U.S. Airlines Should Have A Fully Profitable 2023
January 24, 2023
By Ben Baldanza, Forbes
January 24, 2023
The last time that the U.S. airlines earned profits as a group for the full year was 2019. This was a continuation of strong airline earnings from about 2012, ignited by major consolidation from eight large to four huge companies. High oil prices initially kept capacity constrained, and airlines saw price stability for the first time since 1978’s de-regulation. As oil prices moderated, capacity again stayed ahead of demand but smart planning and fewer competitors led to unprecedented earnings for the industry.
The pandemic was an exogenous shock that no one in the industry could have anticipated. The rapid reduction in people traveling created huge cash losses for the industry, and the players scrambled to leverage assets for cash while trying to figure out when, or if, travel demand would return. Three years after the pandemic first hit, the industry is in its strongest position since March 2020, and 2023 looks to be a great and realistic opportunity to return to industry-wide profitability. Here are five reasons why:
Demand for air travel has been strong since early 2022. The mix of traffic has changed since before the pandemic, with leisure travelers taking up a larger percentage of the traffic. But this leisure traffic is sometimes combined with a business trip and so the overall rate paid to the airline is sometimes more than the commodity price. Business travel volume is at about 80% of 2019 levels, and even Delta Airlines’ president stated that this is the new normal. Even with this, travel is strong and airlines can expect another busy summer.
But what about a possible recession? Some are talking like this, and based on prior years this would likely affect business traffic more than leisure traffic. Since about 20% of the business volume has not returned, though, it’s likely that the existing travelers are more resilient to a recession. If not too deep, this doesn’t change the robust demand forecast for 2023.
A seasoned airline industry CEO once said that “excess capacity is root of all airline evil.” This may be a bit strong, but clearly when the industry offers more seats than demand requires, pricing suffers. The fourth quarter of 2022 was highlighted by higher average fares and this has led both Delta and United into a profitable quarter. Keeping fares at this level while demand is high would be threatened by airlines adding too much growth to their systems.
Boeing and Airbus are helping this by having their own struggles to deliver aircraft on time. While this certainly frustrates the airlines, it also suggests that excess capacity will be less likely. This means price stability is possible for at least the busy times of the year.
Labor Costs Leveling The Playing Field Somewhat
Pilot costs are increasing across the industry. Pilot unions have unprecedented leverage given a shortage of pilots, and the growth need for airlines. The increases in pilot costs will carry over to some extent in other airline groups, too. It might sound odd to talk about a labor cost increase as a reason to be bullish about industry results. But there is rationale to this in part because knowing the targets is better than uncertainty.
Among the big airlines, Delta has led with an approach that sets a standard others can align to. The current offers may not be enough but define a window of realism. Some of the smaller airlines, including Spirit, have already reached agreement on a new contract and these suggest that the gap between the low-cost airlines and the larger airlines is closing somewhat. It’s not great when a primary input cost increases, but given that this is happening at every airline gives each airline the opportunity to think of creative ways to help offset these costs. The most proactive airlines will rely not only on top line increases to cover the new labor costs, but find ways to become more efficient in the non-labor portions of their cost structure.
Balance Sheet Repair
During the first two years of the pandemic, airlines added a lot of debt to their balance sheets. Some of this came from using loyalty programs as collateral, some came by selling owned aircraft to a lessor and leasing them back, and other more creative measures were used too. Debt ratios increased and industry balance sheets all became more leveraged. With a return to profitability largely in the fourth quarter of 2022, airlines can start a multi-year process of balance sheet repair that will bring their ratios back to historically acceptable levels.
Industry analysts understand this and will build this into their financial models. By paying off debt incurred during the earlier days of pandemic, airlines will improve their ability to finance new aircraft and other non-aircraft capital expenses. It’s great that demand is back and the capacity is almost back to 2019 levels, but the airlines can’t really say the pandemic is behind them until their balance sheets are readjusted.
Investors Are Ready
Airlines earning multiples understandably took a hit from the pandemic. Spirit, for example, was trading in the low to mid $40 range before the pandemic, but three years later agreed to sell to Frontier for about $24 before agreeing to sell to JetBlue for about $34. American Airlines is trading at half of their pre-pandemic price. As the industry recovers, post-pandemic demand is fully revealed, cost structures stabilize with new pilot rates, and balance sheets are de-leveraged then multiples will start to recover too. Some investors left the industry but others have taken their place, and those invested now are waiting for this recovery and should be rewarded as 2023 goes on. Still a full valuation recovery will likely take a few years of stable operations.
The airline industry is often unpredictable, and just a few months can make a big difference. While the year looks promising in January, the realities of Spring and Summer will determine what really happens. Even with this, the industry is in its strongest state since 2019.