Airline Weekly - August 3, 2015
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Airline Weekly - August 3, 2015

Prosperity’s Ugly Underbelly: It’s the end of revenue strength as we know it, and airlines feel fine

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Cover Story

Prosperity’s Ugly Underbelly: It’s the end of revenue strength as we know it, and airlines feel fine

By now it’s clear to all: The dominant theme for U.S. airlines during the springtime second quarter was profitability—immense profitability, driven by much cheaper fuel. In fact, the country’s 10 largest carriers produced more than $5b in net profits during just these three months from April through June, with their collective operating margin reaching a stratospheric 18%. But as airlines discussed their Q2 results, other sub-themes emerged, including—most importantly—significant revenue weakness.

How bad was this revenue weakness, and why is it occurring? Only three U.S. airlines actually saw their total Q2 revenues decline y/y, but two of them (American and United) were giants, and this was enough to shrink industry-wide revenues by 1%. All but JetBlue and Virgin America saw unit revenues shrink, with declines for the Big Three ranging between 5% and 7% on just 2% to 3% more ASM capacity.

To a large extent, declining revenues are simply symptomatic of a world with lower fuel prices—non-U.S. currencies weaken, many non-U.S. economies weaken, fuel surcharges snap downward and airline economics change in a way that makes capacity growth enticing. And to be sure, if that’s the cost of cheap fuel, U.S. airlines will take it.

But the pricing pressure is perhaps more sudden and more severe than expected for a few reasons. One is that the U.S. economy, which should be booming thanks to cheaper fuel, hasn’t quite exploded with growth—expansion, on the contrary, has been somewhat tepid, albeit robust relative to just about everywhere else in the world. In addition, the industry is quickly reverting to what Spirit characterized as “pre-consolidation like pricing behavior,” which is another way of saying aggressive fare discounting. Fast-growing ultra-LCCs like Spirit, Frontier and Allegiant might be small in the grand scheme of things, but sometimes all it takes to pressure yields is one or two new flights in a big market. American is aggressively matching the ultra-LCCs with “Advantage fares” for connecting flights. Delta’s weapon of choice, meanwhile, often on directly competing nonstop routes, is its “Basic Economy” fare offering.

They might not be growing quite as fast as the ultra-LCCs, but giant Southwest, and rather large JetBlue and Alaska Airlines... (380 of 1,520 words)

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These are generally happy times in the worldwide airline business—how could they not be, given the monumental collapse in the industry’s No. 1 expense? True, some of the many airlines reporting financial results last week spoke of challenges. But among those reporting for the April-to-June quarter, none lost money (unless you count Virgin Australia, which didn’t officially report but previewed its headline numbers).

Once again, U.S. carriers led the way with double-digit margins at JetBlue, Virgin America and Hawaiian Airlines, all far outperforming the global average even while underperforming the U.S. average. Allegiant, for its part, boasting an extraordinary 29% operating margin, outdid everyone in the world.

Outside the U.S., Japan Airlines, WestJet, Ryanair, Wizz Air, Icelandair and Jazeera Airways produced double-digit operating margins, in some cases without much help from fuel. Much less cheerful were Asian giants like Singapore Airlines and All Nippon.

Europe’s giants are a mixed bunch. As usual, Lufthansa got help from Swiss and its maintenance arm, lifting profits to respectable levels. But compared to IAG, its strategic challenges are greater. Together, British Airways, Iberia and Vueling did only a bit better than Lufthansa, but with zero help from fuel (that help is coming) and with a future that seems brighter.

Not content with swelling profits, nor ownership stakes in Virgin Atlantic, Gol and Aeroméxico, Delta is now buying into Shanghai’s China Eastern. It’s also investing to take New York’s LaGuardia Airport from “third world” to first.

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