Airlines Shine in August

After turning in inconsistent performances this spring, airlines have bounced back with a very strong summer travel season. In July, the five largest U.S. carriers posted strong unit revenue growth across the board. The same pattern played out in August as well.

Airline

Unit Revenue Change

Capacity Change

AMR (UNKNOWN: AAMRQ.DL  )

Up 3.0%

Up 4.2%

Delta Air Lines (NYSE: DAL  )

Up 4.0%

Up 3.3%

Southwest Airlines (NYSE: LUV  )

Up 4.0%

Up 1.4%

United Continental (NYSE: UAL  )

Up 3.5%-4.5%

Down 1.4%

US Airways (NYSE: LCC  )

Up 5.0%

Up 5.1%

Source: Airline press releases 

Unit revenues stay strong
All five top U.S. airlines reported healthy unit revenue increases within a tight range of 3%-5%, just as they did for July. Moreover, capacity growth ticked up somewhat sequentially. Once again, US Airways and its prospective merger partner AMR led the industry in capacity growth. Delta was right behind them in terms of growth.

US Airways has been the fastest growing major U.S. airline recently

By contrast, Southwest Airlines increased capacity by just 1.4%, which is much slower than its typical growth rate in recent years. Moreover, it cut departures by 4% year over year. Thus, its capacity increases were the result of having more seats per plane (on average) and operating longer flights.

One laggard
Once again, United was the only carrier to cut capacity last month. Despite reducing capacity, it remained firmly in the middle of the pack with respect to unit revenue growth. This may not seem especially worrisome: United is already the largest carrier in the world, so it can afford to shrink without compromising the competitiveness of its network.

However, the result is that United's cost structure -- already one of the highest in the airline industry -- is diverging even more from peers. Cutting capacity boosts United's unit revenue by reducing the supply of seats on certain routes to better match demand. However, it also means that United is spreading its fixed costs over fewer seat miles.

As a result, United expects Q3 non-fuel unit costs to jump by 6.4%-7.4%, whereas Delta projects a modest increase of 0%-2%. US Airways also expects low single-digit growth in non-fuel unit costs this quarter, followed by a decline in Q4. Southwest expects a "slight increase" for Q3, in line with its plan for a 1% increase in non-fuel unit costs this year.

In other words, United's competitors will be able to translate solid Q3 unit revenue growth into strong profit growth. By contrast, while United may also be able to increase its earnings, it will likely see much less margin growth than its competitors. Analysts currently expect United to grow EPS from $1.35 in Q3 2012 to $1.97 this year. That projection seems overly optimistic based on United's current outlook.

Foolish bottom line
Airlines posted solid unit revenue increases this summer. This should translate into solid increases in pre-tax earnings -- for those airlines that have kept their costs in check. However, United Continental has been shrinking capacity in order to keep unit revenue aloft, contributing (along with other factors) to significant cost inflation. This will keep its margins well below peers for the foreseeable future and make United a prime target of other airlines' expansion plans.

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  • Report this Comment On September 11, 2013, at 12:48 PM, Inspectigator wrote:

    The coming shortage of pilots should result in reduced capacity, less competition, higher ticket prices and profits. The regionals and ultra-low-cost carriers have already acknowledged they aren't able to find enough pilots to replace those retiring or leaving. They are unable to grow and are beginning to cut routes. This will accelerate when the majors start hiring off the street (mostly regional pilots) late this year.

    SouthWest will be the first to benefit, as they compete most with the regionals and ultra-low-cost carriers. Southwest offers a more desireable career for pilots and has new airliners on order, they will have no problem staffing their cockpits as they expand where regionals contract.

    Other majors will be hit harder, as half their domestic networks are contracted out to regional airlines. Things could get ugly for them.

  • Report this Comment On September 11, 2013, at 1:16 PM, bigmikejones wrote:

    I can tell you United is getting away from what made Continental great and will fail. Large dont mean a thing when you screw over passengers, late flights, cancelled flights and leave Service out of the mix. Delta has moved up a few notches in their quality but South West, still sitting at the top of the heap. Sorry United, You lost me as a customer due to your lack of service to the customer, you know, the ones who pay to fly in your crappy worn out airplanes.

  • Report this Comment On September 11, 2013, at 9:21 PM, TMFGemHunter wrote:

    Thanks for the comments.

    @ Inspectigator: I don't think the pilot shortage will be as severe as you think, though it could be a real issue longer-term. In all likelihood, it will eventually drive pilot costs even higher than they are today.

    The key mitigating factor is the decline of 50 seat regional jets. For instance, Delta is replacing about 200 50-seat regional jets with a combination of 76-seat regional jets and 110-seat Boeing 717s over the next two years. Since pretty much all commercial aircraft today require two pilots, Delta can get the same amount of capacity with fewer pilots (my estimate is this frees up 600-800 pilots between now and the end of 2015).

    United and American are also replacing 50-seaters with large regional jets, though at a slower pace than Delta. Furthermore, all of the airlines are "upgauging": flying larger planes on average (or fitting more seats on each plane). These actions will blunt the impact of new crew rest regulations and retirements, at least for the next few years.

    Adam

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