 |  |  |  |  |
2005 is shaping up to be a very tough year
January 5, 2005 l Vaughn Cordle, CFA
Our analysis suggests that the big stories in '05 will be the failure of US Airways and Delta’s new
fare policy initiative. As much as we would like to see USAir survive, they may not be able to
overcome the negative press reports and their impact on forward bookings and revenue.
The biggest risk has always been labor and the IAM is threatening to strike the airline. The
Christmas holiday "operational meltdown" may not have been that big of a deal in terms of
operational costs, but the revenue hit could kill the company.
We examined the revenue forecasts for 53 industries in the US and find that the economy will
decelerate this year. In other words, GDP growth may be 100 to 150 basis points lower in 2005.
Add to that excess capacity, plunging domestic yields and high fuel costs and 2005 is shaping up to
be the year of the shake out in the financially distressed airline industry.
It is a make or break year for bankrupt airlines like United and USAir and it appears that USAir will
break. Industry capacity growth will slow from about 7% in '04 to perhaps 5% this year; however,
this is not enough considering the pricing environment and need to raise fares. The problem of
course is that average fares will continue to fall.
Delta's new pricing strategy is something that someone should have tried long ago, however, the
fear of taking a revenue hit in the short run has always held back management.
Passengers will perceive that the new pricing policy reduces the risk of being treated unfairly and
gouged by an uncaring and money-grubbing airlines. This is the perception that exists even as
consumers benefit from historically low fares.
Perhaps the greatest value to the legacies of adopting a fair and consistent fare structure is winning
back market share from the LCCs.
The expensive labor agreements of the past have masked the benefits of the network and are largely
the reason why legacy airlines had to manage yields in a way that destroyed passenger goodwill
over the longer term.
Delta's lower simpler fare strategy in Cincinnati is positive because Cincinnati was a high fare hub.
However, if they roll out the pricing scheme system wide the stimulative effect will be muted
because low fares already exist in most markets.
Our work suggests that the industry as a whole is price inelastic. In other words, if yields fall 1%
systemwide traffic only increases .85%. In contrast, when Southwest's yields decrease 1%, traffic
increases 5.5%. This is because Southwest is going into high fare markets against airlines like
USAir.
We suspect that Delta has overestimated the stimulative effect and underestimated the revenue hit.
The higher fares (and the perception that they were unfair) allowed the LCCs to gain market share.
LCCs now dictate domestic pricing and this is why Delta and others are forced to change their fare
policies. Aggressive yield management produced short-term revenue gain, but long-term revenue
pain!
Simple fares mean less cost for the airlines and it improves the value proposition for the
passenger. Unfortunately, we believe that the stimulative effect of lower average fares will not offset
the hit to revenue. It most likely will be a negative short AND long-term revenue proposition. This is
not the same as saying it is a bad strategy, but it appears that it accelerates the shake out
underway. It will take a shake out before a recovery can take hold.
The strategy works for Delta if other competitors do not match them and someone fails. If they do
match and no one fails or pulls down capacity growth everyone loses including Delta.
Unless some capacity comes out of the system, i.e., a collapse of USAir, more airlines, including,
Delta could find themselves in bankruptcy. Delta is already facing over $6 billion in under funded
pensions and has over $20 billion in debt.
The assumptions being made at AirlineForecasts are that USAir could fail and that Delta is counting
on this. It is a high stakes game and somebody has to lose before the industry recovers. In other
words, it is a war of attrition.
With new labor agreements in place and relief from the ATSB and GE, USAir's economics suggest
that they can survive - at least for a while. It is reasonable to assume that the ATSB will provide relief
now that labor agreements are in place.
Creditors and labor do not want the airline to shutdown and the company should be able to pay its
bills with recent the new labor agreements in place.
The biggest risk is labor in the form of IAM job actions and the revenue hit from Delta's new fare
initiatives. Fare wars and labor wars can put them over the edge. However, for now their fate is in
the hands of the ATSB and a bankruptcy court judge. It is highly likely the ATSB will provide relief, but
the company must still raise exit financing. No easy task given their competitive situation.
No relief in sight for fuel costs.
WTI oil averaged $31 in '03 and $41.52 in '04. A good point estimate for 2005 is $45. A good range
estimate is $37 to $48. A swing in price of just one dollar affects the 13 US airlines we follow by
about $350 million, which factors in the benefits of fuel hedging programs. Even given a best-case
scenario with oil prices falling to the low $30s, this still means the industry only breaks even in '05,
and this before the revenue hit from Delta's fare initiative.
The big themes for 2005 are: 1) decelerating economic growth, 2) high fuel costs, 3) excess
capacity, and 4) fare wars.
Delta’s new fare initiative, if matched by others, could reduce industry revenue by $1 to $3 billion.
Without additional cost reductions and fuel savings, this would imply that industry will lose $4 to $5
billion this year, which follows 2004’s $5.5 billion in losses.
The losses are unsustainable and something has to give or someone has to shrink or go out of
business for an industry recovery to take hold. This is great news for the consumer, but bad news for
the airline industry.
January 5, 2005 l Vaughn Cordle, CFA
Our analysis suggests that the big stories in '05 will be the failure of US Airways and Delta’s new
fare policy initiative. As much as we would like to see USAir survive, they may not be able to
overcome the negative press reports and their impact on forward bookings and revenue.
The biggest risk has always been labor and the IAM is threatening to strike the airline. The
Christmas holiday "operational meltdown" may not have been that big of a deal in terms of
operational costs, but the revenue hit could kill the company.
We examined the revenue forecasts for 53 industries in the US and find that the economy will
decelerate this year. In other words, GDP growth may be 100 to 150 basis points lower in 2005.
Add to that excess capacity, plunging domestic yields and high fuel costs and 2005 is shaping up to
be the year of the shake out in the financially distressed airline industry.
It is a make or break year for bankrupt airlines like United and USAir and it appears that USAir will
break. Industry capacity growth will slow from about 7% in '04 to perhaps 5% this year; however,
this is not enough considering the pricing environment and need to raise fares. The problem of
course is that average fares will continue to fall.
Delta's new pricing strategy is something that someone should have tried long ago, however, the
fear of taking a revenue hit in the short run has always held back management.
Passengers will perceive that the new pricing policy reduces the risk of being treated unfairly and
gouged by an uncaring and money-grubbing airlines. This is the perception that exists even as
consumers benefit from historically low fares.
Perhaps the greatest value to the legacies of adopting a fair and consistent fare structure is winning
back market share from the LCCs.
The expensive labor agreements of the past have masked the benefits of the network and are largely
the reason why legacy airlines had to manage yields in a way that destroyed passenger goodwill
over the longer term.
Delta's lower simpler fare strategy in Cincinnati is positive because Cincinnati was a high fare hub.
However, if they roll out the pricing scheme system wide the stimulative effect will be muted
because low fares already exist in most markets.
Our work suggests that the industry as a whole is price inelastic. In other words, if yields fall 1%
systemwide traffic only increases .85%. In contrast, when Southwest's yields decrease 1%, traffic
increases 5.5%. This is because Southwest is going into high fare markets against airlines like
USAir.
We suspect that Delta has overestimated the stimulative effect and underestimated the revenue hit.
The higher fares (and the perception that they were unfair) allowed the LCCs to gain market share.
LCCs now dictate domestic pricing and this is why Delta and others are forced to change their fare
policies. Aggressive yield management produced short-term revenue gain, but long-term revenue
pain!
Simple fares mean less cost for the airlines and it improves the value proposition for the
passenger. Unfortunately, we believe that the stimulative effect of lower average fares will not offset
the hit to revenue. It most likely will be a negative short AND long-term revenue proposition. This is
not the same as saying it is a bad strategy, but it appears that it accelerates the shake out
underway. It will take a shake out before a recovery can take hold.
The strategy works for Delta if other competitors do not match them and someone fails. If they do
match and no one fails or pulls down capacity growth everyone loses including Delta.
Unless some capacity comes out of the system, i.e., a collapse of USAir, more airlines, including,
Delta could find themselves in bankruptcy. Delta is already facing over $6 billion in under funded
pensions and has over $20 billion in debt.
The assumptions being made at AirlineForecasts are that USAir could fail and that Delta is counting
on this. It is a high stakes game and somebody has to lose before the industry recovers. In other
words, it is a war of attrition.
With new labor agreements in place and relief from the ATSB and GE, USAir's economics suggest
that they can survive - at least for a while. It is reasonable to assume that the ATSB will provide relief
now that labor agreements are in place.
Creditors and labor do not want the airline to shutdown and the company should be able to pay its
bills with recent the new labor agreements in place.
The biggest risk is labor in the form of IAM job actions and the revenue hit from Delta's new fare
initiatives. Fare wars and labor wars can put them over the edge. However, for now their fate is in
the hands of the ATSB and a bankruptcy court judge. It is highly likely the ATSB will provide relief, but
the company must still raise exit financing. No easy task given their competitive situation.
No relief in sight for fuel costs.
WTI oil averaged $31 in '03 and $41.52 in '04. A good point estimate for 2005 is $45. A good range
estimate is $37 to $48. A swing in price of just one dollar affects the 13 US airlines we follow by
about $350 million, which factors in the benefits of fuel hedging programs. Even given a best-case
scenario with oil prices falling to the low $30s, this still means the industry only breaks even in '05,
and this before the revenue hit from Delta's fare initiative.
The big themes for 2005 are: 1) decelerating economic growth, 2) high fuel costs, 3) excess
capacity, and 4) fare wars.
Delta’s new fare initiative, if matched by others, could reduce industry revenue by $1 to $3 billion.
Without additional cost reductions and fuel savings, this would imply that industry will lose $4 to $5
billion this year, which follows 2004’s $5.5 billion in losses.
The losses are unsustainable and something has to give or someone has to shrink or go out of
business for an industry recovery to take hold. This is great news for the consumer, but bad news for
the airline industry.
©Copyright 2006 AirlineForecasts, LLC All Rights Reserved