U.S. Airlines Insist Demand Still Red Hot: But for How Long?

It’s like that bunny in the old Energizer battery commercials: Still going.

Covid’s cork on travel demand finally popped off roughly one year ago, unleashing some of the strongest bookings for air travel that U.S. airlines have ever seen. Well, that demand is still going strong, according to a parade of U.S. airline CEOs that presented at a J.P. Morgan investor event in New York last week.

Delta Air Lines’ Ed Bastian: “I can tell you at Delta, our demand is strong and getting stronger.”

American Airlines’ Robert Isom: “From a demand perspective, I can tell you that what I see coming to the summer, it looks really positive.”

Southwest Airlines’ Robert Jordan: “I’m just really pleased with our first quarter revenue outlook.”

Spirit Airlines’ Ted Christie: “Our unit revenue production is very much on track. Demand has been strong heading into the peak part of the spring break leisure period and being a Florida-based carrier where a lot of our capacity is, it’s going to be a very good spring break for us.”

You get the point. One day before the investor event, United did introduce some unease by disclosing weaker-than-expected revenue trends for the current quarter, putting it on track for a quarterly loss. However, CEO Scott Kirby, while apologizing for the bad first quarter forecast, dismissed its significance the following day. January and February, as it turned out, came in weaker for United.

Why? As Kirby and his colleague Andrew Nocella explained, these are off-peak months that historically saw a fair amount of corporate travel to prop up yields. Well, corporate travel hasn’t yet returned to 2019 levels. Meanwhile, Nocella, perhaps more importantly, hinted that the airline might have pushed too
far on yield management, taking fares up too high.

Ignore all that, United is saying. “Putting aside where we are in (the first quarter),” Nocella said, “the financials and the outlook are really great. We’re on target for everything we said we’d be on target for the year.”

“We had a bad forecast, and we own it…,” Kirby said. “(But) the bigger picture is the outlook looks really strong.”

Sure enough, United is sticking to its full-year forecast of earning a 9 percent pre-tax margin excluding special items. That happens to be exactly what it earned in 2019.

Concerns for Airlines

United’s disclosure to investors, however, also mentioned what seems to be a more threatening headwind, one sweeping across the entire U.S. airline sector. The Chicago-based airline said costs are coming in higher than planned. Its first quarter non-fuel unit costs, specifically, will be flat or up slightly versus last year, it now says. It forecasted a 3-to-4 percent decline in January.

To be clear, this merely reflects a decision to account for costs associated with a pilot contract that doesn’t yet exist but will at some point probably soon. But quarterly accounting practices aside, the underlying fact here is that pilot costs are about to spike. And they’re spiking industry-wide. Delta’s pilots say their new contract will cost the airline some $7 billion over four years. American, still in negotiations like United and Southwest, is offering a contract that it says would eventually pay widebody captains close to $600,000 a year.

Only the heavens know what lies ahead for fuel prices. But as 2023 progresses, a central question is emerging: Can U.S. airlines maintain enough revenue strength to offset spiking labor costs? Throughout most of 2022, they showed that yes indeed, revenue strength was sufficient to overcome all sorts of cost headaches, from fuel shocks to operational mayhem to higher airport and interest costs to poor asset utilization.

So far this year, fuel has been more friend than foe, albeit with some variance by region. Asset utilization, staffing, and operational integrity have improved as well. Newly arriving aircraft, however behind schedule, are likewise helping to alleviate unit cost pressures. But make no mistake, these new union contracts are adding a lot to the industry’s cost base.

The pessimistic view? That demand will not maintain its momentum, instead buckling under the weight of a softening economy and pinched household finances. The recent distress in the banking sector certainly doesn’t allay those fears. Despite what’s still a healthy job market and lower energy prices, Americans are now spending less on almost everything, from goods to services like dining out. Travel is a rare exception of a demand category still going super strong.

Can this really last? As Prince might say, airlines are partying like its 1999, a year in which fuel prices were low, the economy was booming, and U.S. carriers were awash in profits — even ones with extreme cost bloat like US Air. All signed expensive new labor contracts. Lo and behold, the dot.com recession would follow in 2000, sinking the industry’s fortunes a good year before the scourge of 9/11. Revenues can vanish quickly. Costs are much stickier.

Stop the fearmongering, say the optimists. It’s not 1999. It’s 2023. Yes, the industry’s cost base is rising sharply, the cheerleaders admit — but for a reason that will actually lead to more revenues. United’s Kirby, the unofficial spokesperson for this theory, explains that costs are rising due to long-term structural impediments to capacity growth — labor shortages, aircraft shortages, airport facility shortages, air traffic control capacity shortages, etc.

And as Economics 101 teaches, constricted supply leads to higher prices. Besides, the optimists argue, airline revenue as a percentage of U.S. gross domestic product is way below its historic norm, implying lots of revenue that has yet to rematerialize post crisis. Of course, demand might be running below normal because there’s not enough capacity to handle it all or because demand is getting priced out by excessively high fares.

The optimists, furthermore, point to corporate traffic that’s not yet fully back. China’s reopening could add fuel to the demand fire as well. On the cost side, airlines still have underutilized planes, people, and airport property. And don’t overlook all the steps airlines themselves are taking to make their businesses stronger:

American Airlines

American is concentrating more flying at its most profitable hubs, namely Dallas-Fort Worth and Charlotte. It’s shoring up its coastal flanks by cooperating closely with JetBlue and Alaska. Debt repayment is a concern for company executives. Fortunately, upcoming capital expenditure needs are modest thanks to a young fleet, implying healthy future cash flows. American cut a lot of costs during the pandemic. Its sunbelt-heavy network is overweighted to fast-growing metros. Its Latin America network is second to none. Its strength in giant overseas markets like London and Tokyo should held it overcome its limited presence in Asia. Like most of its U.S. peers, American says its loyalty program is performing exceptionally well.

United Airlines

United points out that as international demand continues its recovery, domestic routes stand to benefit since so many customers on domestic flights are connecting to and from international flights. Asia, it says, is all but fully recovered excluding China. Deep South America is the only other notable area of international softness. It adds that international flying overall — buttressed by cargo activity and strong joint ventures, including a new transborder one with Air Canada — produces higher profit margins than domestic.

International should get even stronger as more domestic capacity is restored, facilitating more overseas connecting options. United is most aggressive among its peers in ordering new planes, opting for large-gauge narrow-bodies in part to replace the roughly 300 regional jets no longer flying.

Delta Air Lines

Delta took a bit of a dig at United and its guidance miss, saying its own “forecasts and guidance (are) right in line, if not slightly better than we were thinking.” CEO Ed Bastian explained that the airline just enjoyed its 10 highest sales days in company history. “So if anyone is looking for weakness, don’t look at Delta,” he said.

Some of the current demand, it acknowledged, is carryover from trips unable to happen a year ago, even after Covid receded, because so many springtime flights were canceled due to weather or operational issues. Bastian talked in some detail about Delta’s ambitious plans for free inflight Wi-Fi, working with companies like T-Mobile and Paramount, both of which are eager to access the airline’s “captive audience” of some 200 million passengers a year.

He refers to the inflight Wi-Fi opportunity as a potential “gold mine.” Delta of course has its lucrative SkyMiles loyalty program, its prized relationship with American Express and its treasured hub in Atlanta. It also has a collection of joint ventures with international partners like Air France-KLM, Virgin Atlantic, Latam, Aeromexico, and Korean Air, all of which cut costs dramatically, in some cases via bankruptcy.

One challenge though, is that roughly a quarter of Delta’s employees are new to the job, which implies some inexperience that could result in lower productivity and perhaps a decline in customer service.

Southwest Airlines

Southwest said it’s pleased with first-quarter revenue trends, with yields and loyalty point redemptions remaining. But remember, an epic operational meltdown during the fourth quarter dragged it to an uncharacteristic loss. The incident continues to reverberate into the first quarter, which should see a revenue hit between $300 million and $350 million. That’s related to people avoiding Southwest and instead booking on rival carriers during January and February, though the practice seems to have ended in March.

Managed business revenues, a proxy for corporate travel, are now largely back to where they were pre-crisis, a big and significant milestone for the company. It also said booking curves — referring to how long before departure people book their flights — are back to pre-crisis patterns. This for one means that leisure travelers are no longer booking so close to departure as they were throughout much of 2022.

Operations have stabilized, with the company insisting it can better handle disruptions now. It has no plans change its core business model. Southwest will, however, lose money again in the first quarter, not surprisingly given that $300 million-plus revenue hit and the first quarter being off-peak for most of its network. One other point to make, though it didn’t come up at the JPMorgan event: Southwest has a lot of exposure to the California market, where the state’s giant tech sector is contracting.

Alaska Airlines

Alaska is has even more to the reeling tech sector but insists that giants like Microsoft and Amazon still have plenty of money to travel. And besides, such companies are being extraordinarily generous with layoff severances, supporting spending power. In any case, the company made no changes to its original first quarter revenue forecast, noting lower load factors but strong yields. Bad winter weather in the west was unforeseen and ditto for elevated jet fuel refining spreads.

But in the long term, Alaska sees opportunities like the potential to generate more connecting traffic through Portland. A partnership with American is helpful, as is oneworld membership. Chief Financial Officer Shane Tackett does have at least one regret though:

“I think if we had a do-over, we would have tried to get more of our version of First Class into aircraft…,” Tackett said. “That’s the one thing we probably would like to do over is just have a higher number of seats in the First Class or premium economy cabin.”

Fortunately, it will have an opportunity to add more as new Boeing MAXs arrive.

JetBlue Airways

JetBlue finally has something positive to say about the weather in the northeast — a rare absence of snow this winter has greatly benefitted operations, resulting in more available seat miles than forecast. The benign weather hasn’t stopped northeasterners from flying to Florida and the Caribbean, however.

CEO Robin Hayes said both markets are performing well. The big topic at JetBlue, of course, is its pending merger with Spirit, now subject to hostilities from both the Departments of Justice and Transportation. The DOT hasn’t yet weighed in but said it would. JetBlue faces Washington pushback on its alliance with American as well. Hayes defended both transactions as pro-consumer, adding that the American partnership has greatly amplified its strength in Boston while also adding lots of value to its loyalty plan.

Another big strategic push for JetBlue is its European expansion, held back by Airbus delivery delays. In a regulatory filing last week, JetBlue said it “continues to experience robust travel demand trends, which strengthened into Presidents’ Day weekend and beyond. The company is seeing very strong demand in
our core leisure and visiting friends and relatives (VFR) markets.” On the other hand, it faces elevated jet fuel prices due to refinery issues in the northeast.

Spirit Airlines

Spirit itself defended the JetBlue merger, which it once fought hard to prevent. It too by the way faces higher than expected fuel costs, now forecasting an average of about $3.50 a gallon for the quarter, up from its previous guess of $3.20. Its new pilot deal also adds to expenses. Most frustrating are engine-related delays on Airbus Neos.

But like the rest of the industry, Spirit is exceedingly pleased with demand trends, including during the all-important Florida peak now underway. The airline likes its position at capacity-constrained airports, including New York LaGuardia and Newark. Its critical ancillary revenues are strong. It’s pricing better too, including what it charges for its Big Front Seats. CEO Ted Christie did say that more traditional seasonal patterns are returning, and that costs remain the company’s number one focus after safety.

Frontier Airlines

Frontier, which tried to merge with Spirit before a higher-paying JetBlue spoiled its plans, insists that its cost advantage versus the industry is widening. Bookings look great. It feels lucky to have a large order book of hard-to-get Airbus Neos. But it does say Airbus delivery delays have left it with a surplus of pilots that hurts productivity. The pilot shortage, however, seems to be easing, it says, citing milder pressures at SkyWest — “they’re kind of the canary in the coal mine.” Frontier, by the way, thinks it will benefit from the JetBlue-Spirit merger.

Sun Country

Sun Country echoed what everyone else told investors in New York last week: Demand looks great. It said pilot attrition is down. It’s gaining share in Minneapolis, though not at Delta’s expense. And it sees lots of additional opportunities to grow. Sun Country has a unique business model that includes a lot of cargo and charter flying.

Air Canada

Though primarily a U.S.-focused conference, Air Canada presented as well and — you guessed it — spoke of strong demand. Transatlantic is especially strong. Premium demand and Air Canada Vacations demand too. Overall, demand is growing faster than capacity. It also said its new cross-border joint venture with United is surpassing expectations.

International flying, it added, has long been higher-margin than domestic for Air Canada.

This story was first published in the March 20 issue of Airline Weekly, a Skift brand.