I snagged this from a 3rd party report I get in my email at work, I have been very busy and unable to post like I want, I hope things will slow down so I can blog, and sleep, LOL..well sleep first.
Credit: Gary Hershorn/Getty Images
Although United Airlines is battling near-term cost headwinds, the carrier remains steadfast in its belief that a significant shift has occurred in the U.S. industry resulting in diminished viability of the ULCC model.
Chicago-based United has been outspoken on the trend for quite some time, and maintains that cost convergence, and its broad range of product offerings will only strengthen its competitive advantage going forward.
With labor costs at all U.S. airlines rising rapidly, United Chief Commercial Officer Andrew Nocella during an Oct. 18 earnings discussion described the LCC tendency to operate with larger gauge aircraft as a constraint for those carriers in being able to drive costs materially lower. ULCCs Frontier and Spirit have already forecasted negative pre-tax and operating margins, respectively, for the 2023 third quarter (Q3).
Additionally, “market saturation of the low-cost business model in certain regions is creating very low marginal RASM [revenue per available seat mile] for some of our competitors, in fact, many of our competitors have marginal revenues that are negative,” Nocella explained. There are only so many seats that Las Vegas, Florida, or Cancun can support in such a short period of time, he said.
Those operators use larger gauge equipment to gain lower costs without the benefit of connectivity garnered by the hub and spoke business model, Nocella said. “Expansion of the low-cost model into smaller and medium sized markets with these very large jets lacking connectivity just creates low marginal RASM.”
“The other factor is the percentage of ASMs [available seat miles] that these airlines have in new markets,” Nocella said, explaining that very fast growth rates create a higher percentage of new capacity, which in the best of times is below average. United is deploying less than 1% of its capacity into new markets during the fourth quarter, he said.
Capacity growth as a strategy to maintain low costs without revenue accretive markets can cause “the entire business model [to] break,” Nocella concluded. “And that is what we think is happening right now.”
United CEO Scott Kirby told investors his airline and another carrier are expected to account for 98% of the total U.S. industry revenue growth in Q3 and more than 90% of total pre-tax profitability.
The company’s business model can support dramatically higher gauge and once that occurs the airline spills less traffic to competitors, Nocella explained. Previously, United has said that its average seats per departure in 2019 averaged 104, and the company expects that number to jump more than 40% to over 145 by 2027.
United also believes its complexity and range of product offerings is far from a disadvantage, rather “there’s a structural advantage that generates more than the costs it creates by the complexity and just cannot be replicated.”
Its product offering ranges from Basic Economy to First Class; during Q3 revenue for its Basic Economy offering grew 50% year-over-year. Kirby explained one thing that has changed for United over the last year is “we finally started to get the gauge right; we couldn’t make this work when we were flying 650 regional jets around the country.” Basic Economy is a better product for United, he explained. “We’ve figured out how to make it work, but we now have the gauge to be able to sell the product.”
The airline’s total revenue in Q3 increased 12.5% year-over-year to $14.5 billion, and the company’s operating expenses grew 11.6% to $12.7 billion. United’s Q3 net income grew from $942 million last year to $1.1 billion, and its pre-tax margin was 10.8%.
But United is facing cost challenges in the fourth quarter, driven by numerous issues. It recently suspended flights to Tel Aviv following Hamas’ attack on Israel. If the airline resumes service to Tel Aviv after October, its unit costs excluding fuel (CASM-ex) will grow 3.5% year-over-year; but if flights remain suspended until year-end, CASM-ex will grow 5%. Service to Tel Aviv represents around 2% of United’s capacity.
United’s CFO Mike Leskinen explained the carrier’s capacity in the fourth quarter will be roughly three points lower than it planned three months ago. Two points is attributed to Captain upgrade issues and the remaining one point is driven by the suspension of service to Tel Aviv.
“The industry is facing other issues, but that’s what happened here at United, and we expect to mitigate that in 2024 and beyond,” Leskinen said.
United’s CFO said another issue the carrier is facing is maintenance costs, explaining he was not certain how persistent the challenge will be. “Maintenance costs throughout the years have been higher than we expected, and for United the big piece has been an increased need for spare parts,” Leskinen said, “particularly on engines as the work scope has been larger than we expected.”
Some of the spare parts challenges are stemming from supply chain issues, “and it’s difficult to see where that ends,” Leskinen said. United is not giving cost guidance for 2024 at the moment, citing inflationary, labor and maintenance cost pressures persistent in the industry.
“What I will commit to today, is that United will be industry leading in how we manage our costs,” Leskinen said. “Cost convergence is a structural trend; it is what is causing the lower cost carriers ... to struggle.”
I remember the 70s, when 4.5-6 cents per seat mile was the 'total revenue' after costs, and 70% of seats filled was 'necessary' for the flight to be profitable. I'm guessing it's considerably higher today on both counts.
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