Airlines Rake in Cash as Fares Stay Cheap. What’s Wrong With This Picture?

Wall Street squares off against the industry while travelers benefit.

Air Travel Is Up, Fares Are Down, Here's Why

It’s a strange time in the airline industry. Wall Street can’t seem to say enough bad things about carriers awash in profits. The four largest U.S. airlines banked $4.1 billion this spring, but saw revenues slide about 2 percent industrywide due to an avalanche of cheap fares, a notion some analysts call pricing dysfunction. On Friday, American Airlines Group Inc. became the latest to join the “best of times, worst of times” club, announcing a $1 billion second-quarter profit on revenue that was nevertheless down 4.3 percent.

So, for the airlines, profits are fine. For passengers, fares are great, too. These things aren’t supposed to travel together. Here’s what’s going on:

  • Supply v. demand: Seat capacity across the industry is growing at roughly 5 percent, compared with about 2.5 percent growth for the U.S. economy as a whole. Cheaper fuel prices have enabled much of the flying growth, especially on traditional off-peak days such as Saturdays and Tuesdays. This is likely to end, with Delta Air Lines Inc., United Continental Holdings Inc., and American all announcing plans to trim capacity later this year. Southwest Airlines Co. says it modeled ways to do the same, but couldn’t find any capacity cuts this year that didn’t dent income. But the carrier is likely to follow suit in 2017.
  • Business travel bargains: The trouble airline executives cite most is a steep decline in “close-in yields,” which is jargon for business travelers aren't paying nearly as much as they used to for last-minute tickets. A Los Angeles to New York ticket that once cost as much as $1000 when bought the day before a flight was selling Thursday for as little as $230. “They’re getting a deal right now,” American President Scott Kirby said Friday. Seat capacity is surpassing the consistent, though flat, demand for corporate travel generally subsidized by employers. While business flyers still represents the most lucrative part of the industry, all those extra seats mean airlines are left trying to sell even more tickets to price-sensitive leisure travelers.
  • Fare rules: For years, airlines imposed a variety of “fences” to manage inventory, trying to keep business fares high and leisure fares low. The Saturday-night stay, round-trip only, and 14-day and 21-day advance purchase requirements ruled supreme. Those types of restrictions are increasingly archaic, with the net effects being lower fares and more benefit for travelers.
  • Cheap fuel: While crude oil has rallied from its low, a barrel still costs around $44, with prices down 28 percent in the second quarter from a year earlier. For airline executives who grew accustomed to $100-plus per barrel, this low energy cost creates an enormous amount of buffer. It also lets them focus on defending turf and attacking rivals.
  • The Spirit effect: A trio of ultra-low cost carriers—Allegiant Travel Co., Frontier Airlines Holdings Inc., and Spirit Airlines Inc.—has expanded into cities with bargain-basement fares the majors no longer ignore. (Example: New York-Dallas, $39.) Almost everyone with a competing nonstop flight in a particular market has matched the lowest fares. “We must match [prices] to get that traffic. It’s just that simple,” Southwest Chief Executive Officer Gary Kelly said Thursday. American's Kirby echoed that sentiment, adding: “There’s just absolutely no choice.”

Put it all together and investors are mighty nervous, with the Bloomberg U.S. Airlines Index down 19 percent this year, including an 11 percent drop for Southwest on July 21, a day when a JPMorgan Chase & Co. analyst referred to the revenue situation as an “industry crisis.” Southwest’s record second-quarter income of $757 million—and the big summer profits to come—are apparently irrelevant.

Despite what this may mean for the industry and investors, the airlines and Wall Street will have to forgive harried travelers for not shedding many tears.

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