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U.S. Airline Future: In the Eye of the Storm
By Anthony L. Velocci, Jr.
02/29/2004 11:25:47 PM
IN THE EYE OF THE STORM
When Aviation Week & Space Technology last took the collective pulse of the U.S.' six legacy hub-and-spoke airlines in November 2002, their vital signs were weak. All of the operators were suffering from high labor and fuel costs, a recession, the lingering aftermath of the 2001 terrorist attacks, grinding competition from low-fare rivals and, except for one or two of the companies, weak management. Most of the conditions over which carriers have little or no control have improved or don't exist now, and demand for travel is rebounding. Still, the industry's health remains fragile and airlines face an uncertain future. In the following update on the state of the traditional majors, their challenges and prospects are explored.
For the six largest U.S. legacy airlines, the maelstrom is over--for now.
But the calm won't last. The day of reckoning has only been postponed, thanks mainly to a strengthening domestic economy and a gradual recovery in air travel demand.
In the 15 months since Aviation Week & Space Technology published its special report on the U.S. airline industry's precarious financial state (Nov. 18, 2002, pp. 52-69), there's no denying that the majors as a group have made progress.
They've reduced expenses, due in some cases to lower labor costs and higher productivity. While revenues are still depressed from the pre-Sept. 11, 2001, doldrums, ticket sales are increasing. Near-term liquidity and operating margins have improved. The carriers no longer are piling up unsustainable losses, though they're still swimming in red ink. Net losses totaled $5.3 billion in 2003--most of it in the first half of the year--versus $7.4 billion in 2002. Furthermore, some carriers may actually break even or post a slim profit in 2004.
American Airlines, which barely escaped Chapter 11 filing last summer, and United Airlines, which has operated under bankruptcy protection since December 2002, have come the farthest. Embattled US Airways, which exited Chapter 11 in April 2003, is again teetering on the brink, while Delta Air Lines and Northwest Airlines are lagging. Continental Airlines is doing a respectable job but was recently overtaken by American as the lowest cost operator among the legacy hub-and-spoke carriers.
The airline crisis of 2001-03 is over, and there is unlikely to be any more Chapter 11 filings anytime soon, declared Philip Roberts, vice president and managing partner of Unisys R2A, a transportation management consulting firm. That's how UBS Warburg analyst Samuel Buttrick sizes up the sector too. Barring a serious shock to the U.S. air transportation system, he thinks the most recent cyclical downturn is unlikely to force any more major airlines into Chapter 11. "They will muddle through," he said. That's if they're lucky.
Despite the majors' current and near-term momentum, J.P. Morgan bond analyst Mark Streeter pointed out they face numerous long-term problems. Roberts put it more bluntly: "Although the short-term results suggest the worst is over, the picture is still very ugly." Analyst Philip Baggaley, managing director at Standard & Poor's, offered a similar assessment: "They're coming out of the downturn alive but crippled." (S&P, like Aviation Week, is a unit of The McGraw-Hill Companies.)
The cost of labor is still too high in relation to operators' revenues and overall cost structure, according to many of the 14 industry observers interviewed by Aviation Week for this special report. The price of fuel remains stubbornly high and shows no signs of easing in the foreseeable future. Thus far, the majors are taking only baby steps toward true restructuring of their expensive hub-and-spoke business models. In addition, low-cost competitors--such as AirTran, JetBlue Airways and Southwest Airlines--are continuing to take market share away.
"They must dig out of such a deep hole that even meaningful progress in any one quarter will bring them only part of the way up the side of this incredibly deep pit," Baggaley said. Even if they became respectfully profitable tomorrow--most operators have never earned their cost of capital--they would still be carrying a substantially heavier financial burden than they have historically, he added. "It is very unlikely they will ever prosper or get on a solid financial footing, and it is very likely we'll have an airline sector in which the participants will be weak and vulnerable for the next decade. Who survives and how much market share they give up will depend on geopolitics and how skilled their management teams are."
Of course, one of the six existing majors could fail and have to liquidate its assets, reducing total industry capacity. Even then, Baggaley thinks the remaining survivors would get only short- to intermediate-term relief. Still remaining would be the vexing problem of how to effectively counter low-cost competitors. The latter almost certainly would snatch a sizable amount of whatever capacity came up for grabs. The rate at which they are gaining domestic market share may slow, but the basic trend probably is irreversible. In time, low-cost operators are expected to dominate 40-50% of the U.S. market, up from 7-8% 10 years ago and about 20% now.
Waiting in the wings are embryonic groups that aspire to be the next JetBlue success story. "There are a lot of people who are trying to launch a low-cost carrier," said Ray Neidl, an analyst at Blaylock & Partners. "Most won't get off the ground, but you can't dismiss the possibility that someone will have the same winning formula--a good concept, good management and plenty of capital."
There was a time when traditional hub-and-spoke airlines gave little or no credence to the low-costs. "Now majors are more worried about low-cost competition and less about terrorism," Baggaley said.
They have good reason to worry, of course, but it's US Airways whose survival is most at risk.
This spring, Southwest plans to invade US Airways' fortress hub in Philadelphia, which generates about 17% of the latter carrier's total system revenues. US Airways already faces stiff competition from other low-cost airlines in the six markets Southwest will serve initially. As a result, the immediate impact may not be as dramatic as many observers expect.
But in the longer run, Southwest is expected to make mincemeat of US Airways because its operating costs are so much lower (7.7 cents per available seat mile versus US Airways' 11.7 cents in the fourth quarter of 2003). The likely outcome of this competitive mismatch is that US Airways' viability as a network carrier may well come to an end forever. To make matters worse, JetBlue has also successfully penetrated some US Airways markets on the East Coast.
Buttrick shares Neidl's somber outlook. "It's extremely difficult to be optimistic about US Airways' long-term future," he said. "As the carrier is now configured, it will be almost impossible for them to make it."
Still, even the most troubled airlines have demonstrated a remarkable ability to hang on in the face of seemingly impossible odds. There's no better example than Trans World Airlines, which practically was on life support for 10 years. In the case of US Airways, Buttrick pointed out that it posted respectable profits several years in the mid-to-late 1990s. There is nothing to preclude a bout of profitability in the future as demand for travel continues to improve, although its long-term outlook is extremely poor, he said.
"Not everyone will survive--only those who are nimble enough to respond to market demands," outgoing Continental Chairman and CEO Gordon Bethune said. He ought to know. In 1994, Continental was on the verge of Chapter 11 for the third time, and Bethune was able to inspire all of the carrier's stakeholders to pull together and adopt a more business-like approach. But steering clear of Chapter 11 and doing well is not all about forcing wage cuts on an otherwise dedicated workforce, he said. "It's also about how you run your company. You've got to listen to your customers."
Could the majors actually be in control of their own fate? One would never know it, judging from how rare it is for executives running major airlines to be called to task--despite the billions of dollars of wealth they have destroyed through the years relative to their compensation packages. Management's role is a subject everyone seems to tiptoe around, as opposed to the subject of labor, which is usually pilloried as the principal cause of the airlines' troubles. But as one industry analyst put it, "Who's supposed to be running the show?"
While all of the legacy airlines currently in operation won't survive, Bethune also noted they aren't all going to disappear in mass either. The question is how many, if any, will ever become truly healthy and resilient, as Southwest is, regardless of business cycles. Some industry observers believe none will achieve such success until there is sweeping change in executive suites as managers are brought in, probably from outside the industry. "These companies aren't going to get where they need to go through incremental change," one observer said.
No such transformation appears in sight, although one never knows. Former Delta Chairman and CEO Leo Mullin recently stepped down, and Bethune--the last Big Six CEO who dates from Sept. 11, 2001--plans to retire at the end of this year. Both companies could settle for only minor adjustments to their business models--or seize the opportunity to implement real structural change. But if past is prologue, don't count on it.
As the majors' market share continues to erode, Edmund S. Greenslet, head of ESG Aviation Services, expects to see their numbers also drop. It's impossible to predict the stages this "forced consolidation" will go through, he said, but it's likely to span a combination of possibilities. These include at least one failure, a merger or two and code-sharing agreements that stop just short of a full merger. "There is room for four or five, but not all six," he said.
Assuming the U.S. economy continues to improve in 2004, Greenslet expects the industry to move into the black either this year or next. Whether the profits will be sufficient to sustain them is another matter, but he feels certain that profits will be substantially less than they were in the late 1990s. Consequently, legacy majors will remain "extraordinarily vulnerable to economic twists and turns." He suspects it will be some combination of these events that will cause the group to lurch toward the next round of consolidation.
The shortest route to the scrap heap will be following a business-as-usual approach, which has been the historical pattern of the majors, said Thomas Hanson, who heads the airline consulting practice at Booz Allen Hamilton. "As it is, all of them suffer from corporate cultures that have blinded them to the fact that it's a new world," he said, "and that culture is fundamentally incompatible with the new paradigm."
That thought was echoed in a recent edition of Unisys R2A Scorecard: "The salvation of the legacy carriers does not lie in external events--waiting for Southwest to lose control of its costs, for example, or fuel prices to return to 40 cents a gallon, or government intervention. Rather, it lies within the grasp of each airline that is willing to seize control of its own destiny and make the hard choices--based on a realistic analysis of the world as it is, not as one would like it to be--necessary for success."
U.S. Airline Future: In the Eye of the Storm
By Anthony L. Velocci, Jr.
02/29/2004 11:25:47 PM
IN THE EYE OF THE STORM
When Aviation Week & Space Technology last took the collective pulse of the U.S.' six legacy hub-and-spoke airlines in November 2002, their vital signs were weak. All of the operators were suffering from high labor and fuel costs, a recession, the lingering aftermath of the 2001 terrorist attacks, grinding competition from low-fare rivals and, except for one or two of the companies, weak management. Most of the conditions over which carriers have little or no control have improved or don't exist now, and demand for travel is rebounding. Still, the industry's health remains fragile and airlines face an uncertain future. In the following update on the state of the traditional majors, their challenges and prospects are explored.
For the six largest U.S. legacy airlines, the maelstrom is over--for now.
But the calm won't last. The day of reckoning has only been postponed, thanks mainly to a strengthening domestic economy and a gradual recovery in air travel demand.
In the 15 months since Aviation Week & Space Technology published its special report on the U.S. airline industry's precarious financial state (Nov. 18, 2002, pp. 52-69), there's no denying that the majors as a group have made progress.
They've reduced expenses, due in some cases to lower labor costs and higher productivity. While revenues are still depressed from the pre-Sept. 11, 2001, doldrums, ticket sales are increasing. Near-term liquidity and operating margins have improved. The carriers no longer are piling up unsustainable losses, though they're still swimming in red ink. Net losses totaled $5.3 billion in 2003--most of it in the first half of the year--versus $7.4 billion in 2002. Furthermore, some carriers may actually break even or post a slim profit in 2004.
American Airlines, which barely escaped Chapter 11 filing last summer, and United Airlines, which has operated under bankruptcy protection since December 2002, have come the farthest. Embattled US Airways, which exited Chapter 11 in April 2003, is again teetering on the brink, while Delta Air Lines and Northwest Airlines are lagging. Continental Airlines is doing a respectable job but was recently overtaken by American as the lowest cost operator among the legacy hub-and-spoke carriers.
The airline crisis of 2001-03 is over, and there is unlikely to be any more Chapter 11 filings anytime soon, declared Philip Roberts, vice president and managing partner of Unisys R2A, a transportation management consulting firm. That's how UBS Warburg analyst Samuel Buttrick sizes up the sector too. Barring a serious shock to the U.S. air transportation system, he thinks the most recent cyclical downturn is unlikely to force any more major airlines into Chapter 11. "They will muddle through," he said. That's if they're lucky.
Despite the majors' current and near-term momentum, J.P. Morgan bond analyst Mark Streeter pointed out they face numerous long-term problems. Roberts put it more bluntly: "Although the short-term results suggest the worst is over, the picture is still very ugly." Analyst Philip Baggaley, managing director at Standard & Poor's, offered a similar assessment: "They're coming out of the downturn alive but crippled." (S&P, like Aviation Week, is a unit of The McGraw-Hill Companies.)
The cost of labor is still too high in relation to operators' revenues and overall cost structure, according to many of the 14 industry observers interviewed by Aviation Week for this special report. The price of fuel remains stubbornly high and shows no signs of easing in the foreseeable future. Thus far, the majors are taking only baby steps toward true restructuring of their expensive hub-and-spoke business models. In addition, low-cost competitors--such as AirTran, JetBlue Airways and Southwest Airlines--are continuing to take market share away.
"They must dig out of such a deep hole that even meaningful progress in any one quarter will bring them only part of the way up the side of this incredibly deep pit," Baggaley said. Even if they became respectfully profitable tomorrow--most operators have never earned their cost of capital--they would still be carrying a substantially heavier financial burden than they have historically, he added. "It is very unlikely they will ever prosper or get on a solid financial footing, and it is very likely we'll have an airline sector in which the participants will be weak and vulnerable for the next decade. Who survives and how much market share they give up will depend on geopolitics and how skilled their management teams are."
Of course, one of the six existing majors could fail and have to liquidate its assets, reducing total industry capacity. Even then, Baggaley thinks the remaining survivors would get only short- to intermediate-term relief. Still remaining would be the vexing problem of how to effectively counter low-cost competitors. The latter almost certainly would snatch a sizable amount of whatever capacity came up for grabs. The rate at which they are gaining domestic market share may slow, but the basic trend probably is irreversible. In time, low-cost operators are expected to dominate 40-50% of the U.S. market, up from 7-8% 10 years ago and about 20% now.
Waiting in the wings are embryonic groups that aspire to be the next JetBlue success story. "There are a lot of people who are trying to launch a low-cost carrier," said Ray Neidl, an analyst at Blaylock & Partners. "Most won't get off the ground, but you can't dismiss the possibility that someone will have the same winning formula--a good concept, good management and plenty of capital."
There was a time when traditional hub-and-spoke airlines gave little or no credence to the low-costs. "Now majors are more worried about low-cost competition and less about terrorism," Baggaley said.
They have good reason to worry, of course, but it's US Airways whose survival is most at risk.
This spring, Southwest plans to invade US Airways' fortress hub in Philadelphia, which generates about 17% of the latter carrier's total system revenues. US Airways already faces stiff competition from other low-cost airlines in the six markets Southwest will serve initially. As a result, the immediate impact may not be as dramatic as many observers expect.
But in the longer run, Southwest is expected to make mincemeat of US Airways because its operating costs are so much lower (7.7 cents per available seat mile versus US Airways' 11.7 cents in the fourth quarter of 2003). The likely outcome of this competitive mismatch is that US Airways' viability as a network carrier may well come to an end forever. To make matters worse, JetBlue has also successfully penetrated some US Airways markets on the East Coast.
Buttrick shares Neidl's somber outlook. "It's extremely difficult to be optimistic about US Airways' long-term future," he said. "As the carrier is now configured, it will be almost impossible for them to make it."
Still, even the most troubled airlines have demonstrated a remarkable ability to hang on in the face of seemingly impossible odds. There's no better example than Trans World Airlines, which practically was on life support for 10 years. In the case of US Airways, Buttrick pointed out that it posted respectable profits several years in the mid-to-late 1990s. There is nothing to preclude a bout of profitability in the future as demand for travel continues to improve, although its long-term outlook is extremely poor, he said.
"Not everyone will survive--only those who are nimble enough to respond to market demands," outgoing Continental Chairman and CEO Gordon Bethune said. He ought to know. In 1994, Continental was on the verge of Chapter 11 for the third time, and Bethune was able to inspire all of the carrier's stakeholders to pull together and adopt a more business-like approach. But steering clear of Chapter 11 and doing well is not all about forcing wage cuts on an otherwise dedicated workforce, he said. "It's also about how you run your company. You've got to listen to your customers."
Could the majors actually be in control of their own fate? One would never know it, judging from how rare it is for executives running major airlines to be called to task--despite the billions of dollars of wealth they have destroyed through the years relative to their compensation packages. Management's role is a subject everyone seems to tiptoe around, as opposed to the subject of labor, which is usually pilloried as the principal cause of the airlines' troubles. But as one industry analyst put it, "Who's supposed to be running the show?"
While all of the legacy airlines currently in operation won't survive, Bethune also noted they aren't all going to disappear in mass either. The question is how many, if any, will ever become truly healthy and resilient, as Southwest is, regardless of business cycles. Some industry observers believe none will achieve such success until there is sweeping change in executive suites as managers are brought in, probably from outside the industry. "These companies aren't going to get where they need to go through incremental change," one observer said.
No such transformation appears in sight, although one never knows. Former Delta Chairman and CEO Leo Mullin recently stepped down, and Bethune--the last Big Six CEO who dates from Sept. 11, 2001--plans to retire at the end of this year. Both companies could settle for only minor adjustments to their business models--or seize the opportunity to implement real structural change. But if past is prologue, don't count on it.
As the majors' market share continues to erode, Edmund S. Greenslet, head of ESG Aviation Services, expects to see their numbers also drop. It's impossible to predict the stages this "forced consolidation" will go through, he said, but it's likely to span a combination of possibilities. These include at least one failure, a merger or two and code-sharing agreements that stop just short of a full merger. "There is room for four or five, but not all six," he said.
Assuming the U.S. economy continues to improve in 2004, Greenslet expects the industry to move into the black either this year or next. Whether the profits will be sufficient to sustain them is another matter, but he feels certain that profits will be substantially less than they were in the late 1990s. Consequently, legacy majors will remain "extraordinarily vulnerable to economic twists and turns." He suspects it will be some combination of these events that will cause the group to lurch toward the next round of consolidation.
The shortest route to the scrap heap will be following a business-as-usual approach, which has been the historical pattern of the majors, said Thomas Hanson, who heads the airline consulting practice at Booz Allen Hamilton. "As it is, all of them suffer from corporate cultures that have blinded them to the fact that it's a new world," he said, "and that culture is fundamentally incompatible with the new paradigm."
That thought was echoed in a recent edition of Unisys R2A Scorecard: "The salvation of the legacy carriers does not lie in external events--waiting for Southwest to lose control of its costs, for example, or fuel prices to return to 40 cents a gallon, or government intervention. Rather, it lies within the grasp of each airline that is willing to seize control of its own destiny and make the hard choices--based on a realistic analysis of the world as it is, not as one would like it to be--necessary for success."
