Guest Commentary - Outlook for the Airline Industry
By Helane Becker, Managing Director and Senior Research Analyst, Cowen and Company
We’re in the middle of an extended period of positive earnings for the airline industry, mostly due to lower jet fuel costs. The industry has had seven years of net profits and mostly growing revenues; 2017 is expected to be another profitable year. Net income probably peaked in 2015, when U.S. airlines reported $25.6 billion on $168.9 billion of revenue for a margin of 15.2 percent. This is far superior to any prior cycle.
In our view, most of the improvement in net income has been due to lower jet fuel prices. Spending on jet fuel declined from the 2012 peak of $44 billion to last year’s $21.6 billion, a 51 percent savings. Airlines were profitable at higher jet fuel prices, and with oil down from approximately $110 per barrel to about $50, they aren’t keeping the $60 savings. The airlines passed approximately 33 percent on to their employees in the form of higher wage rates, approximately 33 percent to consumers in the form of lower ticket prices, and kept the remainder, although some airlines are doing their best to give some of that away, too.
We can’t ignore the positive effects of consolidation, but the decline in the number of airlines hasn’t resulted in the high fares many regulators and naysayers warned were coming. The fastest growing airlines are the ultra-low-cost airlines, and they’re growing more than 18 percent annually while the legacy airlines continue to grow in the low single-digit range. As a result of this spread, the ultra-low-cost carriers control 7 percent of industry capacity. Southwest Airlines is the largest low-cost airline with 22 percent of the market. Southwest thinks of itself as a low-cost carrier, and with its everyday low fares and free baggage policy, the airline can keep the rest of the industry honest.
This year started with higher labor and jet fuel costs, and we expected that fares would trend higher as a result. We anticipated margin pressure from higher costs until airlines took steps to raise ticket prices. Early in the year, we saw some higher fares, but airlines weren’t in a rush to raise ticket prices, in part due to continued relatively low fuel costs. Around mid-year, we saw strong leisure demand, but corporate demand slowed, and airlines lowered fares to stimulate leisure travel.
As we look to the rest of this year, we see continued price discounting, especially in Chicago, Ill.; Newark, N.J.; Denver, Colo.; and Houston, Tex., as United Airlines defends its domestic U.S. hubs from incursions led by ultra-low-cost airlines. Demand for air travel should be strong as fares are low and the U.S. economy is growing at a low single-digit rate. In addition, going into the December quarter, Thanksgiving, Christmas, and New Year’s are major leisure travel periods—and we don’t anticipate this year will be different.
We expect low fares to persist through at least mid-2018. In addition, we expect particular weakness in east Texas and south Florida. It will take time for these regions to recover from the September hurricanes, and it’s unlikely that people who don’t have roofs over their heads, or are rebuilding after losing their worldly possessions, will travel. We expect airlines to assess the damage to airports in the Caribbean and in Florida and rebuild where needed in order to resume flights for the summer months.
Finally, with jet fuel costs at current levels, the industry’s largest cost item is once again labor. The airline industry has always been capital-intensive and labor-intensive. U.S. airlines continue to replace their older fleets with new aircraft that act as a hedge against higher jet fuel prices. In addition, new aircraft contribute to greater reliability, fewer maintenance events, and improved on-time performance. We believe reinvesting in the fleet and the product sends a positive message to employees that the airline is here to stay.
Being a pilot is likely to be a great career again. Over the next decade, more than 21,650 pilots are due to retire, creating a major hiring spree at the top five U.S. airlines. The opportunity for a great, well-paying career at these airlines should not be underestimated.
