U.S. airlines could be on their way to becoming “regular” businesses, rather than a group of companies that struggles to eke out profits even in the best of times, according to a recently released report from international management consulting firm Oliver Wyman.
“For U.S. carriers operating in the wake of what is likely the final major U.S. airline merger, the combination of healthy demand, stable fuel prices, capacity restraint, and an ample supply of slim-line seats resulted in very strong financial performance over the past year,” according to Oliver Wyman’s Airline Economic Analysis 2014. “Although industry watchers remain concerned about clouds on the horizon, this upturn was sufficient to raise the question of whether the airline business was becoming a ‘regular’ business with sustainable profits.”
Separately, Bank of America Merrill Lynch analyst Glenn Engel is predicting that North American airline earnings will climb 73 percent to $19 billion in 2015, primarily because of lower jet fuel costs.
Oil prices have tumbled recently, with Brent crude closing at $70 a barrel Nov. 28, down about 40 percent since June. Several analysts, including Engel, are predicting an average price of Brent crude at about $80 for 2015. That compares to this year’s projected average of about $104 per barrel, and to an average $108.41 per barrel in 2013.
High and volatile oil prices are partly to blame for the airline industry’s dismal performance in the 2000s, although other factors, such as the Sept. 11 terrorist attacks, the Great Recession and lack of capacity discipline, all played crucial roles. Nine U.S. carriers combined for $58 billion in losses from 2001 to 2009 before returning to profit in 2010.
The Oliver Wyman report points to less volatile fuel prices, capacity controls, higher seat densities and ancillary revenues as key factors in bringing airlines back to sustained profitability.
“Fuel prices, while high, were less volatile than they’ve been for a decade,” the report notes, referring to prices for the year ending June 2014. “With fuel comprising over 30 percent of airline operating costs, this helped significantly in stabilizing overall costs for both network and value carriers. During the year ending June 2014, unit costs increased only 1.4 percent for network carriers and 0.7 percent for value carriers.”
Capacity constraints have been in place at most airlines for the past five years or so, a reaction to the sharp downturn in demand during the recession that began in 2008. Rather than add back capacity when the economy improved, airlines have been more selective in how and where they deploy equipment.
“In the domestic market, value carriers continued to grow at higher rates than network carriers, with 3.0 percent growth in 2014, compared with 1.1 percent for network carriers,” the report notes.
Regional carriers a third straight year of flat or declining capacity, the report says.
“Both network and value carriers increased their average load factor during the past several years primarily by operating at higher load factors during the off-peak months,” the Oliver Wyman report says.
Although airlines have been slow to add in domestic capacity in the form of more planes or flights, many have reconfigured their aircraft to carry more passengers. The report notes that the lowest cost carriers, Spirit Airlines and Allegiant Air, were able to sustain their cost advantage in part by operating with very high seat density. Other carriers, while operating the same aircraft with fewer seats, have been progressively adding seats to help lower their costs, as well.
On the revenue side, the “unbundling” of airline services and perks continued to drive revenue growth.
“Ancillary revenue, often described as the difference between airline profitability and loss, continues to grow at double digit rates,” the Oliver Wyman report says. “Miscellaneous revenue, ranging from priority boarding to in-flight entertainment, has become the largest source of ancillary revenue and ancillary revenue growth, displacing reservations change fees and baggage fees.”
Those revenues helped boost revenue growth for both domestic and international flights, the report says, halting the trend of network carriers relying largely on their international operations for revenue growth.
“Both network and value carriers achieved the best margin performance in the past decade,” the report says. “Although value carriers continued to substantially outperform network carriers in margin in the domestic market, network carriers made substantial progress in turning their domestic service, which has lagged behind their international service over the past decade, into a profitable business – a major accomplishment.”
