Business Travel Outlook Gets Mixed Reviews

As the travel industry faces an uncertain fall there are some ominous signs for regional airlines.

After the nation's gross domestic product (GDP) grew at an average 6.5 percent since last fall, the U.S. economy has "downshifted" into a slower growth mode. The expansion is not dead, but its suddenly slowed pace has caused penny-pinching businesses to pause before embarking into new business ventures.

In the cause-and-effect world of economics, if businesses are not investing and expanding then their employees are not traveling. Thus, fewer business travelers translate in to fewer sales of high-fare seats on the network carriers and their regional partners.

The Big Picture

"There has been a significant downshift in the U.S. economy," said Andrew Hodge, an economist with Global Insight. "When we started the recovery it was a very active and accelerated recovery for about three quarters. Now we see the second quarter came in weak - 3 percent [GDP growth]. It is a lot lower than the 6.5 percent that the economy averaged starting in the third quarter of last year. We have downshifted into a still active, but economically less powerful expansion. I would not call it slipping back like in 2000 or 2003. It is a significant downshift from the excellent expansion we had."

Global Insight will be revising its forecast for the third quarter GDP of 4.6 percent down to 3.8 percent or perhaps 4 percent, he said. "This is still a reasonably active growth number," Hodge added.

The economy began its expansion last year with an explosive 8.4 percent GDP in the third quarter.

Last year the economy grew by such a robust rate, he said, in part because the nation was "slightly elated that the Iraq War had gone so well." Other contributing factors included the individual and business tax cuts that Congress enacted, low interest rates, which continued to fuel the housing boom and the wave of refinancing, and the stock market has turned around. "The tax cuts were certainly a major help. I was glad to see them even though they increased our budget deficits."

So what has cooled the economy? In a word: Inflation. "The temporary surge in inflation - particularly energy prices - has deflated the consumer's income so they could not spend as much. It also called into question a lot of planned auto purchases. Both auto sales and production plummeted."

In pure economic lingo: "The possible reason for the falter is the supply side response to the U.S. economy. In effect a lot of that demand leaked out as inflation rather than the U.S. industries efficiently meeting demand without raising prices. Another part of the demand leaked out as extra imports. We have imported 10 percent more in the last two quarters."

In addition, the rise in interest rates, which has dampened refinancing, has cooled the economy, he said. The simulative impact of the tax cuts also appears to have run its course.

Narrowing The View: The Travel Industry

While the travel industry had been picking up "nicely," as measured by both employment and sales, Hodge said that over the last couple of months it has faltered. The sector went from hiring by the thousands down to minimal hiring in recent months.

Despite the hiring slump, Hodge remains convinced that the travel industry will be a "strong sector going forward or even a leading sector in the U.S. economy." Hodge based his outlook in part on three years of pent-up demand. Not only has the industry suffered through the recession, he said, but it was severely depressed by the Sept. 11, 2001, terrorist attacks, the Iraq War and the outbreak of SARS in the Far East and Canada.

The lingering impact of Sept. 11 is one of the reasons that the sector faces an uncertain autumn, said Mark Bonn, an expert in the hospitality industry at Florida State University.

The recent rise of the security level to code orange, the continuing hassles of airport screening, higher fuel prices, instability among the nation's oldest airlines and a slowing economy are all factors clouding the fall outlook for the air travel industry. "I just don't see that it is going to be very positive for air travel unless some of these variables just don't pan out," Bonn said. If terrorists do not strike within the next six weeks or if fuel prices come down, then it may spur more interest in traveling.

Business travel still has not returned to the pre-recession levels. "Businesses are still trying to pinch pennies to make sure their quarterly reports to the shareholders are positive," Bonn said. During the recession many businesses found - and are still using - alternatives to travel, including teleconferencing.

"The group business travel has fallen off the radar screen for corporate hotel properties. We don't think it will ever be back the way it was," Bonn said. "The attendance at these shows will never be as large as they were in the past."

In what may be bad news for the regional airlines that specialize in short -distance flights, Bonn said more companies are turning to the automobile and using it for short trips. "Auto travel is going well because it is the most economical way to travel. While it may not be the best way to travel time-wise, when companies are sending four or five people from Tallahassee to Atlanta, they are driving."

If a community is not a state capital, home of a major university or host to a major military base, then its air carriers will suffer. These communities "will be at the mercy of all these environmental factors," Bonn said.

In Florida, one barometer of the economy is the rental car business. "In the height of the vacation season, travel by car has been far stronger than by air." Florida's tourism promotion efforts are funded in part by rental car fees. The fee income has fallen off so much - because air travel is down - that the state is now exploring alternative funding sources so it can continue to promote itself.

And, there is more bad news for the airlines. Bonn said hotels and local tourism boards are putting a greater emphasis on the automobile. Even though gas prices are up, travel by car has not suffered this summer, he said. Promoters are now encouraging short drive-to destinations instead of flying.

Zeroing In On Air Travel

"Air traffic has been growing very strong relative to a year ago, particularly in the early part of the year - when traffic was depressed a year ago," said David Swierenga, an economist with AeroEcon. "It is going to taper off a bit as we go through the balance of the year. I would still expect to see above-average rates of growth as the economy continues to grow and airline prices remain very, very low."

The regional airlines and the low-fare carriers have been the two fastest-growing segments in the industry. The increased utilization of regional jets has continued to fuel the growth of the regional sector. "We see that segment continuing to grow as carriers add capacity.

"The interesting thing about the little jets is that they have so much greater range than the turboprops that they replace. This allows for connecting service for hubs that are much more distant. I do expect to see the reach of the hubs extended because of the range of the jets. On the other hand, the small size of the airplanes lends itself to developing new markets. You may have the frequency, but not enough passengers for a full size jet."

The economy has improved enough, Swierenga said, so that business travelers have returned. "That segment has been depressed. We are seeing it return to normal distributions. It is a little hard to judge who's who now days because so many business travelers are now traveling on airfares only available to pleasure travelers in the past. You have to be able to dissect what is going on in the coach cabin, which is harder than it used to be."

Prior to the onset of the recession and the rise of the low-fare carriers, the business traveler was the backbone of the network carrier. Businesses paid high-priced fares for the luxury of last minute trips and the flexibility to easily change flights.

One factor that could hinder the airlines is the hike in the price of oil. "Airlines would normally make money in the second and third quarters to build up their bank balances and have enough cash to live on as they go through the thinner fall and winter months. Instead of building up cash reserves, they are handing the money over to the oil companies," Swierenga said.

While the regional carriers are mostly insulated from the direct impact of the higher aviation fuel bills because their code-share contracts enable them to pass the fuel expenses onto their partners, the network and low-fare carriers have been forced to absorb the higher fuel prices. Delta Air Lines [DAL] earlier this month disclosed that it spent $744 million from its cash reserves in the first six months on higher fuel bills and salaries. By the end of the year Delta's cash balance could fall below $1.5 billion - millions below the threshold it needs for working cash.

>>Contact: Andrew Hodge, Global Insight, (610) 490-2625; Mark Bonn, FSU, (850) 644-8244; David Swierenga, AeroEcon, (703) 255-3315.<<