Analysis: Rising costs fuel worries about U.S. airlines' heavy debt loads
09/09/2022 11:00
By Rajesh Kumar Singh
CHICAGO, Sept 9 (Reuters) - A scramble by U.S. carriers to
fill empty cockpits is fueling cost pressures just as mounting
economic worries have cast a shadow on travel demand, sparking
concerns about debt-laden airlines' ability to repair their
balance sheets.
Even as ticket sales remain strong, investors worry about
consumer spending should the economy slip into recession. They
fear carriers might be forced to borrow even more money to fund
operations and further delay returning cash through share
buybacks or dividends.
Some have stayed away from investing in the industry despite
a rebound from the pandemic-induced slump, believing carriers do
not have enough tools to offset cost pressures.
"Airline investors would be better off if the Wright
Brothers' plane crashed and burned," said Act Two Investors
Chairman Jeffrey Scharf, who follows the sector but does not
currently own stocks in it.
"I can't think of a worse business – high fixed costs,
commodity product, worsening service, alienated customers sick
of being nickeled and dimed for every amenity."
For the traveling public, it could mean fewer and packed
planes as airlines drive up revenue through higher ticket
prices.
Reducing debt is a priority for an industry that went on a
borrowing binge to survive the pandemic. The big three national
carriers - American, United and Delta Airlines – had $85 billion
in net long-term debt at the end of the second quarter.
(Graphic: https://tmsnrt.rs/3Rt2qpp)
Airlines need strong and sustained profits to reduce those
debt loads, but rising fuel and labor costs are making that
difficult, analysts say.
United Airlines' UAL.O wage and fuel expense as a
percentage of revenue is up by 10 points this year versus 2019.
In the first six months of 2022, the company spent 59% of its
revenue on wage and fuel bills. American Airlines AAL.O has
had similar increases.
"These carriers have multi-year balance sheet repairs ahead
of them," said aviation analyst Robert Mann. "Job No. 1 is going
to be using free cash flow to pay down those increased debt
levels."
Cost pressures are set to worsen as a pilot shortage at
smaller, regional carriers means dramatic pay increases.
Mesa Air Group MESA.O , which operates flights for American
and United, last month raised pilot salaries by as much as
172%.
That came days after CommutAir, a regional carrier partially
owned by United, increased pilot wages by up to 40%. The
increases were in response to American's decision in June to
raise pilot salaries at regional affiliates by as much as
87%.(Graphic: https://tmsnrt.rs/3D18lOj)
The wage hikes have cost implications for the whole industry
as it pressures rivals to offer similar increases.
National carriers are also expected to feel the pinch as
regional partners look to pass along increased costs. Raymond
James analysts estimate pay raises at regional airlines could
increase non-fuel operating costs at national carriers by up to
3.3 percentage points.
Pilots at national carriers are also pushing for big wage
increases.
United is renegotiating with its pilot union after some
pilots expressed reservations with the last agreement that
included a double-digit pay hike.
American's offer for pay increases of about 17% as well as
higher per diem and training pay through 2024 - estimated to
cost the company more than $2 billion - has failed to find favor
with pilots.
Labor costs were the industry's biggest operating expense
last year at about 35%. That figure is only down this year due
to a run-up in fuel costs, but the hiring push is expected to
inflate wage bills.
Meanwhile, costs are expected to remain high. United has
projected a 2022 fuel bill $9 billion higher than in 2019.
PRICING POWER
Airlines have been relying on strong consumer demand and
higher fares to mitigate inflationary pressure.
Investors are not sure carriers will have the same pricing
power should consumer demand slow. And corporate travel - the
industry's cash cow - has yet to recover to pre-pandemic levels.
"There's a big question about who's going to be flying, how
often they're going to be flying and the price that they're
going to be willing to pay," said Tim Ghriskey, senior portfolio
strategist at investment advisory firm Ingalls & Snyder.
American and United on Wednesday played down demand
concerns, saying there has been no slowdown in post-summer
travel bookings. urn:newsml:reuters.com:*:nL4N30E2N8
American said it has surplus cash it plans to use for paying
off debt. However, it is holding that cash due to economic
uncertainty.
Investors also want the return of share buybacks and
dividends. As part of the federal COVID-19 relief package,
airlines have been prohibited from buying back their shares.
That ban is set to expire this month.
Non-fuel cost pressures are expected to ease once carriers
begin operating as many flights as they did before the pandemic.
Most airlines are planning to ramp up capacity next year.
But Michael Wall, portfolio manager at investment management
firm Westwood Group, warned that could backfire in a recession.
"Once the demand goes away, their pricing power goes away,"
he said.
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GRAPHIC- Soaring pilot salaries https://tmsnrt.rs/3D18lOj
GRAPHIC- Airline debt levels https://tmsnrt.rs/3Rt2qpp
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(Additional reporting by Allison Lampert in Montreal, editing
by Ben Klayman and Bill Berkrot)
((rajeshkumar.singh@thomsonreuters.com; +1-313-484-5370;
Reuters Messaging:
rajeshkumar.singh.thomsonreuters.com@reuters.net))