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  • ANALYSIS: Analysts speculate on impact of broader tax law

ANALYSIS: Analysts speculate on impact of broader tax law

The only certainty about the impact of the new US tax law seems to be that some airlines, provided they remain profitable, will pay less federal tax in 2018.

Beyond that, little is known about the broader impact of the tax changes, such as how the overhaul might affect carriers' capacity, fares or new aircraft purchases.

Also unknown is whether consumers who see a bump in take-home pay will spend more money on air travel.

Despite many open questions and little guidance from airlines, however, industry analysts view the tax changes positively and predict carriers will not plough savings into lower fares.

"We believe the benefits of tax reform are real and will create value over the coming years," says investment bank Morgan Stanley in a recent report.

The report says lower tax bills may eventually push up carriers' revenue, income and earnings per share.

Signed by president Donald Trump on 22 December 2017, the bill sets the corporate tax rate at 21%, down from the current rate of 35% of profits in excess of $10 million.

The new law also limits the amount of interest expenses US companies can deduct to 30% of adjusted profits, though US carriers do not exceed those limits, Morgan Stanley says.

The lower tax rate, however, will initially affect only the US airlines that actually pay taxes in cash. Those airlines include Alaska Air Group, JetBlue Airways and Southwest Airlines.

Large network carriers American Airlines, Delta Air Lines and United Airlines have avoided cash tax payments in recent years by offsetting profits with previous years' losses.

But those airlines, too, will benefit because the lower tax rate will enable them to carry those losses further forward into the future, says Hunter Keay, analyst at Wolfe Research.

US airlines have praised the new tax code, and several responded by announcing they will pay employees bonuses of $1,000 each.

But carriers have said little about how the changes will impact broader business decisions. Many did not respond to questions from FlightGlobal; others responded with previously prepared statements.

American said it intends to "invest even more in aircraft and facilities… with even greater confidence in the future", and Southwest announced it had exercised options to purchase 40 Boeing 737 Max 8s.

Delta referenced a 15 December 2017 tax-related post on LinkedIn in which chief executive Ed Bastian said the airline will continue to invest half its profits back into the business, while using the other half to pay debt and fund its pension plan.

Hawaiian Airlines said on 5 January that it will use tax savings to "improve the experience of our guests", citing a redesign of the Honolulu airport as an example.

IMPACT ON FARES

Although airlines have had a long history of slashing fares after realising savings from lower fuel prices, carriers may keep much of the tax savings for themselves, say analysts.

"The US airline industry has a pretty spotty track record of turning something that should be good into something bad," says Keay.

But, he adds, "I'm a little more optimistic the industry can retain [tax savings]".

That is because executives primarily base capacity and pricing decisions on factors like operating expenses and route profitability, not non-operating expenses like taxes, says Keay.

Also, airline chief executives have little personal financial incentive to use tax savings to reduce fares or increase capacity.

A 5 January report from Wolfe notes that pre-tax metrics like profit margins, unit revenues, unit costs and return on investment determine 75% of airline chief executives' compensation, while other metrics associated with stock price and operations determine another 18% of pay.

Companies base only about 7% of chief executive compensation on "after-tax financial measures", Wolfe says.

"Since tax reform doesn't impact pretax metrics… we think it's safe to assume airline CEOs won't push for major changes to existing strategies," says Wolfe's report. "This tax code change doesn't impact how CEOs are paid."

"Lowering fares based on tax reform doesn't make [CEOs] any more money. It might make [them] less money," Keay adds.

CONSUMER DEMAND

Also unclear is whether lower tax bills paid by both corporations and consumers will bump up air travel demand.

"That's a wildcard. No one really knows," says Keay. "At worst, it's neutral."

Morgan Stanley says: "Demand has upside potential given the uplift to [gross domestic product] and corporate profits".

"With travel and experiences in high demand, any further boost to household income may show up in a higher rate of onboards," the bank said in December.

Subodh Karnik, chief executive of US regional carrier CommutAir and a former executive at carriers like Delta, Northwest Airlines and Continental Airlines, questions whether tax savings will really lead to more travel.

"Competition and capacity is a much bigger driver than whether you have another buck in your pocket," he says.

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