Newly found pricing power sent airline stocks soaring in 2013,
but will the "capacity discipline" story that enabled that
strength eventually fall apart?
It wasn't long ago when industry overcapacity led to record
low fares. Those fares spurred huge losses, ignited battles with
unions over givebacks and put many airlines into bankruptcy.
Airlines boost capacity by adding routes, scheduling more
flights, using bigger planes and flying longer distances. They
might have done any or all of those in the past to gain market
More recently, the industry at large reversed the situation by
putting fewer seats in the air. Airlines steered away from
money-losing routes. Under new chief executives in many cases,
they've sought profit rather than share gains.
Industry consolidation has been a factor, reducing the number
of competitors. And some analysts see more mergers coming.
The End of Market Share Wars?
Domestic capacity fell 10% during the global economic crisis
of 2008-09 and remains well below 2004-2007 levels, says
The big question on Wall Street is whether airline capacity,
measured by "available seat miles," will grow at a slower rate
than the U.S. economy. If that scenario plays out, planes will be
more crowded, airlines will offer fewer discounts to fill open
seats, and average fares -- and, theoretically, profits -- will
However, there's reason to be cautious about the long-term
outlook for capacity.
Here's why: Recently merged, out-of-bankruptcy American
Airlines/US Airways, renamedAmerica Airlines Group (
), will be buying new, bigger planes.Southwest Airlines (
) will be free to fly nonstop to anywhere in U.S. from Dallas as
of October 2014 after the Wright Amendment, which has limited
traffic out of Dallas since 1979, expires.
Delta Air Lines (
), which has built out Seattle as a gateway to Asia, could also
expand domestic flights from that city.
Alaska Air Group (
) is expected to continue expanding beyond its West Coast roots.
And divestitures required from American will open up new
opportunities for low-cost carriers likeJetBlue (
), analysts say.
For now, it still looks like airlines won't be their own worst
"There are fewer sick carriers doing crazy things," Robert
Mann, an airline industry consultant, told IBD. "They're all
focused on capacity discipline, making every route pay as opposed
to going for market share and growing inefficient capacity.
That's leading to more pricing power."
A driving force behind that shift, Mann says, has been a
change in leadership at almost every carrier.
"Since 2000 it's been more finance, not marketing people," he
said. "They're targeting financial measures -- return on invested
capital, building margins -- not just market share."
Airlines have also become smarter buyers of aircraft, says
Helane Becker, analyst at Cowen & Co.
"If you look at the industry's past failures, they've ordered
aircraft at the top of the business cycle and taken delivery at
the bottom," she said in an interview. "Now they're smoothing out
capex, there are less peaks and valleys. That has a positive
effect on capacity growth."
Capacity Vs. GDP Growth
Many Wall Street analysts are on board, eying a pickup in air
travel demand if the economy improves.
"There's plenty additional upside for earnings beyond 2014 on
lower capacity and higher fares," said UBS analyst Darryl
Genovesi in a Dec. 18 report. "We don't think it would be
unrealistic for industry EBIT to double over the next 4-5
That assumes capacity growth 6%-8% below GDP on a cumulative
basis, similar to growth over the past five years. However,
there's reason to be cautious about the long-term outlook for
Lower oil prices have been a big factor in boosting industry
profits. But airlines need to show restraint in expanding the
number of flights because of lower costs, analysts say.
"The most important, absolute driver of industry margins is
the level of capacity relative to fuel prices," wrote Barclays
analyst David Fintzen in a Dec. 17 report.
John Godyn, an analyst at Morgan Stanley, expects airline
stocks to perform well in 2014, so the industry can hold capacity
growth to 2% or less. "Our economics team forecasts real GDP
growth of about 2.6%, which sets the industry up for another year
of margin expansion," he said in a Dec. 9 report. "The current
cycle is unique in that it has seen the slowest rate of capacity
rebound compared to any prior cycle since deregulation."
The industry trade group, Airlines for America, says planes
are being packed fuller amid pricing gains. In 2012, 83.2% of
available seats were sold on average, up from 74% in 2004.
"When was the last time you had an empty seat next to you on a
plane?" said Becker. "Airlines are now booking an 85% load
The average round-trip domestic fare climbed to $355.75 in
2012, up from $268.73 in 2004. Airline capacity, measured in
available seat miles, was 994.5 million, about the same as in
Passenger revenue per available seat mile (PRASM), a key
industry financial metric, has been improving. PRASM includes
fares, upgrade fees, baggage fees and other tack-on fees.
Capacity Pressure Rises
While the industry's biggest carriers have guided to capacity
hikes below GDP growth, smaller airlines such as JetBlue,Spirit
Airlines (SAVE) and Alaska Air are expected to continue adding
seats at a faster rate.
Market research firm Diio estimates that Spirit's capacity
jumped 21% in 2013, while JetBlue's rose 5.8% and Alaska Air's
Spirit is expected to grow capacity by 15% in 2014.
Because of their size, the biggest airlines' plans for
capacity growth will either calm or roil investor worries,
The newly joined American Airlines and US Airways created the
largest airline in the U.S., with about 25% of overall domestic
seat capacity. Delta andUnited Continental (UAL) follow with 20%
each. Southwest is No. 4 with 19%.
American Airlines says it expects to grow capacity 3% this
year, as its new aircraft deliveries ramp up. The company plans
capital spending of about $4 billion annually through 2016, above
Delta has forecast 2014 capacity growth of flat to as much as
2%. UAL guided to 1%-2% growth in 2014, above some views.
Southwest has said it will hold capacity flat in 2014.
Southwest says it will increase capacity in 2015, when its new
international terminal in Houston will be completed, if it hits a
goal of 15% return on invested capital.
Cities with the most seat availability -- such as Las Vegas,
Denver, Chicago and New York City -- generally have
lower-than-average ticket costs. U.S. airports showing price
increases include Los Angles, Seattle and Charlotte, N.C.
Delta has added capacity in Seattle, Alaska Air's hub, putting
pressure on the smaller carrier. Barclays' Fintzen says the new
American Airlines has a large market overlap with United, which
could spur a more heated rivalry.
Southwest, which acquired AirTran Airways in 2011, has been
retooling its operations in Atlanta, Delta's main hub. Southwest
will likely rebuild capacity from Atlanta when it's done,
analysts say, and target more business customers.
Southwest and JetBlue, meanwhile, are expected to benefit from
Department of Justice requirements for American Airlines to
divest takeoff and landing slots at Washington's Reagan National
and New York's LaGuardia airports. Bidding for those slots is
limited to low-cost carriers.
The Consolidation Tea Leaves
Industry consolidation has helped tame capacity as the number
of competitors shrinks and redundant routes of merger partners
are streamlined, says a Standard & Poor's report. Future
deals will face tough antitrust reviews, as did the American
Airlines-U.S. Airways deal.
Even so, with cleaner balance sheets and lower debt loads, "it
appears that U.S. airline industry consolidation is not yet
complete," says S&P.
There's speculation over a Delta acquisition of Alaska Air as
they slug it out in Seattle. One hurdle is that Alaska Air
partners with many airlines that might oppose a deal.
JetBlue is expected by many analysts to stay independent. Mann
says a roll-up of some U.S. airlines that use Airbus jet
airliners -- JetBlue, Virgin America, Frontier Airlines and
Spirit -- is also a possibility.
Meanwhile, analysts expect more consolidation among regional
carriers, with SkyWest and Republic Airways remaining the biggest