There’s a new-found religion in the US airline industry, and investors should be thrilled. It’s called discipline.
Carriers added too much capacity recently to chase record passenger volume and all the companies — from large legacy airlines to the ultra low-cost carriers — got burned. The surprise has been that, instead of doubling down and provoking a prolonged fare war, the industry is already cutting back on available seats. The inflection point for overcapacity to drift down will be in mid-August, according to United Airlines Holdings Inc., which cited published flight schedules.
This means that the fare skirmish that broke out over the summer is ending already. The speed at which the airlines reduced capacity has impressed even the longest-serving airline executives, who have witnessed their share of profit-destroying fights over price. If this new discipline takes hold and becomes a permanent feature of the industry, investors can expect more stable airline earnings. Remember, this is a historically volatile industry that has burned storied investors, including Carl Icahn and Warren Buffett.
“I am incredibly encouraged to see the rapid response that is happening,” said Scott Kirby, the chief executive officer of United, which reported earnings late Wednesday and held a conference call on Thursday. “I’ve been through these cycles with capacity many times in my career. This is the fastest response.”
United isn’t the only airline to praise the quick adjustment on available seats.
“We’ve really only been in an oversupply situation for a couple of months here, and the industry has already reacted,” Glen Hauenstein, president of Delta Air Lines Inc., said on its earnings call last week. “I’ve been doing this for 40 years, and I’ve never seen the industry react so quickly to an oversupply.”
Some unique characteristics of post-pandemic travel paved the way for this change in mentality. The biggest difference is that the legacy carriers, including United, Delta and American Airlines Group Inc., had to pivot toward capturing leisure travelers soon after the Covid-19 lockdowns were lifted and people felt safe to fly again. The so-called revenge travel that spread across a nation that was weary of being cooped up represented the first wave of customers to come back. Corporate travelers were slow to return (and are still recovering).
This forced many airlines to offer a basic economy fare to scoop up the budget-minded revenge travelers and, to the surprise of the large airlines, many leisure travelers were willing to pay more for a pleasant flying experience. This shift to premium products is still going strong and is bolstering the margins of airlines that already offered first- and business-class seats and airport lounges that make waiting for a flight less burdensome (and even enjoyable).
These shifts of consumer flying patterns coupled with the move by legacy carriers to offer those back-of-plane cheap seats have severely damaged Spirit Airlines Inc., Frontier Airlines Holdings Inc. and other budget airlines. While United and Delta together are posting a majority of the airline industry’s profits, Spirit has had adjusted net losses of $435 million in the last three quarters, and Frontier’s adjusted net losses have been $90 million. Both have yet to report second-quarter earnings, and Spirit issued a profit warning earlier this week.
The low-cost airlines tried to win back those leisure travelers with more capacity and lower fares. The losses have compelled them to capitulate and begin canceling money-losing routes. They, too, have found the discipline religion, but it’s more about survival than just trying to shore up margins.
The budget carriers have tried to shift capacity to new routes and away from city pairs that have excess seats on offer. These alternative markets, though, are usually more volatile on traffic and not as lucrative. Another tactic for survival has been an attempt to tap into the premium trend. This is difficult for the low-cost carriers because of their plane configurations, which don’t have large sections of more comfortable business-class seats nor fancy airport lounges. At the same time, the budget carriers are struggling to cut costs because of labor and maintenance inflation.
The large airlines are salivating at the prospect of driving the pesky bargain airlines out of business by continuing to add cheap seats while at the same time expanding their premium offerings. United said its basic economy business surged 38% in the second quarter from a year ago. Now that corporate travel is on the mend, Delta, United and other legacy carriers that operate mostly in business-centric cities will prosper.
“The play is almost over,” Kirby said of the low-cost business model during United’s conference call.
The industry overcapacity caught some by surprise because the record number of passengers combined with lower new plane deliveries from Boeing Co. and Airbus SE were expected to squeeze capacity. But airlines have been holding on to older planes longer than usual, which drives up maintenance costs. United said it would now start to retire more old aircraft.
While the new capacity discipline and the potential demise of low-cost carriers would be good news for legacy-airline investors, it would most definitely be bad news for consumers. Frontier and Spirit are pests for the large carriers because they compete on price and keep airfares in check. The more competition, the better for consumers.
It’s also not good for the industry to suffer through the boom-and-bust cycles that mirror under- and overcapacity. So, kudos to the airlines for adopting the religion of capacity discipline. Let’s hope that all the airlines can survive this new-found fervor.
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