Over the past number of years, the airline industry has been hit with a number of man-made and natural disaster calamities, including terrorist attacks, with the worst being on Sept. 11, 2001, in New York. Then, rising oil prices, volcanic eruptions in Iceland in 2010 and in Chile in 2011, unrest in the Middle East and North Africa, and the Japan earthquake with its subsequent tsunami, put another dent in the airline industry’s earning potential.
An already ailing airline industry took a beating with the 2001 terror attack, which set off a domino effect, resulting in earning losses of more than $35 billion, spread over the next four to five years after the disaster. The airline industry alone lost about $13 billion in 2001, while the effect on associated industries, such as the leisure industry, food and beverage industries, and travel industry, can’t be calculated.
The airlines didn’t collapse, but faced one setback after another stoically. The industry took the opportunity to merge with others in the industry, consolidate operations, restructure, trim costs, and search for more fuel-efficient planes.
“The September 11 catastrophe hit the airline industry hard, but it also opened the door for airlines to accelerate the restructuring they already had underway,” according to an article on the Dollars&Sense website.
M&A Activities in Airline Industry
M&A (merger and acquisition) activities are “common in almost every industry, but mergers and huge industry structure shakeups seem to be a recurring trend in the airline industry,” according to an article on the airlinetickets website.
Industry experts put the airline mergers and acquisition trend squarely at the door of deregulation in the industry in the 1970s.
“Deregulation of the 1970s saw the rise of the low-cost airline. It wasn’t just increased competition from these so-called ‘discount’ airlines in terms of the number of providers, it was pricing that created the biggest problems. … As a result, the number of airlines quickly began to shrink due to mergers and acquisitions,” states the article on the airlinetickets website.
In October 2010, United Airlines Inc., after the U.S. Department of Justice and the firm’s stockholders gave their approval, merged with Continental Airlines to form United Continental Holdings Inc.
Southwest Airlines Co. closed on the acquisition of AirTran Holdings Inc. in May, the former parent of AirTran Airways Inc., at a cost of about $3.2 billion.
Delta Air Lines Inc. merged with Northwest Airlines and has become the largest carrier when it comes to the number of customers served. It retained the Delta name. Delta has been in the M&A business for many years, having acquired Northeast Airlines in 1972 and merging with Western Airlines in 1987.
KLM Royal Dutch Airlines was acquired by Air France in 2004 and renamed to Air France KLM.
US Airways Inc., which is considered to be among the 10 largest airlines in the United States, began its M&A related activities by merging with Pacific Southwest Airlines and Piedmont Airlines Inc. in 1989. In 1997, it bought Trump Shuttle. Then in 2005, it merged with America West Holdings. Other acquisitions were Lake Central Airlines and Mohawk Airlines.
“Do mergers actually make sense?” asks the author of the airlinetickets article.
Airline industry experts are of two minds. Those that espouse M&A activities say that given high gas prices and economic turmoil, airlines need to cut costs. By merging, costs are reduced by eliminating duplicate functions and retrenching employees.
Others suggest that “for the airlines themselves there are considerable drawbacks: time spent configuring solutions to complex operational issues, devising a new approach for the competition, strife among workers, and responsibility to honor increased mileage rewards to travelers just to name a few,” according to the airlinetickets article.
Profit Roller Coaster Ride
When high oil prices hit by 2007, the airlines, after bankruptcies and restructurings, again turned a $14.7 billion profit.
The industry, after having lost $16 billion in 2008 and $9.9 billion in 2009, experienced a $15.1 billion profit in 2011.
But nothing is for certain. The International Air Transport Association (IATA) predicted a 78 percent drop in airline industry profits for 2011 to $4 billion when compared to the $18 billion industry profit recorded in 2010.
Airline profit margins, affected by political unrest in the Middle East, North Africa, and Japan, and especially high fuel costs, have taken a beating in 2011. The volatility of future oil prices may also hamper future profitability of companies in the airline industry.
Industry profit margins are based on fuel cost assumptions of 30 percent of total operating costs, which could significantly move either way if such costs are faulty. Therefore predictions always carry a caveat about possible effects on the profit margins.
“Early results for Q2 airline profits are showing the first year-on-year decline for eight quarters,” said the IATA in its July Airlines Financial Monitor.
The market reacted and airline stocks tumbled by June, with the NYSE Arca Airline index value at 32.98 on Aug. 4, a -1.164 (3.41 percent) change from an opening high of 34.14. The Bloomberg global airline index was at -6.535 percent and still moving downward.
Southwest Airlines Co. had a profit margin of .16 percent for June, according to YCharts, and traded at $9.65 at the market close on Aug. 3, down by $3.66 from its 2011 high of $13.31 at the Jan. 4 close.
Delta Air Lines Inc. had a profit margin of 2.16 percent for June and traded at $7.55 at the market close on Aug. 3, down by $5.45 from its 2011 high of $13.00 at the Jan. 7 close.
JetBlue Airways Corp. had a net profit margin of 2.17 percent for June and traded at $4.54 at the market close on Aug. 3, down by $2.56 from its 2011 high of $7.10 at the Jan. 5 close.
US Airways Group Inc. had a net profit margin of 2.63 percent for June and traded at $5.90 at the market close on Aug. 3, down by $5.57 from its 2011 high of $11.47 at the Jan. 10 close.
AMR Corp., parent company of American Airlines, had a net profit margin of -4.68 percent for June and traded for $3.94 at the market close on Aug. 3, down by $4.91 from its 2011 high of $8.85 at the Jan. 7 close.
United Continental Holdings Inc. had a pretax net profit margin of 6 percent for June and traded at $18.13 at the market close on Aug. 3, down by $9.35 from its 2011 high of $27.48 at the Feb. 16 close.
Experts suggest that an investor should take a step back and analyze why a stock has become increasingly more depressed. Pessimism by investors because of certain events, such as the increase in fuel prices, could result in a run on the stock and thus depress prices.
“Identifying and purchasing such distressed stocks, and selling them after the company recovers, can lead to above-average gains,” according to an article on the Seeking Alpha website.
Facing Hard Economic Times
“Passenger business is doing better than cargo. … What is clear is that the rising jet fuel price is putting pressure on the bottom line. … Slower economic growth makes these challenges all the more difficult, said Tony Tyler, director general and CEO at IATA, in a recent press release.
Passenger traffic and cargo shipments slowed down in June, the latest numbers available, over May, although passenger traffic increased by 7.2 percent when compared to the June 2010 figures. However, in a year-over-year comparison, cargo shipments decreased by .9 percent in June.
Business travel is still lagging behind, and airline executives don’t see an improvement until the economy shows marked improvement.
With aviation jet fuel prices at $132.8/bbl, with bbl standing for a unit of volume for crude oil and petroleum products, airlines are responding by buying fuel efficient planes and retiring their gas-guzzling planes.
In mid-July AMR announced that it ordered 460 new planes, the largest airplane order in the history of airplane orders, from the Boeing Co. and Airbus with deliveries between 2011 and 2013. AMR has already arranged for $13 billion in committed financing from the manufacturers.
“These new aircraft will allow American to reduce its operating and fuel costs and deliver state-of-the-art amenities to customers, while maximizing financial flexibility for the Company,” states AMR on its website.
