17 May 2007

Airlines - The Ides of September are coming

In the boom to bust cycle of airlines - the tradition has always been buy at the top and sell at the bottom... not exactly what even your local stock broker would tell you was a smart thing. If you are a student of history you know that Airlines are highly cyclical. Yet many forget that in times of boom. But will this cycle be any different?

Many would argue that this is the top of the cycle and we are approaching the peak of the airlines' net earning capability. Barring a catastrophe - of either an economic or socio-political variety, the airlines as a group should be very profitable this year. But the dynamics are very different this time around. Why?At T2Impact we believe that we are headed for a long term fundamental shift in the structure of the airline system.

Here are some pointers to monitor.

1. We are approaching practical capacity constraints in certain key junction points within the system. For example - The US system is already crowded at peak times yet the investment in ATC infrastructure by successive Administrations has been laughable.
2. Barriers to entry are much higher than they have been - witness the number of new airlines starting in the US market has dwindled to a trickle. In Europe there is a surfeit of LCC startups. Even the robust growth markets of GCC and Asia Pacific are not experiencing a growth of new players.
3. The massive savings gained over the last 10 years in labor cost cuts, distribution cost reductions have been offset by massive increases in fuel. Frankly there are no more major cost cutting areas left.
4. Yields are at historical highs.
5. There is going to be significant labor unrest due to the afore-mentioned labor reductions. is it time for payback? AMR's AA pilots think so with an opening round request for 30% pay increases.So what are the airlines doing with the cash?Plowing it into service improvementsStill off-loading unprofitable marginal routes to affiliate partners.Buying new planes.Etc.

What worries us is that there is no fundamental effort to address the core issues. Neither is there a regulatory mechanism for addressing the true scarcity value of the whole trip and the attendant resources consumed.We believe that a future airline sin tax regime will be introduced. If for no other reason than the usual sin tax revenues on cigarettes (for example) are starting to wane.

Our belief is that the Government bodies - both national and pan-national - and the Industry should be working on improving the efficiency of the system. A fair user fee basis of regulatory payments needs to replace the outmoded and clearly now unworkable 1944 Chicago Convention.

Finally - how about a rainy day fund?In the coming months we will explore different ways that the airlines should be responding to the future. With our new partner InTheKno (http://www.inthekno.com/) we will be examining business models for airlines and the impact on the whole of the Travel and Tourism sector. For airlines – the sky is quite sunny at the moment. But we see storm clouds a-coming.

The Domestic USA market growth is slowing and already we are seeing indicators of a softening of traffic in other markets too. Those high fares are beginning to bite. Once we get past September and we see winter sales coming in at low fares – we will see a pull back and competition for the consumer will again emerge. Round about September 15th.

You have been warned!



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