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US Airways: Fair Warning by ALPA
By Vaughn Cordle, CFA / April 2006
My goodness. The new LCC makes its first profit -- a lousy $5m in net profits in 1Q06 -- and ALPA
is already positioning for higher pay. Can't really blame them, considering their bottom-of-the-list
pay. The problem, of course, is that all of those strong (sell-side analysts) buy ratings and
$70-$100 share price targets are based on current assumptions of costs.
Labor, as a supplier, will always be the winner in terms of which stakeholder receives the greater
value created by a major airline, at least in terms of value above and beyond that required to pay
operating costs and debt. No consideration for the poor old shareholder, whose opportunity costs
do not show up on the income statement. Customers also take a hit because the airline ultimately
will be unable to properly invest in its competitive resources.
In my view, the super-competitive labor costs that US Airways currently enjoys is a temporary
illusion. They are too low, at least relative to industry averages, especially Southwest. Labor will
demand—and get—the higher wages they perceive to be fair. “Fair” is not the same as saying the
airline can afford to pay it.
Everything is relative and, like the shareholders, US Airway's employees will want their "opportunity
cost" returns. The difference, of course, is that labor has the leverage and power to achieve their
targeted returns. Shareholders do not. It is this imbalance of power that makes the airlines such a
high-risk and lousy investment.
The airlines are simply not fit for long-term investment. It's a mature industry in decline and there is
nothing on the horizon that will change the nature of this dysfunctional and wealth-destroying
industry. Boom and bust cycles will continue and the big network airlines will continue to weaken
and be increasingly be uncompetitive in world markets. Older fleets and older flight attendants are
not what customers want to experience when they fly by air. Little things like the comfort/newness of
interiors and employee attitudes are a big deal to customers.
We now believe that the industry’s business cycle is closer to the end than the beginning, and that
further restructuring will be required in two to four years. At this point in the cycle, the airlines should
be building up lots of equity and reinvesting, but it's not happening, which doesn't bode well for
those airlines which have been so inefficient in the past. Many have underinvested for the last
decade and are unable to properly invest today, primarily because of higher fuel costs and
destructive fare competition.
Even if fuel costs fall to levels suggested by supply and demand, the industry will not earn its cost of
capital because (future) capacity growth and labor's demands will not allow it. Hence, the prediction
that airlines are destined to constantly restructure and churn the shareholders. Various suppliers,
labor, lessors, manufacturers, airports, bankers, and consultants will continue to feed off the
primary driver of all of the activity required to keep the aircraft in the air.
In the final analysis, maybe the airline shareholder really doesn't matter, though I don't think this is a
good thing for our nation, consumers, or the industry in the long run. However, as long as suppliers
are willing to provide cheap capital, we will continue to have commercial airlines, even if they supply
an increasingly shoddy and uncomfortable experience. The best a shareholder can do is take
advantage of the high volatility and trade the shares. US Airway's shareholders have been given fair
warning by ALPA.
By Vaughn Cordle, CFA / April 2006
My goodness. The new LCC makes its first profit -- a lousy $5m in net profits in 1Q06 -- and ALPA
is already positioning for higher pay. Can't really blame them, considering their bottom-of-the-list
pay. The problem, of course, is that all of those strong (sell-side analysts) buy ratings and
$70-$100 share price targets are based on current assumptions of costs.
Labor, as a supplier, will always be the winner in terms of which stakeholder receives the greater
value created by a major airline, at least in terms of value above and beyond that required to pay
operating costs and debt. No consideration for the poor old shareholder, whose opportunity costs
do not show up on the income statement. Customers also take a hit because the airline ultimately
will be unable to properly invest in its competitive resources.
In my view, the super-competitive labor costs that US Airways currently enjoys is a temporary
illusion. They are too low, at least relative to industry averages, especially Southwest. Labor will
demand—and get—the higher wages they perceive to be fair. “Fair” is not the same as saying the
airline can afford to pay it.
Everything is relative and, like the shareholders, US Airway's employees will want their "opportunity
cost" returns. The difference, of course, is that labor has the leverage and power to achieve their
targeted returns. Shareholders do not. It is this imbalance of power that makes the airlines such a
high-risk and lousy investment.
The airlines are simply not fit for long-term investment. It's a mature industry in decline and there is
nothing on the horizon that will change the nature of this dysfunctional and wealth-destroying
industry. Boom and bust cycles will continue and the big network airlines will continue to weaken
and be increasingly be uncompetitive in world markets. Older fleets and older flight attendants are
not what customers want to experience when they fly by air. Little things like the comfort/newness of
interiors and employee attitudes are a big deal to customers.
We now believe that the industry’s business cycle is closer to the end than the beginning, and that
further restructuring will be required in two to four years. At this point in the cycle, the airlines should
be building up lots of equity and reinvesting, but it's not happening, which doesn't bode well for
those airlines which have been so inefficient in the past. Many have underinvested for the last
decade and are unable to properly invest today, primarily because of higher fuel costs and
destructive fare competition.
Even if fuel costs fall to levels suggested by supply and demand, the industry will not earn its cost of
capital because (future) capacity growth and labor's demands will not allow it. Hence, the prediction
that airlines are destined to constantly restructure and churn the shareholders. Various suppliers,
labor, lessors, manufacturers, airports, bankers, and consultants will continue to feed off the
primary driver of all of the activity required to keep the aircraft in the air.
In the final analysis, maybe the airline shareholder really doesn't matter, though I don't think this is a
good thing for our nation, consumers, or the industry in the long run. However, as long as suppliers
are willing to provide cheap capital, we will continue to have commercial airlines, even if they supply
an increasingly shoddy and uncomfortable experience. The best a shareholder can do is take
advantage of the high volatility and trade the shares. US Airway's shareholders have been given fair
warning by ALPA.
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