Wednesday, 9 November 2016

USA: Will Airlines Raise Fares

U.S. airlines have been on a good run recently, with every larger carrier reporting steady profits and healthy margins.

This is a big deal, considering the industry lost a combined $28 billion as recently as 2005, a figure that included special charges.

Yet, there’s a surprising pessimism from many investors, as carriers struggle with higher fuel prices and labor costs than a year ago, as well as lower unit revenues. Absolute profits remain impressive — Delta Air Lines in October reported adjusted pre-tax income of $1.9 billion for the third quarter — but investors and airline executives often focus on another metric, and it has been trending downward, industrywide.

Insiders often obsess over passenger revenue per available seat mile, or PRASM, which measures how much passenger-related revenue an airline makes for each seat it flies one mile. United Airlines made 12.64 cents in passenger-related revenue for each flown mile in the third quarter, a number that fell 5.8 percent year-over year. United blamed the decrease in part on lower ticket prices, as well as less revenue from its corporate customers in the oil and gas sectors. Southwest, meanwhile, earned 12.32 cents in passenger revenue per available seat mile, off 5 percent year-over-year.

“The fare environment is very competitive and we have seen an increase in competitor seats in our markets that is fairly significant year-over-year, and so that obviously has an impact on us,” Southwest CEO Gary Kelly said on the airline’s third quarter earnings call.

No matter how large overall profits, or how high margins, investors likely will remain skittish until PRASM trends turn positive. This is especially true now that costs at nearly every airline are increasing. One problem: As airlines have consistently made money, many unions have demanded and received higher wages.

Travelers may not think that matters to them, but it does. To reach their goals, airlines must increase revenues, and the best way to do that is by charging customers more money for fares and ancillary items.

“The challenge is to get RASM back positive and we’re optimistic that’s exactly what we’ll be doing,” Delta CEO Ed Bastian said on his airline’s third quarter earnings call.

Travelers shouldn’t expect any across-the-board fare increases. The industry is too competitive for fares to jump rapidly. But around the edges, carriers will be doing what they can to increase unit revenues.

After the 2008 financial crisis, when U.S. carriers started first making money, they practiced something called “capacity discipline.” Even as demand increased, the largest airlines put relatively few new seats in the market, a move that gave them pricing power.

Airlines were so committed to “discipline” that in 2015, the U.S. Department of Justice opened an investigation into possible collusion, asking Southwest, American, United and Delta for data relating to their strategy. The airlines have denied the charges. Many consumers filed collusion-related lawsuits against the airlines, and those cases continue.

But nothing hurts capacity discipline like cheaper fuel. When fuel is less expensive, previously marginal routes look better, and airlines add flights. Eventually, that leads to lower fares, and less revenue per available seat mile.

“When you’ve got this much cash running around, everybody’s chest falls out a little bit and we all feel real good, real smart and real tough in many cases,” Allegiant Air CEO Maury Gallagher, perhaps the most out-spoken U.S. airline CEO, said in October 2015.

Most airlines now say they’ll grow less in 2017 to better match capacity with supply. Many airlines are planning low single digit growth next year, with even less growth expected in the trans-Atlantic sector, where Brexit and terrorism concerns have hurt revenues.

“We need to be more conservative with our growth,” Southwest’s Kelly said.

On many days, there is more seat supply than demand. When this happens, airlines generally have two choices, they can discount, or they can fly at lower load factors. U.S. carriers seem to be doing a bit of both.

But there’s a major exception. Even in the new paradigm, there are many days when demand is greater than supply, so on the most popular days — when the market can handle it — airlines may increase prices.

Travelers could still see fire-sale prices on Tuesdays, Wednesdays and Saturdays when business and leisure travel lags, and higher fares at other times. Airlines may try to raise prices on Fridays and Sundays, as well as around major holidays.

“One thing that hasn’t changed in my 30-years in the business is Friday and Sunday remains the very best days,” Spirit Airlines CEO Bob Fornaro said on Oct. 25. That has never changed and there’s a lot of opportunity for us when we run 90 percent load factors to enhance the average fares on those days without changing fares during the week.”

At times this year, large U.S. airlines have done something previously unthinkable: They have discounted last-minute tickets.

A business traveler might be able to buy a ticket a day before departure from Chicago to New York for $69, one way. That’s usually a price travelers can only find weeks in advance, with last-minute tickets on busy routes going for $400 or more.

Nearly every airline except for deep-discounters has complained about industry pricing for what they call “close-in” tickets. Most are hopeful airlines will revert to what worked in the past — high prices within a few days of departure. And with airlines paying more attention to unit revenue, more expensive last-minute pricing should return.

If an airline cannot raise its fares because of competitive reasons, it has another lever it use. It can raise ancillary fees for items like baggage and extra legroom seats.

An airline can raise prices across the board, or it can be more creative, perhaps by charging more for bags during peak periods, such as around the Christmas holiday. Both Spirit and Frontier Airlines have raised bag fees around school holidays, a trend that should continue. Travelers may not like it, but it is lucrative.

For bags, major airlines like American, Delta and United tend to prefer a one-price-fits all approach. But they have been sophisticated in how they vary pricing for extra legroom seats, and that should continue.

Airline executives hate fire-sales — think $39 or $49 one-way fares between major cities — but because carriers are fiercely competitive, if one airline puts them into the market, others usually copy.

Analysts often refer to these fares as “junk” or “garbage” or “trash” fares. They’ll still stick around, because sometimes heavy discounts are the only way to sell seats or fight competition. But some have predicted travelers will see fewer of them, at least from larger airlines.

On Allegiant Air’s third quarter earnings call, Lukas Johnson, vice president for network and pricing, said he is seeing fewer bargain fares from big airlines. Discounters like Allegiant will still sell those fares — Allegiant can make money through its fees — but for legacy carriers, it’s more challenging to charge that price and still make money.

“It’s not completely gone, but it’s improved,” Johnson said of the discounting environment. “Certainly, there’s still some aggressive fares out there still.”