Rising costs of US airlines threaten to drag their profit margins
Airlines are paying more for fuel, labor and maintenance, drawing scrutiny from investors who fear the industry's rising costs threaten margins during a record stretch of profitability.
Expenses at the nine largest airlines rose 8.1% in the first nine months of 2017 compared with the prior-year period, according to the Airlines for America trade group, while revenue rose 3.8%. The run-up in expenses is well above the overall US inflation rate of 2.2%.
The imbalance caused the pretax margins of the nine carriers to slide to 12% in the nine-month period from 15.5% the year before. The rising unit costs – the expense to fly a seat a mile – are a worrisome trend in an industry that has a spotty record of reining in expenses.
"We think the airlines have to some extent lost focus on good cost control," said Darryl Genovesi, an airline industry analyst at UBS.
The trend is putting pressure on airline stocks. Shares in United Continental Holdings, Inc. fell 12% in a day in October when the company said its fourth-quarter costs would be at the high end of earlier forecasts and that the pressure would extend into 2018. Alaska Air Group, Inc.'s shares have fallen 16% this year in part because the carrier is incurring extra costs as it completes its late 2016 takeover of Virgin America, Inc., analysts said.
After rising fuel prices, the biggest cost increase airlines faced this year was worker compensation. Since late 2016, Southwest Airlines Co., United, American Airlines Group, Inc. and Alaska have struck costlier labor contracts or catch-up provisions to match the pay offered by rivals. Delta Air Lines, Inc. in October realigned its profit-sharing program to give non-pilot workers the same rich terms as its aviators. JetBlue Airways Corp. and Spirit Airlines, Inc. are near new pilot contracts that will raise their costs.
American said the higher compensation was necessary to erase mistrust built up over the years and to turn its culture into a competitive advantage. The nation's largest carrier also acknowledged that it has too many employees now that its takeover of US Airways Group, Inc., is nearly complete, and hopes to slim down through attrition.
Delta Chief Executive Ed Bastian said at an investor event Dec. 14 that he was disappointed the carrier's unit costs, excluding fuel, are projected to rise up to 5.5% in the fourth quarter, year over year. Carriers tend to look at unit costs excluding fuel as a proxy for their core expenses that they can control.
Mr. Bastian said Delta plans to cut $1 billion in costs over the next several years and contain nonfuel cost growth to a range of flat to up 2% annually.
American, United, and JetBlue also have multiyear initiatives aimed at paring costs and finding new revenue sources. American hopes to cut $1 billion in costs over the next four years by boosting productivity, weeding out duplication and running its fleet more efficiently, Chief Financial Officer Derek Kerr said in September.
JetBlue executives said in October that they were making progress on plans to cut $300 million in costs through 2019. United a year ago said it intended to produce $4.8 billion in earnings improvements through 2020, including some $1.8 billion at the end of this year. In October, the company declined to detail its progress but said most of the initiatives are on track.
Airlines are also fighting rising costs by putting more seats on airplanes or substituting larger aircraft to spread fixed costs over more seats. The practice can bring in more revenue for only marginally higher costs, but more crowded planes and shrinking legroom aren't popular with passengers.
US airlines are still performing well overall. The industry is on track for a record eighth-straight year of profits in 2017 and executives expect more black ink next year.