Much has already been said of the shrewd strategy of American Airlines to induce a pre-emptive bankruptcy filing when the airline still holds more than $4 billion in cash and is in no imminent danger of default on its debts or other financial obligations.
The bankruptcy will most assuredly put American back on the road to economic parity with its chief competitors (Delta and United Airlines), which already restructured and cut costs in bankruptcy proceedings during the tumultuous decade following the 9/11 attacks.
Additionally, American may also find a willing merger partner, to expand its route network as the other network or legacy airlines have already done in recent years. Unfortunately, neither bankruptcy court nor consolidation really address two of the greatest challenges for the U.S. airline industry: high and volatile fuel prices and a mountain of insurmountable debt.
In early 2010, I interviewed renowned airline industry analyst, Darryl Jenkins, for a story published in my Business Traveler column on USA Today.com. In that article, Jenkins highlighted the three biggest issues facing U.S. airlines: 1) high fuel prices, 2) massive debt and 3) the return of overcapacity. While written one year and half ago, those three great challenges are still every bit as relevant as they were back then.
At the time that article was published, oil prices had climbed to $87 per barrel, their highest level in the last 18 months. Today oil prices exceed $100 per barrel and, though prices are still likely to fluctuate, there is no long term relief in sight as world oil demand keeps growing.
Ironically, the initial period of prolonged higher oil prices may have actually helped U.S. legacy airlines turn a profit, but this may not be the case much longer. When oil prices were much lower, low-cost, discount airlines expanded rapidly, forcing airfares downward in every new market they entered and causing their legacy competitors to bleed cash while the low-cost discounters profited and continued their expansion.
The low-cost airline expansion seemed unstoppable until the first prolonged period of surging oil prices in 2008. With higher oil prices, low-cost airlines could no longer afford to expand their networks or compete on price, and the discounters retrenched and raised airfares just to survive, while legacy airline earnings were still buffered by their highly profitable long-haul first and business class operations.
Initially, Southwest Airlines was the lone holdout in raising airfares, because they had successfully purchased hedges to buy jet fuel well below market rates while everyone else was paying the much higher, current prices. Now those hedges are gone and Southwest pays the same price for fuel as everyone else, forcing that airline to raise fares to cover their costs, while the rest of the U.S. airline industry eagerly followed along.
In the current period of sustained higher oil prices, every U.S. airline has terminated unprofitable and marginally profitable routes and slashed capacity. Concurrently, a new round of consolidation among low-cost (Southwest/AirTran/ATA and Frontier/Midwest), as well as legacy airlines (Continental/United, Delta/Northwest and America West/US Airways), has further reduced capacity and driven airfares higher. Additionally, U.S. airlines have successfully tacked on another $13 billion in annual revenue from ancillary fees, like checked baggage, in-flight food purchases and exit row seat upgrades.
As long as oil prices remain constant and airlines do not restore lost capacity, U.S. airlines may remain marginally profitable. Unfortunately, there is good reason to believe oil prices will continue to rise as the new middle class in densely populated countries, like China, India and Brazil, continue to thirst for ever increasing volumes of fossil fuels to power their burgeoning, emerging economies. Periodic disruptions in the oil supply from volatile regions, like the Middle East, Africa or South America, could easily spike oil prices ever higher. The U.S. airline industry will revert into economic calamity again when the next oil price spike occurs and bankruptcy won’t help American Airlines or anyone else.
Insurmountable levels of debt are another albatross around the neck of the legacy airlines. While American will likely shed or refinance some of the airline’s debt in more favorable terms while in bankruptcy, the massive debt problem for U.S. legacy airlines is still obscenely out of control. Prior to the bankruptcy action, American Airlines was carrying at least $10 billion in debt with another $7 billion in unfunded or underfunded pension liabilities. Sadly, even after bankruptcy, Delta Air Lines is still carrying $14 billion and United Airlines $13 billion in debt and pension liabilities.
The level of debt and rising demand for fossil fuels are ticking time bombs for the U.S. airline industry. Additionally, sustained poor financial performance following the period after 9/11/01, devastated legacy airline balance sheets, precipitating draconian budget cuts and the deferment of many vitally important capital expenditures, such as fleet renewal. In many cases, a large portion of the entire aircraft fleet of U.S. legacy airlines is in dire need of upgrade or replacement.
Older aircraft are often significantly less fuel efficient than most newer airplanes, further exacerbating the fuel cost issue and increasing maintenance costs for legacy airlines. While American, Delta and United have fleets ranging from 12 to 15 years in age, smaller or low-cost operators like Alaska or AirTran have fleets in the range of eight to nine years in age, while Frontier and JetBlue’s fleets are only around six years old.
Even across the globe, major airlines, such as Air France, KLM or South African Airways have fleets in the range of eight to nine years of age. Asian airlines like Cathay Pacific, Korean Air or ANA have fleets with an average age of around ten to 11 years. Meanwhile, newer global airlines, like Emirates Airline, boasts a fleet with an average age of around six to seven years, while other rapidly growing Middle Eastern airlines, like Etihad and Qatar, boast fleets as young as four or five years in age.
All this means that legacy airlines will eventually need to take on even more unaffordable debt to finance the purchase of new airplanes slated to replace the older, gas guzzling airplanes. While United an Delta have only begun to update a portion of their fleets, American Airlines recently placed a $38 billion order for more than 500 new airplanes. With the airline now in bankruptcy court, that massive transaction may now be in jeopardy, further deferring the inevitable replacement issue.
While the American Airlines bankruptcy may be a small step in a necessary direction, no U.S. legacy airlines will be able to control their destiny when fuel prices rise again and long term debt comes due.
