Big Airlines To Benefit From Summer Travel Boom, Low-Cost Carriers Not So Much

Airlines are gearing up for another strong summer of travel as pent-up pandemic demand and savings continue to drive bookings even in the face of big challenges.

Carriers are contending with higher oil prices and delays in new plane deliveries, which limit capacity in the sky. The large network airlines such as United Airlines (UAL), Delta Air Lines (DAL), and American Airlines (AAL) have been successful in increasing revenue with ancillary sales derived from offerings like premium upgrades and seat choice. Low-cost carriers, on the other hand, have fewer alternatives to provide passengers, and, as a result, fewer possible revenue streams to tap into.

Post-Pandemic Travel Demand Remains Strong

Post-pandemic demand for air travel remains strong with growth rates exceeding pre-pandemic times, American Airlines Chief Executive Officer Robert Isom said at the company’s investor day in early March. 

“You can see on the horizon very favorable trends,” Isom said, adding that he expects sustainable margin expansion and free cash flow as a result.

Rival Delta’s quarter “is off to a really strong start,” CEO Ed Bastian said at a March conference.

The company will come in at the top half of its guidance of 3%-6% revenue growth for the quarter over the year-earlier period based on strong demand even amid higher oil prices, he said.

“We've had nine of the top 10 sales days in our history all within the last 10 weeks,” Bastian said. “When you think about the strength of the bookings and the confidence we have in our outlook, looking forward, we feel real good about demand and that's setting us on a great platform for continued improvement in the underlying performance of the business.”

Challenges Include Plane Shortage, Fuel Prices

The strong demand for flights comes as airplane maker Boeing (BA) has been slow to deliver planes following supply chain disruptions and amid safety concerns over its jets.

On the face of it, that would appear to be bad news for the carriers, but having less equipment should translate into stronger pricing, according to Steve Trent, Citi aviation analyst, who spoke by phone last month.

“We're heading to higher fares and somewhat less capacity, which is good for the airlines’ unit revenue because it will help them to offset what's happening with oil prices,” Trent said.

While current increases in oil prices are already accounted for in ticket prices, should sharp jumps occur in the coming months the airlines could face a squeeze on profit and margins. Although airlines commonly hedge their fuel costs by buying or selling the expected future price of oil through a range of derivatives, sometimes that’s not enough. 

The network airlines should be able to easily continue to generate revenue given pricing power from the lack of available seats and a successful strategy of segment pricing, like being able to choose a better seat for a price, according to industry experts.

Such ancillary revenue reached a record $117.9 billion globally last year, according to Ideaworks, an airline research company.

“The big airlines have way more tools to pick those extra $20 bills out of everyone's pocket, there's more frills that they can offer,” Morningstar’s Nicolas Owens said in an interview last month. “Once they've sold you the $400 round-trip airfare, everything else on top of that is kind of cake."

Low-Cost Carriers Are in a Different Boat

Low-cost carriers such as Frontier (ULCC), Southwest (LUV) and Spirit (SAVE) offer few add-ons or price-differentiated perks, affecting their ability to boost revenue.

Southwest, for instance, lowered its revenue expectations for the first quarter to up to 2% growth year-over-year, down from a previous forecast of up 2.5% to 4.5%, with volume lower than expected in February and March, the company said in a filing. 

Given the complicated situation for low-cost carriers and non-network carriers, Spirit and JetBlue (JBLU) had sought to combine, an idea shot down recently by the government over concerns of stifling competition and hurting consumers. In March, JetBlue terminated the merger agreement with Spirit. 

Longer Term Challenges Remain

Despite the expected strong travel season, some analysts are quick to point out that the airline industry has historically struggled to sustain profitability.

“As an industry, airlines don't make money. The historical profit margin of the industry is zero, like clockwork zero,” Morningstar's Owens said.

Gains made from robust travel bookings over the past few years will likely get erased over time. “And that doesn't mean they'll be out of business. It just means they're going to have terrible earnings for a couple quarters,” he said.