The global airline industry continues to face challenges in
2012, from rising costs -- fuel, in particular -- and economic
uncertainties. The condition looks bleaker ahead with a weak
outlook for Europe, given its financial problems.
The International Air Transport Association (IATA) projects overall
airline profits of $3.0 billion for 2012. This is down from the
$3.5 billion projected last December and $4.9 billion projected in
Moreover, the 2012 profit outlook is also below the estimated $7.9
billion in 2011 and $16 billion earned in 2010. This steep decline
in the industry's profitability is a function of the overall
unfavorable macro backdrop with which the industry must operate
North American airlines like
United Continental Holdings Inc.
Delta Air Lines Inc.
Southwest Airlines Co.
JetBlue Airways Corporation
US Airways Group Inc.
) have shown improvements thanks to higher ticket prices, capacity
cuts and improved ancillary revenues. Together, these companies are
expected to post profits of $900 million, down from the previous
expectation of $1.7 billion in 2012.
These carriers are expected to record a profit of $2.3 billion in
2012, up from the $2.1 billion forecast previously.
Better-than-expected performance by the Chinese carriers will lead
to the outperformance from the prior outlook. Notably, this is the
highest profit-producing region in the industry outside the home
Middle East & Latin America:
Per IATA, profits from the Middle East carriers are expected to
grow to $500 million from the previous expectation of $300 million.
Profit projection for Latin American carriers remains unchanged at
African air carriers are expected to incur a loss of $100 million
due to weaker yields after touching the break-even point in 2011.
As for the European airlines, the IATA projections show a loss of
$600 million for 2012. Though major Eurozone woes have been averted
to some extent, many of the companies are still experiencing a
downturn due to the continued weakness in cargo and passenger
businesses. Additionally, higher passenger taxes are largely
responsible for the lackluster performance.
U.S. Airline 2011 Performance
Though the airlines have not yet released their global 2011 actual
profit numbers, the IATA projects that the industry should earn
profits of $7.9 billion. This is up from the previous projection of
$6.9 billion, primarily attributable to better performance of the
However, U.S. airlines announced a profit of $390 million overall
in 2011, which is much lower than $2 billion projected by the IATA.
The 2011 profit also plunged 86% from $2.7 billion earned in 2010.
This nevertheless marked the second consecutive year of profits
after incurring cumulative losses of more than $50 billion in the
Fuel price volatility, the worst threat to the airline industry,
represents about 35% of total expenses, up from 30% in 2010. North
American airlines yielded 0.3% of the net margin, down from 2.2% in
2010. Revenue climbed 12.6% year over year with total expenses
rising 15.5%, primarily due to a 36.1% rise in fuel costs.
Further, the U.S. air carriers are providing excellent services to
their passengers. They are performing at record levels when it
comes to arriving on-time, baggage handling, fewer customer
complaints, lower cancellations and lower overbooked flights.
Underlying Factors for 2012 Profits
In the base-case scenario, there are several factors that will
drive overall airline profits in 2012:
Cargo & Freight
With the U.S. economy now moving slowly, airfreight is recovering
as major worries regarding Eurozone crisis have been abated.
Airfreight in emerging markets, China in particular, is showing
growth attributable to the booming e-commerce market, airport
development plans and development in western China.
As travel demand is picking up, the IATA projects global airline
passenger growth of 4.2% in 2012 versus 4% forecasted previously.
The cargo market is expected to remain stable in the first half of
2012 and show considerable improvement in the second half.
Coming to demand-supply balances, demand (measured in traffic) will
outpace capacity (combined passenger and cargo) as the year
advances. Capacity is expected to show an increase of 3.2% while
air travel demand is expected to see a 3.6% pickup. The combination
of freight market stabilization, higher fuel costs and tighter
capacity would lead to passenger yields of 2% this year.
Fuel Price Rise: Bane or Boon?
Airline profit outlook depends on fuel prices, the major variable
component in the industry. Escalating fuel prices are making
aircraft operations expensive and are changing the sector's overall
dynamics. Airlines need to figure out ways to counter rising fuel
High crude oil prices, largely a function of geostrategic forces,
are beyond the control of the airlines. We expect crude oil and jet
fuel prices to increase this year because of the political tensions
in the Persian Gulf, but forecasting this key variable with any
level of accuracy has always been extremely challenging (hedging
strategies discussed below).
While air carriers are contemplating a more effective and enduring
way to counter the rising costs, passing on the increased cost to
customers in the form of fare hikes seems an easy way out. Airlines
imposed about 10 broad fare increases last year, which have all
been successful with the rise in travel demand. If demand remains
strong and the fuel price continues to rise, then carriers will be
able to earn higher through-fare hikes in 2012.
Getting Rid of Unprofitable Jets
Air carriers believe capacity reduction is another way of
countering rising fuel costs. The companies are scrapping or
cutting flights in many small U.S. airports that are unprofitable.
According to the Airports Council International, 27 airports,
including those in St. Cloud, Minnesota and Oxnard, California,
lost services from the well-known airlines over the last two years.
Instead, the carriers are adding long-distance flights. It is easy
to charge more for traveling long distances rather than for shorter
New Advertising Rule
The U.S. Department of Transportation (DOT) set new pricing rules
for the air carriers effective January 26, 2012. Airline companies
have to include all taxes and fees while advertising fares for
their flights. Previously, the carriers were allowed to advertise
ticket prices excluding taxes and fees, which could add up to 20%
to the price of air travel.
We are apprehensive that the new advertising policy will look
expensive to passengers and hit the stocks. As the passengers
switch to lower fares, the new rules might hurt travel demand,
thereby leading to lower industry profits.
Passengers are demanding high quality services with proper
security. Airlines are using obsolete, old and less-fuel efficient
aircraft, flying which are no longer feasible in a fuel-expensive
environment. Hence, air carriers are also focusing on fleet
Though initially expensive, the new aircraft are more fuel
efficient than the existing ones and have helped in lowering
operating and maintenance costs. Global airlines are expected to
invest $3.5 trillion to buy 27,800 new airplanes, having seating
capacity of more than 100, over the next 2 decades (2011-2030). New
airlines business, advanced technology and dynamic growth of air
travel in emerging markets throughout the world are boosting the
demand for these airplanes.
About one-thirds of the demand is expected to come from Asia, which
currently account for 28% of global air passengers. The demand in
Europe and the U.S. is expected to fall to 23% and 20% by 2030,
respectively, from the current 27% that each enjoy.
Airbus, the world's leading aircraft manufacturer, will deliver the
largest number of aircraft to the airline companies, followed by
The Boeing Co.
). The U.S. air carriers have started buying new planes from these
manufacturers in order to provide good customer service. The
progress thus attained would help these companies to regain their
Hedging strategies provide a cushion to the rising fuel prices and
is being used extensively. The carriers use a combination of calls,
swaps and collars at varying WTI crude-equivalent price levels to
U.S. Airlines - 20-Year Projection
The U.S. airline industry is expected to remain profitable over the
next two decades given the improving worldwide trends in air
travel. However, growth may be held back until 2015 due to surging
fuel costs and economic uncertainties in the U.S. and Europe.
Although U.S. airlines will see a small dip this year, the demand
for air travel will double over the next 20 years, as predicted by
the U.S. Federal Aviation Administration (FAA). Passenger demand is
expected to grow 2% to 746 million in 2013 and about 3% in the
future years, reaching $1 billion by 2024 and $1.2 billion by 2032.
The FAA projects air traffic, customarily measured in billions of
revenue passenger miles -- implying a unit of one mile flown by one
passenger -- to grow by more than 90% over the same period. Revenue
passenger miles would jump from 815 billion reported last year to
1.57 trillion by 2032 at an average annual rate of 3.2%.
International traffic is expected to grow 4.2% per year, in
contrast to domestic travel that will growth at a more modest clip
of 2.7% annually through 2032. This projection assumes a steady
economic recovery with no major calamities like a large rise in oil
price, swings in macroeconomic policy or financial meltdowns.
Further, major North American airlines would raise capacity
(available seat miles) at an annual rate of 3.1%, reaching 1.89
trillion by 2032.
The 20-year airline growth is expected to stem from the
implementation of NextGen, the satellite-based navigation system
that aims to make air travel more efficient. The carriers are
taking numerous steps to improve their profitability as described
in the above sections.
Moreover, the growing demand for air travel and a relatively lesser
number of planes will make future fare hikes possible over the next
two decades. Airline mergers and consolidation will bring down the
number of flights and reduce the number of cities served.
We believe industry consolidation and various ancillary revenues
will boost profitability and cost performance of most air carriers
going forward. This is an opportune moment for companies to
consolidate in order to regain their lost profits and operational
A number of supplementary revenue streams helped the airline
industry gain ground in 2011 and 2010 after two years of drought.
Air carriers are adding new features to services as well as
expanding new products to improve passenger satisfaction and
experience. The IATA projects total revenue of $633 billion for
2012, up slightly from $596 million projected for 2011.
Carriers are going wireless with the in-flight entertainment
systems such as American Airlines' Gogo "Vision" wireless
video-on-demand, Delta Air Lines' "Delta Connect" and Lufthansa's
"BoardConnect." Other carriers such as Virgin America, Qantas and
Virgin Australia will soon launch their in-flight entertainment
Cathay Pacific, Malaysia Airlines, KLM, Delta, Qantas and British
Airways have also made
) iPad available to passengers in their lounges, rent them out in
the air as well as use them as a self-service kiosk, customer
survey tool and food ordering tool.
Further, major U.S. carriers remain focused on expanding their
product and service offerings on board and on the ground for higher
Delta Air Lines
) are installing winglets, WiFi and flat-bed seats apart from
expanding Economy Comfort or Economy Plus seats to their fleet.
United Continental is also introducing streaming wireless video in
) is benefiting from EarlyBird check-in, unaccompanied minor travel
and pet fees. The company is renovating in-flight cabins and
redesigning interiors, and has labeled the new appearance as
Evolve: the New Southwest Experience. These fleet modernization
plans and the All-New Rapid Rewards program is contributing to
) is experiencing solid growth given continued success in the
Getaway Vacations Division, as well as the Even More Space product.
Airline companies are consolidating in order to restore profits.
The first in this grouping was Delta Air Lines' successful
acquisition of Northwest Airlines in 2008. The merger catapulted
Delta at the time to the position of largest airline in the world,
generating significant cost savings for both.
In 2010, United Airlines merged with Continental Airlines and
formed a new company, United Continental Holdings. This merger
created the world's largest airline, overtaking Delta. The third
merger was between Southwest Airlines and fellow discounter AirTran
Holdings, which was completed in May 2011.
Another airline consolidation is seemingly underway. The rumors
about American Airlines, a subsidiary of AMR Corp., merging with
another airline have been heating up since the company filed for
bankruptcy protection in November last year. The three labor unions
of American Airlines are, in fact, supporting a plan for the
bankrupt carrier's merger with rival
), the fifth largest U.S. airline. This move represents a first
step toward consolidation -- though creditors, directors and
management have yet to give the green light.
We believe the potential American Airlines-US Airways combination
would be strong enough in scope and size to compete with larger
rivals. In fact, the combination would create an airline identical
to United Continental in terms of revenue and traffic, and would be
better than Delta. Further, the new carrier would leapfrog other
airlines in the U.S. East Coast and Midwest. The potential
combination would have fewer overlapping routes.
The consolidation of American Airlines, if successful, would be the
fourth in the last three years. As United and Delta will be
long-term beneficiaries following the merger actions on both
capacity and cost fronts, we believe American Airlines will also
emerge as a successful candidate by balancing its debt level and
lowering costs. Nevertheless, any potential merger with AMR will
take several months or a year to materialize, as American Airlines
has yet to complete its court restructuring process and will
undergo antitrust scrutiny.
Carriers are making continuous efforts to increase their domestic
and international flights. Delta Air Lines is focusing on adding
flights in New York, Latin America, Mexico and Brazil. Delta Air
Lines is progressing well on the $1.2 billion expansion at New
York-JFK, scheduled to open in 2013, and the new Maynard H. Jackson
Jr. International in Atlanta, slated to open this year.
Internationally, Delta's deal with a Chinese international airline,
China Eastern, should prove profitable.
United Continental is benefiting and enhancing its access from each
other's hubs and networks. Southwest gained a valuable market
presence in Atlanta, the busiest airport in the U.S, post the Air
Tran acquisition in May 2011. The company is introducing services
to new and unexplored domestic markets and expanding services at
New York LaGuardia, Boston Logan, Milwaukee, Baltimore/Washington
and many smaller domestic cities. The company will also debut in
the Caribbean and Mexican markets in mid-2012.
JetBlue continues to successfully expand its network in two major
growth regions: Boston to New York and the Caribbean.
Air carriers are involved in numerous technology upgrades and
system automation for various activities such as airline
reservation system, flight operations system, website maintenance
and in-flight entertainment systems. These upgrades enable
companies to perform better, lower costs and enhance customer
Major U.S. carriers, Delta, United Continental and Southwest, have
a long-term Neutral recommendation supported by the Zacks #3 (Hold)
Rank for the short term (1-3 months). Additionally, U.S. Airways
also retain a Zacks #3 (Hold) Rank for the short term.
Of the many challenges facing the industry, the most important ones
include volatile fuel prices, economic weakness, natural
calamities, government regulation, unionization, airport
infrastructure constraints and safety concerns.
Oil Price Volatility:
Fuel price volatility continues to be one of the significant
challenges, as the cost of fuel is largely unpredictable. Fuel
prices, though high currently, remain well below the 2008 level of
over $140 per barrel that had ravaged the airlines industry. The
company's ability to pass along the increased costs of fuel to its
customers is limited by the competitive nature of the airline
industry. Thus, even a small change in fuel prices can
significantly affect profitability.
The airline business is labor intensive. Most of the employees are
unionized and depend on various U.S. labor organizations. The
relation between airlines and labor unions are governed by the
Railway Labor Act, which states that a collective bargaining
agreement between an airline and a labor union does not expire --
instead it becomes amendable as of a stated date. Failure to amend
terms and conditions suitably may lead to work stoppages or
strikes, and thereby hamper operations.
The airline industry is highly regulated, in particular by the
federal government. All companies engaged in air transportation in
the U.S. are subject to the regulations implemented by the DOT.
Further, airlines are also regulated by the Federal Aviation
Administration (FAA), a division of the DOT, primarily in areas of
flight operations, maintenance and other safety and technical
The airline industry has a lousy record of capacity discipline,
though it has largely been mindful of this issue in this cycle. It
remains to be seen how long the current trends remain in place
before old habits return.
) is expected to underperform the broader market in the long term,
with the Zacks #4 (Sell) Rank.
BOEING CO (BA): Free Stock Analysis Report
DELTA AIR LINES (DAL): Free Stock Analysis
JETBLUE AIRWAYS (JBLU): Free Stock Analysis
US AIRWAYS GRP (LCC): Free Stock Analysis
SOUTHWEST AIR (LUV): Free Stock Analysis Report
UNITED CONT HLD (UAL): Free Stock Analysis
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