Unsure footing

Regional airlines on both sides of the Atlantic are facing up to changes brought by labour cost hikes and the worsening global economy

The good times could not last forever, even for the booming regional airline sector. This year the slowdown has indeed been confirmed more profoundly than anyone could have expected. In the key markets of North America and Europe finances have been hard hit by the world's worsening economic fortunes and a bout of labour strife. The recent acts of terrorism may affect regionals less than their mainline masters, but the downturn and uncertainty they have brought are cause for further concern.

Already last year there were signs from the regionals, in common with the airline industry as a whole, that profits were coming under pressure from a mix of rising fuel and falling yields. Revenues clearly boomed again in 2000, as shown by the 15% hike registered in the Top 50 regional airline ranking (see table below). Yet despite such growth, profitability began to slip over the year, with operating margins in the ranking dipping to 5.8%. That still marks a good performance but the sector had been used to margins closer to double digits.

Admittedly the figures are only a rough guide, but the trend seems clear enough. Europe in particular appears to have sunk to net losses, penalised as fuel and exchange rate fluctuations raised costs. Although US regionals continued to report robust profits, the margins were down from the double digits. And the weaknesses that were already becoming evident last year have carried through to the first half of 2001.

In the USA, both labour and the slumping economy have come to the fore. Comair, now wholly owned by Delta Air Lines, grounded itself for 89 days over a pilot compensation dispute. At issue was the pay scale for regional jet (RJ) pilots. The wage dispute at Delta cost the company $195 million, but - more importantly - it resulted in a pilot pay scale that will reach $117 per hour at the end of the contract, up from the previous hourly ceiling of approximately $70 albeit on some larger aircraft.

The contract was quickly used in negotiations at other regionals, resulting in even more expensive contracts. Pilots at Alaska Airlines affiliate Horizon Air now top out at $120/h and the bill at Air Wisconsin looks set to approach $135/h.

Pay rises such as these throw the attractiveness of RJs into serious question. Lower labour costs - coupled with passenger approval - were key reasons why mainline carriers channelled so much flying down to their regional affiliates. The new higher pay rates throw that equation into serious disequilibrium, even as new RJs - ordered during the boom - continue to be delivered.

Among other side effects of this situation could be an end to activeness of regional affiliates as an acquisition target for majors. After Delta's experience, Northwest Airlines put on ice its plans to assume ownership of Mesaba. Indeed, analysts think that the timing of Continental Airlines' announcement that it would publicly float its Express arm was also no coincidence.

While history suggests that regionals are not as adversely impacted by economic slowdown as their parents, they are by no means completely insulated.

Debbie McElroy, president of US trade group the Regional Airline Association, says that the RAA membership will suffer from "the twin challenges of the decline in business travel and falling yields"as well as the cost implications. She adds that the labour situation at the country's majors will also magnify the negative effects arising from the economic slowdown. "In past downturns, the majors could transfer some of their routes to regionals, but labour contracts have been revised, making that a lot less easy than it used to be." Further, analysts believe that cost-cutting at the majors could lead to the renegotiation of contracts with regionals.

Although they have so far been little affected by terrorism in the USA, Europe's regionals too are preparing for downturn. Mike Ambrose, director general of the trade body European Regions Airline Association (ERA), says that the his membership has seen lower passenger growth rates than at any time in the past decade, although they still remain higher than those posted by the majors.

While he attributes some of these declines to a natural slowing of what had been extraordinary capacity and traffic growth, Ambrose is quick to add that the regionals "are quite evidently feeling the cool winds of economic recession". He also believes that the events of 11 September will exacerbate the slowdown, but takes some solace from the fact that regionals have historically been less impacted by such disasters.

While that represents a rare piece of good news, it is only a glimmer. As the recession continues to loom, the way ahead promises plenty of financial turbulence for regional carriers on both side of the Atlantic.

Source: Airline Business