Up In The Air - 2008

Last year, Delta’s successful emergence from bankruptcy eliminated one of the headwinds restraining Georgia economic growth, but in 2008 high fuel costs and a possible merger cloud the outlook for Atlanta’s largest employer.

Meanwhile, other airlines, especially AirTran, will continue to expand into the Atlanta market to take advantage of scarce airport infrastructure and a huge customer base. Atlanta ranks as the number one U.S. airport in both landings and arriving and departing passengers, but ranks 11th in terms of air cargo.

In 2008, air passenger volume will be well above its 2000 peak, but spending on air travel will account for a much smaller proportion of the economy than it did prior to 9/11. The Air Transportation Association of America indicates that spending on air travel amounted to only 0.75 percent of GDP in 2006, well below the industry’s historical band of 0.9 percent to 1 percent of GDP. The main reason is that the nominal fare paid per mile hasn’t increased very much even as the prices of most other goods and services have risen significantly.

Vigorous competition within the industry will continue to limit pricing power, holding down ticket prices even when costs rise. Competition among airlines has trained customers to be more price-sensitive.

Meanwhile, airlines’ fuel costs, security costs, debt service costs and federal tax burdens continue to rise rapidly. In fact, fuel costs recently displaced labor as airlines’ largest operating cost.

Because many of these problems are structural rather than cyclical, it takes more than just a long period of sustained economic growth to heal the large network airlines. Major carriers must reinvent their business plans – which depended on time-sensitive rather than price-sensitive travelers as the main profit center – while drastically lowering costs. Barring government intervention, major carriers unable to lower costs to more closely match those of low-fare carriers are unlikely to survive the restructuring.

There isn’t much the industry can do to control fuel costs; but since 9/11, 127,000 air transportation jobs have been cut nationwide. That amounts to a drop of 20 percent in employment. Despite Delta’s ongoing restructuring, only 4,900 air transportation jobs have been lost in Georgia – a drop of only 11 percent. Georgia’s smaller percentage decline reflects the strength of Atlanta’s customer base and air carriers’ willingness to expand operations in the Atlanta markets even as Delta was downsizing.

Since mid-2006, Georgia’s air transportation companies have added back 1,400 jobs lost in the wake of 9/11; but high fuel costs have already resulted in a hiring freeze at Delta and may soon lead to layoffs.

Over the last several years, major airlines took on massive debt to finance ongoing operations, leaving the industry more exposed to recent and future crises in the financial markets. Meanwhile, lower credit ratings and higher interest rates have made it more expensive for airlines to carry debt.

Some airlines have shed debt through bankruptcy, but the cost of servicing debt will be a major challenge to many carriers’ net margins in 2008. Meanwhile, insurance costs have more than tripled, reflecting both a firming of pricing in that industry as well as higher risks associated with air transportation.

On a more optimistic note, the industry’s capacity is fairly tight, which suggests its pricing power will be on the increase. The percentage of seats filled is more than 79, higher than the 72 percent filled in 2000. Load factors are highest on Pacific (82.9 percent) and Atlanta routes (80.8 percent) and lowest on Latin American routes (75.3 percent).

But, on average, too many airlines still don’t make a profit on too many passengers. Essentially, low fares are filling up planes, but at a price that barely generates a profit, much less a normal rate of return.

Collectively, U.S. Airlines’ net profit margin rose to a positive 1.9 percent in 2006, the first profitable year of this millennium. Revenues rose 8.3 percent and expenses rose 3.6 percent. For 2007, it’s clear that higher than expected fuel costs reduced airlines’ margins substantially.

If the U.S. economy avoids recession, profit margins should widen slightly in 2008; but fuel costs will remain a wild card in any industry forecast.

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