Rising costs fuel concerns over US airlines’ heavy debt load

CHICAGO: A scramble by U.S. carriers to fill empty cockpits is fueling cost pressures just as growing economic worries have cast a shadow over travel demand, raising concerns about the ability of indebted airlines to repair their balance sheets.

Although ticket sales remain strong, investors worry about consumer spending if the economy slides into recession. They worry that carriers will be forced to borrow even more money to finance their operations and further delay the repayment of cash through stock buybacks or dividends.

Some have stayed away from investing in the industry despite a rebound from the pandemic-induced crisis, saying carriers don’t 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 shares in it. .

“I can’t think of a worse company with high fixed costs, a deteriorating commodity, service, alienated customers who are fed up with being nickel and dime for every convenience.” For the traveling public, that could mean fewer planes and crowded planes as airlines boost revenue through higher ticket prices.

Debt reduction is a priority for an industry that has been on a borrowing spree to survive the pandemic. The big three flag carriers – American, United and Delta Airlines had $85 billion in long-term net debt at the end of the second quarter.

Airlines need strong, sustained profits to reduce debt, but rising fuel and labor costs are making that difficult, analysts say.

United Airlines’ salary and fuel spend as a percentage of revenue increased 10 points this year compared to 2019. In the first six months of 2022, the company spent 59% of its revenue on salary and fuel bills . American Airlines saw similar increases.

“These carriers have multi-year balance sheet repairs ahead of them,” said aviation analyst Robert Mann. “Job #1 is going to use free cash flow to pay off those increased debt levels.” Cost pressures are expected to worsen as a shortage of pilots at smaller regional carriers means dramatic salary increases.

Mesa Air Group, which operates flights for American and United, last month raised pilot salaries by as much as 172%.

It came days after CommutAir, a regional carrier partly owned by United, raised pilot salaries by up to 40%. The increases were in response to American’s decision in June to raise pilot salaries at regional affiliates by up to 87%.

Wage increases have cost implications for the entire industry, as they push rivals to offer similar increases.

National carriers are also expected to feel the pinch as regional partners seek to pass on increased costs. Raymond James analysts estimate that wage increases at regional airlines could increase non-fuel operating costs at national carriers by up to 3.3 percentage points.

Flag carrier pilots are also pushing for big pay rises.

United are renegotiating with their drivers’ union after some drivers expressed reservations about the latest deal which included a double-digit pay rise.

American’s bid for pay raises of about 17% plus higher per diems and training through 2024 — which would cost the company more than $2 billion — hasn’t found favor. favor of the pilots.

Labor costs were the industry’s largest operating expense last year at around 35%. That figure is only down this year due to higher fuel costs, but the surge in hiring is expected to swell payrolls.

In the meantime, costs are expected to remain high. United has projected a 2022 fuel bill $9 billion higher than 2019.

Pricing power

Airlines are counting on strong consumer demand and higher fares to ease inflationary pressures.

Investors are uncertain whether carriers will have the same pricing power if consumer demand slows. And business travel – the industry’s cash cow – has yet to recover to pre-pandemic levels.

“There’s a big question about who’s going to fly, how often they’re going to fly and how much they’re going to be willing to pay,” said Tim Ghriskey, senior portfolio strategist at the investment advisory firm Ingalls & Snyder. .

On Wednesday, American and United played down demand concerns, saying there had been no slowdown in travel bookings after the summer.

American said it has excess cash that it plans to use to pay down debt. However, he is holding this money due to economic uncertainty.

Investors also want the return of share buybacks and dividends. Under the federal Covid-19 relief plan, airlines have been banned from buying back their shares. This ban is due to expire this month.

Non-fuel cost pressures should ease once carriers start operating as many flights as before the pandemic.

Most airlines plan to increase their capacity next year. But Michael Wall, portfolio manager at investment management firm Westwood Group, warned that this could backfire in the event of a recession.

“Once the demand disappears, their pricing power disappears,” he said.

Posted in Dawn, September 11, 2022

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