By ATA Vice President & Chief Economist John Heimlich
Although final figures will not be available from the Bureau of Transportation Statistics until May 2008, the past two years (2006-2007) will show the first back-to-back net profit for the U.S. airlines since 1999-2000. While the ultimate margin will undoubtedly be subpar by typical standards for Corporate America, the two consecutive years of profitability come as welcome relief after an unprecedented five-year loss of $35 billion.
Last year I noted that the deregulated U.S. airline industry had never posted a net profit margin higher than that of the average U.S. corporation. Given the industry’s hallmark characteristics of high fixed costs, cyclical demand and fierce competition, that pattern is unlikely to change anytime soon, rendering it difficult for the airlines to borrow money at reasonable rates to invest in the future. Unfortunately, of the 10 U.S. passenger airlines currently rated by Standard & Poor’s (S&P), only one enjoys investment-grade status (i.e., a corporate rating of BBB- or higher). Consequently, renewing fleets, upgrading facilities, improving customer experience, enhancing fuel efficiency and making other prudent business investments all remain difficult, at best, at a time when the need for those investments is clear.
In October, Fitch Ratings wrote that “a number of factors influencing airline credit fundamentals will limit the scope of credit quality and ratings improvement through the next economic cycle.” Among the credit concerns cited were the industry’s unique vulnerability to large demand and fuel price shocks, a fragmented structure that “makes rational capacity planning and sustained pricing power improvement very difficult to achieve,” operational bottlenecks in the U.S. air travel system and undue pressure on capital budgets fueled by the need to replace aging aircraft, especially in 2010 and beyond. Over the next few years, U.S. airlines will continue their quest to attain, or reattain, investment-grade status. Why? The objective is not merely to weather the next downturn – it is to make the critical investments that ultimately will benefit our nation’s highly mobile, just-in-time economy, in part by enabling U.S. airlines to compete effectively in the expanding international arena.
In 2008, ongoing passenger and cargo revenue strength – particularly in the international arena – will help offset a sizeable increase in fuel expenses and a modest increase in nonfuel expense, enabling the industry to post a $3.5 to $4.5 billion net profit. That would make 2006-2008 the airlines’ first profitability “three-peat” since 1998-2000. In the face of uninspiring forecasts for the U.S. economy and yet another record year for crude-oil prices, the nation’s carriers have moved aggressively to redeploy assets and adjust aircraft utilization to trim unprofitable flying. All signs point to another year of improving fuel efficiency, despite air traffic congestion and resultant taxi-out and airborne delays. Comparable load factors are likely to be accompanied by individual airline efforts to realize higher yields by increasing business travel as a share of total traffic.
Passenger and cargo demand is surging outside the United States, making the airline business increasingly global. U.S. airlines must be able to compete head to head on that stage with powerful international competitors. The reality is that the world economy, led by China, India and other developing economies, is growing at twice the rate of the U.S. economy. Accordingly, U.S. airlines have expanded their footprint in international markets. In 2008, U.S. carriers will seek to capitalize on projected growth in these regions, taking advantage of the easing of restrictions of air service between the United States and China, India and the European Union. Over time, of course, liberalization of these markets will heighten already intense competition. U.S. airlines must be ready. In the domestic marketplace, of course, they are competing not only with new-entrant carriers, but also, increasingly, with other forms of aviation such as air taxis or business jets, which continue to benefit from an outdated tax scheme.
U.S. airlines and their employees have done an exceptional job of positioning their companies to weather record-high fuel prices. Consider that in their three best years, 1997-1999, the deregulated U.S. airline industry earned a net profit margin of only 4.4 percent on an average crude oil price of only $18 per barrel. A decade later, with oil likely to average $80 per barrel, we are projecting a third consecutive year of net profits. Global competitiveness, however, demands far more. If the United States is to meet that challenge, the airlines’ path to economic vitality must not be impeded.