Airlines Add Capacity Strategically As Demand For Air Travel Soars

U.S. airlines are continuing to add flying capacity to their networks in order to take advantage of the growing demand for air travel, especially in the domestic and Latin international markets. Earlier this month, the six largest U.S. airlines – American (NASDAQ:AAL), United (NYSE:UAL), Delta (NYSE:DAL), Southwest (NYSE:LUV), JetBlue (NASDAQ:JBLU) and Alaska (NYSE:ALK) – reported significant increases in their flying capacities in the month of July. While Alaska raised its flying capacity by 7% annually, United – the second largest U.S. carrier – raised its flying capacity by slightly over 1% annually last month. ^{[1] [2]} The remaining four airlines – American, Delta, Southwest and JetBlue – expanded their flying capacities at rates which were between those of these two airlines. This clearly illustrates that the demand environment is conducive for growth, and U.S. airlines are seeking to benefit from this growing demand for air travel by expanding their flying capacities.

In all, in the first seven months of this year, with the exception of Southwest, all major U.S. airlines expanded their flying capacities significantly. Southwest’s flying capacity in the year-to-date period has been about flat, as it is transitioning Boeing 717s from its fleet to Delta. Also, the low-cost carrier hasn’t been able to replace these 717s with new 737s at a rate which would have allowed it to raise its flying capacity. But all the other airlines with no fleet constraint, have grown their flying capacities to take advantage of the higher flight demands. These higher flying capacities in turn have grown passenger traffic for all these airlines in the year so far. In the June quarter, gains from higher passenger traffic played a key role in growing revenues for all U.S. airlines.

What is important to note here is, if this ongoing expansion in flying capacities is impacting the load factors of airlines. Load factor refers to the percentage of seats occupied by revenue paying passengers in a flight. If the load factor of an airline declines steadily and significantly (meaning the airline is flying emptier planes), then its profitability gets impacted. This however does not seem to be happening right now, as load factors of Delta and Southwest have increased on a year-over-year basis, in the year-to-date period. While load factors of American, United, JetBlue and Alaska have declined only marginally on a year-over-year basis, in the same period. The decline in the load factors of these four airlines has been less than 1 point, indicating that the airline industry is adding flying capacity in a disciplined manner.

We currently have a stock price estimate of $39.25 for American, marginally below its current market price.

See our complete analysis of American here

Airlines Will Have to Maintain Capacity Discipline to Remain Profitable

Disciplined capacity addition played a key role in enabling the U.S. airline industry to return to profitability after incurring huge losses through early 2000s till 2009. In our opinion, it is absolutely crucial for airlines to add flying capacity with restraint going forward. We figure airlines should add only as much capacity as can be absorbed by the growth in demand. This will allow airlines to maintain their healthy load factors achieved after many years of capacity restraint. Healthy load factors in turn will help the airline industry to remain profitable.

The trend to watch out for at this stage is if load factors of airlines begin to fall at rates exceeding 2-3 points (on a year-over-year basis) month after month. That would indicate that airlines are adding excess capacity. However, that does not seem to be happening as yet.

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1. July traffic results for United, August 2014, www.unitedcontinentalholdings.com [↩]
2. July traffic results for Alaska Air Group, August 2014, www.alaskaworld.com [↩]