Airlines Will Profit No Matter What

Do you think airlines will eventually be able to make money if oil stays near current levels? The analysts I've read say it will be the demise of a lot of them. The hope for them is for oil to come down, not stay where it is.

The airlines will make profits no matter what happens to the cost of fuel.

Mesa and Express Jet (XJT) are on the edge of bankruptcy, hundreds of small jets are being grounded and even hundreds of older large jets are being grounded. If the above question had been "Do you think all airlines will make money?" then the answer would be no.

CNN and Mark Perry have each reported sales of GEO Metros on Ebay (EBAY). 1995 and 1996 models of these pitiful cars are selling for 5 to 7 thousand dollars even when they have about 100,000 miles on them, the sticker price in 1996 was about $9,000. In just a few months, the cost of driving one of these vehicles 100 miles has doubled. During the same amount of time, the cost of driving an SUV 100 miles has also doubled. People are scrambling to buy Metros at double last year's price and scrambling to sell SUVs at half of last year's price. Many a company is scrambling to sell its Gulf Stream Jet while it scrambles to get the best deal on commercial flights.

Analysts have fallen into the trap of believing what the majority believes, but, as Keynes told us, in economic matters the majority is always wrong. Once everyone believes oil prices are going higher, everyone acts in ways to prevent the prices from going higher. The majority believes that we must rapidly move to alternative fuels because we are quickly running out of oil. The reality is that we have used one trillion out of more than 13 trillion barrels of oil. The majority listens to the news that major airlines will spend billions more on fuel without considering that they will only spend these billions because there is demand for high priced tickets or that companies that own small jets are in the same boat as owners of SUVs.

It is likely that GEO Metros will burn more fuel this year than ever before, because they will be purchased by drivers who travel a lot, and it is likely that the amount of fuel burned by SUVs this year will be dramatically lower than the amount of fuel burned by SUVs last year. It is also likely that small jets will see a similar huge drop in the amount of fuel burned.

As usual, the big mistake is in thinking short term. The decision of GM (GM) to close down 4 truck factories is not one that will be reversed any time soon. Big monster trucks are on the way out. Fuel is not going to be wasted. More people will ride the bus and more people will fly together.

A day or so ago, Ryan Air (RYAAY) announced surprisingly good results. Other airlines that own fuel efficient planes have announced good results. United Airlines (UAUA) grounded 100 fuel hogs recently and the price of the shares are up 8%. British Airways (BAIRY.PK) just increased long haul flight fares by 109 pounds or about $218! Even an airline like American  (AMR) that operates 400 MD-80s is running close to break even this quarter and it will ground a number of planes. At $6,000 in fuel per hour, private long haul flights are only for the very rich.

The people staying home are mostly the leisure travelers; the ones who shop for the extra low price. The business traveler is flying long haul at prices that are approaching the prices reached in 2000. Capacity cuts are pushing up the price on many routes. Capacity cuts have been a close match to demand reductions on other routes.

In April, Continental Airlines (CAL) enjoyed a small increase in international load factors and a small decrease in its mainline load factors (domestic flight demand fell a little while international demand continued to grow), but the real story was a 6 to 7% increase in yield! Any business that is able to increase its top line by 6 or 7% during the worst of times should do quite well when times get better.

"The turn is here" means that fuel prices will go back down some, but the turn works, even if prices just level off. Pension funds which boosted their investments in commodity contracts from $16 Billion to $250 Billion in three or four years, make money only if the price of fuel goes up. If the price levels off, there will be more than $250 Billion coming out of commodity funds and into other investments. Another 3.1 Trillion "investment" Dollars sits in money market accounts. Give the American people a shot of confidence and not millions or billions but trillions of dollars will flow into stock investments. Throw in the turn in the US dollar and we will see a flood of US share investments from over seas.

Everyone knows about the airline problems. As the problems subside, the story will be told time and time again by virtually every media outlet. It will not take much of an upturn in profits to send airline shares soaring.

Disclosure: None

Comments

[Pundit]

This article is flat wrong on many points. Airlines have not been profitable, if viewed in the aggregate over the course of commercial aviation history.

There is no evidence that "...many a company is scrambling to sell its Gulfstream jet." Quite the contrary, orders for so-called "general aviation" jet aircraft are at historic highs and order backlogs are long. The execrable state of the U.S. airlines are a primary reason for this, and that is why private aircraft operators are willing to suffer the high price of fuel.

[Sophisse]

"The reality is that we have used one trillion out of more than 13 trillion barrels of oil."

You really need to back that up. Serious oil analysts will debate about new finds, how much can come online at what price over what duration, whether the Saudi fields are as large as they say, etc. But nobody (that I've found) ever says anything like 1/13.

A few years ago, people were looking at $35 oil saying that it had to come down from its highs. Now people are hoping it will drop below $100. The futures market is currently pricing 5-year oil at over $120. Plenty of people think it will drop - but not many think it will radically drop.

Personally i could expect a drop but then starting to rise again. We need these high prices in order to justify, and pay for, the large investment needed to bring new sources of oil (and/or alternatives) online.

Prices are now permanently high, at least compared with a decade ago. Airlines are forced to raise prices, which won't even make them more money, just pays for their higher costs. Higher prices make people travel less, an effect amplified by the higher costs of food and gas that leave less discretionary income people's pockets. Meanwhile the airlines are stuck with debt, losses, and a big pile of inefficient aircraft. They need to reduce staff, reduce flights, and upgrade some of their aircraft and junk the rest. All this costs new capital. Old investors are gonna lose their shirts - whatever shirts they have left!

[CrossProfit]

Still looking for one true statement of fact in this article!

Oh where to begin...let's try from beginning to end.

1) "The airlines will make profits no matter what happens to the cost of fuel."

Not true. The airlines can raise ticket prices just so much before passengers opt for other means of transportation or other means of communication or other venues for vacation and recreation.

Airlines need to balance price and capacity very carefully. Always have done so and always will. Higher fuel costs make this balancing act impossible for some lower margin airlines. At some point it becomes impossible for ALL airlines.

2) "hundreds of small jets are being grounded and even hundreds of older large jets are being grounded"

From your comments later on in your article, we assume that you are referring to business jets when saying "hundreds of small jets are being grounded". As of yesterday, there was still a three month waiting list for most new small jets. Small jets that were 'grounded' are the ones that are taken out of service as it no longer pays to maintenance them. Not even close to what you are implying.

As for the larger jets that the airlines are 'grounding', all fleets have varying ages of jets. Whenever there is a downturn, it makes sense to ground the older jets first. Likewise, when replacing fleets, the older jets are replaced first and sent to the scrap yard. They are being grounded in order to improve occupancy rates and margins, not because they use more fuel. If the airlines had the passengers to fill them, they wouldn't be grounding them.

3) "Many a company is scrambling to sell its Gulf Stream Jet while it scrambles to get the best deal on commercial flights."

Name ten prospering companies that are doing so! We will make it easier, name only five companies worldwide!

4) "major airlines will spend billions more on fuel without considering that they will only spend these billions because there is demand for high priced tickets"

See item 1 above. This is a new twist for the basic rule, lower prices create more demand, higher prices diminish demand. The twist is "because there is still some demand at higher prices, this proves that cost of goods sold can increase without concern about volume". Mr. Miller, you should write you own economics textbook. According to your logic, who knows - you might even win a Nobel prize! Sheeesh!!!

5) "A day or so ago, Ryan Air (RYAAY) announced surprisingly good results. Other airlines that own fuel efficient planes have announced good results."

Not true. RYAAY is in the same boat as everyone else as they have used up their fuel hedges. As for 'fuel efficient planes', this can only go so far. BTW, who are the 'other airlines'? Did they hedge their fuel costs?

The list goes on. This article is in dire need of a re-write, NO MATTER WHAT!

CrossProfit

[User 205564]

... I think your wrong. Why airlines may become profitable if oil stays high, the airline industry is probably the worst... the absolute worst... to participate in unless you feel like gambling. Too much competition, the lowest margin cutter gets the revenue... what a bleak outlook. none of these company ever consider shareholder value in their equations.

[Sophisse]

Jack - found your article from Jan 6 when you recommended United Airlines at $32 and American Airlines at $13. UA is now under $10 and AMR is under $8. seekingalpha.com/artic...

Ouch.

[BioInvestor]

Pretty sanguine article! I do like optimism, but I think it's unwarranted in this case.

If you go back and look at the aggregate profit of the industry from 1926, you'll see it runs at a loss. Take away the few billion dollars that Gordon Bethune so masterly squeezed out of the Feds after 9/11 and the situation is even worse. Heck, discount financials up to the Carter deregulation--I'll be generous and just look at aggregate profits for the past 30 years--awful! Ignore Southwest and a dire situation gets even worse. I guess if you include negative profits, then the title of the article has merit! :D

I agree that the price of oil, crude oil will sink. How, I don't know. I know it always happens. There's an underlying trend of higher oil prices, but I think we're in a strange period right now that's not likely to continue.

The big mystery to me is how come everyone associated with the airline industry is profitable except the actual airlines? Airports can be profitable if managed properly; Boeing has done well for the past few decades--granted, it's in a cyclical industry, but it is profitable. Catering companies, service companies, companies that offer training, the list goes on: companies that support the actual airlines are all, or can all be profitable, but the airline industry in aggregate is a money sink.

At least now capacity is being reduced; 10% is a major shift in the supply curve. I don't think it will make the industry profitable, but I fear in this era of tight credit, the first legacy into C11 won't come out--it's going to be hard to get financing. So, the strategy now seems to be to avoid Chapter 11--at least don't be the first that enters. On this trajectory, they'll all be in reorganization within 12 months.

[Xyrus]

Current best geophysical estimates of total world oil reserves including tar sands and oil shale is 3.74 trillion barrels of oil. The easily extractable crude is less than a third of that.

But if you want use your magical figures, let's say there is 13 trillion barrels of oil. A barrel of oil is 84% carbon, and most of a barrel is used for generating fuels. So a barrel of oil is roughly equivalent to about 105 kg (210 lbs) of CO2 production per barrel.

Now using you're magic 13 trillion barrel number, burning it all would release about 1.37x10^15 kg of CO2 into the atmosphere. Dividing by the volume of the earth's atmosphere, that gives us an increase in atmospheric carbon of 5.3x10-4 kg/m^3.

That doesn't sound so bad? The total mass of the atmosphere is about 5.2x10^18 kg. So you've jacked up the CO2 concentration from .03% to 3%. Not so bad still? That's toxic, as in prolong exposure can kill you, as well as most forms of surface dwelling life. Not to mention our planet would be a boiling sauna. Given the carbon cycle is about 150 years and our consumption rate, we'd pretty much guarantee our own extinction, along with the other unfortunate critters who happen to exist at that time.

But fortunately we don't have that much oil, so the damage we can cause from oil is limited. At our current consumption rate (and rate of increase), IF we can extract all the oil, we are looking at 70 years best case. If everyone ramps up to US levels, you can shave another couple decades off that. The easy stuff will be gone in the next 20 or 30 years.

Coal is a whole different (and uglier) matter.

~X~

[CrossProfit]

Correction to previous comment:
"As of yesterday, there was still a three month waiting list for most new small jets."
Should read "three years" - not months. Used small jets take about three months to find and refurbish.

[notsosmart]

was it mr. bronson who said"if you want t become a millionaire start with a billion & invest in airlines?

[Pilot]

Jack , are you really Jack or are you Scott Kirby from US Airways ?? You must be looking through "rose colored" glasses. The Airlines' business plans are very poor (single source revenue business plans do not work very well) (except for Southwest). As long as Southwest is paying less for fuel all domestic airlines will face a problem and maybe chapter 11 for some. I hope that you are right but I would not bet my house on your article.

[rarikola]

While you folks were bitching here all major airlines like DAL, SKYW, CAL, ALK, AMR ,LCC .... gained 50% , 70% 100% !!! and more.