Industry Profits to Continue

Economic pressures – especially the industry’s inability to get cheap credit for the major projects now facing it, will increase pressure toward consolidation, given the 2008 Air Transport Association (ATA) Outlook. While network carriers posted a third quarter profit margin of 8.8 percent...

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Economic pressures – especially the industry’s inability to get cheap credit for the major projects now facing it, will increase pressure toward consolidation, given the 2008 Air Transport Association (ATA) Outlook. While network carriers posted a third quarter profit margin of 8.8 percent, according to the just released Bureau of Transportation Statistics (BTS) report, regional carriers reported a 5.3 percent profit margin, down from a 10.0 percent profit margin in the third quarter of 2006, meaning the network-carrier performance is coming on the backs of the regionals. The seven regional carriers reported a $132 million operating profit in the third quarter of 2007.

Last year brought the first back-to-back net profit for the U.S. airlines since 1999-2000, according to ATA Vice President and Chief Economist John Heimlich, adding it was a welcome relief after a five-year loss of $35 billion. Still, he said, airline margins were still below those of the typical American business. Thus, the industry’s sub-par performance means increased difficulty in obtaining financing for much-needed projects such as renewing fleets, upgrading facilities, improving customer experience, enhancing fuel efficiency and making other prudent business investments.
Heimlich cited credit concerns as one of the industry’s major problems. He pointed to a Fitch Ratings report released in October, saying among the credit concerns were the industry’s unique vulnerability to fuel price shocks, a fragmented structure that “makes rational capacity planning and sustained pricing power improvement very difficult to achieve,” operational bottlenecks in the U.S. air travel system and undue pressure on capital budgets fueled by the need to replace aging aircraft, especially in 2010 and beyond.
“U.S. airlines and their employees have done an exceptional job of positioning their companies to weather record-high fuel prices,” he said. “Consider that in their three best years, 1997-1999, the deregulated U.S. airline industry earned a net profit margin of only 4.4 percent on an average crude oil price of only $18 per barrel. A decade later, with oil likely to average $80 per barrel, we are projecting a third consecutive year of net profits. Global competitiveness, however, demands far more. If the United States is to meet that challenge, the airlines’ path to economic vitality must not be impeded.”
Although, BTS's official year-end airline financial results will not be released until May, since it lags industry reports by two quarters, its recently released third quarter statistics indicate the group of 20 selected passenger airlines reported a system operating profit margin of 8.2 percent in the third quarter of 2007, the highest third quarter profit margin since 1999 and the first time since 2000 that airlines have had six consecutive profitable quarters.
Network carriers, reported an operating profit margin of 8.8 percent. ATA Airlines failed to report its third quarter financials to BTS short-circuiting any calculations for the low-fare carrier group.
The top three operating profit margins were all reported by network carriers Northwest Airlines, Alaska and United Airlines. Regional carrier ExpressJet Airlines and low-cost carrier America West Airlines reported the only operating loss margins. ExpressJet operates both point-to-point service under its own brand and regional service under contract for network carriers.

Heimlich noted that the deregulated U.S. airline industry had never posted a net profit margin higher than that of the average U.S. corporation. “Given the industry’s hallmark characteristics of high fixed costs, cyclical demand and fierce competition, that pattern is unlikely to change anytime soon, rendering it difficult for the airlines to borrow money at reasonable rates to invest in the future,” he said in his 2008 outlook released last week. “Unfortunately, of the 10 U.S. passenger airlines currently rated by Standard & Poor’s (S&P), only one enjoys investment-grade status (i.e., a corporate rating of BBB- or higher). Consequently, all remain difficult, at best, at a time when the need for those investments is clear.”
He predicted that, in 2008, ongoing passenger and cargo revenue strength – particularly in the international arena – will help offset a sizeable increase in fuel expenses and a modest increase in nonfuel expense, enabling the industry to post a $3.5-to-$4.5 billion net profit. “That would make 2006-2008 the airlines’ first profitability ‘three-peat’ since 1998-2000,” he said, adding in the face of uninspiring forecasts for the U.S. economy and yet another record year for crude-oil prices, the nation’s carriers have moved aggressively to redeploy assets and adjust aircraft utilization to trim unprofitable flying. “All signs point to another year of improving fuel efficiency, despite air traffic congestion and resultant taxi-out and airborne delays. Comparable load factors are likely to be accompanied by individual airline efforts to realize higher yields by increasing business travel as a share of total traffic.”
Even so, passenger and cargo demand is surging globally, he noted, making the airline business increasingly global. “The reality is that the world economy, led by China, India and other developing economies, is growing at twice the rate of the U.S. economy,” he said. “Accordingly, U.S. airlines have expanded their footprint in international markets. In 2008, U.S. carriers will seek to capitalize on projected growth in these regions, taking advantage of the easing of restrictions of air service between the United States and China, India and the European Union. Over time, of course, liberalization of these markets will heighten already intense competition. U.S. airlines must be ready. In the domestic marketplace, of course, they are competing not only with new-entrant carriers, but also, increasingly, with other forms of aviation such as air taxis or business jets, which, continue to benefit from an outdated tax scheme.

Airlines Report Most Profitable Third Quarter Since 1999
ATA’s predictions came as the BTS, the statistics indicated that the healthy margins once enjoyed by regionals have been recaptured by their major partners.
The network group’s profit margin of 8.8 percent in the third quarter was a 3.4 percentage point improvement from the 5.4 percent profit margin in the third quarter of 2006. The seven network carriers reported a combined operating profit of $2.4 billion in the third quarter for the group’s sixth consecutive quarterly profit margin. In the third quarter of 2006, the seven network carriers’ operating profit was $1.9 billion.
The network carriers, with a gain of 0.8 cents per available seat-mile (ASM) to 14.9 cents per ASM, were the only group to report higher unit revenues in the third quarter of 2007 compared to the third quarter of 2006. For the first time since 2004, when all the carriers in the regional group were required to file quarterly financial reports with BTS, the regional carriers failed to report the highest unit revenues as their third quarter revenue of 14.7 cents per ASM was down 0.3 cents per ASM from the third quarter of 2006.

The highest unit revenues were reported by network carrier US Airways and regional carriers Comair and American Eagle Airlines. The lowest unit revenues were reported by low-cost carriers JetBlue Airways and Spirit Airlines and regional airline Pinnacle Airlines. Regional carriers reported the highest unit costs in the third quarter at 14.0 cents per ASM compared to 13.6 centers per ASM for network carriers.
Comair and American Eagle, both wholly owned by their partners Delta and American, respectively, reported the highest unit costs along with US Airways. The carriers with the lowest unit costs were low-cost carriers JetBlue and Spirit and regional carrier Pinnacle Airlines
The regional airlines passenger yield, although down from the third quarter of 2006, at 18.7 cents per revenue passenger-mile (RPM), was still higher than the network carriers’ yield. The network carriers at 13.0 cents per RPM reported year-to-year yield gains.

The top passenger revenue yields were reported by regional carriers American Eagle, Comair and Atlantic Southeast Airlines. The lowest passenger revenue yields were reported by low-cost carriers JetBlue, Spirit and America West. Alaska reported the highest passenger yield of any network carrier.