canyonblue
Everyone loves Southwest
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- Nov 26, 2001
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Southwest the Leader in Cost Management in the Wall Street Transcript Airline Industry Report
Tuesday April 12, 10:13 am ET
67 WALL STREET, New York--April 11, 2005--The Wall Street Transcript has just published its Airlines Report offering a timely review of the sector to serious investors and industry executives. A roundtable panel of leading industry analysts, in-depth interviews with top management from 2 firms, examine the Airlines sector in this 19-page report.
The airline industry remains a challenging sector for long-term investors. The panel believes the winners, however, will be the airlines with low cost, the LCCs. These companies are also outperforming on service like better on-time arrivals and lost-baggage statistics. Two of the legacy players are already in bankruptcy, Delta is on the verge of it, and three other majors are racking up sizable operating losses. The current environment, given high fuel prices and overcapacity, which is keeping fares pretty weak, even for the low-cost carriers, is problematic even for LCCs. Topics include: Market share battles; Higher fuel costs; Hedging against fuel prices; Future of regional airlines; Bankruptcies and shakeout; Restructuring of European airlines; Lower costs and productivity; Outlook for fare increases; Benefits of e-ticketing; Transcontinental market; Possible liquidations or mergers; Foreign low-cost airlines; Stock picks; Stocks to avoid.
In this brief excerpt, the panel discusses how Southwest has remained the cost leader in the airline industry for several decades.
TWST: Sam, how about your take on this industry five years from now?
Ms. Panella: With respect to the regional airlines, first of all, if we see some legacy carriers go away, our thought is that the other airlines that remain will want to fill the void that's left, and the easiest way to do that would be to pick up the regional feeder carriers left behind. And in all of this, we think we're going to see even larger aircraft operated by the regional airlines. Of course, the scope clauses at the legacy airlines would have to be changed by the legacy airline pilots. But with JetBlue introducing the Embraer 190 aircraft at the end of this year, we think that's going to eventually cause the legacy airlines to allow their regional partners to operate aircraft of that similar size so that they can offer a competing product at a competing cost structure.
With respect to the low-cost airlines, as they grow, it does, in our opinion, force the legacy airlines to rely on their regional airline partners. And right now, we don't have any of the low-cost airlines flying to Europe, but eventually, that could be something we see five to 10 years out. The LCCs could eventually serve the transatlantic market and cause a change in the industry there as well. That's our long-term thinking at this point.
TWST: I guess the low-cost carriers are also causing a restructuring of European airlines.
Ms. Panella: Yes, Ryanair Holdings (RYAAY), essentially being the Southwest Airlines of Europe, has really changed the industry over there. It's interesting that we're actually seeing consolidation occurring ahead of that in the US, so the capacity situation does appear to be easing in the European market ahead of that in the US.
There's one other thing I'd like to mention with respect to costs. With Southwest being more than 30 years old, if we adjust their costs and everyone else's on a similar stage length using a similar aircraft type, Southwest is still the low-cost leader after all those years.
TWST: So they've already gone through the cycle of senior employees.
Ms. Panella: Yes, they have among the highest paid pilots in the industry. And obviously, their fleet is older than that of JetBlue or AirTran. Yet, if I look at their costs on a 1,000-mile stage length, they are the lowest cost carrier in the industry still.
TWST: So if you have good management, you can keep the cost side under control.
Ms. Panella: Right. In our opinion, that's better achieved at these essentially post-deregulation airlines with an entrepreneur at the helm keeping the low cost structure intact than it is at the legacy airlines where, though they're able to get these cost concessions during bad times, typically, when times turn around and they're profitable again, we could see labor go back to management and ask to be made whole. That has typically been the cycle.
TWST: Jim, what's your take on the cost outlook here?
Mr. Corridore: I certainly think that Southwest is the model that all airlines should be trying to emulate as they age, and obviously, the legacy carriers should be trying to emulate the Southwest model more. Southwest has been able to have high labor costs yet still have lower unit costs because of their high productivity and the way they compensate their employees with profit-sharing and stock options - things that are actually worth something because the company is profitable! That's obviously what differentiates them from the other airlines. It's management, but it's also the way the structure is set up. They are lucky enough to not have a defined benefit pension plan, which is hammering all the legacy carriers right now, and the way they compensate their employees sets them apart from the rest of the industry.
TWST: Who's their closest emulator at this point, Jim?
Mr. Corridore: I would say JetBlue. They came to the game only a few years ago and set out to offer services that customers are willing to pay for. For a low-cost carrier they're also a high-service carrier, but they do have the Southwest model of profit sharing.
TWST: Chris, what's your take on the cost outlook for this space?
Mr. Lozier: I think Jim hit the nail on the head. People concentrate on costs a lot, but if you pay close attention to what it is that Southwest has done over the last 30 years, you'll see that their cost structure is competitive because of the efficiencies they've been able to achieve. That definitely has something to do with management, and it has something to do with compensation; they've really got it figured out. In other words, you can pay your employees more as long as you can get the incremental productivity from them.
Much of this stuff can be emulated, and again, I think that's what JetBlue is doing. And I might throw Ryanair into the hat there as the next closest emulator of the Southwest business model.
TWST: Chris, while we're on the cost side, what has been the impact of these sharp rises in fuel prices on the group?
Mr. Lozier: Devastating is one word that comes to mind! Those that have the ability and the creditworthiness to hedge their fuel requirements are obviously in a better position, but even for those folks, doing so is an expensive proposition; then they still get hit on the percentage that's not hedged. Crude oil is back well above $50 now, and we estimate that a $1 increase in crude oil translates to between $500 million and $1 billion in additional fuel expense for the industry. So clearly, in an industry with high fixed costs like this that floats around the breakeven point, $1 billion can be a make-or-break for this industry.
And our fuel and energy team doesn't foresee fuel returning to desirable levels anytime soon. They're forecasting $48 as an average fuel price over the course of 2005 and maybe just below $40 for 2006. A lot can change (that's a long way off), but either one of those numbers would spell huge losses for the industry.
TWST: Sam, in your opinion, has anybody in the space done a decent job of hedging against these prices?
Ms. Panella: Southwest has done the best job in hedging. They've had their hedging strategy in place since, I believe, 2000, so they are the best hedged for 2005 with about 80% of their fuel requirements hedged at around $26 per barrel. They're hedged, actually, out through 2008. Of course, the price increases as the years go out since we've seen such a rise in fuel prices. Again, Southwest is the best hedged. Nevertheless, given the large scope of their operations, $55 oil prices on the part that's unhedged still impacts earnings.
TWST: But they still have an advantage having 80% hedged.
Ms. Panella: Exactly. From an earnings standpoint, their earnings in 2005 would be less volatile to changes in fuel.
TWST: Following on your mention of the Internet, how important has the shift in the industry to e-ticketing been? Is that a major cost saving?
Ms. Panella: It's a big cost savings. To have a ticket booked on the Internet, you're talking less than $1, whereas I believe with travel agents it was, at one point, $7 or $8 per booking. So it is a big cost saving that airlines have been able to benefit from.
TWST: Have they gotten most of the benefit or is it still to come? Ms. Panella: At the low-cost airlines, a lot of them have really ramped up their Internet bookings. Though there is still some room for upside, I don't think they'll get to the levels, for instance, that we see in Europe with Ryanair, which does above 95% of their bookings via the Internet. There could still be some cost savings, but I think the low-cost carriers are getting to a saturation point with that.
Tuesday April 12, 10:13 am ET
67 WALL STREET, New York--April 11, 2005--The Wall Street Transcript has just published its Airlines Report offering a timely review of the sector to serious investors and industry executives. A roundtable panel of leading industry analysts, in-depth interviews with top management from 2 firms, examine the Airlines sector in this 19-page report.
The airline industry remains a challenging sector for long-term investors. The panel believes the winners, however, will be the airlines with low cost, the LCCs. These companies are also outperforming on service like better on-time arrivals and lost-baggage statistics. Two of the legacy players are already in bankruptcy, Delta is on the verge of it, and three other majors are racking up sizable operating losses. The current environment, given high fuel prices and overcapacity, which is keeping fares pretty weak, even for the low-cost carriers, is problematic even for LCCs. Topics include: Market share battles; Higher fuel costs; Hedging against fuel prices; Future of regional airlines; Bankruptcies and shakeout; Restructuring of European airlines; Lower costs and productivity; Outlook for fare increases; Benefits of e-ticketing; Transcontinental market; Possible liquidations or mergers; Foreign low-cost airlines; Stock picks; Stocks to avoid.
In this brief excerpt, the panel discusses how Southwest has remained the cost leader in the airline industry for several decades.
TWST: Sam, how about your take on this industry five years from now?
Ms. Panella: With respect to the regional airlines, first of all, if we see some legacy carriers go away, our thought is that the other airlines that remain will want to fill the void that's left, and the easiest way to do that would be to pick up the regional feeder carriers left behind. And in all of this, we think we're going to see even larger aircraft operated by the regional airlines. Of course, the scope clauses at the legacy airlines would have to be changed by the legacy airline pilots. But with JetBlue introducing the Embraer 190 aircraft at the end of this year, we think that's going to eventually cause the legacy airlines to allow their regional partners to operate aircraft of that similar size so that they can offer a competing product at a competing cost structure.
With respect to the low-cost airlines, as they grow, it does, in our opinion, force the legacy airlines to rely on their regional airline partners. And right now, we don't have any of the low-cost airlines flying to Europe, but eventually, that could be something we see five to 10 years out. The LCCs could eventually serve the transatlantic market and cause a change in the industry there as well. That's our long-term thinking at this point.
TWST: I guess the low-cost carriers are also causing a restructuring of European airlines.
Ms. Panella: Yes, Ryanair Holdings (RYAAY), essentially being the Southwest Airlines of Europe, has really changed the industry over there. It's interesting that we're actually seeing consolidation occurring ahead of that in the US, so the capacity situation does appear to be easing in the European market ahead of that in the US.
There's one other thing I'd like to mention with respect to costs. With Southwest being more than 30 years old, if we adjust their costs and everyone else's on a similar stage length using a similar aircraft type, Southwest is still the low-cost leader after all those years.
TWST: So they've already gone through the cycle of senior employees.
Ms. Panella: Yes, they have among the highest paid pilots in the industry. And obviously, their fleet is older than that of JetBlue or AirTran. Yet, if I look at their costs on a 1,000-mile stage length, they are the lowest cost carrier in the industry still.
TWST: So if you have good management, you can keep the cost side under control.
Ms. Panella: Right. In our opinion, that's better achieved at these essentially post-deregulation airlines with an entrepreneur at the helm keeping the low cost structure intact than it is at the legacy airlines where, though they're able to get these cost concessions during bad times, typically, when times turn around and they're profitable again, we could see labor go back to management and ask to be made whole. That has typically been the cycle.
TWST: Jim, what's your take on the cost outlook here?
Mr. Corridore: I certainly think that Southwest is the model that all airlines should be trying to emulate as they age, and obviously, the legacy carriers should be trying to emulate the Southwest model more. Southwest has been able to have high labor costs yet still have lower unit costs because of their high productivity and the way they compensate their employees with profit-sharing and stock options - things that are actually worth something because the company is profitable! That's obviously what differentiates them from the other airlines. It's management, but it's also the way the structure is set up. They are lucky enough to not have a defined benefit pension plan, which is hammering all the legacy carriers right now, and the way they compensate their employees sets them apart from the rest of the industry.
TWST: Who's their closest emulator at this point, Jim?
Mr. Corridore: I would say JetBlue. They came to the game only a few years ago and set out to offer services that customers are willing to pay for. For a low-cost carrier they're also a high-service carrier, but they do have the Southwest model of profit sharing.
TWST: Chris, what's your take on the cost outlook for this space?
Mr. Lozier: I think Jim hit the nail on the head. People concentrate on costs a lot, but if you pay close attention to what it is that Southwest has done over the last 30 years, you'll see that their cost structure is competitive because of the efficiencies they've been able to achieve. That definitely has something to do with management, and it has something to do with compensation; they've really got it figured out. In other words, you can pay your employees more as long as you can get the incremental productivity from them.
Much of this stuff can be emulated, and again, I think that's what JetBlue is doing. And I might throw Ryanair into the hat there as the next closest emulator of the Southwest business model.
TWST: Chris, while we're on the cost side, what has been the impact of these sharp rises in fuel prices on the group?
Mr. Lozier: Devastating is one word that comes to mind! Those that have the ability and the creditworthiness to hedge their fuel requirements are obviously in a better position, but even for those folks, doing so is an expensive proposition; then they still get hit on the percentage that's not hedged. Crude oil is back well above $50 now, and we estimate that a $1 increase in crude oil translates to between $500 million and $1 billion in additional fuel expense for the industry. So clearly, in an industry with high fixed costs like this that floats around the breakeven point, $1 billion can be a make-or-break for this industry.
And our fuel and energy team doesn't foresee fuel returning to desirable levels anytime soon. They're forecasting $48 as an average fuel price over the course of 2005 and maybe just below $40 for 2006. A lot can change (that's a long way off), but either one of those numbers would spell huge losses for the industry.
TWST: Sam, in your opinion, has anybody in the space done a decent job of hedging against these prices?
Ms. Panella: Southwest has done the best job in hedging. They've had their hedging strategy in place since, I believe, 2000, so they are the best hedged for 2005 with about 80% of their fuel requirements hedged at around $26 per barrel. They're hedged, actually, out through 2008. Of course, the price increases as the years go out since we've seen such a rise in fuel prices. Again, Southwest is the best hedged. Nevertheless, given the large scope of their operations, $55 oil prices on the part that's unhedged still impacts earnings.
TWST: But they still have an advantage having 80% hedged.
Ms. Panella: Exactly. From an earnings standpoint, their earnings in 2005 would be less volatile to changes in fuel.
TWST: Following on your mention of the Internet, how important has the shift in the industry to e-ticketing been? Is that a major cost saving?
Ms. Panella: It's a big cost savings. To have a ticket booked on the Internet, you're talking less than $1, whereas I believe with travel agents it was, at one point, $7 or $8 per booking. So it is a big cost saving that airlines have been able to benefit from.
TWST: Have they gotten most of the benefit or is it still to come? Ms. Panella: At the low-cost airlines, a lot of them have really ramped up their Internet bookings. Though there is still some room for upside, I don't think they'll get to the levels, for instance, that we see in Europe with Ryanair, which does above 95% of their bookings via the Internet. There could still be some cost savings, but I think the low-cost carriers are getting to a saturation point with that.
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