The airline industry’s profit margins are “appropriate for a charity, not a business.” So said Giovanni Bisignani, then head of the International Air Transport Association, back in March. But that was when the industry was on track to make a $8.6 billion profit this year. Those estimates were slashed by more than half last month to a paltry $4 billion profit — on nearly $600 billion in expected revenues.
The industry’s greatest peril: fuel prices. U.S. debt ceiling negotiations might have spooked oil prices last week, but IATA says jet fuel prices still will average $128 per barrel for 2011 — adding some $61 billion to the industry’s fuel bill. That’s a tough break for airlines, as fuel accounts for at least a third of their total operating costs.
Airline investors are well-acquainted with the sector’s woes: The top U.S. airlines lost $5 billion of their stock valuation in the month of July alone, according to the Dallas Morning News. US Airways (NYSE:LCC) lost 30% of its value, JetBlue (NASDAQ:JBLU) and American Airlines parent AMR Corp. (NYSE:AMR) lost 21.5% and United Continental (NYSE:UAL) lost nearly 20%. Delta (NYSE:DAL) and Southwest (NYSE:LUV) shares lost 14% and 12.8%, respectively.
All of these numbers illustrate how difficult it is for airlines to make money. But that doesn’t mean airlines have stopped trying to offset pricey fuel with other income. Here are three ways airlines are trying to recoup some of those lost profits:
Pocketing Lapsed Federal Taxes
If necessity is the mother of invention, panic is its father. When Congress failed to reauthorize funding for the FAA in July, the agency was forced to close down some of its operations for the first time in history — including collection of the 7.5% federal tax levied on airline tickets. Those taxes add up to big money: about $29 million a day.
In the absence of those taxes, most major airlines have hiked their base fares to pocket the money. Only Alaska Air (NYSE:ALK) and its Horizon subsidiary passed the tax savings on to customers. On Delta’s earnings conference call last week, company officials boasted that they are pocketing $4 million to $5 million per day on the lapsed federal taxes. The airline probably hoped that news would cushion the blow that its second-quarter earnings fell by more than 58% compared to last year.
Capacity Cuts
Another cost-cutting tool at airlines’ disposal is reducing the number of seats available to passengers. Known throughout the industry as capacity cuts, airlines cut the number of seats available for purchase by substituting smaller aircraft and paring down or eliminating less profitable routes. The impact of these changes on passengers typically is higher fares, fewer flight options and more cramped planes.
But for airlines, capacity cuts are an all-important weapon to preserve some profitability. Airlines scaled back capacity by as much as 3% in March, and most have planned even deeper capacity cuts in their fall schedules. There are signs that this tactic might be working. Although U.S carriers’ demand growth fell from 4.5% in May to 1.3% in June, airline capacity cuts enabled carriers to fill 85.3% of their available seats — the highest load factors of any region in the world.
New Aircraft
Higher fuel prices — the average is $3.05 per gallon compared to about $2.30 this time last year — took a severe toll on airlines’ second-quarter earnings. American took the worst hit, with fuel costs ballooning its second-quarter net loss to $286 million from the $11 million loss for the same quarter in 2010. Of course, carriers will continue to raise fares and ancillary fees, but that’s not nearly enough to secure their future profitability.
Airlines increasingly are looking to mothball their gas-guzzling planes and buy new, fuel-efficient aircraft. American plans to buy 460 new jets from Boeing (NYSE:BA) and Airbus beginning in 2013. In 2016, United Continental should start taking delivery of 50 new fuel-efficient, wide-body jets in an order split between Boeing and Airbus. But Delta, which announced plans to buy 100 to 200 new narrow-body jets earlier this year, has backed off that strategy, revealing last week that it will add a “modest” number of new jets to replace the oldest planes in its fleet.
As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here.
