By ATA Vice President & Chief Economist John Heimlich
From an economic viewpoint, 2006 was a much-improved year for the U.S. airline industry. Including the all-cargo sector, the Air Transport Association estimates that the industry will report earnings ranging from $2 billion to $3 billion. On the heels of $35 billion in net losses over the previous five years, of course, any full-year profit comes as welcome relief.
The initial economic outlook for 2007 is the most promising in several years. In addition to a healthy revenue environment, U.S. airlines are seeing the results of painstaking, ongoing cost reduction efforts and balance-sheet repair. Although the industry is optimistic and well positioned to move forward, the reality is that events beyond airlines’ control could easily push them off course.
While the last few quarters have been relatively good for the airlines, it is worth noting that the deregulated (post-1978) U.S. airline industry has never posted a net profit margin higher than that of the average U.S. corporation. From 1979 to 2005, for example, the median margin for a U.S. corporation was 5.2 percent, well above the negative 0.4 percent margin experienced by the airlines. U.S. industry margins peaked in 2005 at 9.1 percent, versus 4.7 percent for the airlines in 1997. And in the worst year of the period for each group, the average U.S. corporation made money, recording a net margin of 3.1 percent in 1986, while the airlines posted a negative double-digit margin of 10.3 percent in 2002. That is a 15-point spread for airlines versus a six-point spread for the average U.S. business, clearly reflecting the industry’s earnings volatility.
While conditions have improved and the overall financial outlook is guardedly optimistic, debt levels remain high, leaving the airlines vulnerable to fuel spikes, recession or exogenous shocks (e.g., terrorism, pandemics, natural disasters), let alone ill-advised public policy decisions. The challenge we face is to achieve meaningful and sustainable profits, and to improve credit ratings to the point where airlines can weather normal economic turbulence while simultaneously investing in the future.
To enhance the travel experience, renew fleets, refurbish facilities, expand customer-interface tools, retain talented employees and promote economic stability – in other words, to invest in the future – the industry must reestablish its financial health. This means not just a quarter or two – or even a year or two – but many years of profitability. We are talking about achieving a normal rate of return, at least covering our cost of capital. Airlines, which help drive 8.8 percent of the nation’s employment, are working hard to achieve some sort of financial normalcy, a reasonable goal that should be within reach.
It is in that context that ATA is projecting an aggregate net profit (excluding bankruptcy restructuring and/or reorganization charges) of $4 billion for 2007, on operating revenues exceeding $150 billion. That would make 2006-2007 the first back-to-back years of profitability since 1999-2000. Given the risks of an economic slowdown and unrelentingly high fuel prices beyond 2007, pressure to control non-fuel costs and to identify new sources of revenue will remain paramount. Carriers are optimistic about their future but realistic about taking the necessary steps to preserve the remarkable strides they have made over the past several quarters.
Airlines continue to simplify their operations, in part by reducing the number of aircraft types. They have disposed of hundreds of older airplanes to curb not only fuel and labor expenses but also maintenance costs and fuel-related emissions. This important trend is expected to continue in 2007. At key hubs, airlines continue to streamline schedules while simultaneously increasing their global presence both through their own flights and via expanded worldwide alliance arrangements. They also have closed obsolete facilities, shifted bookings to lower-cost distribution channels, expanded the deployment of self-service check-in kiosks at on- and off-airport locations, and improved Web site functionality to provide customers with more options and control of their travel experience. Again, by necessity, the changes are numerous and ongoing.
Meanwhile, balance sheet repair is well underway and airlines should be able to generate meaningful cash flow in 2007, allowing them to continue to pay down debt while revisiting opportunities to acquire new aircraft with the sharpest focus in years. Let us cherish the moment and hope that we are entering a new era in air transportation.
A recent Bear Stearns report noted, “the improved environment in the U.S. is only temporary, in our judgment. The business remains highly cyclical.” Whether or not Bear Stearns proves to be correct, the airlines have every reason to remain focused on reducing existing costs and dodging looming commercial or governmental impediments to growth.
Ultimately, financial stability in the airline industry is good not only for airlines and for their customers, but also for the rest of the economy. U.S. airlines must remain competitive globally to continue to foster the nation’s economic growth. If only airlines were as profitable as the average U.S. company.
For more detailed information, please visit ATA 2007 Economic Outlook: Questions and Answers.