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Flights Are Packed—Time to Cut Back

U.S. airlines are in their best shape in years, so why the rush to slow growth? When even Southwest is in a cooling phase, it's worth a look

It has been a fine summer financially for U.S. airlines. Nightmarish weather and congestion delays, along with packed planes, aren't cooling sizzling demand—and the resulting profits are landing on investors nicely. The latest spiffy performance news came July 24, with United Airlines' parent reporting its largest quarterly profit since 2000, and JetBlue Airways' second-quarter income rising 50%.

United reported a $274 million second-quarter profit, aided by strong international results and lower costs, its best performance since the same quarter seven years ago. At JetBlue (JBLU), which was hobbled by February storms that scrubbed 1,700 flights and marred its reputation for customer service, income rose to $21 million, up from $14 million in the spring quarter of 2006.

Tucked into the latest round of earnings reports was an added bonus for Wall Street: less domestic growth. UAL Corp.'s (UAUA) United, the nation's second-biggest carrier, has been culling domestic capacity for much of 2007 and plans to finish the year with 2.5% to 3.5% less mainline domestic capacity. JetBlue said July 24 that it is selling three of its Airbus jets and will take delivery of only seven new planes this year instead of the 10 it had originally scheduled. It also will postpone delivery of 16 smaller Embraer jets, now planned for arrival from 2013 to 2015. "Slowing capacity growth will allow us to strengthen our balance sheet and facilitate earnings growth," said JetBlue Chief Executive Officer David Barger in a July 24 statement.

The news comes just a week after Continental Airlines (CAL) said it will tap the brakes on its growth plans. The carrier says it will slow capacity growth next year to 3% to 4%, down from the previous target of 5% to 7%, and it will sell 15 Boeing 737s from its domestic fleet through November, 2008. Southwest Airlines (LUV) announced a 15-plane decrease in its planned 2008 fleet expansion, while American Airlines' parent, AMR Corp.AMR, said its full-year domestic capacity will be 2.6% below 2006's.

More Hassles

For frustrated travelers, the implications are clear: Even though airlines will have lower traffic after the summer, you're likely to pay higher air fares, have a harder time finding alternate flights if you're bumped, and face more hassles in redeeming frequent-flier miles. The efforts to curtail growth mean the airlines will be able to mitigate the seasonal financial effects to a degree. United spokeswoman Jean Medina says it is shifting flying to its United Express regional unit, which will buttress seat availability. Airline executives aren't certain that the economy's apparent rebound after a dismal first quarter has stamina, and many were grousing in late spring that future revenue trends appear soft.

U.S. carriers are reassessing the mix of supply and demand and where best to deploy planes at a time when oil hovers around $75 a barrel and many airlines are not pleased with their revenue quality. "I do think there is a greater sensitivity to the fact that in a very high fuel-price environment, keeping pricing as robust as possible is more paramount," says Jim Higgins, an analyst at Soleil Securities Group. Higgins says airlines are seeing greater seasonality, with the need to keep both supply and demand tight. "That tends to make peak periods…the second and third quarters, even peakier, if you will."

That tightness has meant that Americans have endured a summer of jam-packed flights, with passenger loads hovering near 90% for many of the majors. The June figures tell the tale: a record 89.1% for United, 88% for Northwest, 87.1% for American, 85.9% for Delta, and 83.8% for JetBlue. Continental was at 86.2% for this month as of July 23.

And forget about much space relief when the summer ends. The airlines' domestic-capacity reductions are driven by a zeal to fly more lucrative international routes, the tendency to avoid new flights when gas is so high, and slower expansion among low-cost rivals. Combine that with industry fatigue over what UAL's chief revenue officer, John Tague, earlier this year called "foolish pricing," and you've got the makings of a decent insurance policy against the airlines' typical seasonal slowdown when schools reopen. "They certainly set up the table for a much better result than we would have achieved," Tague said at a July 24 conference about United's earlier capacity cuts.

Still, no one expects the airlines to eliminate the troughs of autumn and winter. Those seasons tend to have the lowest fares of the year, such as sub-$400 flights to Europe. "Fares will go down, but they will not go down as much as they have in years past," predicts Rick Seaney, CEO of in Dallas.

Southwest, Too?

Much of the current thinking can be traced to sentiments voiced May 9 by Southwest CEO Gary Kelly. "We don't want to grow just for growth's sake," Kelly said at a Bear Stearns BSC Global Transportation Conference, discussing a weak revenue environment. He added that "if things continue to be sluggish, we will continue to think about our growth rates in 2008 and beyond."

When Southwest Airlines—the granddaddy of airline growth stories—decides to hit the brakes, it's bound to cause a stir. Southwest has expanded at a torrid clip for decades, chugging along against rivals with a mix of low labor costs, smart hedges against fuel costs, and a revenue machine geared to high traffic volume and low fares. But the Dallas carrier now faces a very different competitive landscape, Higgins notes. Southwest's most advantageous fuel contracts expired just as the majors have restructured their finances to better compete on costs. And fare hikes this year—among the rare times Southwest has led any—have not kept pace with fuel prices.

"They're scaling back their growth in part because they aren't able to raise fares as much as they'd like to cover these large fuel costs," says Phil Baggaley, an airline analyst at Standard & Poor's (S&P, like BusinessWeek, is a unit of The McGraw Hill Companies (MHP).)

The long-troubled airline industry is finally figuring out effective ways to prop up profits. But what's good for the carriers may not be so good for travelers.

See BusinessWeek's slide show of the 10 best business classes in the sky.

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