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Tuesday
Jun172008

10 Airline Issues That Have My Attention

Note: at 634pm I made some minor edits to the orginal post. Immediately after posting, a personal issue arose that required immediate attention. I apologize.

But before we go there I will share my favorite headline of the week gone by: Congress, get off your gas, and drill!

1. Crandall

It is interesting to me that Gordon Bethune has gone quiet for the most part and has now been replaced by Crandall. The entire industry recognizes what Crandall recognizes and that there is little obvious cost cutting that remains other than capacity cuts and that the revenue line must become the focus for the industry. The interesting note to all of Crandall's suggestions for some form of reregulation is how US airline labor generally, and American Airlines' labor specifically, are hanging on his words of late. Is it Crandall the leader or the suggestion of reregulating the industry? Crandall the leader would not be handing out big increases in compensation in this fuel environment; yet Crandall the re-regulator is the silver bullet that would enable the industry to charge enough for an airline ticket to offer a return of the concessions and still employ all 400,000+ people that remain in the industry?

2. IATA Annual General Meeting

Mark Pilling of Airline Business writes Airline bosses call for strict capacity discipline following IATA’s Annual General Meeting last week in Istanbul. This piece is good reporting on the differing levels of cuts being considered around the globe. With the US undertaking the most aggressive actions: Europe is now beginning the process of how to react; the Asia-Pacific carriers are exiting some routes but redeploying capacity to other more promising routes; and the Middle East is continuing on their aggressive growth path. Is the industry serious about capacity discipline this time and will we really put capacity down as a reaction to outside forces and inherent inefficiencies? Or is this just a time out?

3. Labor PR and of Course Fuel Does Not Matter

I did not think I would see ALPA take a page out of APA’s tired play book, but they have. On Sunday night, the following appeared: labor Relations Darken at Hawaiian Airlines. But my favorite story in this topic area was written last week as Continental pilots picket for higher pay, benefits. I have no issue regarding a union’s right to picket. But I do have an issue with yet another irresponsible statement from a labor leader. In the Continental story, Captain John Prater, President of ALPA is quoted as saying: “Don't try to use the price of gas," said Prater. "The industry is unstable, and the only way to add labor stability is through a solid contract." What does that mean? Of course the price of gas will have absolutely nothing to do with the outcomes of negotiated agreements John [emphasis added]. With so many things happening in the interesting Hawaii market, I only wish I could write on some of them.

4. European Carriers

Over the last few months, stories have been appearing that suggest the underlying fundamentals in the European market are weakening. Austrian Airlines has suggested the carrier will seek a strategic partner. We all know of the woes at Alitalia. Among the Big 3 in Europe, British Airways has been warning of turbulence ahead for the carrier in the face of high oil prices and the carrier’s exposure to the weakening US market. And now there are even rumblings from Lufthansa and Air France/KLM. For each of those two carriers the revenue synergies have been captured through their acquisitions. Now there will be a renewed focus on costs. Finally, the US is not alone.

5. Asian Carriers

For me, things were starting to get interesting in this critical world region immediately following Singapore’s earnings announcement in February that was less than stellar. Then Cathay Pacific suggested it would begin to curb capacity growth. Then Qantas. Each of these carriers has a place on the list of global elite airlines and are not immune from the environment either. AFP reports that Oil costs will push some Asian airlines under: analysts. Thinking about it, this region’s airlines carry passengers long distances and we know that the price of fuel and long-haul flying are not in concert today in all markets. In the article it is suggested that the region’s airlines are not close to doing enough and that SARS-like capacity actions should be considered in some cases. With or without high oil prices though, this region is certain to lose airlines along the way given its early stages of development.

6. Boeing and Airbus – A Couple of Things

Julie Johnnson of the Chicago Tribune writes that Foreign carriers' woes could hurt jetmakers. I have heard that some deliveries will be deferred. Certainly today’s issues will only prolong the needed replacement programs for the US industry, except for Southwest, Continental, AirTran and others. The manufacturers and lessors cite the fact that aircraft can be quickly placed into another carrier’s portfolio if positions or newer generation aircraft come available. But we still have not felt the full effects of the economy’s headwinds in my judgment.

At the same time the manufacturers are doing the industry no favors by perpetually delaying the delivery of the new generation aircraft that promise significant efficiencies and fuel savings. I found it most interesting in Continental’s announcement last week that it would park its older aircraft but continue to take delivery of new aircraft. This will be a story to watch.

7. Liquidity and US Airline Equities

Bill Greene, Morgan Stanley’s airline analyst, published another very good piece of research today where he continued to write on his tipping point theme. He writes: Too soon to begin buying US airlines, in our view. "As we’ve written in the past, we believe that amid the current macro backdrop, airlines will not become attractive investments until the industry reaches a Tipping Point - when extremely bearish fundamentals trigger broad, acute financial distress and restructuring that leads to significant capacity reductions (beyond current announcements); thus, serving as a very bullish catalyst for shares in surviving airlines. After updating our estimates for $130/bbl oil, it appears that a Tipping Point catalyst is more a question of when rather than if."

In Greene’s liquidity analysis of his tipping point theory, some very interesting findings are expressed. I have written often of liquidity concerns and that this period’s focus will remain firmly on the balance sheet and the cash flow statement. Yes we are in a cash burn scenario yet again. As Greene analyzes the airlines he covers, he points to the steeply downward sloping liquidity positions for each of the carriers assuming $3.81 jet fuel and taking into account all fixed obligations between now and the end of 2009.

Through 2009, he ranks the US airlines he covers from worst to best in terms of liquidity: US Airways, and a need to raise $1.5 billion to maintain a liquidity balance equal to 10 percent of last 12 month revenues; American, and a need to raise $2.6 billion to maintain a liquidity balance equal to 10 percent of last 12 month revenues; Northwest, and a need to raise $856 million to maintain a liquidity balance equal to 10 percent of last 12 month revenues; Continental, and a need to raise $260 million to maintain a liquidity balance equal to 10 percent of last 12 month revenues; United, and a need to raise $290 million to maintain a liquidity balance equal to 10 percent of last 12 month revenues; Delta with no need to raise cash; and jetBlue, with no need to raise cash.

8. Continental's Announcement of Capacity Cuts

Last week, Continental described in detail its planned capacity reductions. Can we learn anything from their list as we look toward the detailed cut announcements to be unfurled by United, American, Delta, US Airways and others as we approach fall? Markets with leisure attributes that demonstrate little to no hope of being able to charge for the full cost of fuel, let alone all other expenses associated with carrying a passenger from A to B will either be eliminated or cut back significantly. Long-haul regional jet flying will be scrutinized, and reduced, as Continental cut a number of these city pairs. City pair routings of a highly seasonal nature might be totally eliminated during the shoulder season. And while much has been made of the shift to international flying, Continental certainly demonstrated that underperforming international markets will be cut as well. Finally, the elimination of service to certain cities that offer little hope of ever being profitable were dropped from their network map. Distinct patterns will develop as other carriers make their announcements.

9. The Mixed LCC Bag

Samer A Majali from Royal Jordanian was named the new Chairman of IATA. In an interview where he discussed issues confronting the global airline industry, he stated that fuel prices to hit budget airlines the hardest. In the US we have witnessed this very issue. We have seen ATA liquidate; Skybus liquidate; Frontier file for Chapter 11 reorganization and still searching for capital; and just recently Sprit announced that it will begin to cut capacity and headcount. This is not a very good time to be a "bottom fisher". AirTran and jetBlue have each sold aircraft and/or delivery positions to bolster liquidity. A question to ask: what will Southwest do when it has to run an airline instead of a trading desk? Will Southwest become the savior for big leisure-oriented markets like Las Vegas and Orlando and will these will be the markets that “fuel their growth”? Southwest is the one that scares me on the capacity discipline issue.

10. Those Frothy Commodity Markets

Today, the Air Transport Association called on Congress for U.S. curbs on oil speculators. I just get nervous when this industry calls on Congress for anything as it seems to be an invitation for layering on more favors that tend to make this industry even more inefficient than it is. But I do understand the need to investigate anything and everything that could help in the jet fuel area.

Finally and based on my previous post, the world’s best golfer was crowned yesterday. Only issue is - he had already been identified.

Monday
Jun022008

Rambling, Musing and Pondering on Airline Industry Issues

In past years, the industry’s trade associations have not always been strong voices for issues, particularly economic issues, impacting the industry, whether it is the global industry or the US industry. In recent years that has changed. Each respective organization is fortunate to have two very capable Chief Economists: Bryan Pierce with the International Air Transport Association; and John Heimlich with the (US) Air Transport Association. The data and analysis provided by each should be a link on every serious industry watchers favorite list. And watch them daily, as meaningful insight is provided by each man.

The IATA Annual General Meeting opened today in Istanbul and IATA CEO Giovanni Bisignani warned that the global industry is on course to lose $2.3 billion if oil should average $107 per barrel and $6.1 billion if oil should average $135 per barrel. Less than a year ago, IATA was forecasting a global industry profit in excess of $10 billion. Bisignani has been a loud voice on the need for consolidation in the global industry citing important facts regarding this industry’s unhealthy and fragmented state. I really like this guy and I particularly like his call for a clean whiteboard as this blogger has wanted the UPS whiteboard guy to redraw the global map for some time.

United; United-US Airways; American; and Jim “Hell NO”berstar

I don’t know about you, but I am very happy that United said “NO” to walking down a road toward a formal combination with US Airways last week. Something just did not feel right about that one. Yes the labor issues were significant. The IT issues were significant. The combined networks left a bit to be desired from my perspective as the regulators would surely have required some auctioning off of valuable airline real estate. United has more than its share of problems to be sure, but the deal was far better for US Airways’ stakeholders from my perspective as there is little the Phoenix-based carrier could offer in terms of route portfolio diversification.

It took us 30 years to get into this mess and it will take time to get us out.

Despite industry consensus, Tilton did not pursue a deal for deal’s sake. Instead he said "NO" – at least from public reports. The historic US industry leaders – American and United – both began the process of battening down the hatches last week. Each carrier began to make announcements and pronouncements that their respective businesses would be managed in the near-term as stand-alone entities. So Jim “Hell NO”berstar looks less like a soothsayer as the wave of industry deals he suggested has come to a halt.

I like the decisions. I particularly like United’s decision because Tilton has been saying that the industry needs to restructure. Consolidation is part of the restructuring he has suggested. Consolidation has been the operative word used for mergers in the industry – but mergers rarely consolidate much if anything. Consolidation has been the scare word used by the naysayers to signal that consumers will get hurt. Consolidation has been used by labor to extract monopoly rent only to return to the bargaining table to give most of the rent won back to the respective company. Consolidation has been used by those on Capitol Hill to suggest that service will be lost.

Well, we are about to begin a real consolidation of the industry and it cannot be laid at the feet of a merger and acquisition proposal/era. Capacity will be cut because it is not economic to run individual networks of the scope that are operated today. Prices will go up, but not because of a merger and acquisition proposal but rather because a business that needs to pass on the costs of providing the service. Labor will negotiate their next contracts just as they have before, except for the Delta pilots that recognize that certain scope restrictions standing between revenue and principal are not in anyone’s interest. And the condition of the economic environment will be taken into account in either direct or mediated talks or whether the case lands in front of a Presidential Emergency Board.

American and United are, and will be making some tough decisions. Delta and Northwest have made a tough decision to join hands. But that decision is in the best interest of two companies that are so dependent on network scope to maintain service to a maximum number of points. Northwest would be particularly hard-pressed to maintain all of the service it provides. Continental is blessed by geography but still has fragility in its financial position. And the question becomes for the remaining legacy carrier, is US Airways’ cursed?

As for the sectors incorrectly referred to as Low Cost and Other Carriers: Southwest is blessed with capital and well all that is-Southwest; Alaska, jetBlue and Virgin America are arguably blessed with a brand; and AirTran is blessed – in the near-term with flexibility of selling off delivery positions to help it today - but could hinder it tomorrow when the market does make a turn for the positive.

This really is a cool time in the industry’s history. A time that will be embraced by the survivors. The "oil era" will be sure to have its place in history. And for some the slippery slope caused by the commodity will land some in airline oblivion; for others it will end on a path toward something much better than today.

The Price of Oil and Attributes of a “Bubble”

Over the weekend, a number of articles appeared suggesting that the oil chart replicates some of the stock – or shall we call them commodities’ – charts of the late 90’s. One thing I have learned from years in this industry is not to second guess the markets and not to try and predict the price of oil. Do today’s oil prices have “bubble” attributes in the traditional sense – yes. Does history suggest that anything that is market influenced will remain on this trajectory – no. And this is yet another reason why, if I am labor, I would be putting some chips with insurance on the come line. Leverage with the business is the only hope of coming close to replacing a majority of what was given up during the restructuring period. Only it will be in a one-time payment and not a legacy payment embedded in a contract.

CEOs, Policy Makers and Shareholders

I like to refer to today’s CEOs as “Agents of Change”. Popular? – no. Hell bent on change – yes. Standing in the way of preventing the past practice of doing business – yes. Concerned about their place in history – yes. Afraid to get dirt thrown their way in the process – no. Bringing the shareholder into the “virtuous circle” of airline industry prosperity – yes.

With the exception of Delta-Northwest, the litmus test is underway. Each of the legacy carriers is on a path toward restructuring their respective businesses. The naysayers should be happy. Of the six legacy names, the current construct will preserve five. Yet service will be cut and prices will go up – and it will not be because of consolidation in its historic definition. It will be of business decisions necessary to preserve the capital of the day’s stakeholders. Not all of them. But….. Today’s CEOs will do that as their fiduciary duties begin and end with that fundamental charge.

Labor will be tested and will probably say on some Monday morning: “Man, that merger proposal may have been better than riding out a business that has to make these decisions to cut, cut, cut”. Congress will ask: “Maybe this business is not a utility that serves my region’s airport? Some sort of rethinking the emotional issues may have provided my constituents with something better?” Regulators will say: “I knew if we kept our hands off the US market would be better served”. And hopefully the Executive Branch policy makers will say: “this boom and bust is good for no one, so let’s give them a clean whiteboard and if it gets out of hand will step up. But the way we are doing this just does not work”.

And the shareholders will finally say: “the barriers – oh I mean excuses – have been removed and if this guy cannot do it now then let’s find another guy”.

Thursday
Apr032008

Fuel Up, Forecasts Down and Labor at American Airlines Drills a Dry Hole

Crude Oil/Jet Fuel 101

There will be a time down the road when we will all stop talking about the high price of oil and thus the high cost of jet fuel and the resultant impact on the US and global airline industry’s ability to sustain profitability. But that time is not now.

I will put the impact of fuel costs in some historical perspective. During the second quarter of 2000, the industry paid 1.25 cents per available seat mile (ASM) for fuel and 3.50 cents per ASM for labor. By the fourth quarter of 2007, the industry was spending 3.50 cents per ASM for fuel and 3.00 cents per ASM for labor. At 1 billion plus available seat miles flown in 2007, you can do the math.

John Heimlich, the Chief Economist of the Air Transport Association, keeps us up to date on ATA’s website, http://www.airlines.org/, on energy/fuel issues facing the US airline industry. For serious industry watchers, if you don’t have a link to John’s work on your list of favorites then I suggest that you add it now.

It Is More than the Price of Crude

On the site, Mr. Heimlich regularly updates the presentation entitled: “Coping With Sky-High Jet Fuel Prices” in which he points out very clearly that the price of crude oil is only part of the cost for the airline industry. Heimlich reminds that the industry pays a premium, known as the “crack spread,” which is the difference between the cost of a barrel of crude oil and what the industry pays for crude oil refined into jet fuel. Until, hurricanes Katrina and Rita, the industry historically paid a crack spread price of $5 per barrel. In his initial forecast for 2008, Mr. Heimlich forecasts a crack spread price of $25 per barrel.

That $25 of crack spread forecast for 2008 is roughly equivalent to the cost of a barrel of crude in each 2001 and 2002. Simply stated, at a cost of $110 per barrel crude oil, the industry would pay an all in, or “in the wing,” cost per barrel of as much as $135. According to Heimlich, just last week the New York Harbor price of jet fuel topped $145 per barrel, including a crack spread nearing $35 per barrel.

So the pain the average driver feels at the pump is even worse for the airline industry. Heimlich points out the difference in his analysis comparing gasoline to jet fuel. Whereas the difference between the two was $2 per barrel in July 2007, today jet fuel is $29 per barrel more expensive than gasoline. Even with the many industry efforts to improve fuel efficiency, Heimlich forecasts that airlines will pay in excess of $55 billion for fuel in 2008 -- more than $14 billion more than the industry paid in 2007, without consuming so much as a single gallon more.

Many believe that raising fares will fix all. Yes, fares have increased some. But Heimlich shows that, all told, fares for the first two months of 2008 are 2.4 percent less than the average fares for the same two months in 2000. Over the same period, fuel costs have risen 198 percent.

Revised Forecast

As Heimlich was updating his fuel analysis, Brian Pearce, Chief Economist for the International Air Transport Association, was revising his 2008 global forecast – for the second or third time. Mr. Pearce’s initial outlook, issued early last year, predicted that the global airline industry would see a profit of nearly $10 billion in 2008. In September 2007, Pearce revised his profit forecast downward from $9.6 billion to $7.8 billion, citing both fuel costs and the beginnings of the credit crisis.

Only a few months later, in December of 2007, IATA revised its global forecast down yet again. But that revision caught many by surprise based on its sheer magnitude: in less than a year’s time, the IATA forecast a global airline profit of $5.0 billion – a 36 percent reduction from the previous forecast. Now, only yesterday, Pearce again revised his outlook downward by another 10 percent to $4.5 billion in his report “Stagflation Threatens The Outlook.” It is worth a complete read, but his first three points are powerful:

Our previous forecast in December projected a downturn in traffic and profitability for the airline industry this year. Since then the situation in the US economy has deteriorated and jet fuel prices have risen sharply. Stagflation has returned, a damaging combination of forces to which the airline industry is highly exposed over the year ahead.

The uncertainties facing us are far greater than usual. If central banks fail to reverse the credit crunch the outlook, particularly for the US industry, could be far worse. Our next forecast in June will be able to take a clearer view on the extent of the economic difficulties. In this forecast we have taken a conservative approach to cutting our profits forecast. We now project net profits of just $4.5 billion this year.

US consumer confidence slumped in March to levels consistent with a serious recession. The bursting of the housing market bubble leading to falling house prices and sub-prime mortgage defaults has led to a deepening crisis in the financial sector. The resulting credit crunch is now damaging the wider economy.

Now Let’s Turn to American Airlines’ Labor Issues . . . Yet Again

At this point, AA is in negotiations with all three of its unions, so it’s no longer only the Allied Pilots Association attracting news coverage. This week, it was Transport Workers Union, which represents maintenance, ramp and other workers. Yesterday, Trebor Banstetter of the Ft. Worth Star-Telegram reports on his blog that the union placed John Conley, Air Transport Division Director, on administrative leave. This questionable decision apparently stems from a comment Mr. Conley made at an aviation conference in which he suggested that the meteoric rise in the cost of fuel might impact the negotiating outcome in contract talks between the TWU and American.

I have met Mr. Conley and have listened to him in other public forums. I have always been struck by his thoughtful approach, his knowledge of the industry, and the care he shows for the people he represents. In this case, he simply stated the obvious. The reaction by TWU International President Jim Little is unfortunate, but it is likely one we will see more of.

Tracking the news and managing the expectations of the workers they represent is what union leaders do, or should do. But that has not been the case of late in the airline industry, where zealots and ideologues have set completely unrealistic expectations in their rhetoric surrounding contract talks. The TWU’s overheated reaction to Conley’s comments may have more to do with an ongoing campaign by a rival union, AMFA, to organize AA’s M&E shop. But if that’s the case, workers will face the unappealing choice between one union that attempts to silence one of its key officers for speaking the facts, or another that did a less-than-respectable job in representing its members at Northwest and United.

It has been said in the comment section on this blog a couple of times that I have a disdain for airline employees. As a former airline employee (and union steward) myself, nothing could be further from the truth. But I don’t have much patience for union leadership that overpromises and thus sets unrealistic expectations for members when the industry is under enormous financial and competitive pressure. Actions like this are precisely why I believe that this will be the toughest period in labor history since deregulation.

Since posting this piece this morning, I note that Holly Hegeman of Planebuzz.com wrote on the subject of John Conley’s demotion last evening. It is well worth a read.

Watch Alitalia as it is a precursor. In the US, we are witnessing happenings at Aloha and ATA. And we are still on the A’s.