Times have never been tougher for airlines
If you think it’s getting expensive to fly now in the world of sky-high oil prices, spare a thought for the long-suffering airline shareholder.
While American Airlines is charging passengers $15 for their first bag, and British Airways is announcing another rise in its fuel surcharge, those who have invested in airline shares risk losing their shirts in a way that even Heathrow Terminal Five can’t match.
Last week saw double-digit falls in the share prices of Iberia, Air France-KLM, Finnair, and Lufthansa following a series of profit warnings across the industry. Even Ryanair, with the tightest cost base and the fullest flights, reckons it can do no more than break-even with oil at current prices.
24 down, dozens more to go
Many rivals would see that as an achievement. In the last six months 24 airlines have collapsed while trying to find their share of the extra $99 billion that fuel costs the industry.
Giovanni Bisignani, director general of the International Air Transport Association (IATA) forecasting a loss for the industry of $2.3 billion in 2008, from a $4.5 billion profit he expected just two months ago. If fuel prices remain at $130 a barrel the loss is likely to be $6.1 billion, he told the annual meeting of IATA in Istanbul.
These are dire times for the industry, but then dire times are never far away for this most over-expanded and over-optimistic of industries.
The problems of the airline industry have been blamed on various things over the years. After 2001 it was terrorism, then there were extra security costs for the post-September 11 world, plus inexorable price rises for landing slots at the world’s major airports such as Heathrow.
A list of industry woes
From 2001-2003 the industry fought recession, when businesses cut expenses by forcing many executives to fly in economy class. No sooner was recovery on the horizon then the US-led invasion of Iraq spurred more security fears followed soon after by the SARS respiratory illness crisis of 2004. Finally, in 2005 the soaring cost of fuel hit the top of the agenda and has stayed there ever since.
Losing money, year in year out
Buying airline shares is a remarkably consistent ways for investors to lose money. The only year this century when the industry made money was in 2007, and there won’t be another one for some time to come. Former American Airlines executive Robert Crandall put it succinctly in 2001 when he said: “The airline industry has lost as much money as it has made since the Wright brothers invented manned flight back in Kitty Hawk in 1903.”
For the real and underlying problem of airlines isn’t any of the many factors listed above, which after all are par for the course for businesses operating in an uncertain world. The real problem for the airline industry is its refusal to adjust to the problems of supply and demand. Quite simply there are more seats available on jets than there are bums to put in them, a factor which has remained unchanged for a couple of decades at least.
The flying zombies
Why does this happen? There are a few mechanisms.
Bankruptcy rules in the US which allow financially-dead carriers to continue flying while protecting them from their creditors is one cause. In Europe and elsewhere there is a different problem, which is the reluctance to allow cherished national flag carriers to disappear, or be merged with rivals.
When the Dutch government allowed KLM to be merged into Air France in 2004, it was a rare concession. The combined group went on to become one of the most profitable European carriers. Lufthansa’s digestion of Swiss International Airlines, finally completed in March after three years, finally ended that nation’s unsustainable flag carrier ambitions.
Blame Silvio
However, Italy’s national flag carrier Alitalia is an opposite example. It hasn’t made money in living memory, is currently losing €2 million (£1.6 million) a day and is being supported by government loans that are probably in breach of EU rules.
In any other industry it would have closed long ago, but a combination of union pressure to avoid job cuts and the new government of Silvio Berlusconi scuppered a rescue deal from Air France-KLM. With oil prices now nearly $50 per barrel higher than when it offered a deal, Air France-KLM must be glad the deal collapsed. Olympic Airlines, the Greek national carrier, is in a similar position and is too being supported by the state.
American idle
In the US Continental Airlines, United Airlines and US Airways have all vowed to remain independent, despite overcapacity across their system and their continuing losses.
Denver-based Frontier Airlines in April sought protection under the famous Chapter 11 of the bankruptcy code, joining ATA, Skybus and Aloha Airlines as bankrupt airlines which continue to fly, but cannot be sued for not paying their bills. These airlines, whose unprofitable capacity should be removed from the industry, are actually helping bring other carriers down by continuing to compete for scarce business.
So what next?
“All European airlines are in for a torrid time if oil prices remain even close to current levels. There are likely to be a number of spectacular (financial) casualties,” UK stockbroker Numis Securities said in a recent note to clients. It predicted that once the peak summer season is over, capacity cuts and bankruptcies will be inevitable.
The mathematics are compelling. With fuel at $130 a barrel it now costs $68,000 to fill up the tanks of a modern Boeing 777 for a single trip across the Atlantic from Toronto to London, according to Air Canada. That is $200 for each seat, on the very big assumption that all 349 seats are taken. Yet the fuel surcharge is $147 per passenger. It just doesn’t add up.
Fill seats at all costs
The airline executive’s first instinct is to cut prices to fill seats, followed by purchasing new and more efficient aircraft to keep fuel costs down and attract more passengers. You would think the industry is booming: Boeing alone has enough orders to keep it busy for the next seven years.
The reality is that this is a beggar my neighbour policy, loading airlines with debt they can’t service for aircraft whose seats they can’t fill, while higher fuel prices mean setting fares that too few customers are willing to pay. Something has got to give.
Airlines may have overcome the laws of gravity. The laws of economics are a much tougher proposition.