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Airlines - Sunset Industry

Page history last edited by PBworks 15 years, 8 months ago

Dick,

I believe that the business market will decline slightly as business travelers consolidate trips to save expenses but will continue to travel at a fairly normal rate. On the other hand, the leisure travel will decline significantly. Both younger travelers and older retirees will cut back or stop flying all together. This condition will continue for the next 12 to 18 months. After this period, travel will adjust to the new fare structures and I believe we will see some return to more normal levels. However, traffic will not return to the full level for the next several years. In the long run, I still believe MSP will reach 45-50 million passengers per year by 2025 if Delta treats MSP as a major hub and grows with the market.

           

Jeff

 

Airlines - Sunset Industry?

Monday, June 23, 2008; Posted: 08:30 AM

© 2008 The Connors Group, Inc.

 

(RTTNews) - The beleaguered U.S. airline industry is struggling to make

a 'safe landing' in a turbulent air of financial and operational crisis.

Fleet cancellations, grounding of planes, massive workforce reduction

and bankruptcy filings are among the problems that are compounded by the

skyrocketing of fuel prices. Adding oil to the fire, consumer confidence

and travel demand have been receding, reflecting the slowdown in the

overall economy.

 

 

Fuel expenses of major airlines, which control 71% of the U.S. market

share, increased 128% since 2000 to $27.6 billion in 2007. During

this seven-year period, capacity as measured by Available Seat Miles

decreased 7% and operating revenue remained nearly the same at about $95

billion. The industry has laid off nearly four out of 10 of its

employees over the years. The carriers have also defaulted on about $20

billion worth of pension payments.

 

 

Airline Industry - Evolution

 

The U.S. airline industry was deregulated in 1978 following the Congress

passing the Airlines Deregulation Act. Prior to the deregulation, the

Civil Aeronautics Board controlled routes as well

as ticket prices. 

 

Following deregulation, the industry flourished with the number of

passengers carried rising manyfold. In the early years of deregulation,

there was intense competition among established airlines and from

new entrants as well as from carriers formerly confined to intra-state

markets. In the mid-to-late 1980s, there was a wave of industry

consolidation. The major carriers developed a powerful hub-and-spoke

networks system that secured them monopoly over certain airports and

regions.

 

 

However, coinciding with the Gulf War and the economic recession in the

early 1990s, the industry went into a slump, when airlines like Pan

American and Eastern disappeared. A few gusty players like Continental

Airlines Inc. and TWA, meanwhile, sought protection under Chapter 11

bankruptcy.

 

 

Although low cost carriers operated without much success and were

assimilated by the bigger carriers, the emergence of Southwest Airlines

Co. as a discount carrier in

the late 1990s sent tremors down the spine of the major operators.

Southwest's success rested on its strategy of averting a head-to-head

showdown with the major carriers and the usage of second tier airports

near the biggest cities. It also hedged most of its fuel requirements

and purchased fuel options years in advance to smooth out fluctuations

in fuel costs. In the years 2001, 2002 and 2003, Southwest reduced its

annual fuel expense by $171 million, $45 million, and $80 million,

respectively, through its fuel hedging operations. The company hedged

95% of its fuel usage at $50 a barrel in 2006 and nearly 70% of its

fuel requirement at about $51 per barrel in 2007.

 

 In 2000, just as the industry was emerging from a slowdown, it entered into another

downturn in 2001. In the period between 2001 and 2004, the industry

turned in net losses of $32.1 billion, pressured by an economic slowdown

in 2001, the SAARs epidemic, intense competition, the aftermath of the

September 11 attacks and a rise in oil prices. During this period, the

average crude oil price rose about 60%.

 

 

Fuel Price Impact

 

Of late, jet fuel prices are hovering near new record highs due to

higher prices of crude oil, which in turn, some say, is driven higher by

speculation and fears of supply disruptions. The airline industry

purchases about 80% to 95% of its jet fuel requirements directly from

refiners on a formula pricing basis.

 

 

In the week ended May 30, the price of jet fuel was $160.7 a barrel, a

12.6% rise from April and a 90% increase from the same period last year.

Nevertheless, the price represented a 6.5% decline from the week ended

May 23rd.

 

 

Meanwhile, July crude rose $3.90 to $135.83 a barrel on the New York

Mercantile Exchange on Friday amid supply jitters following news that

Israel practiced an attack on Iran's nuclear sites. Last Monday, crude

for July delivery had settled at a record $139.89 a barrel.

 

 

According to the International Air Transport Association, or IATA, which

represents about 230 airlines globally comprising 94% of the scheduled

international air traffic, jet fuel price would average around $131.5

per barrel in 2008, adding $74 billion more to the 2008 fuel bill of

airlines.

 

 

In 2007, worldwide airline operators' fuel expenses were $136 billion,

roughly 29% of their total operating expenses. In 2006, the fuel bill

reached $111 billion, accounting for 26% of the industry's total

operating expenses. In 2005, fuel expenses, representing 22% of

operating expenses, rose to $90 billion from $61 billion a year ago.

 

 

U.S. airlines' recent quarterly results reflect the impact of soaring

fuel prices on their earnings. Continental, JetBlue, Delta, Northwest,

United and U.S. Airways reported losses for

the first quarter, primarily due to high fuel costs. Revenue growth and

cost control measures did not help United and JetBlue to weather the

weakness induced by higher fuel costs. Delta, which emerged from

bankruptcy in 2007, incurred a goodwill impairment charge of $6.1

billion relating to a decline in the company's market value due to a

surge in crude prices to fresh records. Southwest was the only airline

to post a profit, though lower than the year-ago period, reaping the

benefit of its fuel-price hedging.

 

 

Other Costs and Bottlenecks

 

Other than fuel costs, the airline sector is paying several charges and

fees relating to airport, Air Traffic Control and taxation, all of which

are increasing. These infrastructure charges form the second largest

external cost to airlines after fuel. Worldwide, airlines pay at least

$43.5 billion a year to airports and Air Navigation Service Providers,

or ANSPs, or about 11% of airline revenues. The aviation industry is

also highly taxed in comparison to other transport modes.

 

(Editor's Note: But airlinss pass on these charges to their customers, just

as most other industries routinely do.0

 

 

Further, the industry is facing pressure from Government agencies and

policy makers to harness technology to meet new environmental

challenges, as technological improvements can play a major part in

reducing the "carbon footprint" of the aviation industry. Aviation is

under the spotlight of environmental groups because it is one of the

most rapidly growing sources of greenhouse gases.

 

 

Also, the sector has recently witnessed several unexpected groundings

and flight cancellations due to safety issues and functional checks

following a crackdown by the Federal Aviation Administration (FAA).

The agency has been auditing airline maintenance records following the

discovery of fuselage cracks in four planes of Southwest in mid-March.

FAA directive has ordered the nation's airlines to inspect their older

Boeing 737 jets for problems.

 

 

The latest in a series of grounding of aircraft by United Airlines,

 in April, delayed or cancelled flights due to a functional check ordered on all 52 of its Boeing 777

aircraft.

 

 

Prior to that, American Airlines canceled most of its Boeing MD-80 flights

for FAA-ordered inspections. About 171 of the airline's 2,200 daily flights

were canceled, while about two-thirds of its 300-plane MD-80 fleet was

temporarily grounded.

 

 

Delta had revealed the cancellation of about 275 flights for a voluntary

safety review. Meanwhile, the National Transportation Safety Board, or

NTSB, has been investigating the separation of a composite panel from

the wing of a Boeing 757 aircraft of U.S. Airways on the route from

Orlando, Florida, to Philadelphia, Pa.

 

 

 

U.S. airlines lost $26.5 billion in 2007 as air travelers

made about 41 million fewer trips due to frustrations stemming from

unexpected cancellations and delays and inefficient security screening,

according to a survey by the Travel Industry Association, or TIA. This

is not a small amount for the aviation sector and the economy,

especially when both are trying to find equilibrium in a tough time. The

survey also showed that nearly 50% of air travelers felt the air

travel system was not likely to improve in the near future. Monthly load

factor and traffic data reported by many airlines reveal the impact of

this decline in passenger numbers.

 

 

According to Roger Dow, president and CEO of

TIA, the crisis has hit a tipping point, with more than

100,000 travelers each day voting with their wallets by choosing to

avoid trips. He also said that the time is up for a meaningful reform in

the airline sector.

 

 

Hard Steps

 

With rising fuel costs, the market recession in the U.S, and intensified

competition, the only way for airline operators to limit losses

is under way: capacity reduction and maximum efficiency gains.

With oil hovering near $140 a barrel, many have announced plans to cut service

another 12% this fall after 10% reductions six months earlier. Some analysts are

calling for an overall 20% reduction in industry service to stem red ink.

 

  Continental's chairman and chief executive Larry

Kellner recently declared. "The airline industry is in a

crisis. Its business model doesn't work with the current price of fuel

and the existing level of capacity in the marketplace. We need to make

changes in response." The company has decided to cut 3,000 jobs and pull 67 older,

less fuel-efficient jets out of service. In the first six months of

2008, Continental removed six older aircraft from service.

 

 

Just a day before Continental's announcement, United said that it is

planning to cut as many as 1,600 workers and ground 100 airplanes in its

struggle for viability. United has also hiked domestic fares up to $60

round trip to mitigate the impact of higher fuel prices.

 

 

The hard steps taken by Continental and United were followed by American

Airlines, which will reduce domestic capacity by

11% to 12% in the fourth quarter and retire about 75 airplanes, while

cutting several thousand jobs. The company has also begun charging $15

for the first piece of checked luggage on domestic flights. Meanwhile,

Delta plans to reduce capacity by about 10% and slash 3,000 jobs.

 

Last week, U.S. Airways revealed additional

domestic capacity reductions, eliminating about 1,700 positions and

implementing several new revenue initiatives. The

company's domestic mainline capacity for 2009 is proposed to be reduced

by 7% to 9% over 2008. Additionally, U.S. Airways plans to

introduce a first-checked-bag service fee of $15 and a new in-flight

beverage purchase program.

 

  Northwest Airlines has announced a series of capacity reductions for the second time this year. The company will reduce its

consolidated capacity by 3% to 4%, mainline capacity by 8.5% to 9.5% and

domestic capacity by 7% to 8%. Earlier, in April, the airline had

indicated a 5% reduction in its scheduled domestic system capacity over

the 2008 business plan. In May, the company started collecting fees for two or more checked bags. On June 26, it announced suspension of its two-month-old Minneapolis-Paris nonstop flight this fall, and will terminate  Detroit-Dusseldorf and Hartford-Amsterdam service this fall.

 

Additionally, many carriers have cancelled orders for new aircraft.

JetBlue said it will delay buying 21 new Airbus jets for four to five

years. Qantas Airways also has cancelled an order for a new Airbus jet.

 

Airbus said recently that it expects more cancellations and

postponements for aircraft orders as carriers lower capacity.

 

Meanwhile, beginning June 1, the world's leading airlines have switched

to e-ticketing, which translates into major cost savings in terms of

paper. According to industry observers, airline should emulate

e-commerce companies and increase the number of services they offer

online, such as travel insurance, hotel reservations and rental cars,

all services available to passengers after booking a ticket. It broadens

the revenue base.

 

 

Further, in an effort to tackle fuel price costs, Continental and United

have announced a framework agreement that would link their networks and

services worldwide to create revenue opportunities and cost savings.

Additionally, Continental plans to join the Star Alliance that will

allow the airline to cooperate with other airlines in international

regions.

 

 

Mergers and Bankruptcy Filings

 

As the global aviation sector is waging a war for survival, more mergers

and bankruptcies are likely, according to Willie Walsh, the chief

executive officer of British Airways.

 

 

"I suspect that many airlines out there that struggled when fuel was

less than $100 a barrel are not going to be able to take the required

actions and we will see further failures," Walsh said.

 

 

Seven airlines have failed in the last five months, including Oasis Hong

Kong Airlines Ltd., Skybus Airlines Inc., Frontier Airlines Holdings

Inc., Silverjet Plc and Aloha Airlines. Frontier Airlines and ATA

Airlines filed for bankruptcy in April.

 

 

A Chapter 11 bankruptcy filing, which is considered as a painless

bailout strategy, would mean the unsecured bond holders of the company

are likely to lose about 90% of the value of the security. Ironically,

the fact is that none of the airlines had filed for bankruptcy before

the deregulation.

 

 

Also, the recent $17.7 billion merger agreement between Delta and

Northwest reflect the aviation industry's largely unsuccessful efforts for combinations

that deliver effective cost synergies and additional profit. Many fail on the rocks of unresolved culture issues that affect customer service. The Delta/NWA merger's proposed billion-dollar cost savings are being challenged by many investors as insufficient to cover the recent 60% rise in jet fuel prices.

 

 

Just a day after the Delta-Northwest merger deal announcement,

Continental Airlines said that it is looking at strategic alternatives.

Continental backed away from a rumored merger plan with United. But the two firms have held

discussions about forming an alliance to secure some benefits of working

together without actually going into a merger. There was also media

speculation that United was pursuing talks with U.S. Airways. However,

a report May 30 suggested that United's

officials have decided not to continue the negotiations.

 

 

Industry experts believe that, apart from the Delta-Northwest deal, no

mergers among U.S. carriers are likely to take place until 2009.

However, days of some sort of "combined action", including a strategic

amalgamation or sharing of common amenities, are not very far off, some say.

 

Further, the recent "Open Skies" agreement between the U.S. and the European

Union is expected to open new transatlantic service. The new

deal allows flights from Europe to fly directly to their U.S.

destinations, ending the previous practice tht required governments on both sides of the Atlantic to

negotiate access for airlines to airports on a city-by-city basis.

Continental, Delta and Northwest have already

added flights to London's Heathrow International Airport.

 

 

Also, changes in rules limiting foreign ownership of U.S. airlines is a

major agenda in the "Open Skies" agreement. Liberalizing the cap of 25%

would give carriers another source of potential capital. German carrier

Lufthansa's purchase of 19% stake in JetBlue earlier this year is seen

as a movement in this direction. As per reports, Air France-KLM has

contemplated the possibility of making an investment in Delta.

 

 

Weakening 2008 Outlook

 

With the relentless rise in fuel costs, IATA now expects the airline industry to

lose upwards of $2.5 billion in 2008, compared with a profit of $5.6 billion in 2007. If fuel costs continue to rise, the loss could widen to $5 billion, IATA  

 

 

IATA also believes that assets owned by airlines in other

sectors, which have provided a cushion, would not act as a savior this

year. This source of cash may diminish in 2008 as the crisis in the

financial market makes asset sales more difficult, the firm noted.

 

 

Stock Performance

 

Reflecting the turmoil in the sector, airline stocks have declined more

than 22% in the last three-month period. UAL, U.S. Airways and AirTran

Holdings Inc. were the biggest losers, with their stocks plunging 69%, 64% and 57%,

respectively. Meanwhile, shares of Southwest gained over 15% during the

period.  

 

Tough Time Ahead

 

Few analysts are very optimistic about the immediate future, fearing that the massive job cuts

and layoffs will make the coming years the worst for the industry since 2001.

 

 

"Nobody right now has a viable long-term business plan," said Darryl

Jenkins, a Virginia-based airline industry observer. According to him,

the cuts should have been made years ago. Meanwhile, in spite of the aforementioned criticism,he highlighted the deal between Delta and Northwest as the future business model for legacy carriers.

 

 

Certain industry experts foresee the industry having to cut more than 60,000 jobs

 in 2008. Additionally, with fuel prices showing no signs of decline, passengers have seen ticket prices rise 30% since the first of the year, and may need to face further increases of up to 20% before many airlines can begin a recovery, says Doug Steenland, outgoing CEO of Northwest.

 

 

However, recently, brokerage Lehman Brothers upgraded the U.S. airline

sector to "positive" from "neutral," saying the industry restructuring

was coming at an accelerated pace. "We see real value in the capacity

reductions now under way and believe it is time for investors to revisit

the airline space," analyst Gary Chase said.

 

 

"We believe a compelling survivor play is developing,"

 Chase said. "If nothing changes, bankruptcy risk is significant for the entire industry. It is for that

very reason, however, that we believe significant changes must, and

ultimately will, happen." Chase believes that the industry may

need to access almost $3 billion in new equity in the coming 12 to 18

months to stabilize its liquidity positions.

 

 

Analyst Michael Derchin of FTN Midwest Securities in New

York also suggest that there is still a ray of hope. If the strategies

are effective, 2009 will possibly be a turnaround year and 2010 a

solidly profitable one as actions start to bear fruit, assuming oil

stabilizes at high levels, Derchin said.

 

 

Southwest's new Chairman Gary Kelly is also optimistic that the industry

will rebound. "As they have in past downturns, the best airlines, large

or small, legacy or low-cost, will adjust," Kelly said. He believes

there is a very high demand for air travel, and if improvements can be

made, demand will be even higher. However, "there is not going to be

instant gratification," Kelly added.

 

 

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