The Next Wave Of Airline Bankruptcies

Checking it Out

Veteran
Apr 3, 2003
1,702
0
Jubak's Journal
The next wave of airline bankruptcies

Competition with low-cost carriers is only going to get fiercer. US Airways and Delta look vulnerable, Continental is on the bubble and even Southwest may not be safe.

By Jim Jubak

There’s a dogfight in the skies over Europe, and the outcome of the battle very well could foretell the future of the airline industry in the United States. The continent is now home to more than 50 low-cost carriers, including Wizz Air, Snowflake, VolareWeb, Air Polonia, Now and SkyEurope. And, of course, Easyjet (EJETF, news, msgs) and Ryanair Holdings (RYAAY, news, msgs), the most successful of the bunch.

With so many players, no one is surprised that five newcomers have gone bust recently. And airline analysts expect more to exit the business this winter.

What surprised analysts, however, was the Jan. 28 earnings warning from Ryanair. Earnings for the fiscal year ending in March 2004 would be 10% below earnings for fiscal 2003 and 20% below earlier projections for fiscal 2004, management said.

Investors, reeling in shock, asked “How is this possible?†and drove down Ryanair’s share price by 30% in just one day. After all, Ryanair and its neck-and-neck competitor Easyjet together dominate the intra-Europe low-cost market with a joint share of 58%, according to Credit Swiss First Boston. And the number of passengers flying low-cost airlines intra-Europe has grown at a compounded 38% annually over the last eight years.

The problem was that all that competition, even the competition from failing competitors, was forcing fares lower faster than even Ryanair could cut costs. The company estimated that the average fare would fall by 20% to 30% in the March quarter of 2004.

Informed consumers and too many seats

Things have become both better and worse since Ryanair warned. Fares and profit didn’t drop as much as the company predicted in January. But the price war that began last winter has extended into the summer season when airlines earn most of their profit and will extend into the winter. Ryanair is now predicting a 20% drop in fares for fiscal 2005 from the fiscal 2004 level.Check out your options.
Find the best rate
before you borrow.

The problem is too much supply of a commodity that, thanks to the Internet, is driven by price-sensitive customers.

No one expects supply to drop much, even if more low-cost carriers go broke this winter. In the current aviation market, planes are just so cheap and money so easy to raise either from equity investors or from airplane-leasing companies that it seems that just about any management group with some airline experience can start a new carrier.

Europe’s high-cost majors are fighting back, too, giving ground in the short-haul market only grudgingly. Many are in fact trying to build traffic in advance of the delivery of the new Airbus 380 with its higher passenger capacity.

5 rules for a free-for-all

So here are the five characteristics which, from the evidence of the European example, define the dynamics of the low-cost airline industry:
Average fares will continue to fall under the pressure of continued surplus supply.

Since air travel is a commodity, airlines have no ability to raise prices based on quality or brand.

Continued revenue growth depends on the continued ability of low prices to attract new travelers and on taking share from higher-cost, established competitors.

Profit growth depends on revenue growth outrunning price declines.

Profit margin growth depends on the ability of carriers to increase the percentage of seats they fill on each flight (tough in times of excess supply and further price cuts) and to cut costs further.
This kind of free-for-all will lead ultimately to the demise of many of the established high-cost majors. There is simply no way that a mature company can cut its costs to match those of a startup.

Why the majors can't compete

Sure, the European majors can match Ryanair by removing the seatback pockets in its planes because they increase cleaning time, but they can’t lower the wages of experienced pilots and maintenance workers to match the entry-level salaries at low-cost carriers. They operate at a serious cost disadvantage to the low-cost carriers on benefits as well. A startup doesn’t have to pay any retirement costs because it doesn’t have any workers with enough seniority to retire. Contrast that with an established carrier that has to wage a bloody battle just to reduce pension costs.

But winning this free-for-all doesn’t offer the survivors any security. Since entering the business is so easy, the survivors constantly face new competitors. Some of these drop by the wayside relatively quickly because they are underfinanced or incompetently run. But others gain at least initial success and threaten to devour older survivors.

Because air travel has become a commodity, carriers can’t use their brands to defend market share. Because pricing information is so readily available, increasing market visibility isn’t an effective way to defend market share. Any company with enough financing can offer prices low enough to win market share almost instantly. And as the survivors age, they gradually become vulnerable on the cost front to startups which, again, don’t pay the higher salaries that workers with seniority command or face the higher benefit costs that come with worker seniority.

Same forces at play in the United States

You can see this at work right now in the U.S. low-cost air industry, where newcomer JetBlue Airways (JBLU, news, msgs) has taken the lowest-cost trophy away from the older Southwest Airlines (LUV, news, msgs). In 2003, the cost per seat mile at JetBlue was just 6.1 cents versus 7.5 cents at Southwest, according to Merrill Lynch.

But both show a huge edge over the established carriers. In 2003, despite heroic efforts, cost per seat mile at American Airlines was still 10.1 cents, lower than the 11.1 cents in 2001 but still badly trailing Southwest and JetBlue. Continental Airlines (CAL, news, msgs) costs stood at 9.7 cents, making it the lowest-cost airline among the major established carriers. Delta Air Lines' (DAL, news, msgs) costs stood at 10.6 cents, and US Airways' at 11.5 cents.

Add this to another number and you can see the true extent of the trouble that the established carriers face. Not only is JetBlue’s cost lower, but its planes are fuller. The load factor -- that’s the percentage of seats filled with passengers -- at JetBlue in 2003 was a whopping 84.5%. At Delta, it was just 74.3% and just 73.3% at US Airways Group (UAIR, news, msgs).

Low prices create unit sales in a commodity business, and low unit costs turn those sales into profits.

Which U.S. airlines are now at risk, according to this model? US Airways, with its declining market share and high costs, is under direct assault by low-cost carriers who smell blood. The company is in its third round of labor negotiations in two years in an effort to cut costs. Delta will probably go into bankruptcy to cut costs if it can’t win major concessions from its pilots in negotiations. Continental should be OK if air travel continues to recover, but the airline has very few unencumbered assets that it can use to secure additional financing if something does go wrong.

United Airlines’ costs are still way, way too high. Although cost per seat miles declined to 10.5 cents in 2003 from 11.4 cents in 2002, thanks to cost-cutting, that’s at the high end for the established carriers. In addition, United parent UAL Corp. (UALAQ, news, msgs) faces a huge $4 billion in unfunded pension liabilities due by 2008. With its market share and route network, United is almost certain to get the funding it needs to emerge from bankruptcy, but don’t be surprised to see the airline back in bankruptcy protection within a few years.

The American Airlines unit of AMR Corp. (AMR, news, msgs) has made the most progress in lowering costs of any of the majors, although it also had some of the highest costs before the cuts. Cost per seat mile fell to 10.1 cents in 2003 from 11.1 cents in 2001. If air traffic continues to pick up, AMR could run in the black in the June and September quarters and for all of 2005.

The most interesting case is Southwest. The company has managed to keep costs per seat mile steady since 2001 at 7.5 cents. But thanks to recent expansion into new markets, the carrier’s load factor was just 66.8% in 2003. That should rebound as new markets build traffic. But if it doesn’t, it will show that the challenge from the newer low-cost carriers may be more serious than anyone now thinks.

It’s clear the new low-cost carriers are taking share from the established airlines. The jury is still out on what effect they are having on Southwest.

Challenging the establishment

The five characteristics that I used to define the dynamics of the European low-cost air travel market apply to the future of other industries that sell commodity products as well. In an industry like that, companies must run as fast as they can just to stay in place. Price pressure from new entrants to the industry with lower costs are a constant threat.

Since part of those lower costs is simply a result of newness, investors in these sectors need to reverse the conventional wisdom that gives the edge to the established companies in that market.

The established nature of these companies may put them at a cost disadvantage, and the Internet-enabled price sensitivity of these commodity industries may minimize any advantage that comes with longevity.

In my next column, I’ll take a look at some of those other industries and the way that design can offer a way out of the commodity price crunch.

Changes to Jubak's Picks

Editor's Note: A new Jubak’s Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at [email protected].
 
In 3 years AArogant Airlines will be out of business.
They refuse to change thier business model and we are so management top heavy it is only a matter of time before the ship tips over.
The only thing that changes in this industry are the colors painted on that tail.

:lol: :lol: :lol: :lol:
 
Ooh no! Not bankruptcy! Let's give up our pension and work for $5.00/hr! We must do it now or we are all gonna lose our jobs! Let's "share" and "sacrifice" some more to save the company! Ooh please,please,please TWU give Arpey everything he wants now!
 
TIME FOR CHANGE said:
They refuse to change thier business model and we are so management top heavy it is only a matter of time before the ship tips over.
You hit the nail on the head and everyone knows it. The thing is, as long as the "suits" are making the big bucks they will keep the airline viable. As soon as they can't make a killing, the airline will die and "they" will move on, as will we. There is not a damn thing we or the leadership of the TWU or the amfa can do about it. You amfa guys think you can get in there and "change the world" when in reality the amfa only helps expidite the process. The amfa is a sorry joke.
 
Strake said:
You hit the nail on the head and everyone knows it. The thing is, as long as the "suits" are making the big bucks they will keep the airline viable. As soon as they can't make a killing, the airline will die and "they" will move on, as will we. There is not a damn thing we or the leadership of the TWU or the amfa can do about it. You amfa guys think you can get in there and "change the world" when in reality the amfa only helps expidite the process. The amfa is a sorry joke.
Ditto Ditto
 
Strake said:
There is not a damn thing we or the leadership of the TWU or the amfa can do about it.
Typical twu cowardice!! You have given up before the fight is finished. this is just another reason why the twu will sooner or later be replaced. NO VOTE NO PEACE
 
There is not a damn thing we or the leadership of the TWU or the amfa can do about it. You amfa guys think you can get in there and "change the world" when in reality the amfa only helps expedite the process. The amfa is a sorry joke.

The twu will prolong the agony. You will give back every thing so long as you have a job you are a coward. It is people like you who make the upper management get rich and richer. If you would put up a fight maybe you could better your profession. Instead you roll over like a 2 dollar whore.
I know for a fact that the twu is the reason the upper management is rolling in the dough. The twu gives concession after concession to keep the airline floating. Yet the upper crust gives nothing and changes nothing. Wake up you fool :shock: