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During the summer vacation season, think of a commercial airplane as a flying, broken cash machine: It spits out profit from June to September, but come autumn, the money slows.
That’s when the seat harvesting begins. This year, that annual airline ritual will likely feature deeper pruning than usual because U.S. carriers are desperate to stop the steady decline in revenues. To do so, they need to boost fares, which have sagged as seat supply outpaces demand.
Delta Air Lines Inc. said Thursday it would curb its seat growth to only one percent in the fourth quarter, with much of that cutting focused on the U.K., where the decision to quit the European Union has left airlines deeply uncertain about future travel demand. Delta had previously planned to expand two percent in the quarter, compared with 2015. Its quarterly revenue dipped two percent, to $10.4 billion.
Similar moves may come from rivals American Airlines Group Inc. and United Continental Holdings Inc., which are also striving to reverse slides in this industry metric known as passenger revenue per available seat mile (PRASM). (A seat mile is one seat flown one mile, the standard capacity gauge.)
Wall Street has soured on airline stocks this year, with the Bloomberg U.S. Airlines Index down 14 percent in 2016. Analysts have adopted a we’ll-believe-it-when-we-see-it stance on when passenger revenues will stop declining. Choppy currencies in many regions, periodic terrorist attacks and the unexpected decision by U.K. voters to leave Europe haven’t helped.
Another major problem, from the airline viewpoint, is that business people are reaping some incredible last-minute bargains today compared with what they paid at the counter historically. In some markets, the walk-up fare can be the same as the price six weeks in advance, and many of the traditional rules about Saturday-night stays and advance purchase requirements have collapsed.
“Investors want to hear a robust narrative on managing capacity to right the trajectory,” Credit Suisse Group AG analysts wrote July 14. “In nearly every conversation we have with investors, the question of capacity cuts comes up.”
Much of this revenue degradation is the result of rising jet fuel prices, which declined radically in 2014-15 amid a glut of crude. Prices touched a 12-year low in February, near $25 per barrel, but have since rallied to about $46. As fuel rises—and airlines are estimating even higher prices this winter—the costs of flying to nonessential destinations make less sense.
In this fashion, jet fuel costs operate as a natural capacity restraint. The lag from a fuel increase to the impact on revenue typically takes nine months, Delta President Glen Hauenstein told analysts. All else being equal, fewer seats will mean higher fares.
One irony underlying the current revenue angst is that it wasn’t supposed to happen this way. Three years ago, the U.S. Justice Department and six states sued to block the merger of American and US Airways, arguing the new behemoth would abuse U.S. travelers with higher fares in a rapidly consolidated industry. After a settlement, the merger closed and American became the world’s biggest airline.
But a funny thing happened on the way to higher fares: Crude oil prices collapsed, and the resulting Big Three post-merger carriers began expanding, while also fighting for the extremely price-sensitive customers they used to cede to ultra-discounters such as Spirit Airlines Inc. and Frontier Airlines Holdings Inc.
Average domestic fares have declined in recent years, to $377 in 2015, adjusted for inflation, according to federal data. That was down 4 percent from 2014, and more than 19 percent from 2000. The total value of airline tickets fell four percent in the first half of 2016, to $46.1 billion, from the same period last year, on a six percent increase in ticket transactions, “pointing to the overall effect of lower airfares,” the Airlines Reporting Corp. said July 13.
While this news might cheer travelers, those who focus on revenue declines often overlook some of the hefty numbers that sit near the bottom of airline profit-and-loss statements: net income. At Delta, it was $1.7 billion before taxes, with billions of dollars more expected across the industry this year.
“I realize the [revenue] numbers have been weak, but the final line results have been phenomenal,” Delta’s chief executive officer, Ed Bastian, said.
This article was written by Justin Bachman from Bloomberg and was legally licensed through the NewsCred publisher network.