North American carrier profits, and those of US airlines in particular, continue to dominate the improved global industry performance, even with concerns around the US economy and capacity issues.
The region's operators again prospered in 2014, as this year's Airline Business World Airline Rankings shows collective net profits for the leading American carriers of nearly $8 billion. Though this is below the $12 billion generated in 2013, that figure was distorted by Delta Air Lines' $8 billion one-off income tax.
Collective operating profits showed the improvement more clearly, increasing $3.5 billion to top $17 billion in 2014. That contributed to over half the profits of the top 100 carriers.
Much of this performance has been fuelled by consolidation and tight capacity discipline. The latter now is under scrutiny, both from the markets and, more literally from competition regulators after the US Justice Department revealed it is investigating the possibility of collusion between US airlines on domestic capacity growth.
Wall Street analysts were quick to criticise the move. As Jamie Baker, an analyst at JP Morgan noted in a 2 July report: “The implication that airlines currently enjoy pricing power flies in the face of current data. Roughly 80% of fare increases we track have failed in recent years – so we can’t help but find humour in the suggestion of collusion.”
Indeed the markets of late have been more concerned about a lack of discipline. Gone are the days of near universal passenger unit revenue gains with “capacity discipline” the buzz words of the industry. Analysts now write of “capacity creep” and quarterly drops in unit revenues.
But no one is raising a red flag. US carriers are expected to continue lead as the industry heads for record profits this year. Indeed IATA in its June forecast further lifted net profit expectations for this year among North American carriers to $15.7 billion.
Wall Street analysts and rating agencies also still expect robust profits and margins from North American carriers this year despite the weaknesses in the US market and capacity creep that they have written so much about.
“Notwithstanding the current pressure on unit revenues in the US domestic market, markedly lower costs of jet fuel will more than outweigh the uninspiring trend in passenger revenue per available seat mile, resulting in strong growth in earnings and free cash flow,” said Jonathan Root, a senior credit officer at Moody’s Investors Service, in commentary on the rating agency’s upgrade of United Airlines in June.
Moody’s also upgraded Delta Air Lines in June, citing low fuel prices among its various reasons for the credit rating change.
Delta itself today kicked off the US carrier second quarter earnings season by announcing increased profits for the period.
Brent crude prices stood at $60.54 per barrel on 22 June, US Energy Information Agency (EIA) data shows. While that's nearly 10% higher than the start of the year, it is still nearly half the level of a year ago.
The EIA forecasts an average Brent crude price of $61 per barrel this year and $67 per barrel in 2016. Wall Street anticipates slightly higher average prices at about $65 to $70 per barrel this year and as much as $75 per barrel in 2016.
Low oil prices will provide US airlines with a windfall this year. Net savings could total up to $5 billion at American, $2 billion at Delta, about $1.7 billion at Southwest and, based on a back-of-the-notebook calculation, about $4 billion at United driving impressive cash flow and margin gains.
The airlines have said that plan to use these savings to accelerate their respective capital deployment programmes – primarily reducing debt and returning cash to shareholders.
US carriers are expected to increase domestic capacity by about 5.5% to 6% in the second and third quarters, analysts estimate. This is at least three percentage points higher than The Wall Street Journal consensus forecast of a 2.6% increase in the economic activity.
“In 2015, domestically, capacity is going to be up 5%, 6% this year,” said Scott Kirby, president of American Airlines, in May. “GDP is going to grow much less than that [and] industry RASM [revenue per available seat mile] is going to be down, even domestically… I think most people define ‘capacity discipline’ as supply aligned with demand – it’s not aligned in 2015.”
Industry PRASM is expected to slip about 5% as a result of this mismatch in the second quarter. American forecasts a 6% to 8% drop in PRASM, Delta a 4% to 5% decrease and United 5% to 6% fall compared to the same period a year ago.
The mismatch came as a bit of a surprise.
“I think the fact that we were all somewhat surprised with the economic performance in the first quarter with a negative 0.7% GDP print,” said Ed Bastian, president of Delta, at the beginning of June. The slowdown in economic activity has impacted close-in business bookings, he adds.
United has seen a similar drop in demand related to the slower economic growth, its chief financial officer John Rainey said in June. In addition, the global drop in oil prices has proved to be a double-edged sword for the Star Alliance carrier as oil and gas industry bookings have dropped about 20%.
“We don't want to grow 8%, we're not going to grow 8% and we can easily trim the schedule to stick to 7%,” said Gary Kelly, chief executive of Southwest, in June. “With weaker than expected economic growth, we continue to evaluate our 2016 capacity plans with a current intent to cap our ASM growth to approximately 6% year-over-year.”
The move was welcome by analysts who had attributed much of the domestic US capacity creep this year to the Dallas-based carrier, which is the largest airline in the market.
Southwest is not along in tempering its capacity plans. American has reduced its annual system capacity guidance by 0.5 percentage points to a roughly 2% increase and United by 0.5 points to a 1% to 2% increase in 2015.
Delta has cut two to three points from its fourth quarter capacity guidance to keep ASMs flat during the period. It has not released full year capacity numbers.
“It’s always a bit challenging when you’re posting all-time record profits and margins and still talking about reducing capacity,” says Bastian. “It just goes to show the difference that this industry has made from where it used to be. You would never in this industry see close to a 50% fall in fuel and then airlines talking about reducing capacity in the same sentence.”
More cuts may still be needed. While airlines are trimming capacity growth, it remains well above the consensus estimate for US economic growth.
“Growth generally is still too high,” says Hunter Keay, an analyst at Wolfe Research, in a report on 24 June. “However, our sense is that Q2 will mark the peak for capacity and the trough for PRASM.”
Source: Airline Business