Airline Financial Woes
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THE CYCLICAL CRISIS IN COMMERCIAL AVIATION Professor Dr. Paul Stephen Dempsey Director, Institute of Air & Space Law McGill University Copyright © 2011 by the author. “There are three ways to lose a lot of money: “1. Slow horses; “2. Fast women; and “3. Airlines. “But you know, they’re all a lot of fun.” Omar Fontana, founder, Transbrasil Airlines Airlines are perceived to be a glamorous investment. There are three businesses everyone believes s/he can run: 1. A restaurant; 2. A sports franchise; and 3. An airline. Issues to Be Addressed • How severe is the contemporary financial distress which the airline industry suffers? • What challenges does the industry face in terms of supply, cost and revenue? • Why the disconnect between demand/supply and price/cost? The Maturity of the Market, and the Level of Regulation and Degree of Competition, Impacts Industry Profitability High Profitability Regulated Deregulated Growing Markets Growing Markets Regulated Deregulated Mature Markets Mature Markets Low Profitability The world based on commercial aircraft departures. Economic Theories (circa 1978) • There were no barriers to entry in aviation, other than governmental restrictions. • There were no economies of scale in the airline industry. • Markets were contestable. • Therefore, deregulation would produce nearly textbook levels of perfect competition. Economic Theories (circa 1978) “Unfortunately, those theories turned out to be wrong as they applied to the airline industry . ”[1] and “airline markets cannot be modeled by any reasonably pure version of contestability theory.”[2] [1] Michael Levine, Airline Deregulation: A Perspective, 60 Antitrust L.J. 687 (1991). [2] Michael Levine, Airline Competition in Deregulated Markets: Theory, Firm Strategy, and Public Policy, 4 Yale J. Reg. 393, 405 (1987). Average Fares Continue to Decline U.S. Domestic Average Yield Per Mile Constant 1987 Dollars 80¢ 70¢ 60¢ 50¢ Actual 40¢ Trend 30¢ 20¢ 10¢ 0¢ 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 US AIRLINES PASSENGER YIELDS 1950-2006 16 Before deregulation, real yields fell 14 2.3% annually, on average. After deregulation, they fell only 1.4%. 12 Nominal Yield 10 8 cents per mile cents per 6 Real Yield 4 2 0 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 year US AIRLINES - REVENUE PASSENGER MILES 700000 Traffic has grown significantly 600000 since deregulation. 500000 Domesti 400000 year(000) 300000 200000 100000 Internationa 0 1927 1930 1933 1936 1939 1942 1945 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 US AIRLINES - OPERATINGAirline revenuePROFIT/LOSS has grown too, but 180,000,000 profits have been elusive. 160,000,000 140,000,000 120,000,000 operating revenue operating profit 100,000,000 80,000,000 $(000) 60,000,000 40,000,000 20,000,000 0 1941 1944 1947 1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 -20,000,000 year US AIRLINE INDUSTRY NET PROFIT MARGINS 10 8 6 4 2 0 % -2 -4 -6 -8 -10 -12 Post deregulation: the market cyclesyear have hit deeper troughs. US AIRLINE INDUSTRY NET PROFIT MARGINS 10 8 6 4 2 0 % -21958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 -4 -6 -8 -10 -12 year Post deregulation: the market cycles have hit deeper troughs. US AIRLINE INDUSTRY NET PROFIT MARGINS 1950-2009 15 10 5 0 -5 net profit margins -10 -15 -20 year US AIRLINES - RETURN ON INVESTMENT 20 Volatility has increased. Returns on investment ranged between a high of 11.8% (in 1955) and 15 a low of 1.5% (in 1961), a swing of just over 10 percentage points. Post to a low of -deregulation, industry ROI swung from a high of 14.7% (in 1997) 10 points. 5 -9.6% (in 2002), or a swing of more than 24 percentage % 0 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 -5 -10 -15 year U.S. AIRLINE DOMESTIC FINANCIAL PERFORMANCE IS MORE VOLATILE THAN INTERNATIONAL PERFORMANCE U.S. AIRLINES NET PROFIT (000) 6000 4000 2000 0 -2000 -4000 -6000 -8000 -10000 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 domestic net income (000) 2001 2002 2003 2004 Q 1-2 domestic net income (000) international net income THE MAGNITUDE OF THE FINANCIAL CRISIS • 2000 – U.S. profit $2.5 billion • 2001 - U.S. losses $8.3 billion • 2002 - U.S. losses $11.4 billion • 2003 - U.S. losses $1.7 billion • 2004 - U.S. losses $9.1billion • 2005 - U.S. losses $27.2 billion • 2006 - U.S. profit $18.2 billion • 2007 - U.S. profit $7.7 billion • 2008 - U.S. losses $23.8 billion • 2009 - U.S. losses $2.5 billion • 2010 – U.S. profit $3.6 billion US Carriers cumulatively lost $52 billion in this decade. Industry financial performance during the most recent downward cycle is worse than in any prior recession . 60 • 1970 - $200 million 50 • 1981-1982 - $1.4 40 billion • 1990-1994 - $13 30 billion 20 • 2001-2009 – $58 10 BILLION 0 1970 1982 1994 2005 Billion $ . and have grown progressively worse since deregulation • Pre-deregulation – No airline bankruptcies • 1981-82 – two major airline bankruptcies; one liquidation • 1990-94 – five major airline bankruptcies; two liquidations • 2001-06 – seven major airline bankruptcies; no liquidations; half of US fleet capacity in bankruptcy. Entrepreneurial spirit is abundant. Exec Express America West Tower Air Caribbean Express Midway Airlines Kitty Hawk New York Airways Aeroamerica Pocono Airlines, Inc. Flagship Express Pro Air Florida Airlines Virginia Island Seaplane Virgin Island Seaplane Fine Air Services Indiana Airways Princeton Air Link Trans World Airlines Legend Airlines Air Bahia Qwest Air L’Express National Airlines Tejas Airlines Mountain West Southern Jersey Airways MarkAir Trans World Airlines LANICA Eastern Air Lines Hermans/Markair Express Midway Airlines Coral Air Big Sky Airlines States West Airlines Sun Country Airlines Pacific Coast Air Kentucky Hawaiian Airlines Vanguard Airlines Swift Aire Line Golden Gate Braniff, Inc. Florida West US Airways Pinehurst Airlines Presidential USAfrica Airways United Airlines Silver State Resort Commuter MarkAir Hawaiian Airlines Air Pennsylvania Pocono Airlines Trans World Airlines Midway Airlines Cochise Airlines Braniff International SMB Stage Lines Grand Airways Great Plains Airlines Astec Air East CC Air The Krystal Company Atlas Air/Polar Air Cargo Will’s Air Britt Airways GP Express US Airways Aero Sun Int’l Rocky Mountain Airways Business Express ATA Airlines Aero Virgin Islands Altair Continental Airlines Jet Aspen Southeast Airlines North American Pan Am World Airways Kiwi International Aloha Airlines Island Empire Pan Am Express Conquest Delta Air Lines State Airlines L’Express Air 21 Comair Golden West Continental Airlines Eastern Air Lines Sun Jet International Northwest Airlines National Florida Bar Harbor Airlines Mahalo TransMeridian Air Vermont Northcoast Executive Air South Mesaba Airlines Pacific Express Midway Airlines Western Pacific Airlines Era Aviation Dolphin Combs Airways Grand Airways Mountain Air Express Independence Air New York Helicopter Metro Airlines Pan American World Florida Coastal Air Florida Mohawk Airlines Euram Flight Center Kitty Hawk Aircargo Excellair Jet Express Sunjet International MAXjet Airways American Int’l Emerald Metro Airlines Eastwind Airlines Hammonds Commuter Northeast Access Air Air North Wright Air Lines Oceanaire Lines Atlantic Gulf Connectaire Air One Capitol Air Wien Air Alaska Northeastern Int’l Pompano Airways Far West Airlines American Central Provincetown Boston Sun West Airlines Wise Airlines Cascade Airways Wheeler Airlines Pride Air Southern Express Imperial Airlines Arrow Airways Sea Airmotive SFO Helicopter Trans Air Frontier Airlines Chicago Airlines McClain Airlines Rio Airways Air Puerto Rico Gull Air Royal West Airlines Air Atlanta Air South Inc. Royale Airlines Sun Coast Airlines Air New Orleans Air Virginia Mid Pacific Airlines All of aviation is profitable, except the core. AIRPORTS AIRCRAFT INSURERS MANUF. AIRLINES FUEL LABOR SUPPLIERS AIR NAVIGATION Time, Jan. 28, 2008: “[T]he US has experienced what economist and former Under Secretary of the Treasury John Taylor of Stanford University calls a ‘long boom’ since the Fed started to squeeze inflation out of the system in 1979. For nearly 30 years, Taylor points out, the few downturns the U.S. has suffered have, in historical terms, been short and shallow.” Gary Chase, Lehman brothers: “The industry hasn’t seen a real up cycle. 2006-2007 in retrospect now looks more like a brief reprieve from a down cycle rather than an up cycle. The industry has not been profitable enough to justify investment.” The U.S. airline industry lost all the profit earned since the Wright Brothers’ inaugural flight. This is true, even adjusted for inflation Warren Buffett • Buffett invested $385 million investment he made in US Air. In 1995, he wrote off 75 percent of that investment to zero. • Buffett pointed out that the airline business in the U.S. “has made no money.” • According to Buffett, in 1903, at Kitty Hawk, N.C., when the Wright Brothers flew: • “If there had been a capitalist down there, the guy would have shot down Wilbur.” Giovanni Bisignani – DG, IATA: “Unless investors receive a fairer share of the value the industry creates, future growth in air travel will either be constrained or inefficiently met, with substantial value lost for the global economy. Significant new investment is required to meet the fast-growing demand for air travel, but current rates of return do not even justify retaining the level of capital that is already invested.” Why? • "There is no denying that the profit record since 1978 has been dismal, that deregulation bears substantial responsibility, and that the proponents of deregulation did not anticipate such financial distress - either so intense or so long-continued.” • Alfred Kahn (1988).