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« Analyst Engel Does RJ Math; Swelbar Opines  »

Bank of America/Merrill Lynch airline equity analyst Glenn Engel could not have been more timely in his report published yesterday: “Regional Jet Analysis:  A Look at Profits Per Plane.”  Given the industry-wide focus on the future of the regional jet industry, Engel’s analysis cuts to the heart of the economics of RJs, particularly as to how they are used by network carriers and what effect changes may have on those carrier’s route systems. I do not read the report as having investment implications but rather as an analysis of the economics of regional jets utilized inside of each network carrier’s route system.

A Note on Engel’s Methodology

Engel notes up front the limitations of the analysis:  “1) Disclosure and accounting for regional revenues and costs are inconsistent across the carriers. 2) Differing fleet ownership and usage complicates comparisons; Pinnacle and ExpressJet sublease planes and as a result show lower nonfuel costs relative to SkyWest and Republic. 3) Mainline operations and regional feed mutually benefit each other, which can help cross-subsidize losses.”  In my mind, I acknowledge the importance of accounting but it is the network effects that are most difficult to discern.

Engel’s analysis is done on a per plane basis.  In order to counter the underlying differences in airplane size and the subsequent effect on traditional metrics used to compare like per seat mile costs, he normalizes regional jets operating on behalf of mainline partners into 737 equivalents.  He then assesses efficiency and profitability without structural distortions that are inherent across the entire spectrum of RJ usage.

Engel’s Analysis  

Based on Engel’s analysis, United enjoys the highest profit per regional unit by a factor of three over US Airways, which has the second-highest profitability.  American Airlines is the least profitable, losing $3.1 million per RJ equivalent.  It is no coincidence that the most profitable is the carrier that has among the most liberal mainline scope clause agreements, while the least profitable has the most restrictive contractual rules governing RJ deployment.  According to Engel, Continental, Delta and American each lose money on their RJ operations in that order before network synergies are accounted for.

Today, according to Engel, American is limited by its collective bargaining agreement with the Allied Pilots Association to flying no more than 47 70-seat regional jets.  At Delta, with the most relaxed scope clause, regional partners fly 284 70 and 90 seat jets; at United, regional partners are flying 153 70-seat jets; and at US Airways, regional partners are flying 110 70 and 90 seat jets.  [US Airways is the only network carrier permitted by the mainline agreement to fly regional aircraft larger than 76 seats.] Continental is not permitted to fly any regional jet larger than 50 seats.

Engel estimates that the mainline today flies 5.1 seats to every seat flown by the regional partners compared to 5.8 seats in 2006.  At that time, Delta and Northwest had not completed their restructuring in bankruptcy and United had just aggressively begun replacing unprofitable 737 flying with 70 seat regional jets.  United was able to replace the unprofitable flying only by negotiating the right to relax the scope clause during its bankruptcy restructuring.

At the Core of RJ Profitability:  FUEL

Ultimately, Engel’s analysis underscores the critical role fuel plays. “When fuel prices doubled in 2004, regional jets, especially 50-seat planes that have high fuel consumption per seat, became less attractive relative to mainline flying,” he wrote. Since 2004, mainline airlines have made $1.72 million per 737-equivalent (or $580,000 per CRJ-200 equivalent) more on their mainline aircraft than their regional fleet. The mainline-regional spread peaked at more than $3.20 million per 737-equivalent (or $1.09 million per CRJ-200) when oil prices spiked in 2008.”

The Exception is United

While the US Airways regional jet operation has been the most consistently profitable and American the least profitable, Engel finds that United earns the most per regional jet and is the only carrier where the regional jet operation is more profitable than the mainline operation. According to Engel, United does much less non-hub flying with its regional jets than its peers, operates a higher percentage of larger regional jets (more than half have more than 50 seats) and leverages its powerful domestic and international connections to increase profits.

Engel makes other points:

-          United has the highest utilization of RJs; Delta the lowest primarily because of a disproportionate number of 50-seat RJs.  Delta’s utilization should improve as it goes forward with plans to remove 10 percent of the RJs it operated in 2009. 

-          Legacy carriers fly RJs less but generate more revenue per plane.  United generates 41% more revenue per 737-equivalent from its regional fleet than the industry as a whole, and Delta produces 16% less revenue per regional plane.

-          United pays least for its feed while American pays most.  United spends 27% more per equivalent regional plane while garnering 41% more seat-miles and revenues. In contrast, American spends 10% more per regional aircraft while obtaining 4% fewer seat-miles and revenues.

Engel goes on to break down metrics between Republic, SkyWest, Pinnacle and ExpressJet – the publicly traded regional providers.  My read is that Republic and SkyWest are in the best position to weather the shakeout.  Pinnacle enjoys some strong attributes and SkyWest subsidiary Atlantic Southeast Airlines has announced its intention to purchase ExpressJet. A consolidation phase is playing out inside the regional sector as carriers look to create economies of scale.

What about the Regional Business?  Scope Negotiations?  Small Community Air Service?

New rules and regulations facing the industry will likely layer new costs upon costs, which could change this analysis looking ahead. Already regulators are suggesting that mainline carriers take a much more active role in overseeing their regional operators, which would impose upon them new responsibilities and potential liabilities. One question is whether new costs will tip the balance for Continental, Delta and American in terms of keeping the regional operations profitable.

As we add additional costs on top of already unprofitable flying (absent network effects), there are calls by the American and the United/Continental pilot unions to, in effect, bring all regional flying in-house.  Can the mainline pilots possibly do the flying with better economics?  In an earlier blog, Mainline Pilot Scope: Will Regional Carriers Be Permitted to Fly 90+ Seat Aircraft? I argued that pilot unions should find a more effective way than scope to think about job protection, focusing instead on the economics that will employ the most pilots at the mainline.  That challenge must acknowledge the fact that today’s industry is not the industry of yesteryear.

 As I see it there are two options:  Either 1) relax scope in order to win bigger increases in wages, benefits and working conditions for pilots that remain at the mainline; or 2) embrace the absolute fact that contractual rates, work rules and benefits need to be lower for US domestic mainline flying.   Domestic market flying differentials may be the new trading currency to adapt pilot contracts to the market realities of today.

It won’t be easy for pilot union leaders to agree upon a solution to a problem that they helped to create.  Just as the US Airways East scope clause defines small, medium and large regional aircraft, it is time to define small, medium and large narrowbody equipment necessary to profitably serve the domestic market.   As for the American and United/Continental pilots who believe that all flying should be done by mainline pilots, Engel’s analysis makes clear that United did a very good job in trading out 737’s for EMB 170’s.  The fact that United’s regionals outperform all of their industry peers in efficiency and profitability underscores how difficult it will be to undo the language that they negotiated in the first place.

With Congress’ influence being felt at every corner when it comes to what is best for the regional industry, it is time to discuss the unintended consequences.  As we layer on regulatory costs, it is certain that some of regional flying being done today will no longer be profitable.  Today’s carriers seem to be hell bent on removing unprofitable flying from their networks.  Won’t it be interesting when the next commercial air service airport is disenfranchised from the air transportation grid because the market cannot make money as a result of the new costs?

Then we will hear that the Essential Air Service program – a program that benefits a few at the expense of many taxpayers -- needs more funding.  Will anyone have the political mettle to acknowledge that the program has outlived its intended consequence? Today, 97 percent of US domestic demand is found at the 200 largest commercial airports. Given the razor thin margins in the regional industry Congress and the regulators should be careful for what they ask for. 

What is wrong with the highway being the first point of access to the air transportation system for markets that cannot support direct air service?  Customers seeking low fares have already proven they are willing to drive to whatever airport offers them. But when it comes to NIMBY (Not In My Backyard) Congressional Representatives, lawmakers who support policies that add costs to regional flying must realize that there are consequences to their actions.  Oil has made the 50-seat jet largely unprofitable.  With no replacement aircraft that size in sight, what happens to small community air service when leases are not renewed because small jet aircraft are just too expensive to operate?

Between the price of oil, scope, the legislators and the regulators, I fear that there will be many communities that lose service over the next decade.  And of course no one will take the blame.

 

 

 

 

 

 

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  • Response
    There is an interesting article over on Swelblog in which Bill Swelbar gives us a run down on a recent

Reader Comments (17)

This is great stuff. Small community air service and thin routes are DEAD.

Where does one find Mr. Engel's research?

10.7.2010 | Unregistered CommenterR. C. Arthur

Here's a novel idea...instead of continuously trying to make profits off the backs of labor by slashing their pay, RAISE THE FREAKING TICKET PRICES!!! The idiots that are demanding first class service for a $250 coast to coast tickets need to realize you get what you pay for. I've been stuck at a "regional" airline for the past 9 years due to 9/11, and even though I'm responsible for the lives of over 250 people a day (5 flights x 50 seats + crew), I barely get paid $65,000 a year. I've already taken paycuts and reduction in quality of life aspects of my contract in order to help my company stay in business. Airlines are becoming profitable again and need to start giving back to the people that helped make it that way, not come and ask us for scope relief or paycuts then drive off in your Mercedes and Ferraris (and yes, that's what one of our VP's did).

10.7.2010 | Unregistered CommenterFed up Aviator

Airlines should raise fares. Even if they did, I would pay. Most people would. A ticket on virgin america is cheaper than one on greyhound. It should not be that way considering the time you save on virgin. There will eventually be an equallibrium point when things get right. Right now we are in a transition phase with all the consolidation in the industry. The industry doesn't need congress blindly meddling, but some knowledgable people writing what legislation is needed.

10.7.2010 | Unregistered Commenterjay-jay

There will be no pilots left should wages decrease further, which will further complicate the analysis. Even today, fewer and fewer young people are able to secure the finances necessary to become a professional pilot. Combined with $14,000 a year starting salaries, no one wants to fly as a living any more. To distort the analysis even further, new regulations governing the prerequisite experience to sit in a Part 121 cockpit will further reduce the supply of pilots. Oh, and thousands of pilots will reach the maximum age of 65 in 2012.

How 'bout them "market realities?" Did you totally miss this facet of the equation?

10.7.2010 | Unregistered CommenterHAH!

HAH!

Pay no attention to the man behind the curtain. The MBAs of the world are the same ones who brought you the demise of the US steel industry, the US automotive market and now the US aviation industry. MBAs are very short sighted people who only can focus at most to the next quarter and will bolster the balance sheet so they can rape the employees once again via their bonuses at the expense of all others.

The sharp drop off in the US pilot force won't happen until the age 65 rule catches up December 2012 then you shall start to see parking of RJs because of a lack of warm bodies to man the cockpits. On top of that is the recent ruling of 1,500 hour TT to be a First Officer in a FAR 121 Operation exacerbates the situation that much more.

Soon your Captain on your friendly B777 will be making $75,000 a year and writing back home how he lives like a king with two, that's right two flushing toilets in Queens, New York.

No one is behind us to fill our seats. In five short years you can sit back, relax and enjoy the show.

10.7.2010 | Unregistered CommenterChitragupta

I find this article is humorous at best but in reality Swelbar knows not what he is talking about.
United grounded 100 737's that were being flown for les than 12 cents per ASM and replaced them with RJ's at 12 cents and higher. Someone please tell Southwest and Alaska they are not really consistently making money but are actually losing a pile. They fly an all 737 fleet and pay the highest wages in the industry. They couldn't possibly make a sustained profit with that model, just ask a UAL manager. Garbage in, gargabe out. Again, please tell SWA and ALK their business model doesn't work. Could it be the analysts and the totally broken management/business model at UAL etc. are wrong? The facts speak for themselves...

10.8.2010 | Unregistered Commentertom

I would be curious to know how much money Continental by using RJ's on routes where the demand would have justified larger mainline jets. It appears that in markets such as Houston to Nashville, Charlotte, Corpus Christi and Monterrey, MX, they used 2 RJ roundtrips where a single B737-500 would have been more efficient. Furthermore, it appears that their decision was based on trying to minimize the number of pilots and flight attendants being payed mainline scale rather than economics. When fuel prices went up to $4 a gallon, that policy hurt them considerably. So was their policy based on economics or politics?

10.8.2010 | Unregistered CommenterGSB

Let's say the American & United/Continental pilots bring the regional flying in-house, will they be will to fly those aircraft with pay rates and work rules that will let those aircraft be operated at a profit?

The qustioon that goes along with that is "are those aircraft operated at a profit today" under the pay rates and work rules at the regional carriers or are their operations being subsidized by mainline revenues?

If regional operations are not profitable now, perhaps there is no current justification for their existence or their ticket prices should be raised so they do make a profit.

I see no reason why shareholders (or employees for that matter) should subsidize service to markets that are too small to earn a profit.

10.8.2010 | Unregistered CommenterBob M.

The first sentence should read "...will they be WILLING to fly..."

10.8.2010 | Unregistered CommenterBob M.

What's not added in the author's analysis is the cost of the added operations (delays) that the Regional Jets produce in the carriers hubs. All one needs to do is take a quick look at the OAG out of O'Hare to see the 6 to 12 round trips to cities such as IND, STL that are 100% RJ's and even a mix (UAL) to MSP. By cutting the ridiculous frequencies and using larger equipment to time arrivals to the departure banks at the hubs would create efficiencies for the airline as well as the whole system. The amount of daily operations reduced at O'Hare would provide reduced delays, mis-connects and provide for a better product for the customer. Would one rather have the option of 10 flights to ORD then sit in a small RJ on a delay or 6/7 flights to ORD, depart on time, on a mainline aircraft knowing you'll make that meeting or connection?

10.8.2010 | Unregistered Commenterrealityair

realityair,

Implicit in your post is that the slots opened up by switching to larger aircraft would remain unfilled. That would only happen if the government reduced the number of slots.

Two questions are raised:
1. Where would the RJ's fly after they are replaced?
2. Where would the larger aircraft come from to do this additional flying?

10.8.2010 | Unregistered CommenterBob M.

There is much room still at Victorville,CA et.al. for RJ's and coincidentally there are plenty of 737's (albeit older models) available. Look at DAL, they are trying to get there hands on MD 88's and 90's. Cheap aquisition costs equate to low CASM's on those specific aircraft. Maybe the control needed from the FAA is they say: AA and UAL, "you have x number of slots (5-7?)between ORD-STL, ORD-IND, ORD-MSP..you use them how you see fit". The demand for seats should dictate what aircraft they should use. If you want a delay free O'Hare limit the slots per hour or invest in the ATC system and ground facilites.

Using analysis of data from the Official Airline Guide for domestic U.S. flights arriving at O'Hare on December 1, 2004. an examination of data that day in 2004 shows that regional jets accounted for 44% of operations, but only 24% of seating capacity. Very typical and most likely even worse today.

10.8.2010 | Unregistered Commenterrealityair

Let's just say, hypothically, an airline volunteered (or was forced) to reduce the number of RJ flights from IND to ORD. This hypothetical is called Airline X. There's also an Airline Y which flys to IND and all the same destinations as Airline X except that their hub is Denver and therfore doesn't have to reduce any RJ flying. Airline Y can continue to fly eight RJs eqaully spaced throughout the day from IND to DEN. Now who can guess which of these airlines is going to attact most of the premium traffic? How long before Airline X dehubs ORD?

I have an idea...

10.8.2010 | Unregistered CommenterCAL

HAH!,

I found this on another board about DAL pilot retirements in the next few years. The numbers for US, AA, WN & UA are unknown but should be substantial when they are consider concurrently, enjoy:

Pilot Attrition:

-2013 will have over 100 age 65 pilots
-2011 will have over 850 pilots 60-65
-2016 will have over 2800 pilots 60-65

10.8.2010 | Unregistered CommenterChitragupta

It looks as if Ford's Pinto has made a comeback!!

"Can the mainline pilots possibly do the flying with better economics?"

Two word answer: COLGAN 3407

50 were killed, not died killed, due to hiring incompetent cheap pilots. Recall the Captain had 5 FAA failures. Pilots with stellar records and talents (Sully) cost much more.

Why didn't Engel factor this into the analysis? Perhaps it's already taken into account with the insurance premiums.

What's a life worth?

10.10.2010 | Unregistered CommenterPinto

the author is correct in saying that united profits well from the use of regional jets. looking through the quarterly reports, you will see that united earns a higher profit margin on the regional routes than it does for the mainline routes, around 60% higher.

however, united is also paying around 50% more for the regional jet service. in the last few quarters, united's CASM has been around $0.12 for its own operations, while paying around $.018 for the regional jets.

this is reflected in the ticket cost for cities that united serves with regional jets.

point is, united is paying an exorbitant amount for its regional service, but also makes a premium from it as well. united is a very competitive carrier in terms of cost and pricing on its mainline routes, but is vulnerable on routes served by the regional jets.

10.13.2010 | Unregistered Commenterstratoduck

We won't ever really know how much UAL profited from its UAX operations. Only UAL mgmt knows this and I'm quite sure they won't be sharing the "real" numbers. One can get a partial picture with the O/D traffic but with those who book through the hub to another destination (DOM or ITN'L) how do they allocate the RJ portion of the revenue to the rest of the ticketed segment? Lots of leeway and if you want to justify the RJ portion it would be easy to do so.

10.13.2010 | Unregistered Commenterrealityair

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