How much does Vaughn Cordle know about the state of the U.S. airline industry? Well, the CEO and chief analyst of AirlineForecasts - who has 25 years-plus of experience as a pilot for a major airline - makes a large part of his living selling what he knows about airline finances and economics to hedge funds, government agencies and consulting groups. At the end of a week of airplane horror tales that included raw sewage flowing down the center aisle of Continental trans-Atlantic Flight 1970, I caught up to Cordle by telephone just after he landed in San Francisco - where earlier in the week 400 people on a Cathay Pacific Airways jet had been stuck on a runway for seven hours:
Q: Is this summer going to be as hellish for air travelers as we’re being told it will be?
A: I don’t think so. The benchmark everyone is referring this summer to is the summer of 2000, "The summer of hell," as some call it. That was about labor issues. This summer we don’t have labor issues. Traffic is back up pretty much to where it was in 2000. Fares are much lower. Load factors are at historic levels. So it’s much more crowded on planes and less convenient and there are more travel hassles because of security concerns and TSA security checks. So it's a very uncomfortable summer but delays won’t be as bad.
Q: What’s the airline industry’s biggest problem right now - and who or what is to blame for it?
A: The U.S. airline industry is the least-profitable in the world. I believe there are too many competitors. We’ve been crunching numbers on all the passenger-carrying airlines in the country and there are 34 airlines that produce more than $100 million in revenue. So it’s highly fragmented and hyper-competitive. We estimate that those 34 airlines in the domestic market are coming up about $8 billion short from earning their cost of capital.
The big 12 airlines account for about 96 percent of passenger capacity. They’re doing quite well internationally but it’s the domestic market that is not doing so well. The airlines have to crowd more people into their aircraft. Load factors (percentage of a plane's seats that are sold) have gone from about 65 percent a decade ago to in the low 80s and this summer some airlines probably will have 90 percent load factors. So this means effectively some flights have too many people and they have to turn people away.
It’s crowded and airline employees are demoralized because they are working more for a lot less. And when you have to deal with more passengers, employees are working more and they and passengers are stressed out.
Q: Has the airline industry finally figured out how to make profits?
A: No. They’re still losing money. This year we estimate that the major 12 or 15 airlines will earn about $3.5 billion. Now that’s better than the cumulative $35 billion they’ve lost since 2000, so it is a turnaround year. But the airlines - the money-losing, over-leveraged network airlines (United, American, Delta, etc.) - have had to pull back significant domestic capacity to force those load factors up so they could offset the lower real yields (revenue per passenger carried for one mile). Unit revenue is still about 14 percent lower than it was in 2000 -– that’s the revenue per available seat mile. But the yields are still 25 percent lower. So the higher load factors mask the real weakness in the airline industry, which is low yields.
Q: The Economist magazine recently said that the best thing governments can do to help the airline industry become more efficient and more profitable is to get out of the way. Do you know what The Economist was talking about?
A: Yes I do. I believe that the airline industry could naturally evolve into a more efficient industry if the government just gets out of the way, lets certain airlines fail and lets mergers and acquisitions occur. It is highly fragmented, hyper-competitive, and there are destructive fare wars. Today there was an article in USA Today that said average fares were 2 percent lower than they were last year. Yet we have 80 or 90 percent load factors this summer. So traffic is back up but average fares are at levels that are not healthy for the industry, hence the financial distress and the exceptionally high load factors.
But these airlines have under-invested in their competitive resources -– human and physical -– and they’ve got to play catch-up. If you look at capital expenditures for most of the major carriers, it’s less than depreciation, so by definition they are in a slow liquidation. So they’ve got to invest and replace old and aging aircraft.
Labor costs have come down quite significantly since 9/11 but the salaries are unsustainably low at some of the airlines. Some of these employees have taken 30 or 40 percent pay cuts -– and they are working more with higher load factors. So there is an unhappiness with some of the majors’ employees and the industry needs relief.
Q: Is privatizing the Air Traffic Control system an important idea?
A: I think it’s an important idea. If you look at the productivity increases in the U.S. airline industry, the average network airline has improved productivity from 20 to 35 percent. Even Southwest has improved productivity 20 percent. They went from 85 people per aircraft to a recent 67. United has gone from 160 people per aircraft down to 115 - about a 28 percent improvement in productivity.
Now if you look at the Air Traffic Control system, 90 percent of the cost of the system is labor, and guess what? There’s been zero improved productivity over the last decade. They have outdated systems that need to be replaced. It’ll take tens of billions to modernize the ATC system and that’s part of the problem.
Q: Should it be run by the airlines themselves?
A: Not by the airlines but by a group of users of the airlines. If the users that paid for the system had some say, it would in fact be more efficient than being run by a government agency that has congressional meddling, so to speak. Right now the system is politicized, which is not good.
Q: Can you name a specific airline that really has gotten its act together and is making money and serving passengers well?
A: Oh yeah. We have to distinguish between good airlines and good investments. Most of these airlines are very poor investments, including JetBlue and Southwest, the airlines that do provide high-value service, so that people are generally happy. JetBlue was recently ranked No. 1 in customer service by a couple rating services and Southwest has always been near or at the top in customer service. These are great quality airlines that provide reasonably priced transportation and they do it in a very good way.
Now if you look at JetBlue from an investment perspective, it’s been a negative rate of return if you are a shareholder, when the broader market has been up 59 percent over the last five years. So it’s a lousy investment but a great airline to fly. Eventually that catches up to even the best airlines. JetBlue has been forced to reduce their growth rate from 30 percent a year and half ago to 20, to 18 to 15 and now they are down to 12 percent. We recently did a pretty robust study on all the North American airlines. We took a close look at JetBlue and Southwest and JetBlue will more than likely have to pull in even more growth if they want to get their share price up.
Q: Is what Air Canada’s experimenting with -– offering annual flight passes and charging for specific services – something that more airlines will be doing?
A: You mean the "debundling" of various charges and services? That’s a unique strategy which I think more and more airlines are going to have to move towards. The extreme airline model is the Ryan airline model based over in Ireland. That airline, interestingly enough, is the most profitable airline in the world and the most valuable publicly traded airline in the world. Ryan debundles everything and they have very low fares, but they charge passengers for everything. It’s the extreme low-cost airline.
Now Skybus, which is a new company that started up in Columbus, Ohio, about a month ago, is modeling their business on the Ryan model. They pay flight attendants $9 an hour. They’ll charge very low fares. They kicked off their service by offering $10 fares. Their objective is to get people in the seats so they can charge them for everything else.
Q: Is the future of the airline industry - and therefore air travel for the masses - going to be better or worse?
A: It’s going to get worse as long as we have a highly fragmented airline industry. The big major airlines as of the first quarter produced 64 percent of all capacity. They are only viable as long as they have strong international routes to subsidize their domestic operations, which are losing money. I’ll give you an example. Continental last year lost half-a-billion dollars in their domestic operations but they made a lot of money in their Latin America, Atlantic and Pacific markets. They made over half-a-billion dollars in operating profits in the Atlantic market alone. Continental’s losing a lot of money in the domestic markets, and so are they other airlines, but they need the domestic markets to feed the international routes.
The problem arises when stronger foreign carriers with better balance sheets, higher profits and better service start picking up the pace. We have some mega-carriers forming in Asia and there are going to be a lot of Airbus 380s coming on to the market. They have rules and regulations over there that are different than ours ... and they are very profitable. They have over $5 billion in excess equity. If you look at the top 30 world airlines, not one single U.S. carrier is on the list in terms of profit margins. And if you look at their capital structures, the U.S. network airlines are at the bottom of the world list. They have got over-leveraged balance sheets and we calculate they come up about $8 billion short in revenue. It is a revenue problem. ... In other words the U.S. airline industry would enjoy $30 billion more in revenue today if air travel-personal-consumption expenditures were at the same level in relative terms that they were in the previous decade, prior to 9/11.
