Mary Schlangenstein, Michael Sasso
U.S. airlines are asking shareholders to believe they can raise ticket prices while ramping up the supply of seats. To Wall Street, that sounds like a fairy tale.
Six attempts at broad-based fare increases have failed in the last two months, most recently a bid last week by Delta Air Lines.
That’s creating a confidence crisis for investors, who last week sent airlines to the biggest drop since 2015 when United Continental Holdings Inc. announced an aggressive expansion plan. The No. 3 U.S. carrier is hardly alone. Southwest Airlines Co., JetBlue Airways Corp. and Alaska Air Group Inc. are also planning to grow faster than the economy.
The worry is that the only way to generate enough demand to fill the new seats is by cutting prices. And that risks triggering fresh fare wars just as profits are under pressure from rising fuel costs.
“Capacity is starting to increase faster than demand,” said Samuel Engel, senior vice president at consultant ICF. “At that point any one carrier starts to say, ‘I’d rather add capacity and try to steal share than support a fare increase across the industry.’”
It’s a competitive business, and one carrier’s attempt to raise fares can be another’s opportunity to win new customers with bargain prices. But one reason investors including Warren Buffett have bought airline shares is the expectation that after years of industry consolidation, carriers will be able to maintain steady profits, thanks in part to stronger pricing power.
Delta and American Airlines Group Inc., the two biggest carriers, have slowed their expansion in recent years to let demand catch up with supply – and make it easier to charge more for tickets. They’re only boosting capacity 2.5 percent this year, roughly in line with growth expectations for gross domestic product, a barometer of travel demand.
A slower seat expansion helped defuse fare wars that began in 2015 and flared up again last summer before subsiding later in the year. And with the improving economy, it’s possible airlines will still be able to boost passenger revenue for each seat flown a mile, a proxy for pricing power, despite all the capacity growth.
But a fast-growing supply of seats will be a headwind for efforts to raise fares. United reignited concern last week with its plan to expand as much as 6 percent each year through 2020. JetBlue said it would boost 2018 capacity as much as 8.5 percent, Alaska Air has targeted 7.5 percent and Southwest will grow about 5 percent.
Doug Parker, chief executive officer of American, said Jan. 25 that fares “are too low for oil prices this high.” Carriers will find a way to pass on the increase to consumers, he said, “but it takes time.” There’s generally a gap of at least three months between when fuel climbs and fare increases show up.
Historically, airlines have dealt with rising fuel prices by paring back capacity, Delta CEO Ed Bastian said last month. It’s too early for Delta to think about adjusting its growth plans, but the carrier will be prepared to act if fuel prices “continue on this tear,” he said.
Carriers are right to be cautious about raising fares too quickly, said Rick Seaney, chief executive of 3 Victors, which tracks real-time air fare purchases. There’s a risk that when ticket prices increase enough to cover the cost of fuel, that can also discourage some travel.
“Of the 2 million passengers flying on a given day, 1 percent to 3 percent may not have taken that trip had the price been USD1 or $3 more,” Seaney said. “Each one of those passengers had a breaking point where they wouldn’t have flown. One more dollar and you broke the camel’s back.” Mary Schlangenstein, Michael Sasso, Bloomberg
No Comments