Erlanger
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Bank of America/Merrill Lynch airline equity analyst Glenn Engel could not have been more timely in his report published yesterday: “Regional Jet Analysis: A Look at Profits Per Plane.” Given the industry-wide focus on the future of the regional jet industry, Engel’s analysis cuts to the heart of the economics of RJs, particularly as to how they are used by network carriers and what effect changes may have on those carrier’s route systems. I do not read the report as having investment implications but rather as an analysis of the economics of regional jets utilized inside of each network carrier’s route system.
A Note on Engel’s Methodology
Engel notes up front the limitations of the analysis: “1) Disclosure and accounting for regional revenues and costs are inconsistent across the carriers. 2) Differing fleet ownership and usage complicates comparisons; Pinnacle and ExpressJet sublease planes and as a result show lower nonfuel costs relative to SkyWest and Republic. 3) Mainline operations and regional feed mutually benefit each other, which can help cross-subsidize losses.” In my mind, I acknowledge the importance of accounting but it is the network effects that are most difficult to discern.
Engel’s analysis is done on a per plane basis. In order to counter the underlying differences in airplane size and the subsequent effect on traditional metrics used to compare like per seat mile costs, he normalizes regional jets operating on behalf of mainline partners into 737 equivalents. He then assesses efficiency and profitability without structural distortions that are inherent across the entire spectrum of RJ usage.
Engel’s Analysis
Based on Engel’s analysis, United enjoys the highest profit per regional unit by a factor of three over US Airways, which has the second-highest profitability. American Airlines is the least profitable, losing $3.1 million per RJ equivalent. It is no coincidence that the most profitable is the carrier that has among the most liberal mainline scope clause agreements, while the least profitable has the most restrictive contractual rules governing RJ deployment. According to Engel, Continental, Delta and American each lose money on their RJ operations in that order before network synergies are accounted for.
Today, according to Engel, American is limited by its collective bargaining agreement with the Allied Pilots Association to flying no more than 47 70-seat regional jets. At Delta, with the most relaxed scope clause, regional partners fly 284 70 and 90 seat jets; at United, regional partners are flying 153 70-seat jets; and at US Airways, regional partners are flying 110 70 and 90 seat jets. [US Airways is the only network carrier permitted by the mainline agreement to fly regional aircraft larger than 76 seats.] Continental is not permitted to fly any regional jet larger than 50 seats.
Engel estimates that the mainline today flies 5.1 seats to every seat flown by the regional partners compared to 5.8 seats in 2006. At that time, Delta and Northwest had not completed their restructuring in bankruptcy and United had just aggressively begun replacing unprofitable 737 flying with 70 seat regional jets. United was able to replace the unprofitable flying only by negotiating the right to relax the scope clause during its bankruptcy restructuring.
At the Core of RJ Profitability: FUEL
Ultimately, Engel’s analysis underscores the critical role fuel plays. “When fuel prices doubled in 2004, regional jets, especially 50-seat planes that have high fuel consumption per seat, became less attractive relative to mainline flying,” he wrote. Since 2004, mainline airlines have made $1.72 million per 737-equivalent (or $580,000 per CRJ-200 equivalent) more on their mainline aircraft than their regional fleet. The mainline-regional spread peaked at more than $3.20 million per 737-equivalent (or $1.09 million per CRJ-200) when oil prices spiked in 2008.”
The Exception is United
While the US Airways regional jet operation has been the most consistently profitable and American the least profitable, Engel finds that United earns the most per regional jet and is the only carrier where the regional jet operation is more profitable than the mainline operation. According to Engel, United does much less non-hub flying with its regional jets than its peers, operates a higher percentage of larger regional jets (more than half have more than 50 seats) and leverages its powerful domestic and international connections to increase profits.
Engel makes other points:
-United has the highest utilization of RJs; Delta the lowest primarily because of a disproportionate number of 50-seat RJs. Delta’s utilization should improve as it goes forward with plans to remove 10 percent of the RJs it operated in 2009.
-Legacy carriers fly RJs less but generate more revenue per plane. United generates 41% more revenue per 737-equivalent from its regional fleet than the industry as a whole, and Delta produces 16% less revenue per regional plane.
-United pays least for its feed while American pays most. United spends 27% more per equivalent regional plane while garnering 41% more seat-miles and revenues. In contrast, American spends 10% more per regional aircraft while obtaining 4% fewer seat-miles and revenues.
Engel goes on to break down metrics between Republic, SkyWest, Pinnacle and ExpressJet – the publicly traded regional providers. My read is that Republic and SkyWest are in the best position to weather the shakeout. Pinnacle enjoys some strong attributes and SkyWest subsidiary Atlantic Southeast Airlines has announced its intention to purchase ExpressJet. A consolidation phase is playing out inside the regional sector as carriers look to create economies of scale.
A Note on Engel’s Methodology
Engel notes up front the limitations of the analysis: “1) Disclosure and accounting for regional revenues and costs are inconsistent across the carriers. 2) Differing fleet ownership and usage complicates comparisons; Pinnacle and ExpressJet sublease planes and as a result show lower nonfuel costs relative to SkyWest and Republic. 3) Mainline operations and regional feed mutually benefit each other, which can help cross-subsidize losses.” In my mind, I acknowledge the importance of accounting but it is the network effects that are most difficult to discern.
Engel’s analysis is done on a per plane basis. In order to counter the underlying differences in airplane size and the subsequent effect on traditional metrics used to compare like per seat mile costs, he normalizes regional jets operating on behalf of mainline partners into 737 equivalents. He then assesses efficiency and profitability without structural distortions that are inherent across the entire spectrum of RJ usage.
Engel’s Analysis
Based on Engel’s analysis, United enjoys the highest profit per regional unit by a factor of three over US Airways, which has the second-highest profitability. American Airlines is the least profitable, losing $3.1 million per RJ equivalent. It is no coincidence that the most profitable is the carrier that has among the most liberal mainline scope clause agreements, while the least profitable has the most restrictive contractual rules governing RJ deployment. According to Engel, Continental, Delta and American each lose money on their RJ operations in that order before network synergies are accounted for.
Today, according to Engel, American is limited by its collective bargaining agreement with the Allied Pilots Association to flying no more than 47 70-seat regional jets. At Delta, with the most relaxed scope clause, regional partners fly 284 70 and 90 seat jets; at United, regional partners are flying 153 70-seat jets; and at US Airways, regional partners are flying 110 70 and 90 seat jets. [US Airways is the only network carrier permitted by the mainline agreement to fly regional aircraft larger than 76 seats.] Continental is not permitted to fly any regional jet larger than 50 seats.
Engel estimates that the mainline today flies 5.1 seats to every seat flown by the regional partners compared to 5.8 seats in 2006. At that time, Delta and Northwest had not completed their restructuring in bankruptcy and United had just aggressively begun replacing unprofitable 737 flying with 70 seat regional jets. United was able to replace the unprofitable flying only by negotiating the right to relax the scope clause during its bankruptcy restructuring.
At the Core of RJ Profitability: FUEL
Ultimately, Engel’s analysis underscores the critical role fuel plays. “When fuel prices doubled in 2004, regional jets, especially 50-seat planes that have high fuel consumption per seat, became less attractive relative to mainline flying,” he wrote. Since 2004, mainline airlines have made $1.72 million per 737-equivalent (or $580,000 per CRJ-200 equivalent) more on their mainline aircraft than their regional fleet. The mainline-regional spread peaked at more than $3.20 million per 737-equivalent (or $1.09 million per CRJ-200) when oil prices spiked in 2008.”
The Exception is United
While the US Airways regional jet operation has been the most consistently profitable and American the least profitable, Engel finds that United earns the most per regional jet and is the only carrier where the regional jet operation is more profitable than the mainline operation. According to Engel, United does much less non-hub flying with its regional jets than its peers, operates a higher percentage of larger regional jets (more than half have more than 50 seats) and leverages its powerful domestic and international connections to increase profits.
Engel makes other points:
-United has the highest utilization of RJs; Delta the lowest primarily because of a disproportionate number of 50-seat RJs. Delta’s utilization should improve as it goes forward with plans to remove 10 percent of the RJs it operated in 2009.
-Legacy carriers fly RJs less but generate more revenue per plane. United generates 41% more revenue per 737-equivalent from its regional fleet than the industry as a whole, and Delta produces 16% less revenue per regional plane.
-United pays least for its feed while American pays most. United spends 27% more per equivalent regional plane while garnering 41% more seat-miles and revenues. In contrast, American spends 10% more per regional aircraft while obtaining 4% fewer seat-miles and revenues.
Engel goes on to break down metrics between Republic, SkyWest, Pinnacle and ExpressJet – the publicly traded regional providers. My read is that Republic and SkyWest are in the best position to weather the shakeout. Pinnacle enjoys some strong attributes and SkyWest subsidiary Atlantic Southeast Airlines has announced its intention to purchase ExpressJet. A consolidation phase is playing out inside the regional sector as carriers look to create economies of scale.