is fuel costs." Tom Horton, chief financial officer at American, says "rising fuel prices are a real concern in the second half".
American, the largest US carrier, now expects to shell out an average of $2.11 per gallon of fuel, up from an average of $2.01 last year. At JetBlue, executives had originally budgeted fuel at $1.93 a gallon for the year. They now see average fuel costs rising to $2.07 a gallon, including hedges, from an average of $1.99 a gallon last year.
US Airways also upgraded its fuel cost forecast. The carrier now sees fuel costs ranging between $2.25 and $2.30 a gallon in the third quarter, at least 10¢ higher than in the second, and rising further in the fourth quarter. For the full year, its fuel costs are likely to average $2.17-$2.22 a gallon, up from $2.09 last year, despite hedging 53% of its purchases this year.
While the direction of fuel costs would seem certain and unwelcome, other trends are hardly more welcome as the airlines fly into autumn.
Source: Airline Business
