Why Are The Air Fares Offered By The U.S. Airlines Falling?

A number of problems have plagued the U.S. airlines since the windfall from the fall in crude oil prices. Assisted by decreasing expenses on jet fuel, the air carriers started building capacity, undertaking re-fleeting and upgauging programs, repaying debt, and driving efficiency through fiscal discipline in operating expenses, excluding fuel. However, as the benefits accrued, a number of issues came to the forefront, ranging from terror attacks, to excess capacity, and the consequent pressure on unit revenues. The culmination of these factors built pressure on the carriers to cut air fares. Keeping up with this downtrend, August saw U.S. air fares fall 3.5% year-on-year and 5.5% sequentially. The prices are expected to fall a further 3% by the end of this year.

In the note below, we discuss some of the factors that have caused air fares offered by the U.S. airlines to decline, and the resultant effect of this decline in air fares on the airlines’ top-line.

Factors Causing A Drop In Air Fares:

• The drop in oil prices have allowed airlines to cut running costs by decreasing jet fuel expenses. Initially, the airlines used the increased returns from lower expenses to upgrade their existing fleet and repay the debt which had built-up on their balance sheet. However, as pressure on airlines increased to transfer some of the benefits to passengers, the airlines were compelled to offer cheaper air fares.

• Competition among the U.S. air carriers has progressively increased over the last few years. As low cost carriers, such as  JetBlue, Southwest, and Alaska, annex the market share of legacy carriers, it has become important for airlines to woo customers through cheap air fares to maintain profitability in their operations.

• In the face of a surge in terror attacks, people have been avoiding or delaying their travel plans, especially in the European region. As a result, the passenger traffic of most airlines has fallen or stagnated in the past few months. To counter this, and attract customers, air carriers have had to offer cheaper tickets to their passengers.

• In recent history, aircraft have become more fuel efficient. They can now carry more passengers, at lower costs. Owing to the plummeting oil prices, the airlines could now buy the newer, more efficient narrow-body aircraft. This, in turn, enabled the carriers to decrease their air fares.

• There is substantial excess capacity in Europe, as the European economy continues to stay weak. In such a scenario, it is important for airlines to keep America very competitive to attract business. In addition, in the month of August, most airlines saw their occupancy rate decrease, while capacity grew. To manage the extra capacity from their international business, it has become imperative for the carriers to lower fares and grow traffic in the U.S.

Impact Of Low Fares On Airlines:

While low air fares are favorable for fliers, they hurt the top-line of airlines by pressuring unit revenues (PRASM). The unit revenues of the U.S. air carriers have been in negative territory for over a year now. This is attributable to the slowdown on international routes, coupled with over expansion undertaken by these companies. As a result, despite efforts to bring about some improvement on this front, the profits for airlines have deteriorated. The woes are expected to worsen further due to the impact of declining airfares.

Although, some recovery is being seen in oil prices, they are still much lower than the historic highs of $100 per barrel. As a result, we believe that the air fares will continued to stay low, and may even decline going ahead, as the above mentioned factors stay relevant.

Have more questions about Alaska Air (NYSE:ALK)? See the following links:

• How Did Alaska Air Perform Operationally In August?
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• Alaska Air Reports Another Strong Quarter Backed By Rapid Capacity Growth And Lower Fuel Costs
• Alaska Air Q2’16 Earnings Preview: Capacity Growth, Fiscal Discipline To Support Earnings
• How Will The Virgin America Deal Impact Alaska Air’s Share Repurchase Program?
• Will Alaska Air-Virgin America Face Antitrust Issues?
• How Will The Virgin America Merger Impact Alaska Air’s Cost Of Capital?
• How Will Alaska Air’s Market Share Change Post The Virgin America Deal?
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• How Will The Expected Return On The Alaska Air-Virgin America Merger Compare With The Previous Deals In The Sector?
• How Will The Virgin America Deal Alter Alaska Air’s Capital Structure?
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• Alaska Air’s Earnings Rise On The Back Of Rapid Capacity Growth And Lower Fuel Costs

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Alaska Air Group

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